Remarks by Chairman J. Christopher Giancarlo at FIA Japan, Tokyo, Japan
A New Approach to Cross-Border Swaps Reform:
One Market, One Regulator, One Set of Rules
September 11, 2018
It is time to recognize the systemic risk to the global financial system of dividing global markets for institutional commercial risk transfer into a series of limited and divided trading pools based on the inconsequentiality of corporate nationality. The time has come to complete the important mission of global swaps reform in a manner that is harmonious and effective without fragmenting world markets.
Good afternoon. I am delighted to be speaking to you at FIA Japan. I wish to thank Yasuo Mogi, Richard Clairmont and Mike Ross for organizing this year’s seminar. Ear-lier today, I had the great pleasure to meet with JFSA Commissioner Endo and Vice Minister Himino, who I admire enormously.
I am delighted to be back in Japan, and particularly Tokyo. Tokyo is a vibrant, thriving hub of financial, commercial and artistic activity. From the captivating cityscapes to the dynamic culture, the city is an intricate mix of tradition and modernism. It fuses the past and present together like no other place in the world. This city is truly unique.
Tokyo is also one of the command centers of the world economy where innovations in economic, financial and business activities are continually evolving. I believe these innovations are essential for the growth and prosperity of the Japanese and global economy. And it is in the spirit of innovation that I would like to talk to you today. I would like to discuss my proposal to update and improve the CFTC’s cross-border swaps framework, which I will be formally setting out in a white paper to be published in the next few weeks.
In updating the CFTC’s cross-border approach, I aim to achieve three objectives:
- to increase the CFTC’s cooperation with other global regulators, like the JFSA, in order to reduce duplicative regulation and redundant supervision;
- to rationalize our sometimes overlapping and overly burdensome regulations that have led to higher costs and operational complexity for market participants; and
- to reduce dangerous market fragmentation and foster deep and consolidated liquidity pools that are essential to the resiliency and systemic stability of our financial markets.
I believe this approach is not only mandated by the Dodd-Frank Act and an appropriate use of the CFTC’s capabilities and resources, but it will also enhance market health and resiliency in global markets, such as Tokyo, which is a critical global market for swaps trading and clearing. Indeed, in my view, the CFTC and the JFSA regimes share many symmetries – not just with respect to derivatives regulation, but in a greater sense with respect to our shared commitments to the G20 reforms, market integrity and vigor.
Updating the CFTC’s Cross-Border Framework.
As I explained in London last week, financial regulators around the world have made tremendous progress in implementing the reforms set forth by the G20 leaders in Pitts-burgh in 2009. In the last five years, there has been a flurry of global regulatory activity, including the implementation of trade reporting requirements, central clearing mandates, margin requirements for non-centrally cleared derivatives, and capital requirements for non-centrally cleared derivatives. While the CFTC was one of the first regulators to implement many of these reforms, and merits praise for its leadership in the G20 swaps reform initiative, it does not mean that the CFTC got every aspect of its implementation efforts right in its first attempt.
Problems with the CFTC’s current cross-border approach
I have spent the past five years observing how the CFTC’s approach to cross-border swaps regulation has impacted global markets – not just U.S. markets, but also markets in financial centers such as Tokyo. The CFTC’s approach to imposing CFTC transaction rules on swaps traded by U.S. persons even in jurisdictions committed to implementing the G20 reforms is an over-expansive assertion of our jurisdiction. It is based on a flawed factual premise – namely, the idea that every swap a U.S. person enters into, no matter where and how transacted, must be subject to CFTC swaps regulations. Our miscalculation has resulted in a number of problems and unintended consequences, including the following:
- it is over-expansive, unduly complex and operationally impractical;
- it is conceptually inconsistent in utilizing a “U.S. entity” test for swaps activity abroad and a “territorial” test for swaps activity in the United States;
- it relies on a substituted compliance regime that applies an arbitrary rule-by-rule com-parison of CFTC and non-U.S. rules under which a transaction or entity may be subject to a patchwork of U.S. and non-U.S. regulation;
- it demonstrates insufficient lack of deference to non-U.S. regulators that have adopted comparable swaps reforms for their jurisdictions, which is, in fact, inconsistent with the CFTC’s history of applying the principles of international comity to comparable non-U.S. regulation;
- it fails to distinguish between those swaps reforms designed to mitigate cross-border risk and those swap reforms designed to address trading and operational practices such as transactional procedures that are suitable for tailoring to local trading conditions and market customs; and
- it has driven global market participants away from transacting with entities subject to CFTC swaps regulation and caused fragmentation of what were once global markets into a series of less liquid, separate liquidity pools that are less reliant to market shocks, thereby increasing systemic risk rather than diminishing it.
