March 16, 2016
Thank you, Walt for that warm introduction. It’s good to be back here at FIA’s International Futures Industry Conference.
Before I begin, let me thank FIA and its members for their decades of work in this industry. And I know I speak for my fellow Commissioners Bowen and Giancarlo, as well as our hardworking staff when I say that we appreciate your participation in the activities of the CFTC.
These are anxious times. While many U.S. economic indicators remain positive, including six straight years of private sector job growth, pick up any newspaper and you are likely to see a story about anxiety in financial markets. A few days ago, an op-ed in the Wall Street Journal said that we are “in a new age of anxiety.” It talked about declining energy and commodity prices, the threat of deflation, and concerns as to whether central banks still have adequate monetary policy tools. The New York Times recently reported on “investors’ growing anxiety about global growth.”
The Financial Times recently spoke of the “widespread market anxiety for much of 2016.”
A recent headline in The Economist described global markets as “a tangle of anxieties.”
Last week, a New York Times commentator proclaimed “economic alarm bells are ringing.”
The factors cited in each of these articles vary, but include low growth rates, low interest rates, emerging market challenges, volatility in commodity prices, and concerns about the future direction of monetary policies.
Of course, this is a presidential election year, and so we are in a time of political uncertainty in this country as well.
And Time Magazine recently reported that the possibility of an exit by the UK from the European Union “will only add to investor anxiety.”
Most American families are not focused on investor anxieties related to emerging market growth rates, deflation risk or volatility of commodity prices. But many are also very anxious. A recent Wall Street Journal article entitled “Economic Anxieties Confront Candidates,” reported that fewer than one-third of surveyed households believed the coming year would offer opportunity; more than half said they were bracing for harder times.
And in discussions of the election, one report recently referred to the “angry, anxious” mood of the electorate. Another characterized the electorate as “frustrated and anxious.”
So how do these anxious times affect the work of the CFTC?
Uncertainty and volatility in markets are the very reasons that the derivatives markets exist. Every day, farmers, ranchers, energy companies, and many other commercial businesses use the derivatives markets to deal with uncertainty in commodity prices, interest rates, stock prices, and foreign exchange rates. That is not to say that we welcome anxious times. Quite the contrary. But I believe these times underscore the importance of our mission, which is to make sure these markets function with integrity and transparency, to facilitate competition, and to prevent fraud and manipulation.
In the aftermath of the crisis, our mission is even greater: we must also make sure these markets do not create excessive risk, and do not threaten our financial stability.
The role that derivatives can play in hedging risk, and in dealing with price uncertainty, is well known to all of you. But it is not so well known to most Americans. Most Americans had not heard the word “derivative” until the 2008 global financial crisis. That’s when they came to associate it with bad behavior by big banks – behavior that contributed to the intensity of a financial crisis that left eight million without jobs and millions more without homes.
And so, these times give us all the more reason to pursue our mission with vigor. To make sure the derivatives markets work effectively. To regulate these markets in a way that prevents the creation of conditions that undermine financial stability. And to implement the reforms designed to prevent the buildup of excessive risk in the future.
So today, I would like to talk about some recent actions and events that illustrate our progress and our priorities. I am going to focus on five areas – areas where there has been significant activity in just the last five weeks. In the course of doing so, I will also discuss some of our priorities for the months ahead.
Common Approach for Transatlantic CCPs
The first action underscoring the progress we are making is the agreement that European Commissioner Jonathan Hill and I reached in February, which sets forth a common approach regarding requirements for central clearing counterparties, or CCPs. This accord is significant in a number of ways.
First, of course, it resolves the issues that were standing in the way of Europe “recognizing” U.S. CCPs. And it thereby helps make sure that the U.S. and European derivatives markets can continue to be dynamic, with robust competition and liquidity across borders.
Second, the agreement is an important step in achieving cross-border harmonization of derivatives regulation.
