Keynote Address of CFTC Commissioner J. Christopher Giancarlo Before SEFCON VII
Making Market Reform Work for America
January 18, 2017
Thank you for that kind introduction.
Let me begin with the disclaimer that my remarks today reflect my own views and do not necessarily reflect the views of the Commodity Futures Trading Commission (CFTC), my fellow commissioners or the CFTC staff. Nor do my remarks today necessarily reflect the views of the President-Elect or his nominees to federal office.
If you have followed my work as a CFTC commissioner for the past two and a half years – and even before that – you know that I publicly support the core reforms of Title VII of Dodd-Frank, namely swap data reporting and central counterparty clearing and registration of swaps dealers.
You may also know that I have been outspoken about the CFTC’s implementation of these reforms. Where it has been successful, I have been a vocal supporter, such as the CFTC’s implementation of the swaps clearing mandate. Where CFTC implementation has been less successful, I have said so and proposed alternatives. This has been the case with the CFTC’s flawed implementation of the swaps trading rules, its missteps in cross-border harmonization, and its inattentiveness to the deterioration in trading liquidity and increased market fragmentation and market concentration, especially among futures commission merchants.
I have also called for the CFTC to be less focused on the past and more on the present and the future of derivative markets. I have called for regulators to encourage distributed ledger technology (DLT) and financial technology (fintech) innovation. I have said that the CFTC’s regulatory framework must catch-up to twenty-first century digital markets. And, I have raised concerns about marketplace cyber security, which is undoubtedly one of the greatest threats to functioning world markets and economic stability.
So, in my work as Acting Chairman – and, if I am honored to be nominated and confirmed by the Senate as CFTC Chairman, my priorities should come as no surprise. These priorities are part of an agenda I like to call “Making Market Reform Work for America” that I want to talk about with you today.
While there are many elements in making market reform work for America, I want to address five key elements. They are:
1. Providing Customer Choice in Trade Execution;
2. Fixing Swaps Data Reporting;
3. Achieving Cross-Border Harmonization;
4. Encouraging Fintech Innovation; and
5. Cultivating a Regulatory Culture of Forward Thinking.
Let me be more specific:
1. Providing Customer Choice in Trade Execution
Two years ago, I wrote a white paper1 that analyzed flaws in the CFTC’s implementation of its swaps trading regulatory framework under Title VII. It proposed a more effective alternative. The White Paper asserted that there is a fundamental mismatch between the CFTC’s swaps trading framework and the distinct liquidity, trading and market structure characteristics of the global swaps market. It explained that the CFTC’s current framework is highly over-engineered, disproportionately modeled on the U.S. futures market and biased against both human discretion and technological innovation. The paper concluded that the CFTC’s framework does not accord with the letter or spirit of Title VII.
A key example of this flawed implementation is that the CFTC’s swap execution facilities (SEF) rule requires SEFs to offer an order book for all swaps. For those swaps that are subject to the trade execution mandate, participants must execute them in an order book or request for quote system where the quote is sent to three participants (RFQ System). The RFQ System must be operated in conjunction with the order book.
Yet, the Dodd-Frank Act does not require such limited swaps execution methods. In fact, Congress set out a platform where multiple participants have the ability to execute swaps with multiple participants through any means of interstate commerce. Congress clearly drafted this broad and flexible definition to allow execution methods beyond an order book or RFQ System.
The CFTC’s limited execution method approach also does not comport with the way swaps actually trade in global markets. Trillions of dollars of swaps trade globally each day through a variety of execution methods tailored around their episodic liquidity. In many cases, interdealer brokers exercise discretion in executing counterparty trades. Yet, the CFTC’s swap trading rules thwart trade execution flexibility and limit necessary human discretion.
The CFTC’s flawed swaps trading implementation – and the application of this framework worldwide – has caused numerous harms, foremost of which is driving global market participants away from transacting with entities subject to CFTC swaps regulation, resulting in fragmented global swaps markets.
