Keynote Remarks of Chairman Timothy Massad 4th Annual OTC Derivatives Summit North America
September 15, 2016
Thank you for that kind introduction. I’m delighted to once again kick off this conference.
I would like spend a few minutes reviewing what we have achieved since I spoke here last year. Then, I want to focus on two issues that I know are of interest to you. The first is the implementation of global rules setting margin for uncleared swaps. And the second is the de minimis threshold for swap dealers.
Progress on Swaps Reform
So let me begin with a quick recap. You may recall that in 2015, I discussed our progress implementing the four key components of over-the-counter derivatives reform. As you know, these are central clearing, oversight of major market participants, transparent trading on regulated platforms, and regular reporting.
I am pleased to report we have made substantial progress in all of these areas. On clearing, last year I spoke with you about the need to resolve our differences with European regulators regarding their recognition of clearinghouses in the U.S. Today, that is done. We agreed to an accord that resolved these issues and brought the U.S. and European regulatory regimes closer together. We also have made progress in our efforts to make sure clearinghouses are strong and resilient. We are reviewing recovery plans of our major clearinghouses, and we are working with the FDIC on resolution planning. Last month, we released some detailed guidance on the development of clearinghouse recovery plans. And we are working with regulators internationally on these issues as well, which last month led to the publication of three important documents on clearinghouse resilience, recovery and resolution. And the Commission has unanimously proposed new clearing mandates for interest rate swaps in several additional currencies, where local jurisdictions have mandated or are expected soon to mandate clearing.
With respect to oversight of major market participants, last year I said that we needed to finalize our rules setting margin requirements for uncleared swaps. We did so, and I will return to some of the issues around this rule in a moment. On trading, we have approved the registrations of 23 Swap Execution Facilities (SEFs). We have also improved SEF trading through a number of no-action letters. We are now working to codify these actions in a rulemaking, and harmonize our rules with those coming on-line globally. And we have taken several actions to improve swap data reporting.
Finally, we’re addressing the new challenges posed by technological innovations in our markets. Just last week, the Commission unanimously adopted enhanced cybersecurity testing requirements. And we will soon consider a supplemental proposal related to our proposed rule to address the risk of disruptions caused by automated trading. We are also making progress towards finalizing position limits.
This summer marked six years since the enactment of the Dodd-Frank Act. And today, the framework of regulation for swaps is largely in place. Our focus now is primarily on fine-tuning that framework, and making sure the rules are working—not creating unintended consequences. There continue to be debates, but the reality is today’s derivatives debate is about the details of regulation, not whether we should regulate.
This is as it should be. The derivatives market can generate significant benefits for our economy. But we also saw how an unregulated over-the-counter swap market intensified a financial crisis that was enormously costly for American families. Eight million people lost their jobs and 5 million lost their homes to foreclosure. We cannot let that happen again.
Implementation of Margin Rules
Indeed, one of the most important rules to help guard against another crisis are rules on margin for uncleared swaps.
These rules are critically important to minimizing risk that can come from over-the-counter derivatives. There will always be a large part of the swaps market that is not cleared, as many are not suitable for central clearing because of limited liquidity or other characteristics. Moreover, our clearinghouses will be stronger if we exercise care in what is required to be cleared. But we must take steps to protect against such activity posing excessive risk to the system, which is why these rules are so important.
Because the swaps market is global, it was important to harmonize the substance of the rules with other regulators. We worked very hard to do that, with both our domestic prudential regulators and international jurisdictions.
We also addressed the cross-border implications of transactions. Our rule recognizes that there can be risk to a U.S. entity from a subsidiary’s offshore transactions, even if those transactions are not guaranteed by the parent entity. At the same time, we provided a broad scope of substituted compliance with the rules of other jurisdictions. Recently, we issued a determination of comparability for Japan. And we stand ready to review requests for such a determination from other jurisdictions.
The importance of coordination and harmonization is also why in March of 2015, international regulators agreed on a timetable for implementation. As you know, the first compliance date was September 1, 2016, when initial margin requirements applied to transactions between the largest swap dealers. Initial margin requirements will not apply to transactions with smaller financial firms until one-to-three years from that date.
