Remarks of Chairman Timothy Massad before the Energy Risk Summit USA 2015
May 12, 2015
As Prepared For Delivery
Thank you for inviting me today, and I thank Paul for that kind introduction. It’s a pleasure to be here. I say that in particular because I lived here as a child and still have family here. My father worked in the oil industry, and so we lived in many of the well-known oil towns in this country, including Midland, Texas and Morgan City, Louisiana, in addition to Houston. We eventually moved to Connecticut when he started working in New York. And while my parents in their retirement and my siblings all migrated back to Texas, I was the black sheep of the family who mostly stayed in the Northeast.
I did return to Midland while in college, and spent a summer working for what was then called a mud company. I guess they are called drilling fluids companies today – the companies that provide the sand and chemicals that are mixed with water and pumped down a well. Those were the days when fracking was purely vertical. My job was to load 50 pound sacks onto a flatbed truck, drive out to a rig, unload the bags, and then do it again. It was hard work. I didn’t learn much about fracking. But I did come to appreciate the tough work that goes on around an oil rig.
So I am pleased to be here at a conference on energy risk.
There may be no industry that illustrates how quickly risk can change in the private sector than what has happened in the oil and gas industry recently. The shale revolution has changed long-held, fundamental assumptions about our domestic production capabilities. And the decline in price we have witnessed has surely provided challenges for all of you.
I know also that regulatory change is a separate type of challenge for you. Having worked in the private sector as a lawyer for many years, having advised businesses trying to plan investments and strategies, I appreciate the value of predictability and certainty in regulation. I am committed to trying to provide that as much as possible.
This is not easy, of course, given the challenges that face us. As an agency, we have had the responsibility of implementing a dramatic change to our financial regulatory framework, which is to bring oversight and transparency to the over-the-counter swaps market. This is a market that became global before it was regulated. As with the futures market which we have traditionally overseen, the swaps market has served the needs of commercial end users very well. But we saw in 2008 how the swaps market generated excessive risks that were not well understood, and that contributed to the intensity of the worst financial crisis since the Great Depression. Our country lost eight million jobs and thousands of businesses were shuttered. I spent five years helping our nation recover from that crisis. It staggers my imagination, even today, that the U.S. government had to commit $182 billion to prevent the collapse of one company, AIG, as a result of its excessive swap risk.
So, as I see it, the need for a sensible regulatory framework is clear. Our challenge today is to implement this new regulatory framework in a way that achieves the important goals of bringing some transparency, sensible oversight and prevention of excessive risk, while making sure that these markets still function effectively and efficiently for the many commercial firms that depend on them. After all, that should be the ultimate purpose of the derivatives markets – to help commercial companies manage their risks.
We have a commission of four individuals today who bring very valuable experience and a pragmatic outlook to that task. I know you will also hear from Commissioner Giancarlo tomorrow, and I am delighted to be working with him. We may not always agree, but I think we are all working together constructively.
Today I want to discuss a few of our priorities and some of the specific agenda items we are working on that I think will be of interest to you. These priorities include addressing concerns of commercial end users, finishing the rules that Congress has required we implement; clearinghouse resiliency; and some recent enforcement cases on benchmarks and automated trading that also raise policy issues. I then would be happy to take your questions and hear your thoughts.
Addressing Concerns of Commercial End Users
One of my priorities since taking office has been to address concerns of commercial end-users, to make sure they can continue to hedge risk effectively in these markets. We have taken several actions in this area. Let me turn to some specifics.
Embedded Volumetric Optionality. Last month, the Commission voted to finalize a proposal we made in November regarding contracts with embedded volumetric optionality – a contractual right to receive more or less of a commodity at the negotiated contract price. Specifically, we proposed to clarify when a contract with embedded volumetric optionality will be excluded from being considered a swap. I know contracts with this feature are important to many of you. We received a number of comments on this and we have incorporated some of the concerns in the final clarification. Today, I am pleased to announce that, following action by the SEC last week, we are today releasing the final interpretation. By clarifying how these agreements will be treated for regulatory purposes, the interpretation should make it easier for commercial companies to continue to use these types of contracts in their daily operations.
Trade Options. Also last month, the Commission voted to issue a proposed rule revising the rules regarding trade options, which are a subset of commodity options. Specifically, the proposal would reduce reporting and recordkeeping requirements for trade options, including by eliminating the requirement to file Form TO. These products are commonly used by commercial participants, so this action should help those participants continue to do so cost-effectively.
Special Calls. The Commission also recently revised its procedures concerning special calls. We actually make two types of requests for information that are called special calls. Some are truly special – infrequent requests triggered by unusual market activity or some other event observed by our surveillance team. Another is a more routine request automatically triggered when a market participant trades above set levels, in which case we ask for very limited information to help us reconcile transactions with position data. We discovered our system for making these latter requests was generating too many of them. So we notified some who received these requests that they did not need to complete them, and we made adjustments to fix the problem going forward.
Utility Special Entities. Last fall, we made it easier for local utility companies to access the energy swaps market. These companies, which keep the lights on in many homes across the country, must access these markets efficiently in order to provide reliable, cost-effective service to their customers. The Commission unanimously approved a change to the swap dealer registration threshold for transactions with special entities which will make that possible.
Reporting of Illiquid Swaps. CFTC staff also granted relief from the real-time reporting requirements for certain less liquid, long-dated swap contracts. The staff did so because it recognized that in a very illiquid market, immediate reporting can undermine a company’s ability to hedge.
