Tuesday, October 18, 2011
Good morning. Thank you Mr. Chairman and thank you to the teams that have worked so hard on the final rules before us today and on the amendments to the Commission’s July 14, 2011 Order relating to the Effective Date for Swap Regulation. The current Order expires on December 31, 2011, and I am glad we are addressing the necessary amendments to that Order now instead of waiting until the last minute to provide certainty to market participants.
Today we will first be voting on final rules for DCO’s. In my opinion, these rules are needlessly prescriptive and go beyond what is required by the statute. Our registered DCOs have a fantastic track record of protecting their own financial safety and soundness and have proven themselves, even during the financial crisis, to be excellent at managing margin and risk. We should allow them to continue to do so without imposing unnecessary and inflexible rules, regulations, and restrictions upon them.
It appears that these rules, and many others we have proposed and finalized, are largely colored by the perception that swaps are inherently riskier than futures and options and as a result require a more prescriptive regulatory oversight regime.
To that I say, futures and options are, and always have, been risky. Swaps that are exchange traded and cleared will likely have a similar risk profile as exchange traded futures and options. We should not be creating a separate regulatory regime for economically equivalent products. I believe this approach will not stand the test of time and will have to be re-thought as the market evolves.
The fact that we are allowing letters of credit to be used as initial margin for futures and not for swaps is an example of this thinking – and is a distinction that is not legally or factually justifiable. We should treat them the same way unless there is a compelling reason not to. This is especially the case given the fact that today, there are end-users that voluntarily clear swaps using letters of credit as initial margin. Once we ban that practice, voluntary clearing will become more expensive for these end-users, and therefore less attractive to them. If we want to encourage clearing, which I think was one of our goals, we should not be taking steps to make clearing less attractive to those that are not required to do it.
It has been nearly two years since the Commission issued its January 2010 proposal to impose position limits on a small group of energy contracts. Since then, Commission staff and the Commission have spent an enormous amount of time on the issue of imposing speculative limits.
For me, this vote today on position limits today is no doubt the single most significant vote I have taken since becoming a Commissioner. It is not because imposing position limits will fundamentally change the way the U.S. markets operate, but because I believe this agency is setting itself up for an enormous failure.
As I have said in the past, position limits can be an important tool for regulators. I have been clear that I am not philosophically opposed to limits. After all, this agency has set limits in certain markets for many years. However, I have had concerns all along about the particular application of the limits in this rule, compounded by the unnecessary narrowing of the bona-fide hedging exemptions, beyond what was required by the Dodd-Frank Act.
Over the last four years, many have argued for position limits with such fervor and zeal, believing them to be a panacea for everything. Just this past week, the Commission has been bombarded by a letter-writing campaign suggesting that the five of us have the power to end world hunger by imposing position limits on agricultural commodities.
This latest campaign exemplifies my ongoing concern and may result in damaging the credibility of this agency. I do not believe position limits will control prices or market volatility, and I fear that this Commission will be blamed when this final rule does not lower food and energy costs. I am disappointed at this unfortunate circumstance because, while the Commission’s mission is to protect market users and the public from fraud, manipulation, abusive practices and systemic risk related to derivatives that are subject to the Commodity Exchange Act, and to foster open, competitive, and financially sound markets, nowhere in our mission is the responsibility or mandate to control prices.
When analyzing the potential impact this final rule will have on market participants, I am most concerned about the effect on bona fide hedgers – that is, the producers, processers, manufacturers, handlers and users of physical commodities. This rule will make hedging more difficult, more costly, and less efficient, all of which, ironically, can result in increased costs for consumers.
Currently, the Commission sets and administers position limits and exemptions for nine agricultural commodities. Pursuant to this final rule, the Commission will set and administer position limits and exemptions for 28 reference contracts. Along with the 19 new reference contracts comes the new responsibility to administer bona-fide hedging exemptions for the transactions of massive, global corporate conglomerates that on a daily basis produce, process, handle, store, transport, and use physical commodities in their extremely complex logistical operations. Their hedging strategies are no doubt equally complex.
At the very time the Commission is taking on this new responsibility, the Commission is eliminating a valuable source of flexibility that has been a part of regulation 1.3(z) for decades – that is, the ability to recognize non-enumerated hedge transactions and positions. This final rule abandons important and long-standing Commission precedent without justification or reasoned explanation, by merely stating “the Commission has . . . expanded the list of enumerated hedges.” The Commission also seems to be saying that we no longer need the flexibility to allow for non-enumerated hedge transactions and positions because one can seek interpretative guidance pursuant to Commission Regulation 140.99 on whether a transaction or class of transactions qualifies as a bona-fide hedge, or can petition the Commission to amend the list of enumerated transactions.
These processes are cold comfort. There is no way to tell how long interpretative guidance will take. Moreover, if a market participant petitions the Commission to amend the list of enumerated transactions, if the Commission chooses to do so, it must formally propose the amendment pursuant to APA notice and comment. As we know all too well, that is a time consuming process fraught with delay and uncertainty. In the end, neither of these processes is flexible or useful to the needs of hedgers in a complex global marketplace.
When the Commission first recognized the need to allow for non-enumerated hedges in 1977, the Commission stated “The purpose of the proposed provision was to provide flexibility in application of the general definition and to avoid an extensive specialized listing of enumerated bona fide hedging transactions and positions. . . .” Today the global marketplace is much more complex than it was in 1977, as are complex hedging strategies. I am not comfortable with notion that a list of eight bona-fide hedging transactions in this rule is sufficiently extensive and specialized to cover the complex needs of today’s bona-fide hedgers. Repealing the ability to recognize non-enumerated hedge transactions and positions is a mistake and the statute does not require it.
For decades, the Act has allowed the Commission to define bona-fide hedging transactions and positions “to permit producers, purchasers, sellers, middlemen, and users of a commodity or a product derived therefrom to hedge their legitimate anticipated business needs….” This provision is Section 4a(c)(1). In addition, Section 4a(c)(2) clearly recognizes the need for anticipatory hedging by using the word “anticipates” in three places. Nonetheless, without defining what constitutes “merchandising” the Commission has limited “Anticipated Merchandising Hedging” to transactions not larger than “current or anticipated unfilled storage capacity.” It appears then that merchandising does not include the varying activities of “producers, purchasers, sellers, middlemen, and users of a commodity” as contemplated by Section 4a(c)(1), but merely consists of storing a commodity. This limited approach is needlessly at odds with the statute and with the legitimate needs of hedgers.
I have always believed that there was a right way and a wrong way for us to move forward on position limits. Unfortunately I believe we have chosen to go way beyond what is in the statute and have created a very complicated regulation that has the potential to irreparably harm these markets.
Thank you again to both of the teams who are presenting today and have worked tirelessly…for many, many months on these very important rules.
Last Updated: October 18, 2011