This week, the Commodity Futures Trading Commission (CFTC) issued three orders imposing civil monetary penalties of over $50 million combined in actions involving several of the largest financial institutions in our nation and several of the most significant institutions in global swaps markets—JP Morgan Chase Bank, N.A. and affiliated entities (JP Morgan); Bank of America, N.A. and Merrill Lynch International (BAML); and Goldman Sachs & Co. LLC (Goldman) (collectively, Respondents).  JP Morgan, BAML, and Goldman will pay civil monetary penalties of $15 million, $8 million, and $30 million[1] respectively.  Collectively, the banks’ swap data compliance failures (the failure to report swaps to swap data repositories entirely or incorrectly reporting swap data) impacted nearly 65 million transactions.

The orders entered into by the Commission and Respondents reveal two critical issues: the necessity of remaining vigilant regarding the CFTC’s mission to mitigate systemic risk in derivatives markets, and the importance of utilizing (novel) tools in enforcement actions to ensure market participants’ compliance with regulations adopted to mitigate systemic risk.

1. Enforcement of Swaps Regulations Aims to Mitigate Systemic Risk

In enforcement actions involving compliance with swap data regulations it is imperative to recall and remain focused on the systemic risks engendered by activity in global swaps markets.

1. Regulatory Oversight, Real-Time Reporting, Transparency, and Data Integrity in Swaps Markets

It has been more than a decade since the Commission adopted Parts 43 and 45. Four guiding principles have motivated the adoption, implementation, and enforcement of these regulations:  regulatory oversight, real-time reporting, transparency, and data integrity.

In 2008, the near collapse of the bespoke over-the-counter swaps market, most notably the credit default swap market, was a precipitating cause of the global financial crisis (GFC).[2]  In the aftermath of the 2008 GFC, the G20 leaders met in Pittsburgh and the leaders of the G20 agreed to introduce order, transparency, and supervision in the bespoke, bilateral swaps market.[3]

In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) amended the Commodity Exchange Act (CEA) and introduced a framework for the regulation of swaps that imposed central clearing and trade execution requirements, registration and comprehensive regulation of swap dealers, swap data reporting, and recordkeeping and real-time reporting requirements.[4]  The regulations imposed clearing requirements on standardized swap transactions designated as made-available-to-trade and mandated clearing swaps on registered or exempt designated contract markets (DCM) or swap execution facilities (SEF).

The Dodd-Frank Act was intended to increase transparency in an otherwise opaque bilateral swaps market by creating robust regulatory and real-time reporting regimes.  Part 43 ensures real-time public dissemination of swap transaction and pricing data.  Price transparency improves price discovery, decreases risk (such as liquidity risk), and enhances the efficiency of swaps markets.  The Commission’s notice of final rulemaking for Part 43 two years after the passage of the Dodd-Frank Act explained:

At the foundation of these [real-time swap data reporting] regulations [is] the Commission’s belief that that real-time public dissemination of swap transaction and pricing data supports the fairness and efficiency of markets and increases transparency, which in turn improves price discovery and decreases risk (e.g., liquidity risk).”[5]

In other words, the CFTC takes the approach to transparency embraced by former U.S. Supreme Court Justice Louis Brandeis:  “Publicity is justly commended as a remedy for social and industrial diseases. Sunlight is said to be the best of disinfectants; electric light the most efficient policeman.”[6]

Part 45 enhances transparency, promotes standardization, and reduces systemic risk, by requiring the reporting of all swaps, whether cleared or uncleared, to SDRs, who then share the same data with regulators.  The CFTC Swaps Report

is designed to be a valuable public service due to its unique combination of data aggregation, free availability, and weekly publication frequency.  The CFTC Swaps Report aggregates a comprehensive body of swap market data that was not previously reported to regulators or regulated entities, and makes that information freely available in a form that is readily usable by both market participants and the general public.[7]

Failing to report data or reporting incomplete or inaccurate data impacts pricing and may lead to significant risk management implications or have downstream, knock-on effects for diverse market participants.  These compliance failures may also may hinder the CFTC’s ability to effectively surveil markets.

2. Systemic Risk Implications Across Financial Products and Markets

An unfamiliar observer might question the importance of reporting swap data given that the orders make no findings that, for example, the reporting failures were intended to hide deeper misconduct.  But this position exactly misunderstands the role of swap data reporting in market integrity and the significance of disclosure as a fundamental guardrail for our markets.

Nearly twelve years after the CFTC adopted its swap data reporting rules, the Commission’s motivation for creating and implementing data reporting requirements remains the same: we seek to preserve the integrity of our markets; identify and mitigate against systemic risks that threaten to introduce crises in our markets; and eliminate concerns regarding the need for government intervention to address systemic risks or even liquidity crises.