And third, the fact that we needed to reach such an agreement signifies how far we’ve come in just a few short years. We needed this agreement because of the progress we have made in increasing the use of central clearing, a critical G-20 reform. Clearing of standardized over-the-counter (OTC) swaps is cleaning up the spider-web of opaque complexity that arose from the bilateral OTC world, complexity that threatened to lead to domino-like defaults in the crisis.
Today, we are able to better monitor and mitigate risk.
The agreement provides for some modest changes on both sides of the Atlantic that will help bring our regimes closer together and reduce the possibility of regulatory arbitrage. For example, the European Securities and Market Authority (ESMA) is consulting on whether the EU should allow EU CCPs to use the U.S. model for the collection of customer margins. Meanwhile, U.S. CCPs that seek recognition will show that they can comply with certain EU requirements, including two-day liquidation periods for house margins. I’m pleased that yesterday the European Commission published its formal decision finding that the U.S. regulatory framework is equivalent.
The final agreement reflects the fact that from the beginning, we worked hard to ensure that any agreement with the EU does not increase costs in our market unless there was a good reason for it. And in particular, we wanted to ensure we did not impose undue burdens on the commercial end-users who rely on the derivatives markets to hedge routine risk—and who were not a cause of the financial crisis. We also agreed to a specific exemption for U.S. agricultural contracts. This was critical because of the strong nexus of these contracts to the U.S., their importance to American farmers and ranchers and the lower degree of systemic interconnectedness.
I also believed strongly that cooperation among regulators in the oversight of major clearinghouses is the right way forward, and this agreement provides a foundation for that.
While it preserves our framework for registration of foreign CCPs in certain cases, a key aspect of the agreement is that the CFTC would consider a “substituted compliance” determination that would permit European CCPs to comply with many of our rules by adhering to the corresponding European Market Infrastructure Regulation (EMIR) requirements. And today, I’m pleased to announce that the Commission has fulfilled this step: we have unanimously approved a comparability determination that will further harmonize our regimes. This will also streamline the registration process. Concurrently with this determination, staff is issuing no-action relief from the application of Commission regulations to discrete aspects of a clearinghouse’s non-U.S. clearing activities.
We and our CCPs are already working with the ESMA to submit any additional information that is required to complete their applications. As a result, I expect there will be no problem completing the recognition process in a timely manner, so that the global derivatives market can continue to function smoothly and efficiently.
The equivalence accord provides a good basis for further work with Europe and other jurisdictions on cross-border harmonization. But it is not the only progress we have achieved recently on this front. Our adoption of a final rule on margin for uncleared swaps late last year also underscores these advances – and illustrates our progress in reforming the OTC swaps market. The rule is a cornerstone of our overall regulatory framework, and we worked very hard to harmonize our rule with international standards as well as the specific rules being considered by Europe and Japan. Soon, we will take up our proposal on the cross-border application of the margin rule. I will then ask the Commission to consider reproposing our rule on capital for swap dealers. This is a very important complement to the margin rule.
Resolving the equivalence issue also allows us to turn more attention to our swap trading rules, where we are working with our European counterparts to understand similarities and differences in our rules in order to make further progress toward harmonization.
Also on that front, this spring I will ask the Commission to consider a number of rule changes to enhance trading and participation on swap execution facilities (SEFs). This will include formalizing a number of the “no-action” positions the staff has taken, and considering additional issues, such as whether the Commission should play a greater role in the “made available to trade” determination process.
Let me turn to a second area of recent activity, which concerns clearinghouse resiliency. There have been several meetings over the last few weeks that exemplify all the good work going on to make sure clearinghouses are strong and resilient. These meetings didn’t grab headlines, but they are every bit as important as the events that do.
In late February in Frankfurt, Germany, CFTC staff met with their counterparts from regulators around the world to continue the extensive work being done by a joint effort of the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) on clearinghouse strength and stability.
One subcommittee under CPMI-IOSCO is assessing the implementation of the Principles for Financial Market Infrastructures, or PFMIs, by examining outcomes at 10 representative CCPs. A second is examining whether further granularity or guidance is needed with respect to the PFMIs on a wide range of issues, including margin methodologies, adequacy of financial resources, stress testing, guidance with respect to the liquidity of CCPs; and CCP governance. It has received extensive input from 30 CCPs.
