Remarks of Commissioner Rostin Behnam before the FIA/SIFMA Asset Management Group, Asset Management Derivatives Forum 2018, Dana Point, California
February 8, 2018
Good afternoon. And thank you for your warm welcome, and most importantly for inviting me to share your warmer weather. When Laura Martin invited me to speak here today, she kindly offered that I pick the structure. Given my fondness for illuminating and sometimes irreverent one-on-ones with FIA President and former CFTC Commissioner (and Acting Chair) Walt Lukken, I didn’t want to pass on that opportunity. But, before that, I thought I would begin with some brief remarks to give you a sense of my current approach as a relatively new Commissioner.
You’ve caught me at a good time. I’m about five months into my term. I’ve formed my legal team, and still in the early days of a listening tour, I have traveled to seven states and met with over forty market participants, convened the Market Risk Advisory Committee (MRAC) to open up a dialogue on the self-certification process of the first bitcoin futures contract, and weathered a government shutdown by only missing a single scheduled speaking appearance. Fortunately – well, actually, I will let you all be the judge – there is no threat that I will have to leave an empty chair today.
In November, I delivered my first remarks as a CFTC Commissioner at Georgetown University. I said a lot that day, but my main message was that I believe the CFTC is at an inflection point in implementing the Dodd-Frank Act, and that while there are a lot of strategic decisions ahead, our policy goals are firm: reducing systemic risk, preserving market liquidity, and above all else, incentivizing market participants to use the derivatives markets to manage risk.
It’s only been a few months since that maiden speech, and while I can’t say that I’ve been asked to deliberate on issues impacting Dodd-Frank reforms or even some more strategic initiatives, the wheels are turning and CFTC staff is working diligently on putting together a 2018 agenda. Of course, that last statement is not quite true when it comes to our Division of Enforcement, which has either filed or settled 27 cases since I took my oath in September.
During these past months, I’ve taken a slightly different approach to the Commissioner position, preferring to share my views directly with members of industry, market participants, end-users, and the public instead of making prepared public remarks. I believe that delivering remarks on issues that are not ripe for consideration can at times become white noise, and ultimately get drowned out when it’s time for action. So, instead of speechmaking, I’ve been partaking in meetings and conversations in an effort to formulate the goals and ideals that will guide and anchor me for the next few years, and to make sure my goals and ideals are grounded in the real-world concerns and challenges of market participants. Colored in part by the events of the last two months involving the relatively nascent crypto asset space, and my own experience in convening the MRAC, I’ve formulated some initial thoughts on how I can add value to the Commission and to the legally significant and systemically important issues on the horizon.
I’ve been thinking about goals and priorities. Are there issues I can support that have remained in the margins but deserve to be in the headlines of our agenda? How can I bring greater transparency and engagement into Commission decision-making? How do we remain thoughtful, deliberative regulators amidst the urge to rapidly keep pace with technology driven changes?
Right now, as I think of the possible answers to these questions and more, I keep returning to accountability. The Commission needs to account for its actions, accept responsibility, provide transparency, and act responsibly. In turn, our registrants and the market participants must also be accountable. Support and buy-in to our regulations—and in some instances, the concept of being regulated or exempted from regulation—is critical to achieving accountability. And we do that through collaborative efforts and engagement.
The issues that will shape the 2018 agenda present opportunities to reach workable solutions within the tenets of our regulations and the Dodd-Frank Act. While I strongly oppose any roll backs of Dodd-Frank initiatives, I believe a principles-based approach to implementation can be suitable in certain instances. A principles-based approach provides greater flexibility, but more importantly focuses on thoughtful consideration, evaluation, and adoption of policies, procedures, and practices as opposed to checking the box on a predetermined, one-size-fits-all outcome. However, the best principles-based rules in the world will not succeed absent: (1) clear guidance from regulators; (2) adequate means to measure and ensure compliance; and (3) willingness to enforce compliance and punish those who fail to ensure compliance with the rules.
Moving Forward in 2018
Turning to some of the issues I will likely be elaborating on with Walt, I’d like to begin by providing a brief recap of last week’s MRAC meeting. I would then like to discuss Reg AT—the Commission’s proposed rule for addressing the regulation of automated trading. In the second part of these remarks, I will attempt to level set expectations for the Commission’s agenda when it comes to your interests and make a few suggestions. Finally, I would like to share some thoughts on the Enforcement Division’s current efforts and progress in employing its self-reporting strategy.
