September 9, 2015
Good afternoon and thank you, Jim for that warm welcome.
As someone who likes beer, it’s a pleasure to speak with many of the companies responsible for producing and importing it in the United States.
I spend a lot of time speaking to financial institutions such as clearing firms, asset managers and swap dealers. Often, I talk about the reforms being implemented in response to the global financial crisis — a crisis that caused massive damage to our economy, as you know. I often talk about how those reforms will affect their businesses, businesses that deal in financial products that are intangible, and often a bit esoteric for most Americans. So speaking to this audience is a nice change of pace. It’s nice because you make something that is tangible and enjoyed widely by many Americans. And I think I can safely predict that your products will never cause a financial crisis. To the contrary, I suspect that your products were actually the source of a lot of comfort for many of us during the global financial crisis.
One of the things I try to do in my job is to explain what the Commodity Futures Trading Commission does in terms that are easy to understand. Most people do not participate in the derivatives markets, as you know, and yet these markets have a profound impact on the prices we all pay for food, energy, transportation and other goods and services. They are critical to the ability of many businesses to hedge risk.
Now, often when I try to explain all that to friends or relatives, I can see their eyes start to glaze over. But when I told a few friends recently I was going to speak to the beer industry, the nature of my work became much more interesting.
I think people might be surprised to learn the importance of these markets to industries such as yours. But it is an excellent example of why what we do is so vital to such a broad swath of American business.
About the CFTC
Our job is to ensure that the commodity futures and swaps markets function with integrity, and without fraud or manipulation. We want to do all we can so that businesses like yours are able to use these markets efficiently and effectively to hedge the routine commercial risks you face every day. That may mean hedging in the grains complex, or perhaps hedging the cost of metals for packaging – or even the electricity and other fuels used for production, transportation and distribution.
In recent years, our work has become more challenging. The futures and options markets traditionally overseen by the CFTC have grown enormously in size, sophistication, and technological complexity.
In fact, the number of actively traded futures and options contracts has doubled since 2010. And the 2010 Dodd-Frank Wall Street Reform Act expanded our responsibilities to include overseeing the $400 trillion dollar U.S. swaps market.
These markets continue to change rapidly – and overseeing them presents unique challenges.
So today I’d like to discuss some of our priorities in overseeing these markets – and point out a number of areas that I believe will be of particular interest to you. First, I’d like to review some of the steps we have taken to address current concerns of commercial end-users. Then I’d like to briefly discuss our efforts to prevent market abuses, and talk about the issues surrounding warehouse practices for aluminum. Then I’d like to mention our progress toward finishing the rules mandated by Congress. And finally, I would like to discuss our focus on algorithmic trading and cyber security. I then would be happy to take your questions.
Ensuring Markets Work for End-Users
Since taking office last year, I have focused on a number of critically important issues. For me, a top priority has been to address the concerns of commercial end-users. There are many manufacturers, farmers, ranchers, and other businesses that rely on these markets to hedge price, production and other types of routine risk. Therefore, anyone in my position has to measure themselves against a fundamental set of questions. First, are we making the markets better for the businesses that need them? Are we doing all we can so that they operate with integrity and without fraud? And finally, can businesses use these markets effectively and efficiently?
So throughout the past year, the Commission has been actively listening to market participants and taking a number of actions to address their concerns.
For example, we have made sure that our proposed rule on margin for uncleared swaps exempts commercial end-users. Requiring margin for uncleared swaps is one of our most important reforms, but it should be focused on swap dealers and large financial institutions, not commercial end-users. We hope to finalize this rule in the fall.
In addition, we have amended our rules so that publicly-owned utility companies can continue to effectively hedge their risks in the energy swaps market, which helps them provide reliable, cost-effective service to their customers.
In March, the Commission unanimously approved a modification to what is known as our “residual interest” rule, which can affect when customers must post collateral with clearing members.
We have proposed to exempt end-users from certain recordkeeping requirements related to text messages and phone calls, to avoid undue burdens.
And we have made some important rule adjustments and clarifications addressing trade options and contracts with embedded volumetric optionality.
These are just some of the actions we have recently taken to make sure these markets work for commercial end-users. And we will continue to focus on end-user concerns.
I want to underscore that our door is open, and that we are always willing to hear your views and concerns.
Preventing Fraud and Manipulation
We are also focused on the prevention of fraud and manipulation through a robust enforcement and compliance program.
The Commission spends a significant amount of time on surveillance and enforcement. Our compliance, examinations and registration work also is intended to make sure that customers are protected, participants comply with their obligations and the markets operate with integrity and transparency.
For example, we have brought enforcement actions against many of the largest banks in the world for manipulation or attempted manipulation of critical benchmarks, including foreign currency and LIBOR. We have brought actions against those who engage in spoofing, one of the newer forms of attempted manipulation. And we have brought actions against traditional types of frauds, such as precious metal investment scams perpetrated on retirees.
And today, I’m pleased to announce we are launching an important new tool that will further protect customers from bad actors. Today we are unveiling the Registration Deficient List – or “RED List.” This is a list on our website that identifies unregistered foreign entities that the CFTC has reason to believe may be illegally soliciting and/or accepting funds from U.S. residents. This initiative will allow people to make more informed decisions about investing –and help protect themselves against financial fraud. It can be found at our website, in the section dedicated to our “SmartCheck” program.
The Aluminum Market
Now, let me turn to another issue of importance to many of you here today –the issue of warehouse practices for aluminum. Many of you have expressed concern over the long queues for delivery of aluminum at warehouses licensed by the London Metal Exchange (LME).
