SPEECHES & TESTIMONY

Keynote Address of Commissioner Dan M. Berkovitz at ISDA’s 2019 Annual North America Conference

September 26, 2019

Turning to a New Decade

Good afternoon and thank you for the warm welcome.  I would like to thank Scott O’Malia and ISDA for inviting me to speak at this event.  I am pleased to be here at the one-year anniversary of my having joined the CFTC as a Commissioner.  It also is the ten-year anniversary of the G20 Summit in Pittsburgh where global leaders adopted many of the financial regulatory principles that still guide our work today.  This is a good time to take stock of how far the Commission and the global derivatives industry have come in recent years, and to highlight what I see as an opportunity to facilitate more effective and efficient compliance.

One housekeeping item: the views I express today are my own.  They do not represent the views of the Commission, its staff, or my fellow Commissioners.

Ten years ago, the G20 leaders met in Pittsburgh and agreed on reforms to the global financial system.[1]  Less than a year later, the United States adopted the Dodd-Frank Act.[2]  Over the past decade, market participants, the CFTC, and indeed regulators throughout the world have worked together to reduce systemic risk, increase transparency, and foster market integrity.  Our efforts, including significant investments by many of the firms represented in this room, have made the financial system safer and more robust.

Regulators and market participants have accomplished a great deal, and we have much to be proud of.  However, we can improve on our accomplishments.  Today, I will take stock of the progress we have made, and put forth a new proposal.  Specifically, today I am calling upon us at the CFTC to work with fintech developers and market participants to facilitate more effective and efficient compliance using fintech.

The Success of Financial Market Reform

In 2009, G20 leaders at the Pittsburgh Summit called for raising bank capital standards, requiring the clearing and exchange trading of standardized derivatives, and fostering fair and transparent competition in financial markets.[3]  Congress responded promptly by enacting the Dodd-Frank Act.  The CFTC took the baton and over the next several years worked energetically to fulfill Congress’ mandate to decrease risk and increase transparency.  Swap dealers are now regulated, more liquid swaps are required to be traded and cleared, and all swaps must be reported to the public and regulators.  I was privileged to serve as CFTC general counsel for much of the agency’s Dodd-Frank rule-writing efforts, and I remain proud of our work during those years.

It was then the financial industry’s turn to develop the compliance systems necessary to meet the Commission’s requirements.  And the industry met that significant challenge.  Over 100 swap dealers have now registered and 98% of all swap transactions involve at least one registered dealer.[4]  More than 20 swap execution facilities (“SEFs”) are registered.[5]  ISDA data shows that about 60% of interest rate swaps are traded on a SEF, and almost 90 percent are cleared.  In CDS, 97% of the main high-yield index CDS and 98% of the main investment grade index CDS are traded on a SEF.  Clearing rates are even higher.[6]  Our markets are more transparent and safer than ever before.

These achievements are a testament to the people in this room and throughout the derivatives industry.  Your engagement with regulators, human and financial investments, and acceptance of a common undertaking have improved our markets for the common good.

After leaving the CFTC in 2013, I spent over four years in private legal practice.  I came to appreciate market participants’ efforts to comply with regulatory requirements.  I saw first-hand the work required for market participants to understand a new legal regime, build technology, train staff, and revamp core business strategies to comply with new regulations.

Swap dealers have borne a large share of the costs associated with implementing CFTC regulations arising from the Dodd-Frank Act.  End users also have incurred expenses, both directly and as costs passed through to them by dealers.

Dodd-Frank has promoted increased competition among existing swap market participants through mandatory trading and greater transparency.  However, it also may have had the unintended consequence of discouraging some potential competitors.  The increasing concentration of clearing services in a few large banks is one example.

It would be inaccurate, however, to attribute the issue of increasing concentration in the financial industry solely—or even primarily—to Dodd-Frank.  Increasing concentration is a trend across many sectors of our economy and other factors affecting the financial system have been at play as well.

