Statement of Commissioner J. Christopher Giancarlo before the Market Risk Advisory Committee Meeting

    April 26, 2016

Thank you Commissioner Bowen for convening today’s meeting and for your sponsorship of the Market Risk Advisory Committee (MRAC). Today’s MRAC meeting will discuss two important topics: market health and portfolio compression.

    I. Market Health and Trading Liquidity

Market participants know that trading liquidity is the lifeblood of healthy financial markets. Today, there are ever increasing concerns that trading liquidity has been fundamentally changed in many asset classes and markets and not just those markets overseen by the CFTC. Accounts of liquidity distortion extend from U.S. Treasury securities1 to German Bonds,2 corporate bonds,3 equities,4 U.S.5 and euro6 interest rate swaps, single-name credit default swaps,7 cross-currency swaps,8 repos9 and energy swaps and futures.10

I have been speaking about diminished trading liquidity for well over a year now. Similar concerns have been voiced by the International Monetary Fund,11 the Bank for International Settlements,12 the Bank of England,13 Federal Reserve Chair Janet Yellen,14 financier Stephen Schwarzman of Blackstone,15 and noted economists Nouriel Roubini16 and Mohamed El-Erian.17 While some central bankers voice skepticism over a lack of quantitative evidence of illiquidity,18 there is real concern among those with financial market responsibility and knowledge, including financial market regulators.19

Quantifying liquidity is certainly challenging, though not impossible. It is more easily qualified through a range of characteristics such as market depth, width, volume, resiliency, immediacy, participation and turnover. As we discuss the present situation, I take small comfort in accounts of narrow bid offer spreads while much evidence exists of deterioration in the quality of many of these other, fundamental liquidity characteristics.

The fact of diminished trading liquidity and the resulting sharp volatility spikes will have enormous implications for 21st century markets. My informed and considered view of current financial markets is that a significant cause of reduced trading liquidity is the aggregate impact of uncoordinated regulatory policies of U.S. and overseas bank prudential regulators imposed in the wake of the financial crisis. Most of these disparate regulations have the effect of reducing the ability of many small, medium and large financial institutions to deploy capital in trading markets.

The question that must be asked is whether the amount of capital constraint prudential regulators are placing on financial institutions is properly calibrated to the amount of capital that those institutions need to deploy to support market health and vibrancy. Those of us with direct responsibility for overseeing financial markets need to ask that question. We need to understand the full implications of constrained capital on market health and resiliency and the ability of financial markets to underpin sorely needed global economic growth.

Vibrant capital and financial markets are essential to American free enterprise; free enterprise is essential to American freedom.

I look forward to today’s discussion on liquidity and other topics related to market health.

    II. Portfolio Compression

Today’s second panel will explore portfolio compression.

I believe that portfolio compression is of great benefit to the safety and soundness of the market. I believe it should be incentivized, not penalized.

In my January statement on the final rule for margin requirements for uncleared swaps, I expressed my disappointment that the Commission decided to treat the results of portfolio compression of legacy swaps as new swaps subject to the margin rule.20 I warned that this may well discourage portfolio compression.

Treating swaps created by compressing legacy swaps as new swaps is inconsistent with no-action relief of the Division of Clearing and Risk (DCR). That no-action relief applies to clearing for amended or replacement swaps that are generated as part of a multilateral portfolio compression exercise and are subject to required clearing, provided that certain conditions are met.21 In issuing the no-action relief, DCR staff recognized that “multilateral portfolio compression allows swap market participants to net down the size and/or number of outstanding swaps, and decrease the number of outstanding swaps or the aggregate notional value of such swaps, thereby reducing operational risk and, in some instances, reducing counterparty credit risk.”22

I urged the Commission to revisit this issue prior to implementation of the margin requirements. In the preamble to the final margin rule, the Commission expressed an openness to further discussing this issue.23 I would be grateful to hear from today’s participants on any progress in this regard.

Thank you and I look forward to today’s discussion.

1 Joe Rennison, U.S. Treasuries Market Faces Liquidity Concerns, Fin. Times, July 29, 2015; see also Xiao Wang, Market Liquidity Has Been Drained by Regulations, Says DBS Chief, Asia Risk, Sept. 17, 2015 (quoting Piyush Gupta, Chief Executive Officer, DBS Group).