Shortly before the Frankfurt meetings, the Financial Stability Board’s resolution group met to further its work enhancing CCP resolution planning and international coordination. The CFTC is also involved in this effort, and is working directly with our domestic regulators on this type of crisis planning.
And to that end, on March 7, CFTC staff hosted a half-day meeting with staff from the Federal Reserve, the FDIC and the Treasury to engage in an exercise to explore how U.S. regulators would potentially respond if a clearinghouse faced credit or liquidity shortfalls as the result of the defaults of multiple participants.
So there is a lot going on, and clearinghouse resiliency will continue to be at the forefront of our agenda. The CPMI-IOSCO subcommittees will produce reports in mid-2016. And we will continue working with fellow regulators on recovery and resolution planning throughout the year.
Promoting Customer Protection and a Robust Clearing Member Industry
The third action is a CFTC staff roundtable in early March discussing the implementation of the Commission’s “residual interest rule.” Why do I mention this? Because it illustrates the progress we have made in enhancing customer protection. It illustrates our commitment to looking at the health of the clearing member industry. And it is a further illustration of our willingness to fine-tune rules where appropriate.
As you know, the rule addresses when a futures commission merchant (FCM) must cover a customer’s account if it becomes undermargined. And that in turn, affects the deadline for when customers must post collateral. Shortly after I took office, we took action to remove an acceleration in that deadline which many feared would impose a significant burden, particularly on smaller customers.
The views of participants at the roundtable were virtually unanimous: we should not accelerate the residual interest deadline, because that would likely lead to operational difficulties, particularly for small customers. But in addition, participants said the rule and the other customer protection measures we have taken are working. They have enhanced the safety of customer funds, and have not caused customers to withdraw from the markets. In short, we have struck the right balance.
We will continue to engage with market participants on these and related issues. We will continue to make sure our regulatory framework strikes the proper balance. We must make sure that customer funds are protected and that all customers—particularly smaller ones—have access to these markets. And we need to make sure the clearing member industry remains robust. That is critical to access, and it is critical to the resiliency of clearinghouses. And that is why I continue to believe it is important to consider fine tuning the supplementary leverage ratio with respect to its effects on clearing.
Addressing Emerging Threats to the Financial System
The fourth set of events that illustrate our progress are the comment deadlines for two important proposed rules: the deadline for our proposal to enhance cybersecurity protection in our markets, which has just passed, and the deadline for our proposal on automated trading, which is today.
These two proposals, adopted unanimously, show that we not just looking back, as we must, to address the causes of past crisis. It shows that we are also looking ahead, and taking action to address future threats to financial stability.
The threat of cyberattacks may be the greatest threat facing our financial system today. Our proposal is simple: the private firms that run the critical infrastructure in our markets should follow best practices when it comes to testing their defenses and other protections against similar technological risks. Our focus on this issue will not cease, however, with the adoption of this rule. We will continue to make this a priority in our examinations. We will continue to work with other agencies to enhance intra-governmental cooperation, and cooperation between government and industry, so that we share information about threats – and plans for responses. I expect that cybersecurity will be a top priority for the agency in the years ahead.
Similarly, automated trading has dramatically expanded in recent years. Our proposal seeks to minimize the risk that it will result in market disruptions by requiring adequate risk controls, monitoring and other measures. Once again, it is principles-based and it builds upon industry best practices.
I know many of you are concerned about the issue of confidentiality of source code. Let me underscore my commitment to a final rule that respects and protects confidentiality while at the same time ensuring that source code is preserved and is available to us when we need to reconstruct market events.
I also know some of you asked that we extend today’s comment deadline. We have declined to do so. But as always, we will review comments carefully and decide if there are any issues on which it would be beneficial to invite additional comment.
We hope to finalize both of these rules later this year.