It is time to address this issue. It is time to recognize the systemic risk to the global fi-nancial system of dividing global markets for institutional commercial risk transfer into a series of limited and divided trading pools based largely on the inconsequentiality of corporate nationality. Fragmented pools of trading liquidity are shallower, more brittle and less resilient in the event of sudden market events, resulting in higher price and transaction volatility. Such fragmentation of global swaps markets is not prescribed by the Pittsburgh swaps reforms, nor is it justified as an unavoidable by-product of reform implementation. The time has come to complete the important mission of global swaps reform in a manner that is harmonious and effective without fragmenting world markets.
Last week in Europe, I described a new approach to the cross-border implementation of swaps reform that is focused on mitigating systemic risk transfer across borders while affording regulatory deference to trading jurisdictions that have adopted comparable swaps reforms. The goal is to better calibrate global swaps reform in a cooperative manner across jurisdictions to enhance market durability, increase trading liquidity and stimulate broad-based economic growth and revival.
In jurisdictions that have adopted G20 swaps reforms that are comparable on an out-comes-basis with the CFTC’s swaps framework, my approach would reconstitute currently divided liquidity pools into consolidated trading markets under one sovereign regulator and one set of comparable swaps rules. In Vienna, one experienced industry observer dubbed the approach the “One-One-One Plan”, meaning each jurisdiction should have one undivided trading market, one competent regulator and one set of trading rules appropriate to local market conditions. This approach achieves two goals. First, it enhances financial stability and resiliency of global markets by consolidating sufficiently deep liquidity pools to better respond to market volatility. Second, it promotes the development and growth of global markets, including here in Japan.
Turning the page
To construct a more balanced and appropriate cross-border approach, I have set out a series of principles.
The first principle is distinguishing between swaps reforms that focus on market structure and trading practices, on the one hand, and those swaps reforms that focus on global systemic risk concerns, on the other. For the former, we should show greater deference to non-U.S. regulatory authorities’ rules designed to address local market structure and trading practices. For example, whether or not a non-U.S. trading venue requires a request for quote from three or ten dealers has almost nothing to do with transfer of counterparty risk to the U.S. financial system. Thus, the CFTC should not seek to regulate and oversee that behavior. Rather, the focus of its cross-border over-sight should be with respect to cross-border activity that has direct systemic risk considerations for the U.S. markets.
When it comes to swaps reforms that do involve global systemic risk transfer, another principle is the pursuit of multilateral coordination to achieve strong levels of comparability on the basis of comity, but not identicality. The alternative world is one in which every regulator asserts global jurisdiction over swaps trading abroad by their home-domiciled institutions. This in turn leads to overlapping, duplicative and even inconsistent regulations that would be deleterious to the global economy.
In turn, regulation of U.S. swaps markets can and will only be done by U.S. regulatory authorities, not by others. The CFTC has exclusive statutory responsibility in this area, and it will be a rule maker for these markets, not a rule taker of foreign swaps rules. The CFTC will decide what is appropriate regulation for U.S. markets and market participants, just as other non-U.S. regulators should be expected to act as rule makers for their jurisdictions. The CFTC has been successfully regulating derivatives trading for decades and has extensive systems, capabilities and experience. The CFTC has every right to expect that non-U.S. regulators defer to it on oversight of U.S. derivatives trading markets.
Another principle is the utilization of a flexible, outcomes-based approach to substituted compliance. The CFTC has a long history of working collaboratively with non-U.S. regulators, and we have tried to do so in our substituted compliance program. But we need to rethink our rule-by-rule approach. Where there is a sufficient level of regulation to justify a comparability assessment in the aggregate, we can streamline our substituted compliance determinations. We also need to avoid including conditions or complexity when it is not needed. Particularly for swaps execution and cross-border activities of swap dealers, we should all recommit ourselves to deference processes (such as equivalence and substituted compliance) to increase regulatory harmonization and reduce market balkanization.