The purpose of last week’s MRAC was to provide a public forum for open dialogue regarding the CFTC’s regulatory self-certification process for new products. This process has been in place for over 15 years, and has served market participants, the CFTC, and the general public very well. In addition to having a very good discussion about the CFTC’s authority under Part 40 of its regulations, much of the day focused on the listing of the first Bitcoin futures contracts. My message was twofold: I unequivocally support the self-certification process; however, I believe, specifically with respect to the Bitcoin contracts, the CFTC should have exercised its existing authority to accept voluntary product submissions for review and approval – by the entire Commission, instead of self-certification.
Ultimately, the CFTC received sharp criticism from large market participants, and responded after self-certification with the ad-hoc adoption of an informal “heightened review” process. Formality aside, the Commission’s overall approach to the Bitcoin futures was appropriately calibrated to the level of risk presented. Nevertheless, as highlighted in the various discussions at the MRAC, the approach presents itself as a hybrid between the somewhat ministerial act of self-certification and the more fulsome evaluation underlying Commission approval. This approach muddled the record, left major market participants out of the conversation and ill-prepared to serve their clients, and raised concerns that this will be the new status quo. In the end, I think many market participants were left scratching their heads, and the public was left in the dark.
Several of the MRAC statements focused on how any process beyond that contained in the self-certification rules amounted to a bureaucratic stall, undermining innovation and the free market approach. We heard that it’s not the Commission’s job to determine the suitability of products trading in our markets nor should we engage even when products are introduced that have questionable social utility. Our job, it was said, is simply to ensure that the new contracts are not readily susceptible to manipulation. Echoing the Chairman’s eighth element of heightened review, commenters maintained that it is the exchanges’ duties, as self-regulatory organizations (SROs), to consult with futures commission merchants, liquidity providers, and end-users prior to listing new products. Our job in this process would be no more than to receive a disclosure of the steps taken to gather and accommodate appropriate input from concerned parties. Although, at least one MRAC member suggested that while it appeared that the exchanges and Commission were proceeding through the requirements of voluntary submission for Commission review and approval, the processes for both Bitcoin contracts ended abruptly with self-certifications – much to the surprise of market participants.
These statements seem to presume that our political motivations as Commissioners inhibit our ability to provide sound judgement, to be held accountable, and to protect our markets to our fullest capabilities within our authority. Further, they suggest that the voluntary submission and approval process may be obsolete. I hope that really is not where we are, and I am optimistic that the entire Commission will have the opportunity to deliberate and invite public comment on whether to incorporate the Chairman’s “Heightened Review” into our existing regulatory framework, or perhaps just use the tools that we already have available to us through the voluntary submission process.
To be clear, I’d like to believe that there are facts and circumstances that evoke the desire to have the regulator involved, and that our expertise and experience is a value added. Even if the only purposes we serve – beyond satisfying ourselves that new products comply with the Commodity Exchange Act (and Commission regulations), and are not readily susceptible to manipulation – is to bring transparency to the process, level the playing field in terms of information, and provide a public forum for open dialogue.
Reg AT and Beyond
The Commission issued proposals for Reg AT, or Regulation Automated Trading, in both 2015 and 2016,1 in order to establish pre-trade risk controls to mitigate the potential dangers of an unchecked automated trading system. I think the Commission must prioritize this issue and take action before an automated trading system runs amok, causing harm to market participants through a flash crash or other system failure. In this age of technology driven financial markets, the question of a flash crash or automated trading system failure is not a question of if, but simply when.