The European Commission’s announcement of a delay in the implementation of their rules was a disappointment. However I, alongside my fellow federal financial regulators, decided that it was appropriate to maintain the September 1, 2016 initial compliance date.
We made this decision for a few reasons.
First, we considered the scope of the initial compliance date. The September 1 date applies only to swaps between the largest swap dealers— those transactions between counterparties that each have $3 trillion in gross exposure. The estimates are that approximately 20 global firms are affected by this initial date. This includes essentially all of the largest swap dealers in Europe. Notwithstanding the delay, these European institutions are required, as of September 1, to post margin in their transactions with U.S., Canadian, and Japanese institutions. In fact, the only transactions that are not covered are transactions between two European institutions – in which neither is a European affiliate of a U.S., Canadian, or Japanese firm.
Even the European Commission, in one of its formal notifications about the delay, confirmed this. It highlighted that –and I’m quoting – “the small number of firms covered by the first wave of the requirements will in many cases also be covered by rules in other jurisdictions and therefore should continue to prepare for implementation.”
Second, I believe that this delay will be short. I believe that Europe is committed to minimizing it; and I know that we are committed to working with our European colleagues toward that end.
Following the European announcement, I met with Vice President Valdis Dombrovskis of the European Commission, who has assumed the portfolio for Financial Stability, Financial Services and Capital Markets Union following the resignation of Jonathan Hill. In fact, we met on his first day after assuming that portfolio.
He assured me that the European Commission is committed to minimizing the delay, and we discussed specific steps it would take to do so. I was pleased that a few days after our meeting, the European Commission released its proposed modifications to the margin standards, which were mostly technical, as they had told us. The Commission’s implementation schedule also confirmed the possibility that the standards could be in place by March 1. I also met with many members of the European Parliament, who must review the standards in order for them to become effective. They expressed their commitment to doing so as quickly as possible.
Finally, and perhaps most importantly, our primary responsibility as a United States regulator is to ensure the full implementation of our laws. While coordination with other regulators is an important and worthy goal, the purpose of our margin requirements is to preserve the stability of the United States financial system.
We will continue to work with our international counterparts as well as with market participants on implementation. We did announce a 30 day grace period with respect to getting custodial arrangements in place, recognizing there were some difficulties due in part to the limited number of providers of custody services. And I would note the comments last week of the head of the International Swaps and Derivatives Association, who said that the rollout “went relatively smoothly.”
Let me note one other issue we considered in thinking about the implementation schedule, following the European Commission announcement.
As I mentioned, that announcement noted that the small number of European firms covered by the first compliance date are subject to our rules. What are not covered, as I explained, are transactions between European firms. That’s because our rule provides an exclusion for such transactions, rather than a substituted compliance standard. Because those European firms are registered as swap dealers with us, those transactions could instead be made subject to a substituted compliance standard. We have, after all, a legitimate interest in the health of those swap dealers – they are registered due to the large volume of business they do with U.S. persons. If a substituted compliance standard – instead of an exclusion – applied to those transactions, then U.S. margin rules would apply today until European rules are in effect and deemed comparable.
So this is where we are today. We continue to be mindful of the fact that, on March 1 of next year, a much broader scope of firms will be subject to variation margin requirements. I am hopeful that the European rules will be in place by then. We will keep an eye on this date and we will explore alternative actions that we could take to address any further consequences in the event the delay is not minimized.
On this critically important issue, I also want to take this opportunity to thank our staff, as well as the staff of the National Futures Association, for their hard work. I know the review of margin models in particular was very intensive. I also want to recognize the hard work on the part of swap dealers to get ready for these new rules. These are significant changes. But I am committed to working with all market participants on them.
De Minimis Threshold
Now let me turn to another important topic on which we have been spending some time: the swap dealer de minimis threshold.
As many of you know, the de minimis threshold determines when an entity’s swap dealing activity requires registration as a swap dealer, which triggers oversight by the CFTC, as well as disclosure, recordkeeping, and documentation requirements.
Like our uncleared margin rules, the registration of swap dealers was a pillar of Dodd-Frank, and critically important to provide transparency and reduce risk within the financial system. There are now more than 100 swap dealers provisionally registered with the CFTC, which include most of the largest global banking entities.
