February 5, 2016
Thank you Patrick, for that introduction.
I’m very honored to be here today. It’s always a pleasure to be back at Treasury. I spent five years here. I had not worked in the government before, and every day that I walked into this building I was excited and proud. Excited to have the opportunity to work on so many challenging issues with so many capable, dedicated people. Proud to be able to serve my country, particularly at a time of crisis, and proud to work in this institution, which has such an exemplary tradition and culture.
Seeing so many friends brings back many fond memories. Of course, it also brings back a little post-traumatic stress. The early days of my tenure here in particular, during the dark days of the crisis, were extremely challenging and stressful. The problems we were confronting were huge, complex and unprecedented. It wasn’t clear our responses would work. So I look back upon those times through glasses that are not so rosy: I do not wish to repeat those days.
But it also serves as a reminder of how far we’ve come in rebuilding our economy following the devastation of the crisis, and the progress we’ve made to ensure our financial system is stronger, stable and more resilient than ever before.
For example, when I first joined Treasury in the spring of 2009, the Financial Stability Oversight Council and the Office of Financial Research didn’t exist. There was no entity working to bring regulators together to look at what is happening across the financial system, as the FSOC does today. There was no entity dedicated to analyzing potential threats to financial stability, like the OFR is doing today.
The work of the OFR is extremely important. Through OFR’s efforts to improve the scope and quality of financial data, and the development of tools to measure and monitor risk, regulators can better assess potential threats to financial stability.
We at the CFTC have made important progress as well. As you know, the CFTC saw a dramatic expansion of duties following the enactment of Dodd-Frank, as we were tasked with bringing the $400-$600 trillion over-the-counter swap market out of the shadows.
Five and a half years later, we have made significant progress.
As many of you know, there were four key components of Dodd-Frank related to OTC swaps. They were: central clearing of standardized swaps, oversight of the largest market participants, transparent trading on regulated platforms, and regular reporting.
Today, we have this framework in place.
Clearing is now required for most interest rate and credit default swaps. Approximately 75 percent of swap transactions in our markets are being cleared, as compared to only about 15 percent in 2007.
We have implemented a program for the oversight of major market participants. In fact, we just recently finalized our rules on margin for uncleared swaps, which is a key part of this effort.
Trading on regulated platforms is taking place, and is bringing increased transparency and integrity to the process. Our trading rules have been in place for a few years now, and we have 18 permanent and five temporarily registered swap execution facilities (SEFs).
It is worth pointing out important research that demonstrates the reforms we put in place are working. A recent report by the staff at the Bank of England noted trading on SEFs has led to significantly lower transaction costs and better liquidity. And that includes better liquidity in both the U.S. and European markets, despite some fragmentation.
We are also building out the reporting system, which has already substantially increased transparency for market participants and given us the ability to be better regulators.
Of course, there is more work to be done in all of these areas. But today, I’d like to focus on just a few of the items on the CFTC’s agenda that relate to today’s theme of “financial resilience.” Specifically, I’d like to talk about clearinghouse resilience, swap data reporting, and a few additional actions we are taking that relate to new emerging risks.
Let me begin with clearinghouse resiliency. Central clearing is one of the great innovations of the financial system. It enables market participants to reduce exposures through netting, mitigate counterparty credit risk, and mutualize tail risk. But as you all know, clearing does not eliminate risk. And some have suggested that by requiring greater central clearing, we are creating new concentrations of risk in the financial system. I believe that our model is a good one, but I do believe that increased vigilance is warranted.
So as we increase our use of central clearing, it becomes even more important to focus on making sure clearinghouses are strong and resilient. And it will be a critical focus of regulators all over the world for the next several years
Domestic Efforts. Here in the U.S., we at the CFTC have been involved in the oversight of clearinghouses for many years. And since the crisis, we have been particularly focused on clearinghouse resiliency.
In the last few years, we have done a major overhaul of our clearinghouse oversight. We have substantially strengthened our requirements regarding risk management and transparency. We did an extensive revision of our rules after the passage of Dodd-Frank, and incorporated international standards into our regulations. We also strengthened customer protection measures. And we have expanded and enhanced our examination, compliance, and risk surveillance programs.