Following these principles, I am recommending that the CFTC adjust our current cross-border approach in a number of ways. One adjustment is with respect to the expansion of the CFTC’s use of its exemptive authority for non-U.S. CCPs that clear swaps. If the non-U.S. CCP is regulated comprehensively in a jurisdiction that has comparable regulations to the CFTC’s regime, and does not pose substantial risk to U.S. markets, the non-U.S. CCP should be able to seek exemption from registration as a derivatives clearing organization (DCO). The exemption would permit such non-U.S. CCPs to pro-vide clearing services to U.S. customers indirectly through non-U.S. clearing members, without the non-U.S. CCP or its non-U.S. clearing members having to register with the CFTC as a DCO or futures commission merchant (FCM), respectively.
This is analogous to how non-U.S. CCPs clear foreign futures through the CFTC’s Parts 30 and 48 regimes without registering in the United States. This is a balanced approach, ensuring the same treatment for both the futures and swaps markets and demonstrating a commitment to deference as a pillar of the CFTC’s cross-border framework.
Similarly, the CFTC should exempt non-U.S. trading venues from registering as swap execution facilities (SEFs) if they are subject to comparable and comprehensive regulation elsewhere. Generally, the particular mechanics of swaps trade execution on a regulated trading platform supervised by a competent, non-U.S. regulator that has adopted comparable swaps reforms generally does not present concerns of global systemic risk requiring the imposition of the CFTC’s particular form of trading rules.
Symmetries with Japanese regulatory approach
When I considered the CFTC’s cross-border reform approach and recommendations, I noted the symmetries with JFSA’s recent decision to adopt a more substantive, forward-looking and holistic approach to its framework. Both the CFTC and the JFSA have reflected on how we each have implemented the recent reforms.
As former JFSA Commissioner Mori observed, we need to be mindful of the cumulative impact of the many forms of medicine that regulators have delivered to the economy and we should consider whether our reform efforts are addressing the root causes of the financial crisis and meeting the goals of the G20 reforms.[i]
We do need to be flexible in our implementation because over time our rules will require adjustment as the circumstances in the swaps markets change and the effects of our initial reform efforts become known to us and market participants. I completely agree with the JFSA that:
- our mutual goal of financial stability must be balanced with sustainable growth;
- we need to assess the unintended consequences of our regulations; and
- we must adopt a “forward-looking” approach, for the future threats may differ from the past threats.[ii]
This is perfectly aligned with my views on how to implement a balanced cross-border approach. It is important to not just focus on individual parts but look at the “total picture.”
For example, consider the principle of conducting CFTC’s substituted compliance through a holistic lens that promotes consistency between regulatory frameworks. This is far better than a rule-by-rule comparison premised on the mistaken belief that all global markets and market participants are identical and should be regulated and supervised exactly the same.
Sometimes the solution is not always more detail, more regulation or greater quantity of rules. Sometimes the solution is simply better regulation.
The stakes are high. Global swaps reforms, properly coordinated, should foster sustainable growth. They should not divide global markets into a series of ever smaller, more fragile and less durable pools of trading liquidity that is a threat to market resiliency.
The CFTC and the JFSA oversee some of the world’s largest derivatives markets. It is perhaps overlooked globally, but never by either of us, that we fit well together. We share a like-minded vision of a balanced and effective implementation of G20 reforms that is in accord with sustainable growth. Our symmetries benefit both of our economies.
I conclude by providing a concrete example. Last month, the CFTC issued an Order of Registration to Osaka Exchange to provide its members with direct access to its electronic order and trade matching systems. The registration of Osaka was premised on deference – that the laws of Japan are consistent with the laws of the United States. This deference gives market participants in both of our jurisdictions the opportunity to develop their business and to prosper without sacrificing our need as regulators to vigilantly maintain the financial stability offer markets. This is a winning formula. One I hope we can repeat many more times in the future.
The time has come to complete the mission of global swaps reform in a manner that is harmonious and effective without fragmenting world markets. I thank you, our dear Japanese friends and colleagues, for being our partners in that vitally important mission.
[i] Rethinking Regulatory Reforms, Remarks by Nobuchika Mori, Commissioner, Financial Services Agency, Japan, at Thomson Reuters 6th Annual Pan Asian Regulatory Summit, Hong Kong (Oct. 13, 2015), available at: https://www.fsa.go.jp/common/conference/danwa/20151013/01.pdf.
[ii] Creating Economic Opportunities and Shared Value in Society, Speech by Nobuchika Mori, Commissioner, Financial Services Agency, Japan, at the Annual Conference of U.S. - Japan Council, Washington, D.C. (Nov. 17, 2017), available at: https://www.fsa.go.jp/common/conference/danwa/20171113.pdf.