2 Marius Zaharia, Investment Focus: As Liquidity Shrinks, Bond Trading Becomes a Grind, Reuters, June 12, 2015.

3 See Int’l Monetary Fund, Global Financial Stability Report 49-53 (2015); Joe Rennison, Market Liquidity Warning from IMF, Fin. Times, Sept. 30, 2015; see also Bd. of Governors of the Fed. Reserve Sys., Senior Credit Officer Opinion Survey on Dealer Financing Terms 2 (Sept. 2015); BlackRock, Viewpoint: Addressing Market Liquidity 1–2, 4–7, 9–10 (2015); Tracy Alloway, Why Would Anyone Want to Restart the Credit Default Swaps Market?, Bloomberg, May 11, 2015; Huw Jones, BoE Delves Deeper into Asset Managers, Uncertain Market Liquidity, Reuters, Sept. 25, 2015.

4 See Justin Baer, James Sterngold & Gregory Zuckerman, Large Banks Retreat from Trading Frenzy, Wall St. J., Sept. 3, 2015, at C1–C2.

5 See Peter Madigan, U.S. End-Users are Losers in Swaps Liquidity Split, Risk.Net, Apr. 28, 2014.

6 Lukas Becker & Catherine Contiguglia, Hidden Price Pressures Grow in Euro Swap Market, Risk Magazine, Sept. 8, 2015.

7 See Alloway, supra note 3; Michelle Davis & Hugh Son, Deutsche Bank Said in Talks to Sell $250 Billion Swaps Portfolio, Bloomberg, Oct. 8, 2015.

8 Callum Tanner, Illiquidity Worries U.K. Insurers in Forex Hedging Switch, Insurance Risk, Aug. 24, 2015.

9 See Bank for Int’l Settlements, 85th Annual Report 106 (2015); Ryan Tracy, Banks Retreat From Market That Keeps Cash Flowing, Wall St. J., Aug. 13, 2014; see also Lawrence Goodman & Stephen Dizard, Fixing the Fed’s Liquidity Mess, Wall St. J., July 21, 2015 (citing data indicating that the availability of repurchase agreements, commercial paper and money-market funds is nearly 30% below the level reasonably needed to support liquid markets and economic growth).

10 See CFTC, Transcript: Energy and Environmental Markets Advisory Committee Meeting 108 (July 29, 2015).

11 Int’l Monetary Fund, supra note 3, at 49–53; Rennison, supra note 3.

12 Bank for Int’l Settlements, supra note 9, at 36–40 (citing the increasing “liquidity illusion” in which credit markets appear liquid and well-functioning in normal times, only to become highly illiquid upon market shock).

13 Jones, supra note 3.

14 Ian Katz, Yellen Says Regulators Ready to Act as Panel Cites Risks, Bloomberg, May 19, 2015.

15 Stephen A. Schwarzman, How the Next Financial Crisis Will Happen, Wall St. J., June 9, 2015.

16 Nouriel Roubini, The Liquidity Time Bomb, Project Syndicate, May 31, 2015.

17 Mohamed A. El-Erian, The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse 114-119 (Random House 2016).

18 See Lael Brainard, Governor, Bd. of Governors of the Fed. Reserve Sys., Address at the Policy Makers’ Panel on Financial Intermediation of the Salzburg Global Forum on Finance in a Changing World: Recent Changes in the Resilience of Market Liquidity (July 1, 2015).

19 Michael S. Piwowar & J. Christopher Giancarlo, Banking Regulators Heighten Financial Market Risk, Reuters, July 12, 2015; see CFTC, Transcript: Market Risk Advisory Committee Meeting 7–8, 90–101 (June 2, 2015); Bank of England, Financial Stability Report 16–17 (2015); see also Martin Wheatley, Chief Executive, Financial Conduct Authority, Keynote Speech at the Association for Financial Markets in Europe Annual European Market Liquidity Conference: From Intellectual Certainty to Debate (Feb. 25, 2015).

20 Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 81 Fed. Reg. 636, 708 (Jan. 6, 2016).

21 CFTC Letter No. 13-01.

22 Id. at 2.

23 81 Fed. Reg. at 675.

Last Updated: April 26, 2016