September 13, 2012
I would like to thank Steve O’Connor, Bob Pickel and Mary Johannes from ISDA for inviting me to speak with you today. This is my first appearance at an ISDA conference, but I see many familiar faces in the audience. I have found the dialogue with all of you to be very constructive during my first year with the Commission, and I look forward to continuing that dialogue in the months and years ahead.
This year’s conference comes at a critical time for the derivatives markets. The Commission has now finalized many important rules to implement the swap regulatory regime, including rules relating to business-conduct standards, reporting, documentation, and risk-management practices, as well as the cornerstone definitional rules.
The swap-dealer-registration process has already begun—the first swap dealer applied for provisional registration in July. And, between now and the end of the year, the Commission likely will finalize much of the remaining regulatory framework for the swap markets.
But recently the focus of discussions has shifted from Dodd-Frank rulemaking to implementation challenges. Those charged with bringing their firms into compliance with Dodd-Frank have raised concerns about their ability to build the programs and systems that will be necessary to fulfill their regulatory responsibilities, especially within the timeframes set forth in the Commission’s rules. Those concerns, of course, are also concerns of the Commission.
In short, the focus of this conference, “Implementing the New Market Framework,” could not be more relevant at this stage of the Commission’s work to implement Dodd-Frank.
I would like to discuss several topics in my remarks today. First, I would like to reiterate the guiding principles that I rely upon in reviewing, shaping, and voting on the final rules presented to the Commission. Second, I would like to discuss the application of those principles to the Commission’s cross-border guidance. Finally, I would like to conclude with remarks on the road ahead and the challenges of transitioning the existing swap markets to the new structure envisioned by Dodd-Frank.
Guiding Principles for the Dodd-Frank Rules
In reading through the comment letters, I am often reminded that financial markets are mobile and can be fragile, and efforts to regulate them can lead to unexpected results. Consequently, the Commission must carefully exercise its rulemaking responsibilities or risk dislocating or damaging a marketplace that has been valuable to so many U.S. and global companies.
We already have seen one example of how the Commission’s rules and compliance timeframes are impacting the structure of the swap markets, albeit in a harmless (and perhaps even a positive) manner from my perspective. The IntercontinentalExchange, Inc. (“ICE”) plans to migrate its complex of energy swaps from its exempt commercial market to its futures exchange next month. These contracts will be converted to futures and continue to trade on a central limit order book, with the full panoply of protections applicable to futures contracts.
This is not an example of the Commission deliberately driving the swap markets towards the futures framework. By all accounts, this decision was driven by the wishes of market participants who currently trade ICE’s energy swaps. It seems clear, though, that this business decision by ICE’s management team was primarily motivated by, and in reaction to, the Commission’s implementation of Dodd-Frank.
In any event, these events show that the Commission’s actions can and will have real consequences for the structure and viability of the U.S. swap markets. Regulators inevitably act with imperfect information, and we therefore should proceed towards our regulatory objectives with appropriate caution.
I continue to believe, however, that the financial crisis demonstrated that we cannot entirely rely upon market participants to regulate their own activities. There is a role for policymakers to oversee the markets, establish clear and fair rules, and use those rules to realign incentives, where appropriate, in furtherance of the objectives of Dodd-Frank.
In my judgment, adhering to the following principles will maximize the public benefit of the Commission’s rulemakings as well as minimize dislocations or other unintended consequences.
First, the Commission needs to provide as much clarity as possible. It may not be possible to come up with a bright-line test that easily addresses all circumstances and is not susceptible to abuse or evasion. But the Commission’s answer to the question of what falls within the scope of a rule, or how a rule will operate, cannot too often be: "It depends.” Compliance with our rules should not be a guessing game.
On occasion, I have supported final rules that have taken a facts-and-circumstances approach. But I have strived to make them exceptions in our rules rather than the norm. And I have encouraged the Commission to provide sufficient guidance on the contours of its rules when the facts and circumstances control.
Second, the Commission should take a measured approach to rulemaking. It is not possible to predict the evolution of the swap markets after Dodd-Frank. And given the Commission’s limited resources, as well as its currently limited view of these markets, we should cast our net only as wide as necessary to protect the public.
Finally, the Commission’s rules must be workable. The public benefits of our rulemakings will not be achieved if requirements can’t be met. In many cases, workability can be achieved simply by providing enough time for compliance.
In my experience, while the Commission has not always provided the exact amount of time requested by market participants, in almost every instance where a good case has been made, some additional time has been provided. It is worth noting as well that the Commission has finalized a number of rules with phased compliance periods to provide for an orderly transition in the markets.
For instance, based upon comments to the proposed internal-business-conduct rules, the Chairman and I worked together along with the other Commissioners to finalize a phase-in period for confirmation timeframes in the various asset classes. The Commission similarly revised a proposed phase-in schedule for categories of firms coming into compliance with clearing determinations.
Cross Border Guidance
These guiding principles should be applied to all of the Commission’s rulemakings. But nowhere is it more important that the Commission be clear and make measured and workable policy than in our cross-border documents.
Before I discuss the application of these principles to the Commission’s proposal, I first would like to focus on what should be the primary objective of the cross-border releases: Ensuring against gaps in the global swap regulatory regime that could harm the U.S. economy.
Coincidentally, four years ago to the day—September 13, 2008—policymakers and executives from a number of large financial institutions convened to discuss the best means to address a crisis in the financial markets. The next day, Merrill Lynch was sold to Bank of America, and the following day Lehman Brothers filed for bankruptcy.
