Keynote Address of CFTC Commissioner J. Christopher Giancarlo before the 13th Annual Forex Network Chicago 2015
September 24, 2015
Thank you. I am grateful for that kind introduction.
I want to thank Julie Ros, the Publisher & Editor-in-Chief of Profit & Loss Magazine and the founder of the Forex Network Conference Series. I have tremendous respect for Julie. She is one of the hardest working and most knowledgeable journalists on the subject of the global forex markets. When Julie asked me to participate in today’s conference, I immediately said yes knowing it would be a great program.
I am pleased to see a lot of familiar faces from my first foray into the derivatives industry fifteen years ago. So, I am very pleased to be speaking to all of you today.
I’d like to say at the outset that my remarks reflect my own views and do not necessarily constitute the views of the Commodity Futures Trading Commission (CFTC or Commission), my fellow CFTC commissioners or the CFTC staff.
Today, I would first like to discuss the CFTC’s made available to trade process and swaps trading rules as they relate to foreign exchange (FX) options, currency swaps and non-deliverable forwards (NDFs), and then I would like to discuss some recent developments in the retail over-the-counter FX markets.
Made Available to Trade Determinations
As many of you know, in November 2012, the U.S. Treasury Secretary issued a determination that exempted FX swaps and FX forwards from many of the requirements imposed by the Dodd-Frank Act.1 The exemption did not extend, however, to FX options, currency swaps or NDFs, which are subject to the full array of Dodd-Frank and CFTC rules applicable to swaps, including the clearing and trading mandates (unless the end-user exemption is available).
Last fall, the Commission’s Global Markets Advisory Committee met to discuss the implications of a prospective clearing mandate for FX NDFs. CFTC staff identified twelve currency pairs that could potentially be subject to the mandate. A number of participants expressed concern that a clearing mandate could quickly lead to a trading mandate under the CFTC’s “made available for trading” rules, which would likely have adverse consequences for U.S. investors.2
The Commodity Exchange Act (CEA or Act), as amended by the Dodd-Frank Act, provides that any swap subject to mandatory clearing must be executed on a swap execution facility (SEF) unless no SEF makes the swap available to trade (MAT).3 In 2013, the CFTC issued rules outlining the process whereby SEFs are authorized to make MAT determinations.4 These rules have proved to be unworkable and have created an unwarranted regulatory mandate.
Under this platform-controlled process, a SEF may certify a MAT determination to the Commission pursuant to Part 40 of the CFTC’s regulations after considering one or more of six factors.5 Consideration by the SEF of any one of the factors is sufficient under the rules.6 The CFTC reviews the SEF’s determination, but may deny the certification only if it is inconsistent with the Act or regulations. It is doubtful, however, that the Commission could find that a MAT submission is inconsistent with the CEA or Commission regulations because neither the Act nor the regulations contain any objective or quantitative criteria on which to base a MAT determination. Nevertheless, once deemed available to trade, these swaps must be executed on a SEF pursuant to the limited execution methods permitted by CFTC rules for “Required Transactions,” that is, they must be executed in an order book (Order Book) or in a request for quote system (RFQ System) in which a quote is sent to three participants operating in conjunction with an Order Book.7
The MAT process, in combination with the CFTC’s limited execution method approach, is problematic for several reasons. It forces swaps to trade through a limited number of execution methods even where a product lacks the liquidity needed to support such trading. Since the MAT process is platform-controlled, a nascent SEF attempting to gain a first-mover advantage in trading liquidity may force certain swaps to trade exclusively through the SEF’s restricted methods of execution before the appropriate liquidity is available to support such trading.
The MAT/limited execution approach has also created an unnecessary tension between the clearing mandate and the trading requirement. The determination of whether trading liquidity in an instrument is sufficient to calculate initial and variation margin to permit central clearing is a wholly different analysis than whether trading liquidity is appropriate for mandatory trade execution through an Order Book or RFQ System.
Flawed CFTC Swaps Trading Rules
The current NDF clearing mandate debate highlights the tension between clearing and trading and the flawed swaps trading regime. Participants at last October’s GMAC meeting observed, among other things, that a mandatory clearing determination, followed by a rapid transition to mandatory trading would bifurcate liquidity between U.S. participants, who would be required to trade on SEFs and non-U.S. participants, who will not be limited to the restrictive SEF trading protocols.8 While some participants voiced concerns about readiness for clearing, most of the concerns were directed at mandatory SEF trading.
