November 18, 2014
As Prepared for Delivery
Thank you for inviting me today, and I thank Terry Duffy for that kind introduction. CME has been a leader in the derivatives markets for many years, and Terry Duffy has been a big part of that. I also appreciate CME’s support and involvement in our implementation of regulatory reforms, and I look forward to continuing to work together in the months ahead.
Today, I would like to discuss where we are in the process of financial regulatory reform. Let me begin by first telling you a bit about my background, and how it shapes my views. Then, I want to share a few thoughts on the historical context of the reforms we are implementing, because that also shapes my views on how we tackle the challenges before us. Then, I would like to turn to some of the specific challenges we face.
First, prior to this job I was at Treasury overseeing the TARP. That makes it easy to remember why we are implementing these reforms. Our country lost 8 million jobs and thousands of business. Having spent five years helping our nation recover from that crisis, having met many struggling Americans coping with sudden unemployment and facing foreclosure, there is not a day that goes by that I don’t think about the importance of making sure that doesn’t happen again. That experience also illustrated the importance of bold action. The U.S. responded to the crisis with overwhelming force and speed, and a number of creative initiatives, of which TARP was just one.
Much of the leadership in taking that action came from one individual who you will recognize later today—former Chairman of the Federal Reserve, Ben Bernanke. Let me add my personal thanks to you, Ben, for your leadership.
My experience as a private sector lawyer also informs my outlook. For twenty five years, I worked with businesses and governments all over the world on all types of transactions. As a young lawyer, I was part of a small group of lawyers that drafted the original ISDA master swap agreements in the late 1980s, which were the foundation for the industry. So I appreciate the importance of these markets to a wide variety of businesses. I appreciate the role the United States has played for decades in setting the gold standard for financial market regulation, and the importance of good regulation to the long-term success of our financial markets.
So as I think about the challenges we face, I draw on those experiences.
Putting Today’s Regulatory Reform in Historical Context: The Importance of U.S. Leadership
I also think about the historical context. Consider the history of the development of the securities and futures markets in this country.
In the 1930s, we created a framework for securities regulation and trading which proved tremendously successful. Many of its mandates such as public reporting by listed companies were revolutionary at the time. Many felt the requirements would be the death knell of capitalism. When the Securities Exchange Act was passed, the President of the New York Stock Exchange said it was “a menace to national recovery.” History has proved otherwise.
Today, these “menacing” requirements are about as controversial as seat belts. Indeed, they have been the foundation for the growth of our securities markets.
The basic principles of our securities laws have remained true to this day. We require upfront disclosure on the securities being sold, we regulate how securities are offered, sold and traded to prevent fraud and manipulation, and we engage in enforcement to ensure compliance with those requirements. But our laws generally do not restrict what can be offered and sold. We do not make normative judgments about whether there is an economic justification for a product, nor do regulators set the price at which a product is sold.
The regulation of the futures market is similar. Congress created a framework for regulation which properly balanced strong oversight while allowing innovation. The CFTC was established in 1975 as a dedicated regulator for the futures market, and that market has grown by leaps and bounds over the last 40 years. In another example of wise, bold leadership, Leo Melamed, chairman emeritus of CME, who is here today, early on recognized the importance of regulation to the growth of the futures markets and supported the agency when many others took a different view.
We have created in our securities and futures markets a sensible framework for regulation – one that has bolstered integrity and transparency, while at the same time, supporting innovation and competition. This has led to dynamic markets that attract liquidity and participants from around the world.
So how do we make sure we continue to do that today?
The Crisis and the Response
Let’s look at where we are. In response to the financial crisis, the U.S. led with an unprecedented response to stabilize the system, and then we moved swiftly to address the causes of the crisis through regulatory reform. We worked with the other G-20 nations to agree on key reform goals, and we quickly put those into law here at home.
The Dodd-Frank Act was a comprehensive response to the crisis. With respect to over-the counter swaps, it implemented the key commitments agreed to by the G-20 nations to bring that market out of the shadows: central clearing, market oversight; transparent trading; and data reporting. Since the crisis, we have made substantial progress in implementing these.
In sum, we have made a good deal of progress. I want to acknowledge and thank the hardworking professional staff of the CFTC. Where we are today is a credit to their dedication and tireless efforts.
But there is much more to do in all these areas. Our rules are new. We are still phasing in some requirements. As we gain experience with their application in the marketplace, we will see what works well and what doesn’t, and we will fine-tune the rules as appropriate. And there is substantial work to be done to harmonize rules across national borders.
So what are some of the challenges ahead, and how will I approach them?
My “Core Principles”
Let me borrow from the Commodity Exchange Act, and suggest what are my own “core principles,” if you will, as to how I think about that. First and foremost, we must remain faithful to the law. Our duty is to implement the law Congress established.
We also must be willing to act. While coordinating our approach is vital – and something I will return to in a moment – we must be willing to implement regulatory reform even if others are not yet ready to do so. These reforms are necessary. We must have the patience to allow the market to adjust. With the basic structure in place, now is not the time to roll back or start over.
At the same time, some fine tuning is necessary. This is particularly true when it comes to making sure these markets continue to work for the commercial companies that depend on them to hedge routine commercial risk. Reforms must help make sure financial markets aren't just a source of profit for Wall Street but rather that they continue to be an engine of growth for all Americans. That means making sure that manufacturers, retailers, farmers and other businesses that provide the goods and services we all consume can continue to use these markets effectively and efficiently. That is why we have been very focused on issues of concern to those market participants, whether it is matters like contracts with embedded volumetric optionality, or the residual interest deadline, or record keeping requirements.
