Opening Statement, Open Meeting on One Final Rule

Commissioner Scott D. O’Malia

March 20, 2012

Today, the Commission will consider one final rulemaking, combining four groups of rules that the Commission proposed in separate rulemakings relating to customer clearing documentation, the timing of acceptance for clearing, the allocation of bunched orders after clearing, and clearing member risk management.1

I thank John Lawton and his team for their hard work and tenacity in reviewing dozens of comment letters and in addressing some of my concerns with this final rulemaking. Unlike certain of our other rulemakings, each group of rules attempts to be non-prescriptive and aims to establish an efficient yet flexible framework.

In general, I support the principles underlying the prohibition against certain provisions in customer clearing documentation, the establishment of rules for the post-allocation of bunched orders, and the development of straight-through processing to reduce the latency period between swap execution and clearing. As I have said before, clearing is a complicated process, but I believe market-driven, technology solutions can and will ensure that swaps market execution operates as smoothly as it does in the futures markets.

Customer Clearing Documentation and Straight-Through Processing

Today’s final rulemaking appropriately combines the customer clearing documentation rules with a group of rules regarding the timing of acceptance for clearing, also known as straight-through processing. I have always been in favor of facilitating prompt execution and clearing of swaps as quickly as current technology will provide.

One thing that is apparent from this rulemaking is that technology is essential in ensuring the success of clearing and the reduction of counterparty risks in the swaps market. For example, it is my understanding that the industry has decided not to embrace the negotiation of trilateral agreements,2 and instead has been focusing on developing technology for pre-trade credit screening. To implement such technology, the industry must undertake a significant build-out and onboarding. These technology solutions are rapidly developing,3 but are many months away from full industry adoption. I am encouraged that the industry (buy- and sell-sides) is working on principles for a technology solution. During our next Technology Advisory Committee meeting on March 29, we will discuss these issues in greater detail and will identify potential impediments and market-based solutions.

The Commission has heard from a myriad of market participants, all of whom have expressed concerns regarding the use of trilateral agreements. They have alleged that through these agreements clearing members could exert influence or restrict a customer’s choice of executing counterparties. While, I concur that trilateral agreements could result in some anti-competitive behavior, I am convinced that technology, not elaborate documentation will improve access to on-exchange trading and clearing.

Clearing Member Risk Management

Additionally, this final rulemaking includes rules that require clearing members to maintain adequate standards of risk management. Essentially, these rules provide the Commission with the ability to go after clearing members who fail to maintain these standards.

These rules call into question whether the Commission continues to view the designated self-regulatory organization (“DSRO”) model as a viable one going forward. I have said in the past that the DSROs are the front-line supervisors of all intermediaries such as clearing members.4 In light of the MF Global collapse, however, several questions arise regarding whether the Commission should do more than review DSROs’ supervision practices.

Under the Commission’s final core principles rulemaking, derivatives clearing organizations (“DCOs”) are required to self-certify their rules with the Commission.5 Under Core Principle D, a DCO must ensure that it possesses the ability to manage the risks associated with discharging its responsibilities, including the establishment of credit risk limits on clearing members.6 With today’s clearing member risk management rules, the Commission is taking the position that the DSRO model is not enough and that to some extent “direct” regulation is necessary. I disagree with this approach. Further, since the Commission is committed to developing MF Global related reforms for both the DSROs and futures commission merchants (“FCMs”), the Commission should have waited to finalize this group of rules to avoid regulating in an ad hoc manner.

Concerns Regarding Implementation

As I stated previously, the Commission continues to play hide the ball by not providing sufficient detail regarding the implementation timeline market participants and registered entities must follow in complying with our rules. This rule is no different. Today’s rulemaking highlights the fact that the sequencing of our rules is haphazard and we seem to go out of our way to make the schedule as complicated as possible.

Notwithstanding the Commission’s acknowledgement that some firms are not currently registered as “swap dealers,” “major swap participants, or “swap execution facilities” (“SEFs”), it sets out blanket effective dates that seem to be chosen out of thin air. This compliance schedule fails to account for the interdependencies between this rulemaking and other rulemakings, which the Commission has yet to finalize. Some of those interdependent rulemakings include rules: (1) further defining the “swap dealers” and “major swap participants;” (2) determining which swaps will be subject to mandatory clearing and will be made available for trading; and (3) establishing guidance for the registration and regulation of SEFs.

I have urged the Commission countless times to make sense of its implementation timelines. The industry has asked for it. I have asked for it. When will we get it right?

Cost-Benefit Analyses Are Still Flawed

President Obama has demanded more comprehensive analyses from regulatory agencies than what is presented to the Commission here today.7 While the analysis is very well written and includes an appropriate baseline that is not tied to an arbitrary presumption,8 it is flawed for two important reasons: (1) the lack of quantification; and (2) the failure to conduct any sort of research or sophisticated analysis.9

To prove my point regarding quantification, this rule’s cost-benefit analysis does not contain one number. How can a rule setting standards for clearing fail to offer one estimate when market participants have been clearing swaps for over a decade? I find it hard to imagine that the Commission could not survey market participants to discern a range of possible costs.

