October 26, 2015
As Prepared for Delivery
Thank you, Shawn for that warm welcome. It’s great to be back at SEFCON. When I was here last year, I spoke about some of the principles guiding my approach to the regulation of swaps trading and swap execution facilities (SEFs). And I spoke about what I believe we should be trying to achieve in the long run.
My overall goal remains the same as it was then. And that is to create a regulatory framework that not only implements the trading mandate in the law and achieves the basic goals of transparency, fairness and integrity in trading – but also one that creates conditions in which participants want to trade on SEFs. A framework that provides a foundation on which the market can thrive and grow.
This conference is a great way to bring market participants together to further the conversation on how we accomplish that goal. I know some of our staff are here and will be participating on various panels. I am especially pleased to be following the panel entitled “Geopolitical Risks in Swaps Trading,” because of the importance of harmonizing rules internationally as much as possible. I know the Financial Conduct Authority (FCA) is with us today, and I’m pleased to see that it is participating in this conversation on behalf of Europe.
In the last year, I believe we have made significant progress towards our goal of enhancing swap trading. Over the past 12 months, we have taken a number of steps to fine tune and improve our rules. And there is more we hope to do.
So I’d like to update you on where we are– and what we’re doing – to improve and further encourage the open, transparent and competitive trading of swaps on SEFs. I will talk about where we are with the registration of SEFs. Next I’ll lay out some of the actions we have taken – to provide relief and fine-tune our rules to improve swap trading. Then I’d like to discuss some of the areas where we’re looking to do more.
Swaps Trading Today
As you know, the changes to the rules around swaps trading were part of an overall package of reforms to the over-the-counter swaps market. The other basic pieces of that package are: central clearing of standardized swaps, oversight of the largest market participants and regular reporting of derivative transactions.
These reforms were adopted as part of a comprehensive response to the worst financial crisis since the Great Depression—a financial crisis that devastated American families – costing us eight million jobs – closing thousands of small businesses – and leaving millions reeling after foreclosures.
Today, five years after the law was adopted, that new framework for swaps is largely in place. This month marks the second anniversary of SEF trading. I believe the trading reforms are bringing greater transparency, better price information and greater integrity to the process.
Currently, we have nearly two dozen SEFs. According to the International Swaps and Derivatives Association (ISDA), SEF trading accounted for about half of the total average daily volume of interest rate derivatives in 2014. And according to data by Clarus Financial Technology, over the first three quarters of 2015, 73 percent of credit default swaps were executed on-SEF – as were 69 percent of all interest rate swaps.
But the swap trading reforms are still new. SEF trading is still new. And we still have significant work ahead of us. Let me tell you what we’re working on.
First, our staff is working hard to make SEF registrations permanent. Currently, 22 platforms are temporarily registered, and the staff will soon make recommendations to the Commission as to whether to grant permanent registration status. We expect to consider those recommendations over the coming months. And for the platforms that have provided complete information to us, we expect to make determinations of permanent registrations by early 2016.
I know that SEFs – and many other market participants – have an interest in the timing of our announcements. We are continuing to consider when this will take place –with a particular focus on ensuring such announcements do not adversely impact pending applications. Our goal is to carry out our responsibility to move forward with determinations in a balanced manner – and avoid sporadic announcements. To that end, I expect that we will not make an announcement until we have a fair number of determinations made—likely more than a majority.
It’s worth noting that while we’d like to be analyzing and processing these registrations more quickly, our resources are spread very thin. The law requires a thorough process. Staff analysis includes a comprehensive review of each facility’s rulebook, trade execution workflows and supporting documentation. These items can change frequently as the SEFs adjust their operating models in light of evolving market conditions. So we are doing the best we can with the limited resources available to us.
Fine-Tuning Rules to Improve Trading
At the same time, we are continuing to focus on fine-tuning our rules to improve SEF trading. Over the past year, Commission staff has taken a number of actions to this end, including the following.