To give just one example pertaining to customer funds, we now can obtain daily confirmations from depositary banks of all customer funds, and we can reconcile the collateral on deposit at the banks to the futures commission merchants’ reports. In addition, during examinations of clearinghouses, collateral that has been deposited by clearing members is reconciled and confirmed to the third-party that is holding the collateral.
We are also actively working on recovery and resolution planning and the adequacy of resources and procedures applicable in the event of a major problem. We are working with the major clearinghouses to review their recovery plans and rule changes, and are engaged in discussions with them and other market participants on how significant problems would be handled. That includes exploring auction procedures to increase efficiency and participation; considering whether, under what circumstances, and to what extent, gains-based haircutting is an appropriate tool to allocate losses; examining the tools available to a clearinghouse, such as partial tear-ups, in order to re-establish a matched book; and discussing the governance mechanisms over the use of recovery tools—and the transparency regarding the potential use of those tools. We are also working with the FDIC on resolution planning.
International Efforts. On the international front, there is a group formed under the auspices of the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) that is looking at a number of issues pertaining to clearinghouse strength and stability. The CFTC is co-chairing this effort. This work includes looking at margin methodologies and the resources available to a clearinghouse in the event of a default, including “skin in the game” and the adequacy of “cover one” versus “cover two” standards. It includes looking at standards for stress tests, which are the critical element in measuring required levels of resources. Extensive surveys were sent to a number of clearinghouses to take an inventory of a wide variety of practices, and the group is currently evaluating the responses. The CPMI-IOSCO plans to issue a report by mid-2016 on these issues. There is a separate but related workstream that involves a number of clearinghouses making assessments of the implementation of the Principles for Financial Market Infrastructures, known as the PFMIs. There will also be a report issued on this.
We are involved in additional efforts led by the Financial Stability Board to examine resolution planning for clearinghouses, including international coordination. Another group that also includes the CFTC is examining the interdependencies among global clearinghouses and major clearing members.
Of course, clearinghouses have themselves been focused on these issues – particularly since the crisis. I applaud the attention they are devoting to these matters, as well as their engagement with us and with market participants.
And let me just add that while we must engage in recovery and resolution planning, our goal is never to get to a situation where either of those is necessary. And that is why risk management is so important. Sometimes in the current discussions about clearinghouse resiliency, the activities that comprise ongoing risk management don’t get much attention. But those activities—the daily margining practices, the stress and back testing, the oversight and ongoing risk surveillance—are critically important. Those activities—carried out by the clearinghouses, the clearing members, and us—are essential. No recovery plan—and no set of rules that kick in when there is a problem—can take the place of these everyday activities.
For example, at the CFTC, our risk surveillance program involves robust oversight at the clearinghouse, clearing member and large trader level. We have extensive daily margin, position and other reporting requirements that enable us to engage in daily risk surveillance. We look at market risk, liquidity risk, credit risk and concentration risk. We seek to identify who is at risk, the magnitude of that risk, and how that risk compares to available financial resources.
Of course, we are a regulator and our role is one of oversight. The clearinghouses themselves have the front line responsibility here—and it is their practices that are most critical to risk management.
The practices and involvement of clearing members are critical too. And transparency is very important. Because clearinghouses mutualize risk, it’s important that clearing members—and customers—have sufficient knowledge of the risk management practices of a clearinghouse—and sufficient input into decisions that may affect overall risk of the clearinghouse.
And we must make sure that the clearing member industry itself is robust. Sometimes, this is not given sufficient attention when people discuss clearinghouse recovery and resolution.
The importance of a robust clearing member industry is obvious when we think about what happens if there is a default by a clearing member. For example, when firms like Lehman Brothers and MF Global collapsed, clearinghouses were able to run successful auctions and transfer customers’ positions to other FCMs. If you cannot do so, you must liquidate positions, which can put more pressure on asset prices. So we must continue to have the ability to run successful auctions if necessary, which depends on the willingness of clearing members to take on additional positions.
Therefore we must consider the factors that affect the health of the clearing member industry. Now there are many factors at play here. Time does not permit me to discuss this issue in a complete way, but it is one that is very much on our minds at the CFTC.
On the subject of clearinghouses, let me also note that last week, the Commission announced the approval of the registration of Eurex Clearing as a clearinghouse. Eurex Clearing is one of the largest clearinghouses in Europe, and we are pleased they have registered with the CFTC. This is an important step forward to enhance global clearing and harmonization of derivatives rules.