Other problematic issues discussed by the participants as requiring resolution before mandatory trading for NDFs is implemented include the application of the Commission’s cross-border guidance to NDF trading;9 a lack of harmonization between the product definitions and rules of SEFs currently trading NDFs and those of the derivatives clearing organizations that clear them; required SEF trading for package transactions involving NDFs; the pre-trade credit checks required by Commission Regulation 1.73; and the technology build outs that will be required.10
Some of the tension between the clearing and trading mandates could be avoided if flexible execution methods were permitted for all SEF trades. Congress expressly permitted SEFs to offer various flexible execution methods for swaps transactions using “any means of interstate commerce.” The law defines a SEF as a:
trading system or platform in which multiple participants have the ability to execute or trade swaps by accepting bids and offers made by multiple participants in the facility or system, through any means of interstate commerce, including any trading facility that – (A) facilitates the execution of swaps between persons; and (B) is not a designated contract market.11
Swaps market participants must be allowed to choose from the broadest possible array of methods of swaps execution that comply with the statutory SEF definition. Those include:
- Electronic central limit order books;
- Simple order books;
- RFQ systems;
- Electronic Dutch Auctions;
- Hybrid electronic and voice execution methods;
- Full voice-based execution methods; and
Swaps transactions should also be permitted by any other “means of interstate commerce” that may today or someday in the future satisfy swaps customer trading and liquidity requirements.
U.S. swaps markets must be reopened to business and technological innovation. Technology is improving American lives today in many ways, from hailing a taxi with Uber to connecting with business colleagues on LinkedIn. “Big Data” and “Peer-to-Peer” technological innovations are also transforming capital markets in such activities as raising money for business start-ups and consumer borrowing. These innovations lower barriers to entry, reduce costs and open markets to a broader range of participants. Unfortunately, the CTC’s swaps rules would prevent such technological innovation in the U.S. swaps markets.
Customer choice and technological innovation, not regulators, must determine the various means of interstate commerce utilized in the swaps market. That is clearly what Congress intended. That is surely the way of a modern market economy.
Revisiting the MAT Process and Swaps Trading Rules
In July, the CFTC’s Division of Market Oversight held a roundtable to discuss the MAT process.12 Participants and commenters argued persuasively for the establishment of a process that would require consideration of objective, quantitative criteria, public comment and Commission approval before a swap is subject to mandatory SEF trading.13 I am very sympathetic to the concerns raised by the participants.
Yet, I believe the choice between a platform-controlled or a Commission-controlled MAT process is a false choice. There would be no need for the flawed platform-controlled MAT process if the CFTC did not limit in the first place the SEF execution methods for swaps subject to the trade execution requirement. If SEFs and their customers had the flexibility to transact swaps through the “means of interstate commerce” that best suited the liquidity characteristics of the particular swap product, then there would be little resistance to conducting all swaps on SEFs as “Required Transactions.” In fact, there would be no reason at all to maintain the artificial dichotomy between “Required” and “Permitted” Transactions.
It is imperative that the Commission take this opportunity to correct the inflexibility of the CFTC’s swap trading rules. Failing to do so will not make the harm go away. It is increasingly clear that Organized Trading Facilities under European swaps trading rules will not be similarly hidebound in methods of trade execution, nor will swaps platforms in Singapore or Hong Kong. This mismatch between CFTC and European rules may well be the basis down the road for another “equivalency” standoff similar to the currently prolonged dispute over central counterparty recognition. Such a wrangle would not be in the spirit of global regulatory reform or in the interests of healthy and efficient markets.
One final observation on the clearing and trading mandates for FX NDFs – it is crucial that key regulators across the globe coordinate the timing and consistency of the mandates. Anything else will perpetuate global swaps market fragmentation.
The European Securities and Markets Authority has decided not to go forward with a clearing mandate for FX NDFs at this time based on the feedback received to its October 2014 consultation,14 and proposed FX NDF clearing determinations do not appear imminent at the Commission. But the push for clearing and trading mandates is bound to resurface, perhaps when regulators issue rules requiring margin for uncleared swaps in the not too distant future.