We understand the seriousness of this matter to you as well as other market participants and producers – and we have focused on it.
As you may know, the LME is principally regulated by authorities in the UK. And we do not have direct regulatory authority over warehouses licensed by the LME. So our authority in this area is limited. Nevertheless, foreign boards of trade like the LME, who seek to make their contracts available for trading by direct access to U.S. persons, must satisfy certain standards. And in light of that requirement, we have had an ongoing dialogue with the LME, as well as its UK regulator. We have expressed our concerns about these practices. The LME is taking steps to address these issues. As you may know, it has implemented some reforms and is considering others. And we will continue to monitor developments closely, and we will listen to all market participants who have an interest in this matter.
Finishing the Remaining Rules
Going forward, it remains a priority to finish the few remaining rules required under Dodd-Frank. Our proposed position limits rule is one. Congress has mandated that the CFTC adopt limits to address the risk of excessive speculation.
We have received substantial public input on this proposal. We continue to consider that input and work on a final rule. We appreciate the importance and complexity of these issues, and we intend to take the time necessary to get it right.
Much of the feedback we have received has been focused on the issue of bona fide hedging. Let me just say that we understand it is vital for commercial end-users to be able to continue to engage in bona fide hedging. We recognize hedging strategies are varied and complicated, and we are considering comments carefully.
It has also been suggested that we rely on the exchanges with respect to the review of applications for what are known as “non-enumerated” exemptions, and we are taking a closer look at this issue. We are also looking at changes to the Commission’s proposal on aggregation – when various entities are under common control. We will have more to say about issues related to position limits in the coming months.
I want to turn now to a couple of issues that are at the forefront of our concerns because of technological developments. Those are the increased use of electronic, automated or algorithmic trading, and the issue of cybersecurity and operational or technological risk generally. Looking specifically at the futures markets, almost all trading is electronic in some form, and automated trading accounts for more than 70 percent of all trading over the last few years.
The increase in electronic and particularly automated trading over the last several years has brought many benefits to market participants, such as more efficient execution and lower spreads. But it also raises important policy questions, and it has fundamentally changed how we execute our responsibilities.
For example, on the policy side, there are the concerns about operational risk: will a fat finger or faulty algorithm cause a sudden spike? And there are questions about fairness: will market participants who do not operate at the speed of light get a fair shake? There are also questions about how these changes in market structure may affect liquidity.
For the CFTC, this activity also creates profound changes in how we conduct routine surveillance. Today, surveillance requires a massive investment in IT, sophisticated analytical tools, and experienced personnel. It has impacted our enforcement activity as well.
That’s why the Commission is looking closely at automated trading and specifically the use of algorithmic trading strategies. We have already adopted a number of measures to address these concerns, including requiring certain registrants to automatically screen orders for compliance, and ensuring that trading programs are regularly tested. We are currently working on some additional proposals to make sure there are adequate risk controls at all levels, and to minimize the chance that algorithmic trading can cause disruptions or result in unfairness. I expect that we will issue these proposals this fall, and there will be a full opportunity for public comment.
System Safeguards and Cybersecurity
Another major concern for us and the institutions that we regulate is cybersecurity and technological or operational risk generally. We refer to this as “system safeguards.” The need to strengthen the security and resilience of our financial markets against cyber-attacks and technological failures is clear.
The stakes are high, because the risk to American businesses and the economy is dramatic. The examples of cyberattacks or significant technological disruptions from inside and outside the financial sector are all too frequent and familiar. And the interconnectedness of our financial institutions and markets means that a failure in one institution can have significant repercussions throughout the system.
So we are addressing this risk in several ways: first, system safeguards are part of the core principles and regulations with which trading platforms and clearinghouses must comply. Second, we are focusing on these issues in our examinations of clearinghouses, exchanges and other institutions – to determine whether an institution is following good practices and paying adequate attention to these risks at the board level and on down.
And third, we are currently working on a proposal to make sure the private companies that run the core infrastructure under our jurisdiction – such as the major exchanges, clearinghouses, and swap data repositories – are doing adequate evaluation of these risks and testing of their own cybersecurity and operational risk protections. The concerns include information security, physical security and business continuity and disaster recovery. And the necessary testing should include control testing, penetration testing, and vulnerability testing. Such efforts are vital to mitigate risk and preserve the ability to detect, respond to, and recover from a cyber attack or other type of operational problem.
We don’t have the resources to do this type of testing ourselves. But these companies do. In fact, many major financial institutions have cyber budgets that are greater than our entire budget. So we will be proposing some principles-based standards on testing to make sure these companies are following best practices. I expect these proposals to be issued this fall also.
In conclusion, I would like to make one final point. One of the biggest challenges we face at the CFTC is very simple: there is more we should be doing. We should be responding more quickly to the concerns of market participants. Examining clearinghouses more frequently. Engaging in more surveillance to prevent manipulation. Processing requests for registration, rule changes, or new product approvals faster. But the CFTC’s current budget has simply not kept up with the growth of the markets and our increased responsibilities. I often remind our staff of the Teddy Roosevelt adage: “we will do all we can, with what we have, where we are.” But we are still faced with significant challenges.
The simple issue here is that our responsibilities were vastly increased a few years ago, and in addition the markets become larger, more complex and more sophisticated every day. We need to keep up with technological innovation and growth. Congress has responded with modest budget increases – which we appreciate. But without additional resources, it is difficult for us to do the job that I believe our markets need and the American people deserve.
Thank you again for inviting me to discuss these issues with you today. I welcome your thoughts and questions.
Last Updated: September 9, 2015