While the events of the financial crisis are a decade behind us, notable disruption in financial markets persists. Our markets have shown tremendous resilience in recent years, weathering the COVID-19 pandemic, significant and persistent inflation in recent quarters, and geopolitical conflict in Europe, specifically Russia’s invasion of Ukraine.  This resilience is arguably a direct result of, among other things, the increased oversight of and visibility into our derivatives markets introduced by the Dodd-Frank Act in 2010.

Yet these market shocks are just today’s known risks.  We must recognize the persistent challenge of the known unknowns as well as risks we cannot yet perceive or quantify.  The next financial crisis, whenever it comes, likely will not take the same shape as the last one, and thus we must do our best to buttress the market against unknown risks as well.

Earlier this year, regulators were presented with an unprecedented set of issues—consecutive bank runs (the collapse of Silicon Valley Bank and Signature Bank) and unanticipated disruption in markets fueled, at least in part, by the dissemination of information on social media.  While certain predictions regarding the threat of ripple effects causing market instability or contagion did not materialize, banking regulators recognized the potential for social media to create a catalyst for accelerated or light speed deposit withdrawals, prompting the coining of the phrase “social media bank run” risk.

As a direct result of the potential systemic risk implications of market activities, supervision of the swaps market remains one of the Commission’s highest priorities.

3. Diversity of Sources of Systemic Risk: Smaller, Regional Banks and Non-bank Financial Institutions

While we learned many lessons from the recent GFC, there is at least one lesson that we must not cease to reinforce.  In our evolving world of complex, innovative financial products, we must appreciate the expanding and diverse universe of issues that may trigger systemic risk concerns.  We must acknowledge correlations among distinct markets and guard against viewing systemic risk implications myopically or seeing risks as “siloed.”  Relevant risks might not emerge from a single asset class or only within a specific class of financial institutions.

Rather, we must view systemic risk implications as potentially emerging across markets. We must also consider the risk implications that may emerge beyond the activities of regulated financial institutions, including risks that may emerge in connection with non-bank financial intermediation, also described as the “shadow banking industry.”

In a recent speech, Martin Gruenberg, Chairman of the Federal Deposit Insurance Corporation explained:

[O]n March 10, 2023, Silicon Valley Bank (SVB), with $209 billion in assets at year-end 2022, was closed by the state banking authority, which appointed the FDIC as receiver.  The events that led to its failure began on March 8, when SVB announced a $1.8 billion loss on sale of securities, and a concurrent plan to raise $2 billion in capital to shore up its balance sheet.  Then on Thursday March 9, shares of SVB fell 60 percent and it experienced a run by depositors.  By that evening, $42 billion in deposits had left the bank with an additional $100 billion staged to be withdrawn the next day.  To put this in perspective, nearly 30 percent of deposits left the bank in a matter of hours, with another 50 percent set to leave.  Of great relevance, over 90 percent of SVB's deposits were uninsured.

. . .

The prospect that uninsured depositors at SVB would experience losses alarmed uninsured depositors at several other regional banks, and depositors began to withdraw funds.  Signature Bank of New York in particular experienced heavy withdrawals.  A contagion effect became apparent and there was clear evidence that the failure of a regional bank in which uninsured depositors faced losses could cause systemic disruption.

On Sunday March 12, just two days after the failure of SVB, the New York State bank regulator closed Signature Bank and appointed the FDIC as receiver.  Like SVB, Signature had experienced a run on deposits and was ultimately unable to meet its obligations, and also like SVB, over 90 percent of its deposits were uninsured.[8]

In testimony before the Senate Banking Committee, Federal Reserve Bank Vice Chair for Supervision Michael Barr noted that the bank failures earlier this year were, at least in part, attributable to risk management failures.  According to Vice Chairman Barr,

SVB's board of directors and management failed to manage the bank's risks.  The bank tripled in size between 2019 and 2021—expanding from $71 billion to $211 billion—as the rise in tech and venture capital activity led to growth in uninsured deposits, which the bank then invested largely in held-to-maturity securities.  As the bank grew, its board and management failed to effectively oversee the risks inherent in the bank's concentrated business model and high level of reliance on uninsured deposits.  The bank repeatedly failed its own liquidity tests, and SVB responded, in part, by changing the assumptions that determined its liquidity needs.  The bank also mismanaged its interest-rate risk. Its senior leadership focused on short-term profits, removed interest-rate hedges that would have helped to protect the bank in a rising rate environment, and ignored multiple breaches of long-term interest-rate-risk limits.