Towards the end of 2016, Chris Clearfield of System Logic, a research and consulting firm focusing on issues of risk and complexity, wrote a piece advocating “Vision Zero” for our markets.2 “Vision Zero” is a multi-national road traffic safety project that aims to achieve a highway system with no fatalities or serious injuries involving road traffic, while increasing safe, healthy, equitable mobility for all.3 It originated in Sweden in 1997, and since then, annual road fatalities in Sweden have dropped by half.4 The success of Sweden’s Vision Zero, Clearfield maintains, provides a lesson that could be applied to our financial markets. “Traffic safety regulators there make errors part of the equation by recognizing that mistakes will happen—and creating structures to absorb and buffer those mistakes.”5 The same, Clearfield argues, should be true of our financial Vision Zero. “In every situation, a trader or a piece of technology might fail, or a shock might trigger a liquidity event. What’s important is that the structures are in place to limit – not amplify – the impact on the overall system.”6
Clearfield’s article provides some insight into what it takes to build those regulatory structures, and it includes reducing regulatory complexity and thoughtful collaboration between firms and regulators. Regulation, he warns, cannot be enforcement-driven, since we must aim to learn from small errors to prevent the bigger ones. We also must recognize, on both sides, that we have difficult and challenging jobs. Regulators, like the CFTC, may find themselves with conflicting mandates; for example, avoid duplicative burdens while protecting market participants. But, as regulators, we also need to acknowledge that not all of our policies provide benefits that outweigh the costs.
As we move forward on Reg AT – and I don’t think inaction is an option – we should keep Vision Zero in mind, and work collaboratively with industry to establish appropriate principles and structures in furtherance of well-reasoned, targeted regulation.
Asset Managers All-in
In preparing for this conference, my staff and I met with the Commission experts in the Division of Swap Dealer and Intermediary Oversight (DSIO) to gather information on the issues raised by your constituency and which may receive some of that headline treatment I mentioned earlier. You’ve all submitted numerous thorough and thoughtful letters in response to Project Kiss and to seek various forms of no-action and other relief stemming from the implementation of Dodd-Frank and related reforms. I’m pleased to report that DSIO has read every letter, is considering your suggestions with its own, and is developing an agenda going forward. Most immediately, DSIO is considering recommending codification of several existing no-action letters and is working with the SEC towards further harmonization efforts. These efforts, which may be tied into the larger conversations between Chairman Giancarlo and SEC Chairman Clayton, will largely focus on identifying duplicative, conflicting, and/or inconsistent compliance obligations for commodity pool operators (CPOs), commodity trading advisors (CTAs), and registered investment advisers, and determining whether and what changes are appropriate to further align the regulatory requirements for asset managers engaging in both the securities and derivatives markets. I’ve been advised that, given the technical nature of the relevant provisions of the Commission regulations and the diversity among the entities they impact, we cannot promise that the industry will see these efforts come to fruition within the next few months. And, just because a matter is not being acted upon immediately does not mean that it is not under active consideration.
In discussing the more specific concerns asset managers have raised, it would be difficult to support a wholesale restoration of the exemptions previously incorporated in Part 4 to their breadth prior to the 2012 amendments.7 There has been much industry opposition to the post Dodd-Frank expansion of the application of Part 4. Commenters generally focus on the lack of benefits that registration provides to investors due to concurrent SEC oversight or the fact that Dodd-Frank never specifically required the 2012 amendments.8Unfortunately, few commenters acknowledge that the Commission has a regulatory interest in overseeing entities that actively engage in the derivatives markets, and even more significantly, provide retail customers exposure to these markets. This is not to suggest that the Commission is not open to considering strategic revisions to the various exemptive provisions of Part 4. However, if we are going to move forward and collaborate, there must be some recognition that our regulatory spheres are not so clearly self-contained. To say that the CFTC brings nothing to the table ignores Congressional mandates, the Commission’s mission, and the institutional knowledge that is unique to the CFTC. The CFTC and SEC’s areas of expertise differ. The CFTC is uniquely situated to understand the risks posed by derivatives as a component of an investment portfolio; the SEC has simply not historically had to develop that same expertise.
I understand there is greater opportunity to harmonize, streamline, and align in areas of reporting and recordkeeping. These are broad areas and require consideration of the timing and frequency of required reports as well as line items and calculation methods. I also understand that past discussions and negotiations have often begun with an assumption that it would be the CFTC abdicating its role as primary regulator or modifying its regulatory approach. In my experience, productive conversations between two parties, regulators or not, rarely start with a request that one party step aside. I would be supportive of an industry led proposal (1) framed around solutions, (2) rooted in a cooperative partnership between the constituents you represent, and (3) supportive of preserving the mechanisms we use to oversee and protect derivatives markets and their market participants.