Nonetheless, as regulators, we should acknowledge concerns over regulatory costs.  Rolling back regulations, however, is not an appropriate or acceptable response.  The human and financial toll of the 2008 financial crisis was orders of magnitude greater than the costs associated with the Dodd-Frank Act and subsequent Commission regulations.  Our goal, therefore, must be to find ways to improve upon regulation and at the same time make them more efficient and cost-effective.  I believe that the intelligent application of technology to regulation and compliance is one way to achieve this result.

More Effective and Efficient Compliance through Fin Tech

In reviewing the agenda for today’s conference, I noted that two sessions this afternoon will address financial infrastructure technology for derivatives.  It is my belief that fintech solutions that digitize and automate derivatives transactions and other swap related activities[7] will lead to compliance that is both more complete and more cost-effective.  The CFTC can and should play a significant role in helping to make that happen where appropriate.

The CFTC has made a major effort in recent years to engage the marketplace on technology innovation.  However, much of our energy has been devoted to cryptocurrencies.  While perhaps not as exciting as crypto, improving infrastructure technology is critical to the CFTC’s core mission of facilitating vibrant, safe, and competitive derivatives markets.  As evidenced by ISDA’s own initiatives, infrastructure technology can also help market participants to better meet their commercial goals.  Accordingly, it is my strong belief that the CFTC should dedicate a significant portion[8] of its fintech initiative to engaging more actively with market participants and infrastructure technology developers to facilitate more effective and efficient compliance with our regulations.  Where feasible, compliance should be integrated into digitized documentation and automated transaction activities and become a seamless part of transacting in swaps.

Most infrastructure technology solutions tend to standardize and automate contract terms, documentation, reporting, record keeping, and other aspects of transactions.  If done well, these solutions tend to reduce the likelihood of human error and other validity issues – a very common cause of compliance violations in the swap space.  Technologies originally designed to reduce costs can have the added benefit of improving compliance.  With a more explicit focus on integrating compliance features into the transaction infrastructure, better compliance rates will be achieved and the public benefits of regulation are more likely to be realized.

What am I talking about more specifically?  Reporting swap transactions is an obvious example.  Automated systems can take swap trading data from a new transaction on a dealer’s system and then report it directly to an SDR.  By standardizing reporting fields and providing a common schema for reporting, this process can be made more efficient for the reporting parties, SDRs, and for regulatory oversight and risk monitoring.  The CFTC has been in the process of establishing standard reporting fields for swap transactions and I encourage that effort.

Numerous other regulatory requirements can be fully or partially automated and standardized across the industry.  Focusing on over-the-counter swaps in particular, pre- and post-trade procedures in electronic documentation, on a distributed ledger, or embedded in smart contract code, could automate numerous transaction level and risk management regulatory requirements.  The swap daily trading records and records retention requirements of CFTC rules 23.202 and 23.203[9] could be automated and integrated into the dealer documentation infrastructure using digital documentation.  The Part 23.500s and 600s regulations address business conduct and risk management requirements.  Requirements such as counterparty verification, material information disclosures, swap confirmation, portfolio reconciliation, and trading relationship documentation, could be more efficiently and completely addressed through standardized and digitized documentation and swap event management systems.

To an extent, this effort has already started.  For example, ISDA Create – IM was developed to allow automation of margin requirement documentation and compliance.  I understand ISDA plans to extend its ISDA Create platform beyond initial margin documentation and may, for example, be digitizing the ISDA Master Agreement Schedule.[10]

An important aspect of fully realizing this vision will be standardizing documentation and transaction event protocols in ways that incorporate compliance requirements.  To comply with the new regulations, many dealers and clearinghouses initially used their own customized systems and unique representations for life cycle events.[11]  While partially automating compliance to widely varying degrees, these individualized systems result in industry-wide inefficiencies because people still need to negotiate too many terms and firms continuously need to reconcile their trades.[12]

The current approach also has been prone to human error.  These errors can lead to compliance failures and enforcement actions.  The enforcement process, however, is a time-consuming, expensive, and blunt tool for attaining compliance.

The benefits of automation are best realized when repetitive processes and documentation are standardized.  Consistency will reduce errors and human input, which will improve the level of compliance over millions of swap trades.  While much of the substantial cost savings from standardization will relate to transaction costs generally,[13] savings from automated compliance can also be expected.

How can the CFTC help realize this Vision?