The second key takeaway is that Federal Reserve supervisors did not fully appreciate the extent of the vulnerabilities as SVB grew in size and complexity.  This meant that SVB remained well-rated through the summer of 2022, even as significant risk to the bank's safety and soundness were growing.[9]

Finally, Vice Chairman Barr noted that supervisors failed to identify vulnerabilities and take sufficient steps to ensure that the bank fixed those problems quickly enough.  Banking regulators in the United States and global financial market regulators are increasingly focusing on the impact of liquidity concerns that may arise due to activities or decisions of smaller, regional banks, and non-bank financial institutions.

4. Enforcing SDR Requirements to Ensure Compliance and Protect Market Integrity

The relevant orders involve three of the most significant financial institutions in our country and a financial product that was at the center of the recent GFC.  The Respondents in these matters are systemically important banks. Few would dispute that a significant disruption in the global swaps market may have ripple effects (and, depending on the level of severity, potentially catastrophic implications) for broader financial markets.  The swap data reporting failures in the three cases put global efforts to protect our markets in jeopardy.

2. Swap Data Reporting Compliance Monitors

As noted above, the resolutions entered into today cast a spotlight on the importance of using all of the tools in the CFTC’s enforcement toolkit.[10]  Among the orders, one settlement seeks to appoint a three-year enforcement monitor to improve supervision of swap data reporting.

Appointing a monitor introduces an important pathway for enhancing compliance and heightening supervision across swaps markets.  As Department of Justice Deputy Attorney General Lisa Monaco recently noted, there are significant benefits to introducing independent, transparent monitoring arrangements that are tailored to address misconduct and related compliance deficiencies.[11]

Reviews of enforcement monitors also rightly point out that imposing an independent monitor "shift[s] the costs of enforcement from the government and the public to" the organization that engaged in wrongdoing.[12]

Consider the following laundry-list of concerns underlying the enforcement orders entered into today.

For a period ranging nearly a half-decade, one Respondent:

1. classified derivative transactions incorrectly;
2. programmed errors into and experienced notable technical failures of their computer systems;
3. relied on an insufficient manual instead of automated system;
4. reported prices and notional sizes of trades incorrectly; and
5. failed to correctly report spot transactions that were constituent components of swaps.

Another Respondent discovered that it was failing to report certain components of swap transactions in October 2016., yet the Respondent made little to no progress resolving the concerns.  Three years later, upon the Division of Enforcement initiating an inquiry, the Respondent reported the compliance issues had not been fully addressed.

One respondent has routinely reported to the Commission in its annual chief compliance officer reports that it had material issues of non-compliance relating to its swap data reporting.  Yet, for roughly six years, the Respondent allowed the reporting issues to persist without remediation.

This Respondent has agreed that within 60 days of the order, an independent consultant will be appointed for a three-year term.  The consultant will assist in the implementation of a remediation plan.  Among other concerns the monitor will assist with ensuring diligent supervision of a wide range of its swap dealer activities including swap data reporting, pre-trade mid-market mark disclosures, clearing member risk management policies, notices regarding an initial margin model and segregation, and disclosure of static material economic terms.

With respect to the use of monitors, this is not the Commission’s first rodeo.[13]  And, unfortunately, evidence regarding the effectiveness of monitors suggests that this approach may yield inconsistent results.  It is imperative, however, that the Commission continue to expand, refine, and adapt mechanisms that facilitate well-tailored to resolutions that address escalating compliance failures or misconduct.

The three orders this week are just the latest in the significant efforts taken by the CFTC’s Division of Enforcement to ensure swap dealers’ compliance with swap data reporting requirements.  In the last year, the CFTC has brought cases against numerous other banks for similar conduct.[14]  Although the facts of these cases often rest upon swap dealers’ past failures to report swap data in a timely, accurate, and complete manner—often resulting in striking quantities of unreported or erroneously reported swaps—our enforcement actions must be forward-looking.

To ensure that our markets remain the deepest and most liquid in the world, the Commission must remain focused on rooting out violations of our regulations arising from mismanagement, unsavory compliance practices, and insufficient supervision among our registrants. We do ourselves a tremendous service when we continue to reinforce each brick in the wall of compliance best practices, enabling market participants and markets to effectively guard against risks.

I want to commend the Division of Enforcement staff responsible for bringing these very important cases, including Lauren Bennett, Michael R. Berlowitz, Brian Hunt, Jason Wright, Trevor Kokal, Amanda Burks, David Acevedo, Dan Ullman, Rick Glaser, Paul Hayeck, Lenel Hickson, and Manal M. Sultan.