Package Transactions. First, package transactions. Last year, the CFTC staff took action to provide market participants with additional time to adapt to exchange-based trading for package trades. The market has developed technical solutions for many packages, and progress is continuing. Recently, Commission staff announced further extension of the relief for remaining packages until late 2016.
Block Trades. We previously provided relief related to executing block trades. Market participants have sought to execute block trades on SEFs because of their ability to facilitate credit checks. CFTC staff provided no-action relief so that block transactions could continue to be negotiated between parties and executed on a SEF. I also support extending this relief.
Correcting Erroneous Trades. Our staff also has addressed the issue of correcting erroneous trades. It is important that we promote trade certainty and straight-through processing for swaps transactions. However, there were concerns that in some cases, our rules resulted in the inability to resubmit or correct trades that either did not go through clearing and were treated as void ab initio – or that did go through clearing and contained correctable errors. There were also concerns that the operational difficulty of resubmitting or correcting an erroneous trade resulted in trades pending for long periods of time in an affirmation process.
To address these concerns, the staff extended no-action relief, which allows trades that have been rejected from clearing due to clerical or operational errors to be corrected within one hour of rejection. The relief also permits new, prearranged trades to offset and replace an erroneous trade that has already been accepted for clearing – if executed and submitted for clearing within three days. We expect the industry to continue to take steps to reduce operational errors.
SEF Confirmations and Confirmation Data Reporting. Further, CFTC staff took action regarding the issue of confirmations provided by SEFs to counterparties for uncleared swaps. As you know, the SEF may not have access to all the relevant non-economic terms of the transaction that are contained in an ISDA Master Agreement between the parties or other underlying documentation. So the staff permitted the SEF confirmation to incorporate by reference the Master Agreement and other freestanding previously negotiated agreements. This provides relief to SEFs from the requirement to maintain copies of the Master Agreements or other underlying documentation. I should note that the relief pertains to a SEF’s obligations. Under the SEF rulebooks, the parties to a swap must maintain relevant trade documents and make these agreements available to the SEFs and the CFTC upon request.
This no-action also provides relief for SEFs regarding their obligation to report confirmation data on uncleared swaps to swap data repositories (SDRs). SEFs expressed concern that – in order to comply with their reporting obligations for uncleared swaps – they might be required to obtain trade terms from the same ISDA Master Agreements or other underlying documentation that, as I have just discussed, are not otherwise available to them. In light of these concerns, this relief clarified that SEFs need only report such confirmation data for uncleared swaps as they already have access to without undergoing this additional burden. I would note that SEFs must also continue to report all “Primary Economic Terms” data for uncleared swaps. In addition, the counterparties to the trade have ongoing continuation data reporting obligations for uncleared swaps.
SEF Financial Resources. Further, our staff has issued guidance that clarifies the calculation of projected operating expenses for the purpose of determining the capital that the law requires SEFs to hold. Specifically, the guidance clarifies that variable commissions that SEFs pay do not have to be included in a SEF’s calculation of projected operating costs.
Methods of Execution. We have also responded to some concerns on methods of execution. We want to make sure there is some flexibility in methods of execution as long as Dodd-Frank’s requirements are met.
Earlier this year, our staff confirmed that an auction match trading protocol was acceptable as long as the SEF rulebook provides adequate transparency regarding the process for setting the offer price.
I am also open to continuing to look at the issue of flexibility in execution methods, provided we continue to meet the basic goals that our rules are designed to achieve. In this regard, some have suggested that the Mifid II rules provide more flexibility in execution methods, but are more prescriptive with respect to pre-trade transparency and what I would call “liquidity provision.” They also have some reporting requirements related to best execution. So we are continuing to study the European rules and discuss the differences with our European colleagues. I will return to this issue in a moment.
In all of these efforts, I want to thank our hard working staff as well as market participants who have provided very useful input. I also want to thank Commissioners Bowen and Giancarlo for their support. In particular, Commissioner Giancarlo has brought very valuable experience regarding swap trading. The three of us don’t always agree, but I am committed to continuing to work with my fellow commissioners to find common ground. And there is more we can – and should – do as I will now discuss.
