September 13, 2011
I would like to thank Stephen O’Connor and the International Swap and Derivatives Association (ISDA) for inviting me to speak with you today. As I was thinking about my remarks for this conference I was struck by its title, “Shaping the Future of Derivatives.” Even before the passage of the Dodd-Frank Act, the Commission has worked to shape the future of derivatives. To date, the Commission has issued 57 advance notices of proposed rulemaking or notices of proposed rulemaking, two interim final rules, 13 final rules, and one proposed interpretative order. Only last Thursday, though, did the Commission finally turn its attention in its last open meeting to addressing how industry will be required to comply with the various implementation requirements for the numerous, intertwined rulemaking initiatives.
The Chairman has frequently used the word “mosaic” to describe our proposed regulatory framework, including during last Thursday’s meeting. I looked up the word in the Merriam-Webster Dictionary, which defines “mosaic” as “a surface decoration made by inlaying small pieces of variously colored material to form pictures or patterns.” The definition notes that, in general, “mosaics” are highly detailed. Unfortunately, the implementation proposals that the Commission approved last Thursday are anything but detailed. Rather than setting forth a guide to understanding how the different rulemaking implementation, or effective date, sections should be pieced together to form a “mosaic”, the implementation proposals themselves more resembled a Jackson Pollack painting from the abstract expressionist movement.
As I have repeatedly emphasized, we can no longer continue to provide the market with broad abstractions. The Commission is in the process of approving final rulemakings. Now is the time for the Commission to give the market concrete direction on how and when to translate the Dodd-Frank rulemakings into an operational reality.
Those of you watching the Commission meeting last Thursday would have noticed that I voted against the implementation proposals. You may have been surprised because, since the beginning of this year, I have continually called for the Commission to present the market with an implementation schedule for notice and comment. I had hoped that an implementation schedule would give market participants the certainty that they need to begin an orderly transition to regulation. I had expected that any such schedule would, at a minimum, specify:
In contrast, the two proposals that the Commission took up for consideration raised more questions than they answered.
First, the proposals only addressed a handful of the rulemakings that we have proposed and finalized. Second, the proposals failed to do several key things. The proposals did not provide market participants with reasoned estimates of beginning and end dates. The proposals did not explain their rationale for determining that 90, 180, and 270-day timeframes were appropriate, rather than the longer timeframes that some commenters had sought when they provided feedback after the Commission’s roundtable on implementation issues. They did not quantify the costs and benefits of the 90, 180, and 270-day timeframes in comparison with alternatives. Finally, the proposals failed to define, or even acknowledge that the Commission intends to define, key triggering terms, such as “made available for trading.”
I voted against the proposals because they failed to provide a comprehensive implementation strategy. They simply did not set forth the clear transition milestones that market participants have repeatedly requested. I hope that the final rulemakings will better demonstrate that the Commission is clear on: (i) how all of its proposals work in concert together; (ii) how market participants can comply with all such proposals; and (iii) when market participants need to be in compliance.
With the hope of giving the market some insight, and based on the limited details in the implementation proposals as well as my deliberations with the Chairman at last Thursday’s meeting, let me share what I believe will be the rough timeline for implementation of the Dodd-Frank rules. I believe that entities that the implementation proposals deem “Category 1” (i.e., swap dealers, major swap participants, and active funds) will not become subject to mandatory clearing until approximately the third quarter of 2012. Entities that the proposals deem “Category 2” or “Category 3” will not become subject to mandatory clearing until 90 or 180 days later. To resolve any lingering ambiguity, the Commission may determine that a swap is subject to mandatory clearing before the third quarter of 2012, but the implementation proposals clarify that entities need not be in compliance at the time of such determination. As I noted last Thursday, the criteria that the Commission will use to make mandatory clearing determinations are still unclear. Therefore, I would continue to encourage market participants, as well as the public, to comment on the letter that I have circulated regarding the need for more guidance on such criteria.1
How should the Commission move forward and responsibly shape the future of derivatives? Given where we are at today, having published the myriad of rules that comprise the “mosaic”, what should our next steps be?
First, the Commission needs to refine its implementation proposals. At a minimum, we need to provide:
The implementation proposals have a 45-day comment period. I urge you all to file comments, not only on the proposals but on the questions that I included in my dissent, which should be published both on the Commission’s website and in the Federal Register shortly.
Second, the Commission needs to focus on resolving extraterritoriality and inter-affiliate issues. If I were to think like a market participant for a moment, the first questions I would ask when confronted with Dodd-Frank are which of my business lines are affected, and which of my entities are affected? Unless the Commission resolves extraterritoriality and inter-affiliate issues, market participants cannot definitively answer these questions and cannot move forward to design the most cost-efficient methods of compliance. Neither issue, however, appears on the preliminary schedule of rules that the Commission will be considering over the next months into the first quarter of 2012 that the Chairman set forth on Thursday.
Third, the Commission needs to focus on international coordination. As I stated last Thursday, it is becoming increasingly clear that the schedule, or timeline, for financial reform is converging among the G-20 nations. It is less clear that the substantive policies underlying financial reform is experiencing the same convergence. That fact may have competitive implications that we have yet to examine fully. Specifically, we need to be more cognizant of imposing costs on entities within our jurisdiction that competitors outside of our jurisdiction will not bear. Also, for entities operating in multiple jurisdictions we should be more cognizant of minimizing unnecessary duplicative regulatory requirements, and opportunities for international regulatory arbitrage.
Finally, I’d like to say a word on regulation of derivatives clearing organizations (DCOs). I noticed that such regulation is an item on this conference’s agenda. As I have stated previously, it will be important for the final regulations to strike the appropriate balance between managing DCO risks and facilitating open access, which includes ensuring that market participants do not find it too costly to clear. Another related topic that has been the subject of much debate recently is participant eligibility. For example, in anticipation of potential Commission regulations ICE Clear Credit lowered its minimum capital requirement for membership to $100 million, but imposed a new excess capital requirement equal to at least 5 percent of customer segregated funds. I understand that there are many different perspectives on this topic. Since I will need to make a decision on final DCO regulations in the near future, I am curious to hear your thoughts on participant eligibility, as well as on any other aspects of DCO regulation. What should I consider in determining whether the final DCO regulations have struck the best balance between risk management and open access?
How We Can Get There
To help the Commission take responsible next steps, I am setting forth specific requests.
First, generally, the following requests implicate all rulemakings:
Second, regarding requests that implicate specific rulemakings:
Finally, on requests that implicate Commission priorities:
I’m looking forward to learning from all of your perspectives on the important issues that are being taken up by the Dodd-Frank Act rulemakings. Finally, before I close, I would once again encourage all of you to submit your comments, both on the rulemakings and also on the issues that I have tried to bring their proper due attention, like guidance on mandatory clearing determinations. So thank you, again, to ISDA and to Stephen for inviting me to speak today, and for arranging for us all to have what I am sure will be a valuable dialogue on these issues.
2 Business Roundtable and the United States Chamber of Commerce vs. SEC, No. 10-1305, 2011 U.S. App. LEXIS 14988 (July 22, 2011).
Last Updated: September 13, 2011