[1] The Goldman order also encompasses the bank’s other compliance failures, including supervision failures and deficiencies in its pre-trade mid-market mark disclosures.  The resolution with Goldman also imposes a three-year compliance consultant to assist the bank in developing a remediation plan and to review and report on the bank’s progress in implementing it.

[2] See Financial Crisis Inquiry Commission, Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States, at xxiv–xxv, Feb. 25, 2011, https://www.govinfo.gov/content/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf (concluding that OTC derivatives contributed “significantly” to the crisis by fueling mortgage securitization that provided protection against default, allowing the creation of synthetic collateralized debt obligations, and adding uncertainty when the housing bubble popped due to the derivatives comprising an unseen and unregulated market).

[3]< European Central Bank, Looking back at OTC derivative reforms – objectives, progress and gaps, Dec. 21, 2016, https://www.ecb.europa.eu/pub/pdf/other/eb201608_article02.en.pdf.

[4]Dodd-Frank Wall Street Reform and Consumer Protection Act, No. 111-203, 124 Stat. 1376 (2010).

[5] Final Rulemaking, Commodity Futures Trading Commission, Real-Time Public Reporting of Swap Transaction Data, 77 Fed. Reg. 1182, 1183 (Jan. 9, 2012). 

[6] Louis Brandeis, Other People's Money and How the Bankers Use It, at 62 (National Home Library Foundation ed. 1933) (1914).

[7] Commodity Futures Trading Commission, Weekly Swaps Report: What is the CFTC Swaps Report?, https://www.cftc.gov/MarketReports/SwapsReports/index.htm.

[8] Martin J. Gruenberg, Remarks by Chairman Martin J. Gruenberg on Recent Bank Failures and the Federal Regulatory Response before the Committee on Banking, Housing, and Urban Affairs, United States Senate, Mar. 27, 2023, https://www.fdic.gov/news/speeches/2023/spmar2723.html.

[9] Michael S. Barr, Supervision and Regulation; Vice Chair for Supervision Michael S. Barr Before the Financial Services Committee, U.S. House of Representatives, Washington, D.C., May 16, 2023, https://www.federalreserve.gov/newsevents/testimony/barr20230516a.htm.

[10] See, e.g., Statement of Commissioner Kristin N. Johnson Regarding Effectively Calibrating CFTC Civil Money Penalties to Deter Repeated Compliance Failures (Aug. 29, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement082923 (emphasizing the role that civil monetary penalties play in achieving the twin goals of general and specific deterrence).

[11] Deputy Attorney General Lisa O. Monaco Delivers Remarks on Corporate Criminal Enforcement, New York University Law School Program on Corporate Compliance and Enforcement (Sept. 15, 2022) https://www.justice.gov/opa/speech/deputy-attorney-general-lisa-o-monaco-delivers-remarks-corporate-criminal-enforcement.

[12] Veronica Root Martinez, Public Reporting of Monitorship Outcomes, 136 Harvard L. Rev. 757, 823 (2023).

[13] See, e.g., In re Bank of Nova Scotia, CFTC No. 20-26, 2020 WL 4926053, at *17 (Aug. 19, 2020) (monitor imposed to address extensive compliance failures); In re Morgan Stanley Capital Services LLC, CFTC No 20-78, 2020 WL 5876732, at *7 (Sept. 30, 2020) (consultant imposed to verify that swap dealer remediated the root causes of the issues identified in the order); In re BGC Financial LP, CFTC No. 19-48, 2019 WL 4915921, at *9–11 (Sept. 30, 2019) (consent order) (monitor imposed assess policies, procedures, and practices of the respondent and provide the Division with periodic reports); In re Deutsche Bank, No. 16 Civ. 6544, 2016 WL 6135664, *2–3 (Oct. 20, 2016) (monitor imposed when firm experience a system wide outage of its swap data reporting system for five days, exposing additional supervision and internal controls failures).

[14] See, e.g., CFTC Orders Swap Execution Facility to Pay $1.9 Million for Swap Reporting and Core Principle Violations (Sept. 30, 2022), https://www.cftc.gov/PressRoom/PressReleases/8604-22; CFTC Orders Designated Contract Market to Pay $6.5 Million for System Safeguard, Reporting, and False Statement Violations (Sept. 29, 2022), https://www.cftc.gov/PressRoom/PressReleases/8603-22; CFTC Orders Swap Dealer to Pay $6 Million for Swap Reporting and Daily Mark Disclosure Violations (July 5, 2022), https://www.cftc.gov/PressRoom/PressReleases/8552-22.