My January 2015 white paper analyzes the many flaws in the CFTC’s implementation of its swaps trading rules.15 It proposes a more effective alternative. Since the White paper’s release, CFTC staff has initiated some small efforts to improve the rules, which I have commended.16
Unfortunately, the CFTC’s actions to date have fallen short overall of the changes needed to truly improve swaps trading. The CFTC’s tweaks of the swaps trading rules in the last seven months, mostly in the form of staff no-action letters, have failed to fix the underlying issues with the trading rules. Last month, I released a Six Month Progress Report that reviews in detail the CFTC’s measures to date and assesses the degree to which they ameliorate rule flaws.17 The Progress Report’s title sums it up: “Incomplete Action and Fragmented Markets.”
The CFTC must make a more concerted effort to fix its swaps trading rules in accordance with the letter and spirit of Title VII of the Dodd-Frank Act in order to align its regulatory framework with the distinct liquidity, trading and market structure characteristics of the global swaps markets. If not, U.S. swaps trading and liquidity will continue to suffer and Congress’s goal of promoting swaps trading on platforms and pre-trade price transparency will not be realized. Furthermore, as mentioned, the CFTC will have a difficult time achieving equivalence with European and other foreign swaps trading regimes, which are not following the CFTC’s prescriptive approach to swaps trading.
Retail Over-the-Counter FX Markets
I would like to switch gears now and talk a bit about some recent developments in the retail over-the-counter (OTC) FX markets. In August, the Commission approved rule and interpretive notice amendments filed by the National Futures Association (NFA) in the wake of the historical volatility that occurred in FX markets when the Swiss National Bank unexpectedly lifted its cap on the Swiss franc’s exchange rate against the Euro.
The NFA amendments require NFA’s forex dealer members (FDMs) to, among other things:
- Establish enhanced risk management programs, similar to those required of futures commission merchants and swap dealers;
- Subject FDMs to increased capital requirements that take into account the risks associated with FX transactions between FDMs and eligible contract participant (ECP) counterparties, especially those acting as foreign dealers;
- Require FDMs to collect security deposits from ECP counterparties, as well as their retail customers; and
- Require FDMs to provide additional disclosures on their websites to permit counterparties to assess risks more effectively.
I support the NFA amendments as a prudent response to evolving market conditions. Regulators must always be vigilant in overseeing the markets within their jurisdiction and take appropriate steps to make improvements when warranted.
I disagree, however, with the view that the retail OTC FX markets require wholesale changes in the way they are currently regulated. The CFTC Reauthorization Act of 2008 gave the Commission broad authority to promulgate and enforce rules in connection with off-exchange FX futures, options, and options on futures, as well as leveraged off-exchange contracts offered to retail customers.18
Following the passage of the Dodd-Frank Act, which provided additional authority to the CFTC in this area, the Commission adopted a comprehensive regulatory framework for retail FX platform operators. That framework requires registration, disclosure, recordkeeping, financial reporting, minimum capital and other operational standards.19
As currently enforced by the staff of the CFTC, that regulatory scheme provides the Commission and the public with market supervision over the retail FX market that is comparable to the CFTC’s oversight of other markets and asset classes under its jurisdiction. I am not aware of any shortcomings or concerns with the CFTC’s supervisory capabilities under this regulatory scheme. In partnership with the NFA, the Commission’s oversight of this market has been, and will continue to be robust.
In drawing to a close, I note that this month marks the 6th anniversary of the Pittsburgh G-20 Summit. At that critical meeting a year after the financial crisis, global leaders agreed to work together to support economic recovery through a “Framework for Strong, Sustainable and Balanced Growth.”20 To achieve these common goals, the Pittsburgh participants pledged to work together to “implement global standards” in financial markets, while rejecting “protectionism.”21
Six years on, I worry that different jurisdictions and different regulators are moving forward unilaterally and in a piecemeal fashion. They’re chopping global financial markets into smaller and smaller regional and national markets. The Pittsburgh summit was not about bringing an end to the era of “globalization” and pointing financial markets in the direction of regionalization and nationalization. Smaller and disconnected regional trading markets in financial products will only increase the systemic risk that regulatory reform was premised on reducing. I don’t think that it is in the world’s interests, or in interest of the country that I am honored to serve.