Looking ahead, in many of the areas where staff has provided relief in the form of a “no-action” letter, I support proposing permanent adjustments to our rules. The staff issued no action letters as a way of providing at least temporary relief, which they believed was appropriate in light of our regulatory objectives and the circumstances in the market. This has also given the market time to develop a solution in some cases, and it has allowed the staff to explore adjustments to rules that will address some of these issues permanently. I expect that we will make some proposals to amend certain rules next year that would incorporate permanent changes with respect to many of the items I have noted. Any such proposals would be subject to public comment – and as always, we look forward to your feedback.
Let me turn to some additional areas we are currently considering. The first is the “made available to trade” – or MAT – determination process. The current MAT rule allows a SEF or designated contract market (DCM) to submit a determination that a swap is “made available to trade” based on its analysis of several liquidity factors. The trade execution requirement currently applies to certain fixed-to-floating interest rate swaps in several currencies and tenors – and to certain credit default swaps based on a limited number of indices.
Some market participants have suggested that the Commission play a larger role here. In July, we held a public roundtable on this process. There was discussion of a number of issues, including the approaches that other jurisdictions, such as Europe and Japan, are considering for their trade execution requirements. As you may know, for example, in the European process, ESMA would make a decision based on a variety of factors, including those related to liquidity.
The roundtable and subsequent comment letters have provided useful input. As a result, we are considering several aspects of this, including:
It has been suggested that any such “made unavailable for trade” review be called the “MUT” determination process.
Another advantage of having the Commission play a greater role in the process is that it may facilitate coordinating “made available for trade” determinations with Europe and other jurisdictions.
I support proposing some revisions to the process so that the Commission plays a greater role. I would not expect this to happen before next spring, given the number of items currently on our plate. And of course, should we decide to propose something in this area it would be subject to public comment.
Straight-Through Processing and Post-Trade Affirmation. Second, we have been asked to provide further guidance regarding the “as soon as technologically practicable” standard for straight-through processing. We are considering this – as well as related concerns regarding post-trade affirmation platforms, which some SEFs use to route trades to clearinghouses. We may comment on this in the near future.
SEF Oversight and Other Matters
Let me turn to a few issues regarding the responsibilities SEFs have with respect to market oversight.
I know that SEFs have been concerned as to how they fulfill their statutory obligations with respect to position limits. The law specifically requires that for each contract, SEFs shall adopt position limits or position accountability standards as are “necessary and appropriate.” Some SEFs have expressed several concerns, including how to set such limits and the difficulty of monitoring compliance, given that the same product can be traded on multiple SEFs. We recognize the challenges here. And in addition to the specific challenges facing SEFs, the Commission, as you know, has not finalized its position limits rule. So I believe that the following is a temporary solution: a number of SEFs have now filed rules stating that they shall adopt position limits and position accountability levels as are necessary and appropriate. And we have advised SEFs that we do not object if they determine that position limits are not necessary and appropriate at this time.
The position limits issue also is related to the general issue of how SEFs discharge their important surveillance responsibilities. I know some SEFs have expressed concern about the audit trail requirements. Here we have tried to be flexible – and we will continue to work with SEFs on this. I also note that many have contracted with third parties, such as the National Futures Association, for assistance with surveillance. Surveillance is critical for market integrity. Having the ability to meaningfully communicate about surveillance techniques can be very helpful. And where appropriate, evaluating trading activity across execution platforms can be of great benefit to the market. I understand that the SEF Chief Compliance Officers routinely meet on cross-SEF issues. I would encourage further collaboration on compliance and surveillance issues and we are happy to work with the SEFs in that regard.
I want to also note a few issues we are working on that we do not expect to apply to SEFs at this time.