Improving Data Reporting
Now let me turn to swap data reporting, as the CFTC is taking a number of important steps to ensure that the swap data we receive is accurate, consistent and timely.
We have come a long way since 2008, when insufficient data left us unable to assess the exposure and interconnectedness of major institutions. But building an efficient system to collect and analyze data from this market is an enormous undertaking, and there is more work to do. Currently, for example, there is considerable variation in how different participants report the same fields to swap data repositories (SDRs), and in how the SDRs themselves transmit information to the CFTC.
When the rules were first written, we purposely didn’t prescribe exactly how each field should be reported – for a number of reasons. First, when the agency issued the reporting rules, we didn’t yet have any data to inform our views. And second, we expected the industry to develop standardized terms. That, unfortunately, did not happen.
So in December, CFTC staff took steps to address this challenge, by proposing technical specifications for the reporting of 120 priority data elements. We are requesting public input on this, which culminated months of work to identify priority areas where standardization or clarification is needed.
I want to take a moment here to thank the Office of Financial Research for their assistance on this effort. They worked with us to identify priority fields and develop proposed specifications. The OFR has been helpful in a variety of ways on data standardization and harmonization efforts, and we are very grateful.
In addition to the effort I just mentioned, we have also proposed actions to clarify reporting obligations with respect to cleared swaps and eliminate unnecessary reporting. I hope we can finalize these rule changes soon. We are also leading international efforts on data harmonization. And we are continuing to take enforcement actions so that participants comply with reporting obligations.
We are also working with international regulators and the OFR to develop effective means to identify swaps and swap activity by participant, transaction and product type throughout the swap lifecycle. The OFR has been the leader in the effort to develop the Legal Entity Identifier—or LEI. This has been extremely important. There are more than 400,000 LEIs issued. Today, we are also working together on the efforts to develop the Unique Transaction Identifier and Unique Product Identifier—the UTI and UPI.
Future Actions to Strengthen the Financial System
Finally, let me note a few other areas where we are working to enhance the resiliency of our financial system.
First, we are stepping up efforts to protect against cyber threats. This may be the greatest threat facing our financial system today.
I know you are all well aware of the importance of strengthening the security and resilience of our financial markets against cyberattacks and technological failures. While we have been addressing this issue through our examinations and existing regulations, we recently made some new proposals, which focus on making sure that the critical market infrastructure that we oversee—the exchanges, swap execution facilities, clearinghouses and swap data repositories—are adequately protecting themselves.
We have proposed principles-based standards. For example, our proposals describe the general types of testing that are needed—including controls testing, vulnerability testing and penetration testing – but leave the detail of how to do the testing to the responsible firms.
Second, the Commission has proposed new rules to address the risks posed by the increased use of automated trading in our markets, which has dramatically expanded in recent years. We seek to minimize the risk that automated trading will result in disruptions in the markets by requiring adequate risk controls, monitoring and other measures.
Both of these are significant proposals – and both are still open for comment. We hope to process this feedback and finalize these rules later this year, which will help ensure our markets remain strong, resilient and poised for growth.
Further, I will soon ask the Commission to finalize our proposed rule on the cross-border application of our recently adopted rules on margin for uncleared swaps. In June of last year, the Commission unanimously approved a proposed cross-border approach, which is an important component of our rule on margin for uncleared swaps because it addresses risk that could be created outside our borders, but still jeopardize our financial stability and our economy.
I believe our final rule will draw a reasonable line that makes clear when we should take offshore risk into account. As with our broader margin rule, I expect it will recognize the importance of harmonizing rules with other jurisdictions.
In addition, the staff is working on reproposing rules related to capital requirements for swap dealers and major swap participants. As with the margin rules, we’re working with our fellow regulators—in this case the prudential regulators as well as the SEC—to harmonize these standards as much as possible.
The resiliency of our financial system is critically important to our economy, to businesses and to the American people. These are just some of areas we are focused on that relate to keeping our system functioning with transparency, with integrity and free of excessive risk.
It’s been a pleasure to be with you all today. Thank you so much for inviting me, and I welcome any questions you may have.
Last Updated: February 5, 2016