The de miminis threshold was set in 2012 by the CFTC and the SEC jointly. At that time, the agencies had limited data on the market. They set the threshold at $3 billion in notional amount of swap dealing activity over the course of a year, but with a phase-in period, during which the threshold is $8 billion. Unless the Commission takes action, at the end of 2017 the threshold will automatically drop from $8 billion to $3 billion. This means that firms must start tracking their activity as of January 1, 2017 to determine whether they must register.
Today, I am announcing that I will recommend to my fellow commissioners a one-year extension of the date on which the swap dealer de minimis threshold is scheduled to drop. This will be proposed through a Commission order. Adopting this order will give us more time to consider this critical issue. Given its importance, a delay is the sensible and responsible thing to do – and doing it now will provide much-needed certainty to market participants.
Last month, CFTC staff issued a final report on the de minimis threshold as required by the rule. It supplements a preliminary staff report issued last November, and it assesses the threshold against the data we have today.
In terms of data, we are way ahead of where we were at the time the threshold was set. Today, swap data reporting is a regular part of market activity. In fact, the Commission received 67 million transaction records for the period reviewed in the preliminary report.
However, as the report notes, the data has limitations – limitations which we are working to improve. For example, we cannot always accurately identify market participants. There may be duplicative records. And a significant concern is the quality of the data with respect to non-financial commodity swaps. The threshold is based on a dollar notional amount, which works well for interest rate and credit default swaps. But we do not have reliable notional data for non-financial swaps, such as energy or agricultural commodity swaps. Units of the relevant commodity—whether it is a barrel of oil or a bushel of corn—are not always reported, and unit measurements are not consistently applied. Moreover, volatility in commodity prices can cause significant swings in the measurement of the threshold.
Notwithstanding these and other limitations, our staff estimated coverage of the market under the $8 billion dollar threshold as well as the effect of lowering – or raising – the threshold. I want to take a moment to acknowledge all of our staff who worked on this report for their excellent work, particularly given the challenges in using the data.
The report presents some interesting findings. For example, it estimates that based on current data, if the threshold were at $3 billion today instead of $8 billion, and levels of activity remained the same, then more companies would be required to register as swap dealers. However, our staff estimated that the outstanding notional amount of interest rate (IRS) and credit default swaps (CDS) that would be covered would increase only about 1 percent.
Some have suggested that, in light of these findings, we should decide today to keep the threshold at $8 billion permanently. I think instead the appropriate course is to pause.
I know that many smaller banks are concerned that they would be required to register if the threshold were to fall. They say their activity is tied to their lending business, where they are providing swaps to help their commercial borrowers hedge their exposures.
Helping commercial end-users to hedge is a core purpose of our derivatives markets. These smaller banks do not have significant market shares in the IRS or CDS market. Swap activity is not a large part of their overall banking activities. So we should look closely at who would be required to register if the threshold were lower, and the benefits of imposing registration versus the costs. Would financial stability be enhanced? Would customer protection be enhanced? What would be the effects on competition?
There are other reasons to take more time to look at the issue of the threshold.
One of the most important is that we should adopt a rule setting capital requirements for swap dealers. This is one of the most important rules in our regulation of swap dealers. It makes sense to finalize this before turning to the threshold. I have asked my fellow commissioners to consider a reproposal of this rule, and I hope we can act on that shortly.
The margin rules I discussed earlier are also a critical component of swap dealer regulation, and in this year, we can also more fully assess how these new rules are working.
Another important reason to take more time is that the threshold pertains not only to interest rate swaps and CDS. It also pertains to commodity swaps. These markets are somewhat different than the IRS and CDS markets. And as I noted, our data is not as good.
There are a wide range of concerns people have raised concerning these markets in relation to the threshold. These include whether letting the threshold fall will affect liquidity – as well as whether failing to do so will undermine our efforts to protect customers and prevent manipulation.
So in short, a year’s delay is the sensible thing to do. Let me underscore that the views I have expressed today are my own. I look forward to hearing the thoughts of my fellow commissioners.
Again, it is a great pleasure to be back before you today and talk about some aspects of our agenda. I look forward to your input as we address these and many other critically important issues.
I thank you for your attention, and I would be pleased to answer any questions you may have.
Last Updated: September 15, 2016