The first is our consideration of the operational risks that arise from automated trading. Automated trading is quite significant in the futures market, as it now represents about 70 percent of all trading volume. Last week, I discussed some additional requirements for pre-trade risk controls and other measures for exchange-based trading that I expect we will propose in the near future. These would not, however, apply to SEF trading at this time.
In addition, we are considering some proposals regarding testing of cybersecurity protections for clearinghouses, exchanges and swap data repositories. I also would not expect these to apply to SEFs at this time.
In both these areas, I believe it is better to allow SEFs – and SEF trading – to develop further rather than propose additional requirements at this time.
Let me briefly mention some items pertaining to data reporting that I know are of particular concern to SEFs. As a general matter, we have made significant progress in the area of data reporting over the last several years. Regulators have better information and market participants have greater transparency.
But there is still much to do. Earlier I noted the no-action relief we have taken with respect to SEF confirmations. I would expect us to include this among the areas where we would propose permanent rule changes.
In addition, as you know we have proposed changes to the reporting obligations for cleared swap transactions. This will eliminate the problem of multiple records for an alpha swap as well as the beta and gamma swaps after clearing. Our proposal will create a simple, consistent process for the reporting of cleared swaps, and thereby reduce reporting costs and improve the quality of the data. It will help ensure that accurate valuations of swaps are provided on an ongoing basis. And it will improve the Commission’s ability to trace swaps from execution through clearing.
We are also working on standardizing and harmonizing data reporting in several other ways. This includes possible changes to our own rules for swap participants and SEFs, as well as working with our international colleagues on harmonization.
In the weeks to come, I will have more to say about our data collection efforts – and some ideas to ensure that we obtain timely, accurate, complete reporting –while avoiding excessive burdens and duplication.
Mutual Recognition of Trading Platforms
Finally, let me return to the subject of the cross-border implications of trading rules. Last year when I was here, I spoke about the challenge that comes from being the first mover—the first jurisdiction to implement trading rules in a market that was global and previously unregulated. Traders will do what business they can outside of our rules where possible.
Now, one year later, as I noted earlier, the MiFID II technical standards have been published. And even though they won’t come on-line before 2017, participants are now able to plan and we can now look at ways to harmonize. I congratulate ESMA on getting these out – I know it was a big challenge.
Now as you probably know, when it comes to clearinghouses, Europe has not yet made a determination of “equivalence” with the U.S. I believe there is an ample basis for them to make that determination, but we are still discussing some issues.
I want to have a shorter process when it comes to how we recognize each other’s trading platforms. Mutual recognition is critical. I believe European Commissioner Jonathan Hill shares my desire. I can’t outline any solutions today. But our staffs, along with staff from ESMA and the Financial Conduct Authority, have been spending time together so that we understand each other’s rules better. That is a first step. And as we do that, we can consider what the best path is to mutual recognition.
There are many differences in our rules on subjects such as pre and post-trade transparency; trading protocols; the “made available for trade” process that I discussed earlier; access; oversight requirements – and so forth. But our overall goals are similar. And I believe we should focus on overall outcomes, not on item-by-item similarity. I believe we can learn from one another. We may find areas where we can improve our rules in light of things we see other jurisdictions doing. Mutual recognition will be a key focus of our activity next year.
It’s important that we do this with other jurisdictions as well. And I would continue to encourage other nations to adopt trading rules. This is an important piece of the overall reform framework agreed to by the G-20 leaders, and I believe it will contribute to the growth of strong markets and the avoidance of costs down the road.
Let me end where I began. I have said to this audience in the past that my goal is to build a regulatory framework that not only meets the Congressional mandate of bringing this market out of the shadows, but also creates a foundation for it to thrive.
Over the last few years, we have taken important steps toward achieving those objectives. But there is much more work to do. As we move ahead, the Commission will remain focused on promoting transparency and integrity in the trading process, to ensure our markets to continue to grow and evolve. I look forward to working with you on this challenge.
Thank you again for inviting me to be here today.
Last Updated: October 26, 2015