September 14, 2011
Thank you to the Futures Industry Association (FIA) for hosting this very timely event. This topic always hits me close to home, as I spent a considerable part of my career focusing on global energy issues and trying to advance the United State’s energy independence through financing energy projects, often with the goal of deploying alternatives.
Personal preferences aside, energy policy is fascinating on a number of levels. I’m not trying to pander to this crowd. If I were pandering, however, I would mention the fact that energy policy is so riveting that it often provides the central or underlying theme in blockbuster films. From Syriana to Cars 2, several James Bond films, and most movies involving alien invasions, plot lines rely upon characters acting out their economic and geopolitical ambitions for cleaner, more efficient and affordable - just plain more energy - to keep us on the edge of our seats.
In reality, energy Policy is undeniably fundamental to every nation’s economic success or failure. It challenges our best and brightest to come up with high tech alternative fuels and advanced materials, while pushing the bounds of efficiency. It is also one of our more expensive endeavors, requiring trillions of dollars in investment over a sustained period, an area where Washington has never excelled. Not only must we compete to provide alternatives that are efficient, clean burning, and transportable, but they must be competitive with the lowest priced natural sources, namely natural gas. Add to that challenge that our most utilized fuels are exchange traded commodities that engage in a sometimes volatile pricing cycle where developers, producers, users and shippers seek to hedge their positions to manage their commodity and storage risk as far out on the curve as they can. Put simply, these are long term investments and there are many, many factors at play.
Where the Jobs are At
Though it is usually more exciting in the movies, I am fully cognizant of the fact that most of the success or failure of exploring new oil and gas fields, and alternatives, will be realized in labs, engineering firms, and out in the field. We need to be mindful that the regulatory requirements we adopt as part of the Dodd-Frank Act’s broad sweeping financial reform do not create unnecessary obstacles to important developments in energy. The Commodity Future Trading Commission (CFTC) now plays a critical role in energy markets, and the decisions we make in executing the Dodd-Frank Act could force companies like yours to make tough decisions. If we are not careful that our regulatory policies do not result in unintended consequences, companies may have to decide between hedging existing commercial exposure in the markets and allocating capital to developing new oil wells, and exploring wind, solar and nuclear power.
Despite yesterday’s press announcements that layoffs were looming on Wall Street, with Bank of America announcing a five-fold increase in its number of layoffs and firms like Goldman Sachs and Credit Suisse quietly laying off employees to lower some expenses, without a doubt Dodd-Frank is also creating Wall Street jobs at unprecedented rates. Banks and financial and commercial firms are merely re-prioritizing their needs and replacing the employees they’ve laid off with sophisticated lawyers, compliance experts, economists, quants, technology whizzes – really anyone who knows a thing about the swaps business - to take on the new regulatory regime. Employees with those knowledge and skill sets are undoubtedly necessary and valuable to help ensure a successful transition to the regulation of the swaps market. Still, I want to make sure that in ratcheting up the regulatory and capital requirements of being in these markets, we don’t create jobs in one sector by robbing another. We cannot sacrifice jobs on Main Street to the always evolving appetites of Wall Street.
Our challenge at the Commission is to balance the need for imposing and effective and efficient regulatory regime for swaps with the goals of not busting your budgets, limiting your ability to hire new workers or keeping you from developing new domestic energy sources. To help shed some light on how the Commission is handling that task, I was asked to provide my thoughts on two of my favorite issues: 1) the rulemaking process; and 2) challenges facing the Commission. Along those lines, I would like to address three topics today: (1) the implementation schedule; (2) the swap dealer definition and avoiding the pitfall of “Too Costly to Clear”; and (3) an overview of my current projects.
First I would like to update you on the Commission’s recent decision to publish two rule proposals for notice and comment addressing the implementation of certain regulatory requirements for swap transactions. While those rule proposals should have given some clarity to the market, I believe they may have raised more questions than answers.
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. 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 with the assumption that the imagery speaks for itself. 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.
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. In order to give market participants the certainty that they need to begin an orderly transition to the new regulatory regime, implementation schedule at a minimum should specify:
In contrast, the proposals that the Commission ultimately put out for comment raise more questions than they answer. First, the proposals only address 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 fail 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. The Commission is obligated to ensure the integrity of its markets, and with that obligation comes the duty to ensure that its rules are clear, effective and enforceable. Clarity is needed to ensure ongoing confidence and participation in the newly regulated swaps markets.