I intend to move forward with the proposed alternative regulatory framework for swaps trading that I detailed in my white paper.2 Making market reform work for America means allowing market participants to choose the manner of trade execution best suited to their swaps trading and liquidity needs and not have it chosen for them by the federal government. My proposed framework will better align regulatory oversight with inherent swaps market dynamics. Crucially, the alternative fully aligns with Title VII and promotes swaps trading under CFTC regulation. It will help to attract, rather than repel, global capital to U.S. trading markets. Making market reform work for America means addressing the market fragmentation that has arisen as a consequence of the CFTC’s flawed swaps trading regime.
2. Fixing Swap Data Reporting
Let me talk about swap data reporting. At the heart of the 2008 financial crisis was the inability of regulators to assess and quantify the counterparty credit risk of large banks and swap dealers. The legislative solution was to establish swap data repositories (SDRs) under the Dodd-Frank Act. Although much hard work and effort has gone into establishing SDRs and supplying them with swaps data, eight years after the financial crisis the SDRs still cannot provide regulators with a comprehensive picture of bank counterparty credit risk in global markets.
Of all the many mandates to emerge from the financial crisis, transparency into swaps counterparty exposure of major financial institutions was perhaps the most pressing. The failure to accomplish it is certainly the most disappointing.
The CFTC has faced many challenges in optimizing swaps data ranging from data field standardization and data validation to analysis automation and cross-border data aggregation and sharing.3 Market participants vary significantly in how they report the same data field to SDRs. Those same SDRs vary in how they report the data to the CFTC.4
The CFTC has taken some steps to address these challenges. Last year, the CFTC adopted final rules to clarify reporting obligations for cleared swaps.5 And, two years ago, the CFTC staff published a request for comment on draft technical specifications for certain swap data elements in an effort to improve data standardization.6 While these are steps in the right direction, much more needs to be done.
I fear that the CFTC and its overseas regulatory counterparts acting alone will continue to struggle to achieve the important objective of full visibility into swaps counterparty exposure. What is needed is a concerted and cooperative effort by regulators, market participants, commercial technology vendors and academia that draws on the emerging fields of big data analysis, network science and financial cartography. It is long past time to broaden this important implementation. Making market reform work for American means bringing all parties together and finally making swaps data reporting a reality.
Yet, from this starting point, I would like to go further. Making market reform work for America means addressing instances of operational and capital complexity and the enormous cost that the CFTC’s implementation of the Dodd-Frank Act has imposed on participants in American markets. Certainly, there must be ways to implement the reforms of Title VII with less complication and expense. I will have more to say about such initiatives in the months to come.
3. Achieving Cross-Border Harmonization
The third element in making swaps market reform work for America is achieving cross-border rule harmonization. Here, I am referring to defining the limits on the cross-border application of U.S. swaps rules in a way that invites international comity, rather than demands international uniformity. It also means no longer asking U.S. market participants to go it alone and take it on the chin in implementing global regulatory reform as too often has been done.7
Now, in discussing cross-border harmonization, I often go back to the G-20 Leaders’ Statement from the Pittsburgh Summit in September of 2009.8 That is because global leaders agreed to several fundamental principles to support economic recovery and embodied a cooperative spirit. The agreement included a commitment:
“to take action at the national and international level to raise standards together so that our national authorities implement global standards consistently in a way that ensures a level playing field and avoids fragmentation of markets, protectionism, and regulatory arbitrage.”9
You will note that the G-20 agreed on “consistent” implementation, not “identical.” Unfortunately, cross-border cooperation between the CFTC and foreign regulators has been hardly “consistent.”
I have faulted the CFTC for starting the rift with its July 2013 Interpretative Guidance10 that many EU regulators saw as a U.S. betrayal of the earlier agreed “Path Forward.”11 While we have made some progress in cross-border harmonization since then,12 the CFTC’s cross-border approach too often has been over-expansive, unduly complex and operationally impractical. And, its substituted compliance regime remains a somewhat arbitrary, rule-by-rule analysis of CFTC and foreign rules under which a transaction may be subject to a patchwork of U.S. and foreign regulation. No wonder the CFTC has had a hard time with international cooperation and comity.