I strongly believe the CFTC should expand its fintech initiative to more comprehensively facilitate incorporation of compliance requirements in infrastructure technology innovation.  In this expanded initiative, the CTFC would work with market participants and fintech providers to facilitate more effective and efficient fintech solutions for complying with our regulations.  To the extent feasible, the CFTC should also be more mindful of the role of technology in compliance, and take further steps to integrate technology considerations into its approach to regulation.

The CFTC should, through its LabCFTC and operating divisions, expand its efforts to engage with fintech developers seeking our input on whether proposed new technologies are consistent with the CFTC’s compliance requirements.  CFTC input could range from the identification of regulatory issues, to working with developers to facilitate the early resolution of any such issues.

In addition, the Commission and CFTC staff should be more mindful of the technology that is often necessary to comply with Commission rules and the benefits of using technology to improve compliance.  In this way, we can assist our registrants to find better and more efficient mechanisms for achieving compliance.

In some areas, the CFTC already excels in the use of technology for regulatory purposes.  We take in and process vast amounts of data, such as large trader and trade capture reporting, swap data, and Volcker metrics data.  Our risk analysts and market surveillance staff work daily with clearing organizations and exchanges to ingest and analyze data to monitor markets.

Engagement with fintech developers and market participants using technology in their everyday activities should ultimately become a routine part of the CFTC’s work, not just part of a fintech initiative.  The CFTC’s entire regulatory program should be willing and able to engage with market participants and technology developers early and throughout the technology development process.  If we can do this successfully, the CFTC will have helped the industry achieve more effective and efficient compliance.  This will be a win-win for the CFTC and the financial industry.

 

[1] See G20, Leaders’ Statement: The Pittsburgh Summit, at 9 (Sept. 24-25, 2009), https://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders _statement_250909.pdf (“G20 Leaders’ Statement”).

[2] See Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).

[3] See G20 Leaders’ Statement.

[4] See CFTC, Provisionally Registered Swap Dealers (as of August 8, 2019),  https://www.cftc.gov/LawRegulation/DoddFrankAct/registerswapdealer.html.

[5] See CFTC, Trading Organizations – Swap Execution Facilities (SEF), https://sirt.cftc.gov/SIRT/SIRT.aspx?Topic=SwapExecutionFacilities.

[6] See ISDA, SwapsInfo First Half of 2019 and Second Quarter 2019 Review, at 2-5 (July 11, 2019),   https://www.isda.org/a/8EWME/SwapsInfo-1H-and-Q2-of-2019-Review-Summary.pdf

[7] For example, reporting, margin calculations, record keeping, portfolio reconciliation, and other activities related to transacting in, and the life cycle of, swaps.

[8] This new effort could come from an expansion or reorientation of a portion of our fintech resources depending on availability.

[9] Regulation 23.202 requires retention of pre-trade communications, date and time stamps, swap execution records of swap terms and other details, post-trade records of processing and life cycle events, ledgers, and trading records for related cash and forward transactions.  Regulation 23.203 addresses the retention, location and inspection of records of swap dealers generally.

[10] See generally Press Release, ISDA, ISDA and Linklaters Launch Full Version of ISDA Create – IM (Jan. 31, 2019), https://www.isda.org/2019/01/31/isda-and-linklaters-launch-full-version-of-isda-create-im/.

[11] See ISDA, What is the ISDA CDM? (Nov. 22, 2018), https://www.isda.org/a/z8AEE/ISDA-CDM-Factsheet.pdf.

[12] Luke Clancy, Patchy Response to ISDA’s Back Office of the Future, Risk.net (Mar. 28, 2019), https://www.risk.net/risk-management/6512226/patchy-response-to-isdas-back-office-of-the-future.

[13] See Deloitte Consulting LLP, Future of Post Trade – Shifting the Cost Curve (2019), https://www2.deloitte.com/content/dam/Deloitte/us/Documents/financial-services/future-of-post-trade.pdf; and Luke Clancy, Patchy Response to ISDA’s Back Office of the Future, RISK.NET (Mar. 28, 2019), https://www.risk.net/risk-management/6512226/patchy-response-to-isdas-back-office-of-the-future.