Swap Dealer Definition
Five months ago, I spoke to a group of financial and commercial end users about my views on the swap dealer definition. I opposed the draft rules as they too broadly defined dealers and provided exemptions that were too narrow. In that speech, I made the case for a risk-based standard to be applied to commercial firms that are in the market and that might be unintentionally caught up in the dealer definition. I proposed that we look at the overall exposure a firm’s trading makes up compared to its total business. I suggested that if a firm’s trading activity makes up 15% or more of its overall business then it should be considered a dealer. The logic goes that if a firm’s trading activities make up a larger percentage of its overall business, then the firm might not be able to weather the worst financial catastrophe and it may have the potential to pose systemic risk.
How did I arrive at 15%? The Dodd-Frank Act in section 102(a)(6) defines a predominance test utilized to, among other things, establish whether a firm is a “nonbank financial company.” In pertinent part, under Section 102(a)(6) to be considered a nonbank financial company 85% or more of the company's annual gross revenues or consolidated assets must be related to activities that are predominantly financial in nature. Notably, the definition of nonbank financial company excludes certain companies, including Farm Credit institutions, national securities exchanges, clearing agencies, security-based swap execution facilities and data repositories, and boards of trade designated as contract markets.
I am interested to know what you think about establishing an 85/15 standard for the de minimus exception. Alternatively, should the Commission raise the $100 million threshold for the de minimus exception to a $1-2 billion level. I believe we should consider alternatives because I adamantly oppose the currently proposed de minimus threshold of $100 million gross notional exposure and more than 20 swap trades per year. This static and arbitrary figure would engulf firms when prices rise and is not properly calibrated based on differences in asset classes.
The consequences of a predominantly commercial firm being designated as a swap dealer are huge. The proposed dealer compliance and documentation regime alone could be burdensome enough to cause some entities to close shop. But, the real kicker would be the mandatory trading and clearing requirement. The margining and capital charge requirements currently proposed could devour firms’ balance sheets and force them to make difficult decisions regarding choosing between making new investments and hedging their current commercial exposure.
Another issue of concern I have heard from firms is that our swap dealer proposal will likely reduce liquidity in many of the regional energy markets, hurting price discovery and widening the bid/ask spread as more participants leave the market. This, again, would create uncertainty and drive up hedging costs. Some unintentional swap dealers have suggested that they will be forced to concentrate on liquid markets and will accept greater commercial exposure with dirty hedges, which are less tailored to their needs.
Our swap dealer definition proposal needs work to narrow its scope to avoid capturing firms that had nothing to do with the financial meltdown, that would never rise to the level of “too big to fail” because they simply are not—nor were they ever—systemically risky. We didn’t bail out Enron or any of its trading partners, and that will not happen in the future. As I have noted in my remarks many times, the policy decisions the Commission is currently considering will have significant and lasting impacts. It is very important that market participants like you provide input on a narrow, risked based swap dealer definition to ensure that the price of hedging and clearing are not out of reach of commercial entities.
Let me turn to my last topic and give you an update on the things I am working on. With regard to my greatest concerns, I have a long list of outstanding issues that I would like the Commission take a closer look at before proceeding with final rules:
I know I started this address with a nod to the movies, how energy policy and your businesses are fundamental to every nation’s economic success or failure, and perhaps to whether or not aliens will attack. The fact remains that in every instance, and for every purpose, we need a plan to ensure that our nation’s economic recovery stays on course. As for our part, and I am taking you back to the movies, the Commission cannot treat the rulemaking process like Clue. The movie, like the board game, had three possible endings. With the movie, your particular ending depended on the theatre at which you saw the movie. This is not a time for businesses to be guessing who, where and how, and then even if you figured out the mystery, possibly be punished because you chose one venue over another.
I know our nation will be better served if companies that are not systemically risky put their capital to work on growth and domestic energy development rather than paying higher costs for hedging.
Thank you, and I’m happy to answer any of your questions.
Business Roundtable and the United States Chamber of Commerce vs. SEC, No. 10-1305, 2011 U.S. App. LEXIS 14988 (July 22, 2011).
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 15, 2011