In November, I highlighted the Enforcement Division’s employment of a self-reporting strategy to incentivize disclosure of violations. I expressed my hope that the self-reporting strategy, akin to cooperation, will produce results. However, I noted that I would be keeping a sharp eye on its progress to ensure the CFTC’s enforcement division remains vigilant in policing the markets, and the primary cop on the beat.
I’ve spent some more time with Enforcement staff and had more opportunities to review and deliberate on enforcement actions since November. I’ve also had some more time to consider how enforcement efforts going forward will aid in shaping a greater culture of compliance. In considering our Director of Enforcement’s initial rollout of the updated advisory on self-reporting and cooperation,9 I appreciate his commitment to ensuring that the program recognizes that to achieve optimal deterrence, there needs to be buy-in from the communities we police, i.e. the markets. That buy-in includes not only ensuring that members of our community cooperate in bringing others to justice, but includes coming together to teach the younger members, i.e. the new market entrants, to behave.
I appreciate this approach, and agree that it should bring about greater compliance. However, I think it’s important that we constantly think about how best to reach the real “community.” We need to be asking ourselves whether the Commission’s settlement orders, which often contain the universe of publicly available information on a matter, are clear in describing the misconduct and how that conduct runs afoul of our Act and regulations. Our “community” cannot be limited to the persons and entities who commit the wrongdoing, because to be optimally effective, the buy-in and teachable moments must reach the entire market. It’s not enough to rely on individuals and individual entities to self-police because the information, the guidance may not make it outside of their immediate circle. We need to remember that our message, our clear statement as to which conduct falls outside our laws, needs to reach new market entrants, and unfortunately as we’ve recently been reminded, the new fraudsters may not operate in any “community.” We need to educate beyond the individuals who are in the closed door negotiations. Accordingly, to increase accountability, as I continue to review enforcement matters, I will be focusing more intently on the story being told and the message being sent with regard to how and why the particular individual or entity reached its settlement.
I hope I’ve given you a little more insight into who I am and how I hope to add value to the Commission. Thank you for having me and I’m looking forward to stepping down and speaking with you further.
1 See Regulation Automated Trading, 81 FR 85334 (proposed Nov. 25, 2016) and Regulation Automated Trading, 80 FR 78824 (proposed Dec. 17, 2015).
2 Chris Clearfield, Vision Zero for our Markets, The Risk Desk, Dec. 21, 2016, at 4.
3 Vision Zero Network, What is Vision Zero?, https://visionzeronetwork.org/about/what-is-vision-zero (last visited Feb 3, 2018).
4 Government of Sweden, Renewed Commitment to Vision Zero; Intensified efforts for transport safety in Sweden (2016), available at http://www.government.se/4a800b/contentassets/b38a99b2571e4116b81d6a5eb2aea71e/trafiksakerhet_160927_webny.pdf.
5 Clearfield, supra note 2.
7 See Commodity Pool Operators and Commodity Trading Advisors: Compliance Obligations, 77 FR 11252 (Feb. 24, 2012).
8 See, e.g., Letter from SIFMA Asset Management Group to Christopher Kirkpatrick, Secretary of the U.S. Commodity Futures Trading Commission, Kiss Initiative –Registration (Sept. 29, 2017), available athttps://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61341&SearchText=SIFMA; Letter from Investment Advisor Association to J. Christopher Giancarlo, Chairman of the U.S. Commodity Futures Trading Commission, Recommendations for “Project Kiss” to Simplify CFTC Rules (Sept. 29, 2017), available at https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61479&SearchText=IAA ; Letter from Managed Funds Association to Christopher Kirkpatrick, Secretary of the U.S. Commodity Futures Trading Commission (Sept. 29, 2017), available athttps://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61475&SearchText=MFA.
9 James McDonald, Speech of James McDonald, Director of the Division of Enforcement Commodity Futures Trading Commission Regarding Perspectives on Enforcement: Self-Reporting and Cooperation at the CFTC, NYU Program on Corporate Compliance & Enforcement/Institute for Governance & Finance (Sept. 25, 2017), http://www.cftc.gov/PressRoom/SpeechesTestimony/opamcdonald092517.
Last Updated: February 8, 2018