I generally believe the best route to regulating the trading of swaps in global markets is thoughtful deference to fellow G-20 regulators within the Pittsburgh Summit’s goal of rule consistency. Regulators must set limits on the cross-border application of swaps rules to achieve the ends of market reform in a spirit of cooperation and deference. And, regulators must follow the flexible, outcomes-based approach advocated by the OTC Derivatives Regulators Group for equivalence or substituted compliance. We cannot expect to achieve cross-border harmonization if we continue to follow an identical, rule-by-rule substituted compliance analysis.
While on the topic of cross-border harmonization, let me spend a minute talking about the upcoming March 1st variation margin deadline for uncleared swaps. I am aware that market participants continue to face hard challenges in meeting this deadline. I am especially concerned that smaller firms, including American pension and retirement funds, may not be able to get their documentation done in time. If they do not, they will be abruptly forced to stop hedging their portfolios at a time of enormous changes in financial rates and global asset values.
Unfortunately, regulators imposed an unrealistic deadline on the marketplace. Many seem intent on sticking to that March 1 deadline regardless of the effect on the health of the market and market participants.13
But, some regulators are taking steps to ease the transition. Last month, Singapore, Hong Kong and Australia announced that their implementation of the new variation margin rules would be subject to a six-month transition period.14 These phased-in approaches seek to avoid market disruption come March 1st.15 I believe these approaches are well-considered.
As Acting Chairman, I also intend to look at solutions to ease the March 1st transition in a responsible manner. Look for the CFTC to have more to say about this in the weeks to come.
I came to the CFTC with the knowledge that the swaps market is global in nature. In the past few years, we have witnessed how market disruption, fragmentation and reduced liquidity occurs when cross-border regulatory harmonization is not achieved. Making market reform work for America means working cooperatively with fellow foreign regulators to implement swaps market reform in a harmonious fashion that underpins durable and thriving global financial markets.
4. Encouraging Fintech Innovation
The fourth element is fintech innovation. By that, I mean making the CFTC more accessible to fintech innovators.
Last year, I spoke a lot about DLT and fintech innovation because I believe in its promising benefits for the financial marketplace and financial regulators. DLT may allow market participants to manage the enormous operational, transactional and capital complexities brought about by Dodd-Frank. At the same time, it may provide regulators with the market visibility necessary to fulfill our mission to oversee healthy financial markets.
However, in order for this technology to flourish, regulators must take a “do no harm” approach.
The CFTC and other U.S. financial regulators are falling behind foreign jurisdictions in promoting fintech. The United Kingdom’s (UK) Financial Conduct Authority (FCA) has already created an Innovation Hub that allows fintech firms to introduce innovative financial products and services to the market and test new ideas through its Regulatory Sandbox. Unsurprisingly, the FCA’s Innovation Hub has received a lot of positive attention and regulators in Australia, Singapore, Japan and other countries are moving forward with their own initiatives.
The CFTC and other U.S. financial regulators must come together and look to emulate the UK, Australia, Singapore and Japan in order to avoid stifling innovation and DLT’s potential benefits. An international consensus around a “first, do no harm” approach is the right way to avoid impeding essential DLT innovation by protracted rule uncertainty or uncoordinated actions.16
Last May, I outlined five practical steps that the CFTC and other financial regulators should take to promote DLT and other fintech:
1. Putting Our Best Foot Forward: Financial regulators should designate dedicated, technology savvy teams to work collaboratively with fintech companies – both new and established – to address issues of how existing regulatory frameworks apply to new, digital products, services and business models derived from innovative technologies, including DLT;
2. Allowing “Breathing Room”: Financial regulators should foster a regulatory environment that spurs innovation similar to the FCA’s sandbox, where fintech businesses, working collaboratively with regulators, have appropriate “space to breath” to develop and test innovative solutions without fear of enforcement action and regulatory fines;
3. Getting Involved: Financial regulators should participate directly in fintech proof of concepts to advance regulatory understanding of technological innovation and determine how new innovations may help regulators do their jobs more efficiently and effectively;17
4. Listening and Learning: Financial regulators should work closely with fintech innovators to determine how rules and regulations should be adapted to enable 21st century technologies and business models; and
5. Collaborating Globally: Financial regulators should provide a dedicated team to help fintech firms navigate through the various state, federal and foreign regulators and regimes across domestic and international jurisdictions.
