Speech by Commissioner Michael V. Dunn, National Futures Association CPO/CTA Regulatory Seminar, USB Conference Center – Chicago, Illinois
Tuesday, March 2, 2010
Thank you for the opportunity to address you all today while you attend NFA’s regulatory seminar for CPOs and CTAs. I applaud you for your attendance at this meeting because I believe it shows a commitment not only to your businesses, but more importantly to the customers you represent and advise. With topics such as disclosure documents, sales practices, and the audit process, it is clear to me that you are willing to work to ensure that your business practices meet the expectations that NFA and the CFTC has set for you. I would also like to thank those responsible at NFA who invited me to this seminar. The CFTC could not have a better partner than the NFA to help us meet our core mission to protect the market and its users from fraud, abuse and manipulation.
We are at the cusp of momentous change in Washington that will affect how anyone using this country’s financial markets does business. The Obama administration and Congressional leaders have each listed financial reform as one of their top priorities. If we have learned anything from the financial crisis, it is that there must be a fundamental reevaluation of risk and regulation in derivatives markets by both Congress and the country’s financial regulators.
Financial regulatory reform is needed to address the financial meltdown of the U.S. financial markets. In my opinion, Congress and regulators should focus on three things:
1. Providing transparency;
2. Reinstating some elements of the Glass–Steagall Act; and
3. Actively pursuing anti-trust laws to address “too big to fail.”
Of these three elements, the CFTC should have a major role in providing transparency to the markets we regulate. In my opinion, the CFTC through Chairman Gensler, has been correct in requesting Congress to give us the authority to regulate the OTC market. He has asked that we be allowed to regulate derivative dealers, bring transparency to the OTC markets and move standard derivatives to regulated clearing houses. I whole-heartedly support these measures.
I will talk today about developments in Washington that may affect the markets you participate in and additional authorities the CFTC may be given to bring greater transparency and regulation to the derivatives marketplace.
I have served at the CFTC as a Commissioner for over 5 years and have a year and a half left in my term. At the CFTC, I chair the agency’s Agricultural Advisory Committee which examines a variety of matters pertaining to the agricultural markets the CFTC regulates, and whose members are taken from a broad cross section of the agricultural community. The CFTC also has advisory committees dealing with energy and environmental topics as well as global markets.
The CFTC was created by Congress in 1974 as an independent regulatory agency to replace the Commodity Exchange Authority which was part of the Agriculture Department. The reason for the change was obvious, since the futures markets had already begun expanding into non-agricultural products. At the time over 90% of futures activities were agricultural in nature. Future growth of the industry was destined to be in the non-agricultural segment; presently less than 10% are deemed agricultural. The CFTC’s mission is to protect markets users and the public from fraud, manipulation and abusive practices related to the sale of commodity and financial futures and options, and to foster open, competitive and financially sound futures and options markets.
The CFTC like the SEC and FTC are referred to as “independent” regulatory agencies which means that after the five Commissioners are nominated by the President and confirmed by the Senate, they are not beholden to the views or dictates of the Administration or the Congress for decisions they make. The Commissioners are to make decisions independent of partisan politics or others holding federal office. No more than 3 of the 5 CFTC Commissioners can be of the same political party—so in establishing the CFTC Congress tried to make the agency as independent as possible.
The CFTC has historically been responsible for the oversight of exchange traded products and have not had authority to regulate over-the-counter derivatives. Prior attempts by the Commission to regulate OTC derivatives were met with stiff opposition from various industry sectors, governmental entities and Congressional offices. The financial crisis has changed the way almost everyone views financial markets and, in particular, financial regulation. Today, I believe there is almost unanimous agreement that oversight is needed in the OTC markets. Of course the devil is in the details and the final complexion of this oversight is yet to be determined.
OTC transactions first came into existence in the early 80s when dealers created specifically tailored financial contracts to meet their clients’ risk management needs. Unlike exchanged traded products, OTC contracts are bilateral in nature and not traded on exchange. Since these transactions are kept on the books of dealers, not on an exchange, the amount of information available to the public is very limited – i.e. actually pricing information is not transparent.
Since the early 80s, the OTC derivative markets have experienced explosive growth increasing from less than $1 trillion in notional value to approximately $300 trillion in the United States alone. Despite this phenomenal growth, the OTC derivatives markets have remained largely unregulated even though the contracts have become more standardized and are often traded on electronic platforms that facilitate the ability to trade in a transparent fashion.
In response to financial crisis, the House of Representatives passed a broad financial regulatory reform bill on December 11, 2009, that provides for comprehensive regulation of OTC derivatives trading regulation. This bill was worked out by Agriculture Committee Chairman Colin Peterson and Financial Services Chairman Barney Frank. It provides that derivatives trading, which was heavily involved as a facilitator of the economic crash, be regulated by mandating a new set of standards and oversight requirements. I support OTC regulation and believe that CFTC oversight of these markets would lower financial risk to our economy and increase market transparency for all market users.