We all understand that the circumstances of four years ago were complicated. But the litany of firm failures and near failures during that time period (and well before and after that time period) demonstrates the very real danger that risks undertaken abroad can seriously impact the health of financial institutions, and the broader economy, here at home.
Regulation will not prevent every risk from materializing at a financial firm in any given jurisdiction, but from a U.S. policy perspective, we must do what we can to prevent such risks from damaging our economy. Taxpayers must be assured that those financial institutions with the potential to directly and significantly impact the U.S. economy—wherever they may be located—will implement appropriate risk-management programs and institutional safeguards.
I believe the Commission’s proposed cross-border releases are consistent with this fundamental objective. I continue to have concerns, however, about the clarity, scope, and workability of the proposals in certain areas.
Clarity. With regard to clarity, the proposed cross-border releases may not have provided the level necessary for market participants to implement the Dodd-Frank regulatory regime. The Commission must do better.
The Commission is fully engaged at this time on issues related to the definition of “U.S. person,” the conduit test for transaction-level requirements, the aggregation of overseas-dealing activities, and the competitiveness of certain legacy business structures. I am confident that the Commission’s final releases will be able to answer and clarify many of the relevant questions and concerns raised in the comment letters on these issues.
Additionally, to achieve the objective of clarity, the Commission’s cross-border documents also must be sufficiently timely. It is therefore my goal to help the Commission finalize these measures as soon as possible. Only then will global swap-market participants have necessary certainty regarding their obligations under Dodd-Frank.
I am not persuaded, however, that our cross-border guidance needs to be a rulemaking rather than interpretive guidance. There are reasons for the Commission to use either mechanism, and decisions with important policy implications have been made before by the Commission through guidance. One example is the Commission’s Brent interpretation.
A final cross-border interpretation, written with appropriate precision, will not be less clear than a rule solely on account of its administrative label. The Commission must provide clear answers to the questions market participants have asked about the reach of the Dodd-Frank rules, and give adequate notice of those answers. If those objectives are met, the means by which they are met should be inconsequential.
Scope and Workability. The other two principles—taking a measured approach and having workable rules—go hand-in-glove in the context of our cross-border documents. It is only by taking a measured approach that the Dodd-Frank regime can be workable in a global marketplace.
In my view, to be consistent with these principles, a rigorous substituted-compliance approach must be a central tenet of the Commission’s cross-border approach.
Certainly, different jurisdictions have moved at a different pace, and the precise requirements in each jurisdiction will be influenced by local laws and practices. But two years ago in Toronto, the G20 nations reaffirmed their commitment to derivatives reforms and pledged to enact those reforms in an internationally consistent manner. I am confident that the G20 nations will honor their commitments. In fact, Europe, as this audience well knows, is not much behind the U.S. in implementing derivatives reform.
Reliance on substituted compliance is critically important. As an initial matter, the law is clear that principles of international comity, and a healthy respect for the sovereign authority of other nations, are an integral part of determining the proper extra-territorial application of federal statutes. Further, in light of the Commission’s limited resources, efficient regulation through deference to comparable regulation just makes sense.
Permitting substituted compliance is not tantamount to abdicating the Commission’s responsibilities. Should a comparability analysis reveal a gap in another jurisdiction’s regulations that poses material risks to our markets, our financial institutions, or our economy, the Commission reserves the right to apply Dodd-Frank to swap activities abroad that satisfy the “direct and significant” standard set out in the statute.
For certain, the devil is in the details. Some of those details will have to be worked out through the Commission’s continuing international cooperation with our counterparts abroad. But for now, I appreciate and continue to review the public comments on whether the proposed approach to substituted compliance is workable and sufficiently robust.
To finish up on the cross-border releases, I recognize that the proposals have shaped expectations about the Commission’s ultimate approach to cross-border issues. And because the documents were released when firms are considering whether they must register as dealers or major swap participants, I acknowledge that they likely had an immediate impact on the business decisions of some firms, even though the documents are not yet final.
But I must remind everyone concerned that the comment period is an important part of this process. I intend to read the comments closely in order to analyze whether my concerns about the proposals are well-founded, and to understand new issues the Commission did not consider. In my personal experience, important changes have been made to Commission proposals before being finalized, and I expect that will happen here if the comments justify it.
As a final note, I would like to recognize many of the people in this room for their efforts in calling for a cross-border proposal and for their role in furthering the dialogue on these important regulatory issues. Your comment letters and discussions with Commission staff contributed directly to the Commission’s decision to issue the cross-border releases. I believe that decision ultimately will lead to the best regulatory outcome for the public, the swap markets and the Commission.
The Importance of Standardization
I would like to close with a plea. Compliance with Commission rules will be much easier and more straightforward in the long run if the industry continues to standardize its processes and documentation where possible. Standardization is in many respects at the heart of Dodd-Frank. It facilitates clearing, promotes transparency, and improves the comparability of pricing information to the benefit of end-users and risk managers.
That is why I believe that ISDA’s Dodd-Frank Protocols are so important, and the ISDA membership’s commitment to them so vital. These Protocols aim to ease the burden on the end-user and dealer community alike by eliminating redundant processes for determining the obligations of swap counterparties, and streamlining the process to re-paper transactions. These initiatives, with appropriate oversight, should facilitate compliance and better ensure that liquidity providers have access to information that is necessary to compete on equal terms for end-user business. I stand ready to assist ISDA in making the Protocols a success in any way I can.
I would like to thank Steve, Bob and Mary again for inviting me to be with you this morning, and I appreciate your willingness to listen to some of my thoughts about the work of the Commission.
Last Updated: September 13, 2012