The Commission’s cost-benefit analysis also seems to rely too heavily on anecdotal feedback to support its conclusions.10 The Commission does not suggest that it researched potential costs or undertook more sophisticated analysis techniques, such as conducting a study or survey of a diverse group of buy-side and sell-side market participants to determine the pervasiveness of trilateral agreements or the range of potential costs associated with the development and onboarding of pre-trade screening technology.11 We must do better. We cannot ignore available sources of data to support our rulemakings.

I continue to believe that our cost-benefit analyses are a crucial part of each and every rulemaking. It is truly inexcusable that we continue to disregard our statutorily-mandated responsibilities, which are to: (1) set an appropriate baseline; (2) conduct research or utilize sophisticated survey techniques; and (3) based on the results of research or surveys, provide a quantification of the potential costs.

Unfortunately, I am unable to support today’s final rules for three specific reasons. The first is that we have failed to develop a clear schedule that integrates with other rules. Second, this rule undermines the self-regulatory approach of designating clearing organizations to manage FCM risk management and calls into question the DSRO oversight regime by substituting the Commission’s judgment over the judgment of our DSROs. This new approach is a solution in search of a problem. Finally, I believe the rule’s cost-benefit analysis continues to suffer from a lack of quantitative analysis. I know the Commission is capable of much more. The question remains, however, if we will ever slow down our rulemaking machine to do the actual work.

My dissent on this rule should not take away from the deep appreciation I have for the hard work of the staff, or my desire to implement an effective straight-through processing regime that eliminates the need for unnecessary and limiting documentation.

1 See Requirements for Processing, Clearing, and Transfer of Customer Positions, 76 FR 13101, Mar. 10, 2011; Adaptation of Regulations to Incorporate Swaps, 76 FR 33066, June 6, 2011; Customer Clearing Documentation and Timing of Acceptance for Clearing, 76 FR 45730, Aug. 1, 2011; Clearing Member Risk Management, 76 FR 45724, Aug. 1, 2011.

2 On June 14, 2011, the Futures Industry Association (“FIA”), together with the International Swap and Derivatives

Association (“ISDA”) published the FIA-ISDA Cleared Derivatives Execution Agreement as a template for use by cleared swaps market participants in negotiating execution-related agreements with counterparties to swaps that are intended to be cleared. See http://www.futuresindustry.org/downloads/ClearedDerivativesExecutionAgreement_June142001.pdf.

3 See, e.g., IntercontinentalExchange’s (“ICE”) Press Release titled, ICE Clearing Houses to Launch New Swaps Credit Risk Management Workflow with Enhanced Execution and Low Latency, at http://ir.theice.com/releasedetail.cfm?ReleaseID=657513.

4 See Commissioner Scott D. O’Malia’s speech at New York University Law School on Jan. 31, 2012 titled, Where Are We? And Where Should We Be? Thoughts on MF Global and High Frequency Trading, at http://www.cftc.gov/PressRoom/SpeechesTestimony/opaomalia-11.

5 See Derivatives Clearing Organization General Provisions and Core Principles, 76 FR 69334, 69432 Nov. 8, 2011; see also 17 CFR § 39.4(b).

6 See id. at 69380; see also 17 CFR § 39.13(h)(i).

7 See Exec. Order No. 13563, 76 FR 3821, Jan. 21, 2011; see also Exec. Order No. 13579, 76 FR 41587, July 14, 2011.

8 In several of the Commission’s rulemakings, the Commission has relied on an arbitrary presumption that, “to the extent that . . . new regulations reflect the statutory requirements of the Dodd-Frank Act, they will not create costs and benefits beyond those resulting from Congress’s statutory mandates in the Dodd-Frank Act.” See, e.g., Swap Dealer and Major Swap Participant Recordkeeping and Reporting, Duties, and Conflicts of Interest Policies and Procedures; Futures Commission Merchant and Introducing Broker Conflicts of Interest Policies and Procedures; Swap Dealer, Major Swap Participant, and Futures Commission Merchant Chief Compliance Officer, 77 FR ___, (unpublished final rule), 2012, at Section IV of the preamble.

9 The cost-benefit analysis indicates in several places that many of the costs in this rulemaking are indirect and highly variable and, therefore, are impracticable to quantify. See 77 FR ___, (unpublished final rule), 2012, (“These factors are highly variable and impracticable to quantify, and, as a consequence, the Commission does not have adequate information to reasonably estimate the additional costs that might be caused by such disclosures, or the value of preventing such costs.”).

10 See id. (“Based on anecdotal feedback from market participants, the Commission believes that trilateral agreements have not yet been widely adopted.”).

11 A good example of a sophisticated study in which market participants were surveyed to determine potential costs of the Commission’s rules can be found in ISDA’s Costs and Benefits of Mandatory Electronic Execution Requirements for Interest Rate Products, 24 (ISDA Discussion Paper No. 2, Nov. 2011), available at http://www2.isda.org/attachment/Mzc0NA==/ISDA%20Mandatory%20Electronic%20Execution%20Discussion%20Paper.pdf. This study commented on the estimated costs that would result from the Commission’s proposed rulemakings with respect to SEFs (Core Principles and Other Requirements for Swap Execution Facilities, 76 FR 1,214, 1,220, Jan. 7, 2011) and real-time public reporting (Real-Time Public Reporting of Swap Transaction Data, 75 FR 76,139, Dec. 7, 2010, as corrected in Real-Time Public Reporting of Swap Transaction Data Correction, 75 FR 76,930, Dec. 10, 2010).

Last Updated: March 20, 2012