As I have said before, healthy capital markets are the answer to 21st century global economic woes, not trade wars and protectionism. The solution to sluggish growth in the developed and developing economies is safe, sound and vibrant global markets for finance and investment. We must maintain liquid and broad global markets in currency, FX and other derivatives. To do so, we must reach an accord on how to regulate swaps execution and clearing in an intelligent, harmonious and market oriented manner within and across jurisdictions.
Thank you very much.
1 See Determination of Foreign Exchange Swaps and Foreign Exchange Forwards Under the Commodity Exchange Act, 77 FR 69694 (Nov. 20, 2012).
2 See Transcript of Global Markets Advisory Committee Meeting, Oct. 9, 2014, available at www.cftc.gov/idc/groups/public/@aboutcftc/documents/file/gmac_100914_transcript.pdf (GMAC Tr.).
3 CEA Section 2(h)(8); 7 U.S.C. § 2(h)(8). The trade execution provisions of the Act pertain to designated contract markets as well, but I will confine my remarks to trading on SEFs.
4 Process for a Designated Contract Market or Swap Execution Facility to Make a Swap Available to Trade, Swap Transaction Compliance and Implementation Schedule, and Trade Execution Requirement Under the Commodity Exchange Act, 78 FR 33606 (Jun. 4, 2013).
5 The factors include: (1) whether there are ready and willing buyers and sellers; (2) the frequency or size of transactions; (3) the trading volume; (4) the number and types of market participants; (5) the bid/ask spread; or (6) the usual number of resting firm or indicative bids and offers. 17 C.F.R. 37.10(b).
6 78 FR at 33613.
7 17 C.F.R. 37.9(a)(2).
8 GMAC Tr. at 57-62, 65-67.
9 See Interpretive Guidance and Policy Statement Regarding Compliance With Certain Swap Regulations, 78 FR 45292 (Jul. 26, 2013).
10 GMAC Tr. at 66-67, 80-82, 86-91.
11 CEA Section 1a(50); 7 U.S.C. § 1a(50).
12 See Transcript of Public Roundtable: The Made Available to Trade Process, Jul. 15, 2015, available at http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/transcript071515.pdf.
13 See, e.g., id. at 120-121, 125-127. See also Investment Company Institute Comment Letter Regarding the Made Available to Trade Process (Aug. 17, 2015), available at http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=60468&SearchText=.
14 See Feedback Statement, Consultation on the Clearing Obligation for Non-Deliverable Forwards, Feb. 2, 2015, available at http://www.esma.europa.eu/system/files/2015-esma-234_-_feedback_statement_on_the_clearing_obligation_of_non_deliverable_forward.pdf.
15 CFTC Commissioner J. Christopher Giancarlo, Pro-Reform Reconsideration of the CFTC Swaps Trading Rules: Return to Dodd-Frank, White Paper (Jan. 29, 2015) available at http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/sefwhitepaper012915.pdf.
16 Statement of Commissioner J. Christopher Giancarlo on the Commodity Futures Trading Commission’s Recent Steps to Improve its Swaps Trading Regulations (Apr. 27, 2015), available at http://www.cftc.gov/PressRoom/SpeechesTestimony/giancarlostatement042715.
17 Statement of Commissioner J. Christopher Giancarlo, Six Month Progress Report on CFTC Swaps Trading Rules: Incomplete Action and Fragmented Markets (Aug. 4, 2015) available at http://www.cftc.gov/PressRoom/SpeechesTestimony/giancarlostatement080415.
18 Food, Conservation, and Energy Act of 2008, Pub.L. 110-246, 122 Stat. 1651, 2189-2204 (2008).
19 See Regulation of Off-Exchange Retail Foreign Exchange Transactions and Intermediaries, 75 FR 55410 (Sep. 10, 2010).
20 G-20 Leaders’ Statement, The Pittsburgh Summit, Sept. 24-25, 2009 at p. 2, available at http://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf.
21 Id. at 7.
Last Updated: September 24, 2015