Chairman Gensler, with whom I agree on this topic, has stated that he believes effective reform requires three essential components:
1. An explicit regulatory framework for derivatives dealers;
2. The trading of standardized derivatives on regulated trading platforms; and
3. The clearing of standardized derivatives.
I believe there is now consensus that OTC dealers should be regulated just like their counterparts in the exchange traded world regardless of whether they are offering customized or standardized contracts. It is imperative that these dealers have sufficient capital and meet margin requirements to reduce the risk there trading has on our financial system. Dealers should also be held to business conduct standards, including standards that promote market integrity by protecting against fraud, manipulation and other abusive practices. Lastly, I believe it is finally time to shed a bright light on this type of trading, and by making dealers meet recordkeeping and reporting requirements, we can bring much needed transparency to this historically opaque market.
Trading on Regulated Platforms
A transparent marketplace is a competitive marketplace. In a transparent trading environment, market users benefit from dealer competition and the lower costs this competition produces. Transparent markets are well-regulated, cost-effective and very liquid. For these reasons, I think it is best to have OTC contracts traded on regulated trading facilities and exchanges.
Not only would customers benefit from OTC trading in a transparent trading environment, but clearinghouses would be in a better position to assess and manage risk by having the ability to mark cleared positions to a reliable and transparent market price. If clearinghouses cannot rely on the transparency provided by trading venues, then they most use less reliable prices when marking to market the products they clear. This scenario leaves clearinghouses in the position of being less able to manage their risk and protect the public.
Clearing Standard Derivatives
I support the required clearing of standard derivatives in regulated clearinghouses. According to estimates, more than three quarters of the OTC market could be cleared by a clearinghouse. For the remaining contracts that are so customized that they cannot easily be cleared by a clearinghouse, I am comfortable allowing these to be transacted bilaterally so long as the dealers are subject to a comprehensive system of regulation for these transactions. Central clearing of the vast majority of OTC contracts would substantially reduce risk to our financial system and hopefully disconnect large institutions that are “too big to fail.”
There has been talk about an “end-user” exemption to the clearing requirement for OTC derivatives. I do not support this idea. Allowing such a large class of transactions to be exempt from clearing would mean that dealers would have more risk on their books. If these dealers fail, this risk could affect the entire financial system. While I do not support a legislatively created end-user exemption, I can see the usefulness of providing the CFTC with the authority to exempt certain end-users on a case-by-case basis if there is a public necessity for doing so.
This past Friday, Democratic Senators Dianne Feinstein, Maria Cantwell and Byron Dorgan, along with Republican Senator Olympia Snowe, sent a letter to Senator Christopher Dodd, Chair of the Senate Banking Committee, in which they strongly oppose exemptions for end-users. The Senators wrote: "If the federal government fails to impose systemic risk controls on derivatives traders, these traders will continue to shift substantial systemic risk onto federal taxpayers.” As Reuters described, the Senators warned Dodd that as long as transactions between swaps dealers and end-users are not required to be cleared, a bankruptcy at a major Wall Street bank could lead to the collapse of energy markets. The Senators said a blanket exemption for end-users was not required, and instead, that the reform bill should mandate that all derivatives be traded on exchanges and meet clearing requirements, unless the CFTC grants a specific exception "based on a public interest or necessity finding." In order to receive an exemption, derivatives dealers would bear the burden of proving that it was actually necessary.
Aside from financial reform in the OTC markets, there are three matters that we are working on at the CFTC that I would like to bring your attention to:
1. Harmonization of standards between the CFTC and SEC for financial intermediaries that offer investment advice;
2. Retail foreign currency regulations; and
3. Position limits on certain energy contracts.
With regard to position limits and retail foreign currency regulation, there are open comment periods I suggest that if you have any interest in either, to please read them and provide your comments to the Commission.
On September 2 and 3, 2009, the CFTC and SEC held unprecedented joint meetings to identify existing conflicts in our respective statutes and regulations with respect to similar types of financial instruments and either explain why those differences are essential to achieve underlying policy objectives with respect to investor protection, market integrity, and price transparency or make recommendations for changes to statutes and regulations that would eliminate the differences. The Commissions discussed in this meeting the obligations that those dispensing financial advice owe to their customers. The joint report issued by the CFTC and SEC made two points:
1. Having inconsistent standards for financial advisers performing similar functions causes confusion.
2. There should be a uniform fiduciary duty standard of conduct for persons providing similar investment advisory services, regardless of whether that advice relates to securities or futures.
I support moving forward to insure that retail customers receive the appropriate level of protection regardless of the products they are trading.
With regard to the proposed rule on the energy position limits, I would like you to be aware that it contains a different approach to disaggregation exemptions from the one taken for agricultural contracts subject to the Part 150 speculative position limits. Briefly, under the current federal speculative position limit regime for agricultural contracts, there are certain exemptions granted to CPOs or CTAs (i.e., eligible entities) with commonly-owned positions to the extent that they are held or controlled by independent account controllers (each controller’s position may not exceed the speculative position limits). The proposed energy limits would not permit positions held by eligible entities such as CPOs and CTAs to be disaggregated pursuant to the independent account controller framework.
Thank you so much for having me here and will be glad to hear your comments or questions.
Last Updated: January 24, 2011