We must also focus on working with our international regulatory colleagues on the cross-border implications of reforms. This requires us to recognize the unique historical situation we are in.
The Cross Border Challenge
When we passed the securities laws in the 1930s, we did not have a global market and did not need to worry about harmonization. Indeed, today, the laws governing how you can sell securities in different jurisdictions are not harmonized. The development of the futures market was similar: we created a domestic regulatory framework; a global market followed.
By contrast, the swaps market grew to a global scale without any regulation. Participants traded across borders without legal constraints and, with no oversight, took on excessive risk. Because of the interconnectedness among swaps participants, when one got into trouble, that risk could easily cascade through the system – often across national borders. We faced the possibility of systemic collapse.
So we face a challenge. We must regulate what is already a global market, but we can only do so through the actions of nation states, each with their own legal traditions, regulatory philosophies, political processes, and market concerns.
The fact is that, even though the G-20 nations have agreed on the core principles of reform, there will inevitably be differences.
The challenge is to try to harmonize the rules across borders as much as possible, recognizing that our responsibility as national regulators is first and foremost to faithfully implement and defend our own nation’s laws. But we must listen and recognize the valid concerns and ideas of other jurisdictions. I think we have made good progress in harmonization, but there is much more to do. It will take time.
The Challenges Ahead
Let me turn to some of the specific cross-border challenges, as well as other challenges, that we now face. Some of these pertain not just to implementing the new swaps framework, but also to our regulation of the futures market.
Clearing and Clearinghouse Oversight
First, clearing. Central clearing has long been commonplace in our securities and futures markets. But the swap industry remained in a predominantly bilateral mode, in part because of its rather unique evolution: there was no regulatory framework, and therefore not much attention being paid to systemic risk. Here, we have made great progress as I noted earlier. We will make more as the clearing mandates in Europe and other jurisdictions take effect in the years ahead.
We are also focused on margin for uncleared swaps, and here I am pleased that the proposed rules being considered by the U.S., Europe and Japan are reasonably consistent.
How we address cross-border issues regarding supervision, and recognition of clearinghouses is equally important. This issue transcends swaps. I know it has been of concern to many of you with respect to the futures market.
Clearinghouses are more important than ever under the new framework. While central clearing is a good way to monitor and mitigate the risk of transactions that would otherwise remain bilateral, it does not eliminate risk. We must be vigilant to insure that clearinghouses themselves do not pose risk to financial stability. It is for this reason that clearinghouse oversight will be an ongoing area of focus. And, with respect to the cross-border challenge, it is for this reason that I believe a simple notion of deference—if the clearinghouse sits on foreign soil, then we defer to foreign regulation—is not sufficient. Instead, I believe the proper model should be based on what has worked – dual registration and cooperative oversight among regulators. We have had clearinghouses located in Europe registered with us and subject to our supervision for some time—since 2001 in the case of the largest global clearinghouse for swaps. This model has worked to protect customers, it worked during the crisis, and it is a model on which the market has grown to be global.
What about swaps trading? I recently outlined some thoughts on how we can move forward in this area to enhance usage of new trading platforms. There is a cross border element here as well. Many have criticized particular aspects of our rules and said they have resulted in market fragmentation. My own view is that whatever fragmentation may have arisen is largely a result of the fact that the U.S. imposed rules on an unregulated, highly mobile trading market long before other jurisdictions did. Still, where we can fine tune our rules so that we create a framework for markets to thrive, we should do so, and we will continue to work with other jurisdictions as their rules come on line to harmonize where possible.
Data is another vitally important area. The establishment of swap data repositories in the US, and trade repositories abroad, is bringing unprecedented transparency to the swaps market. There is a considerable amount of work still to do to collect and use this data effectively. In particular, we have a lot to do to harmonize data standards. But for those who expect this kind of thing to happen overnight, it is worth considering what I might loosely call the “harmonization challenge” with respect to data standards in securities markets. For example, there are different accounting standards for financial statement disclosure by publicly listed companies around the world, and the securities industry has been working on convergence for decades.
In short, the data collection issues will take time, but we are making progress.
We must also focus on cybersecurity, perhaps the single most important new risk to financial stability. Cybersecurity and business continuity generally are important aspects of our oversight for futures and swaps markets. We will be focused on this issue in our examinations of clearinghouses and exchanges in particular to make sure they are doing all they can to address this risk.
Enforcement and Compliance
Finally, we will be vigorous in our enforcement efforts. Robust enforcement and oversight are crucial to maintaining the integrity of our markets, as well as public confidence. You may have seen the orders we brought last week against five of the largest banks in the world for attempting to manipulate the foreign currency benchmark rates.
This was also a good example of cross-border cooperation, as we worked closely with the Financial Conduct Authority in the UK and FINMA in Switzerland.
We will focus on enforcement at all levels, whether it is traditional Ponzi schemes and precious metal retail fraud schemes against retirees, to the new challenges like spoofing that come with our increasingly electronic markets.
Advancing the goals I have outlined and fully implementing the new regulatory framework depends on having the resources that are proportionate to our responsibilities. In my view, the CFTC’s current budget falls very short. The fact is that, without additional resources, our markets cannot be as well supervised; participants cannot be as well protected; market transparency and efficiency cannot be as fully achieved.
In closing, the United States has been a leader in financial markets regulation for decades. We must continue to set sensible, strong standards for both our swaps and futures markets, standards that restore confidence and integrity, standards that recognize today’s global market, and standards that create the foundation for the markets to thrive, just as we have done in the past. I look forward to working with you on that challenge.
Thank you again.
Last Updated: November 18, 2014