And let me also mention another recent event that indicates how the Commission is looking ahead. At a recent meeting of the CFTC’s Technology Advisory Committee, we exchanged ideas on a number of important priorities for the Commission. In addition to discussing our automated trading proposal and our efforts to improve the quality of swap data reporting, our agenda included a discussion about the potential application of blockchain technology. We recognize this could be very important in future years, and we will continue to look at it.
Reducing Burdens on Commercial End-Users
And finally, I am very pleased to announce the fifth action here today. Today, the Commission has unanimously approved a final rule on Trade Options. The changes we have adopted will reduce the burdens on commercial businesses using these instruments. And it illustrates a critical component of our mission that has been a priority of mine since taking office. As we enact significant regulatory changes to enhance the safety and resiliency of these markets, we must make sure that the commercial businesses who use these markets to hedge routine commercial risk can continue to do so efficiently and effectively.
The rule recognizes that trade options are different from the swaps that were the focus of Dodd-Frank reforms. It eliminates certain reporting and recordkeeping obligations for these commercial users.
In addition, concurrently with these changes, the Commission has agreed on proposed guidance regarding the treatment of peaking supply and capacity contracts. These too, are different than most swaps. These contracts pertaining to electric power and natural gas are often designed to meet regulatory requirements. They are entered into to assure availability of a commodity, not to hedge against risks arising from a future change in price of that commodity, nor for speculative or investment purposes. Our guidance is intended to make it easier for regulated entities to use these contracts to maintain reliable energy supplies. This proposal will be released soon, subject to the approval of the SEC, because it relates to our joint definition of a “swap.”
These actions are among the many we have taken to address the concerns of commercial end-users. For example, we have simplified and reduced recordkeeping requirements for commercial companies. We have made sure that these businesses can effectively use treasury affiliates to engage in their derivatives transactions.
We clarified when agreements that include volumetric optionality provisions are forward contracts, rather than swaps. We exempted community development financial institutions and small banks from our clearing requirements. We changed our rules so that local, publicly-owned utility companies can continue to effectively hedge their risks in the energy swaps market. And we granted relief from the real-time reporting requirements for certain less liquid, long-dated swap contracts.
I will continue to make addressing the concerns of commercial end-users a priority, and I know Commissioners Bowen and Giancarlo share this view.
And in this regard, a priority for this year is to finalize the rules related to position limits. I know these rules are of great interest to commercial end-users and other market participants. There are many complex aspects to these rules, such as standards for bona fide hedging, the standards and process for hedging exemptions, and deliverable supply estimates. We have been considering stakeholder input carefully and making good progress toward finalizing these rules.
That gives you a quick review of some recent actions and current priorities. Let me conclude with one final thought.
Last week, my fellow financial regulators and I met with President Obama to review the progress of financial regulatory reform. Afterwards, the President spoke to the reporters in the room and said, “I want to dispel the notion that exists both on the left and on the right that somehow, after the crisis, nothing happened.” He went on to point out all that we have done to strengthen the financial system, to make it more secure, and to curb the excesses and risky behavior that contributed to the crisis. Stronger capital requirements, measures to address too-big-to-fail, reforming executive compensation, greater consumer protection, and tools to allow us to identify and address new threats to financial stability are among these measures.
And, of course, derivatives reform. In the years since the crisis, we have implemented a new regulatory framework for over-the-counter swaps. A framework that is in place and is working. We have also taken many actions that have enhanced and improved the futures market. We have enhanced customer protection and made clearinghouses more resilient. And at the same time, we have focused on making sure the commercial businesses that rely on these markets—and who were not the cause of the financial crisis—can continue to use them efficiently.
The areas and actions I have discussed demonstrate the progress we’ve made. All this work is continuing. The job is not done. There are still a few rules to complete. There is still fine-tuning to do, which is always necessary as the financial system evolves. But the progress we have made to date is dramatic.
And as a result, I believe our system is stronger and more resilient.
Thank you again for inviting me here today. I’d be pleased to take a few of your questions.
Last Updated: March 17, 2016