I plan to make fintech a priority at the CFTC. Making market reform work for America means fostering fintech innovation for the health and betterment of U.S. financial and capital markets, market participants and the American jobs they support.
5. Cultivating a Regulatory Culture of Forward Thinking
The final element in making market reform work is to cultivate a regulatory culture of forward thinking. By this, I mean refocusing the agency to get ahead of the curve of the enormous changes taking place in global trading markets. I spoke last September about how twenty-first century markets need twenty-first century regulation.18 I discussed how we are amidst a fundamental transformation of global trading markets from analog to digital, from human to algorithmic trading and from stand-alone centers to seamless trading webs. This transformation is being driven by a range of breakthrough, exponential digital technologies, including:
- automated, algorithmic trading that now constitutes up to 70 percent of regulated futures markets;
- “big data” capability enabling more sophisticated data analysis and interpretation;
- artificial intelligence guiding highly dynamic trade execution;
- “smart” contracts valuing themselves and calculating payments in real-time; and
- distributed ledger technology that challenges orthodoxies that are foundational to today’s financial market infrastructure.
Meanwhile, market regulation by the CFTC has not kept pace. In too many ways, it remains an analog regulator of an increasingly digital marketplace, curtailing its effectiveness in overseeing the safety and soundness of markets. I hope to change that. In September of last year, I laid out a forward-looking, twenty-first century agenda for the CFTC.19 I intend to move forward with that agenda.
Under Chairman Massad, the CFTC has put a foot into the twenty-first century with its proposed rulemaking for Automated Trading. As most of you know, the comment period for the supplemental notice of proposed rulemaking for Reg. AT ends next Tuesday, January 24th. As Acting Chairman, I intend to allow more time for public comments on the proposal. I believe more time is necessary based on the complexity of the supplemental notice and the well-reasoned requests from interested parties. I mention this now so that parties who intend to submit a comment letter know that I will look to give them more time to do so.
Making market reform work for America means establishing the CFTC as the world’s foremost knowledge center of global risk transfer markets. The agency’s long-standing presence in New York and Chicago gives it access to two of the world’s premier centers for futures and swaps trading. I will welcome the support of knowledgeable and experienced market professionals inside and outside of the federal government to help make the CFTC a twenty-first century regulator for today’s rapidly changing markets.
So, let me bring my remarks to a conclusion, by asking a question:
Why must we make swaps reform work for America?
The answer is prosperity. That is, Americans want prosperity. We have been through almost a decade of the worst U.S. recovery from any recession since the Great Depression – a period that the Managing Director of the International Monetary Fund called the “New Mediocre.”20 It has been a period of historically low economic growth, business start-ups and full-time job participation, a period of stagnant wages, increased poverty and income inequality.
As a result, Americans voted for change. I believe they have had enough with a mediocre economy. I believe they want a great one.
To achieve that, we need to foster vibrant and well-functioning markets, including markets for swaps and other derivatives. As you all know, liquid swaps markets allow the risks of variable production costs, such as the price of raw materials, energy, foreign currency and interest rates to be transferred from those who cannot bear them to those who can. Swaps serve the needs of society to moderate price, supply and other commercial risks. Thus, they free up capital for other purposes, and boost economic growth, job creation and prosperity.
We Americans are and have always been an aspirational people. Whatever our political point of view, we seek a brighter and more prosperous future for our families and ourselves.
On Friday, we will witness a new beginning for our country and a renewed promise for broad-based economic growth. A time to redouble our efforts to rebuild American prosperity:
- to harmonize our work with our overseas partners;
- to foster innovation and market intelligence; and
- to lift the prospects of all for greater human health and harmony.
I intend to do my part, as I may be called upon to serve, to oversee vibrant and durable markets for investment and risk transfer in the new, digital twenty-first century.
Thank you for your time and attention.
1 CFTC Commissioner J. Christopher Giancarlo, Pro-Reform Reconsideration of the CFTC Swaps Trading Rules: Return to Dodd-Frank, White Paper, Jan. 29, 2015 (White Paper), http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/sefwhitepaper012915.pdf.
2 Id. A condensed version of the White Paper was recently published as a chapter in the book Reframing Financial Regulation: Enhancing Stability and Protecting Consumers, edited by Hester Peirce and Benjamin Klutsey, https://www.mercatus.org/system/files/peirce_reframing_web_v1.pdf.
3 See TAC meetings and related documents http://www.cftc.gov/About/CFTCCommittees/TechnologyAdvisory/tac_meetings.
4 See Swap Data Recordkeeping and Reporting Requirements, 77 Fed. Reg. 2136, 2169-70 (Jan. 13, 2012) (providing flexibility to the industry regarding data standards in the final reporting rules).
5 Amendments to Swap Data Recordkeeping and Reporting Requirements for Cleared Swaps, 81 Fed. Reg. 41736 (June 27, 2016).
6 Request for Comment, Draft Technical Specifications for Certain Swap Data Elements (Dec. 22, 2015), http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/specificationsswapdata122215.pdf.
7 See Statement of Commissioner J. Christopher Giancarlo Regarding the Implementation Date for Margin for Uncleared Swaps, Aug. 31, 2016, http://www.cftc.gov/PressRoom/SpeechesTestimony/giancarlostatement083116.
8 G-20 Leaders’ Statement, The Pittsburgh Summit (Sept. 24-25, 2009), available at http://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf.
9 Id. at par. 12.
10 Interpretative Guidance and Policy Statement Regarding Compliance With Certain Swap Regulations, 78 Fed. Reg. 45292 (July 26, 2013).
11 Press Release, The European Commission and the CFTC reach a Common Path Forward on Derivatives, July 11, 2013, http://www.cftc.gov/PressRoom/PressReleases/pr6640-13.
12 Such as reaching agreement with the European Union over its determination of U.S. central counterparty clearinghouse equivalence.
13 Louie Woodall, Regulators Deaf to Variation Margin Concerns, Say Dealers, Risk.net, Nov. 17, 2016.
14 Article, Singapore, HK, Australia Set Date for OTC Margin Rules, The Star, Dec. 7, 2016, http://www.thestar.com.my/business/business-news/2016/12/07/singapore-hk-australia-set-date-for-otc-margin-rules/. Hong Kong and Singapore will allow for a six-month transition period for their initial margin rules as well. Id..
15 Id (citing Kishore Ramakrishnan, director of financial services advisory at PriceWaterhouseCoopers LLC).
16 See Special Address of CFTC Commissioner J. Christopher Giancarlo Before the Depository Trust & Clearing Corporation 2016 Blockchain Symposium, Mar. 29, 2016, http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-13.
17 Technology Advisory Committee Meeting Transcript, at 226-227, Feb. 23, 2016 (citing Brad Levy of Markit describing regulators as a node on the network).
18 Address of CFTC Commissioner J. Christopher Giancarlo to the American Enterprise Institute, 21st Century Markets Need 21st Century Regulation, Sept. 21, 2016, http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-17.
20 Phrase used by the Managing Director of the International Monetary Fund, Christine Lagarde, in warning that the world economy was facing a prolonged period of low economic growth. Robin Harding, Lagarde Warns of ‘New Mediocre’ Era, Financial Times, Oct. 2, 2014, http://www.ft.com/cms/s/0/2bfa11d6-4a44-11e4-8de3-00144feab7de.html#axzz4KSN5Y26Z.
Last Updated: September 14, 2017