Regional Transmission Organizations. The Commission has previously exempted regional transmission organizations, or “RTOs,” from registration and other Commission regulatory requirements because they operate under a regulatory framework established by the Federal Energy Regulatory Commission. We are presently working on a similar exemption application submitted by Southwest Power Pool.
Treasury Affiliates. The Commission staff has also taken action to make sure that end-users can use the Congressional exemptions given to them regarding clearing and swap trading if they enter into swaps through a treasury affiliate.
Customer Protection/Margin Collection. In March, the Commission unanimously approved a final rule to modify what is known as our “residual interest” rule. This rule can affect when customers must post collateral with clearing members. The change means the deadline to post residual interest will not move to earlier than 6:00 p.m. the day of settlement without an affirmative Commission action and an opportunity for public comment.
We have also proposed to modify reporting and record keeping requirements for commercial end-users.
We will continue to look at ways that we can make sure commercial end-users can use these markets effectively and to make sure that the new regulatory framework for swaps does not impose unintended consequences or burdens for them.
Finishing the Remaining Rules
Another priority is finishing the few remaining rules required under Dodd-Frank for the new swaps regulatory framework. Our proposed position limits rule is one.
Regarding position limits, the law mandates that the agency adopt limits to address the risk of excessive speculation. In doing so, we must also make sure that market participants can engage in bona fide hedging. This is a significant and complex rule, and one we are committed to taking the necessary time to get it right.
We have received substantial public input on all aspects of this proposal. We have heard from market participants in particular about exemptions for bona fide hedging. We recognize hedging strategies are varied and complex, and we are considering these comments carefully. It has been suggested that we rely on the exchanges with respect to the review of applications for what are known as “non-enumerated” exemptions, and we are taking a closer look at this issue. Finally, it is important that we have accurate estimates of deliverable supply of a commodity, and we have also solicited and received public input on this issue, including estimates for many commodities.
Another rule we must finish is our proposed rule on margin for uncleared swaps. This would require swap dealers to post and collect margin from their counterparties on uncleared swaps, much as is required on cleared swaps. This helps reduce the risk of those trades and the risk to our financial system as a whole. Our rule, however, makes clear that swap dealers are not required to collect margin from commercial end-user counterparties, who do not pose the same risk as large financial institutions.
Finally, let me note an upcoming issue on a completed rule. As you know, under the swap dealer rules adopted in 2012, the threshold for determining who is a swap dealer will decline from $8 billion to $3 billion in December of 2017 unless the Commission takes action. I believe it is vital that our actions be data-driven, and so we have started work on a comprehensive report to analyze this issue. We will make a preliminary version available for public comment, and seek comment not only on the methodology and data, but also on the policy questions as to what the threshold should be, and why. I want us to complete this process well in advance of the December 2017 date so that the Commission has some data, analysis, and public input with which to decide what to do.
Clearinghouse Oversight and Stability
Clearinghouse oversight continues to be a chief priority. In this post-global financial crisis world, clearinghouses play an even more critical role than before. So we need to make sure clearinghouses have strength and resiliency.
We did a major overhaul of our clearinghouse supervisory framework over the last few years. Today we are focused on having strong examination, compliance, and risk surveillance programs. And while our goal is to never get to a situation where recovery or resolution of a clearinghouse must be contemplated, we are working with fellow regulators, domestically and internationally, on the planning for such contingencies, in the event there is ever a problem that makes such actions necessary.
We have also stepped up our efforts to make sure futures commission merchants safeguard customer funds and meet their financial obligations to clearinghouses.
In addition, we are very focused on making sure clearinghouses and other market infrastructure such as exchanges are paying enough attention to cybersecurity.
Finally, enforcement is a top priority, because there is nothing more important to promoting the integrity of our markets.
Let me touch on two broad areas that also raise important policy issues: benchmarks and automated trading.
Recently, the agency along with our colleagues at the Department of Justice, the U.K. Financial Conduct Authority and New York’s Department of Financial Services announced a settlement with Deutsche Bank over charges of manipulating their LIBOR submission. As you know, LIBOR is used for a wide variety of financial contracts. The process for setting LIBOR was based on submissions by banks, but these banks were changing their submissions in order to benefit their own proprietary positions or protect their reputation. We brought the first case involving LIBOR manipulation in June 2012, and this is the sixth large bank against which we have brought such charges.
Similarly, a few months ago, we held five of the world’s largest banks accountable for their attempts to manipulate foreign exchange benchmarks.
The issue of benchmarks is important in another respect. The European Commission has proposed legislation to regulate the administration of benchmarks. This legislation could prohibit European banks and asset managers from trading products in our markets that are tied to benchmarks, unless the European Commission determines that the benchmarks are supervised in an equivalent manner.
Now as you may know, there are thousands of contracts in our markets that rely on benchmarks or other indices. These range from the S&P 500 to the many benchmarks in the energy markets put out by third parties such as Platts or Argus. And we want to do all we can to see to it that benchmarks are administered with transparency and integrity and are not subject to manipulation. But the United States does not have such a government-sponsored supervisory regime for benchmarks. That’s simply not how our system works.
I have expressed these concerns to European officials. I have encouraged them to recognize that alternatives to government regulation of benchmarks can achieve the results they desire. For example, our law gives us the power to review new proposed contracts and determine whether they may be susceptible to fraud and manipulation, and we can engage in surveillance and enforcement on an ongoing basis to identify and deter manipulation.
I have also encouraged European officials to consider the work of the International Organization of Securities Commissions (IOSCO) in this area, which the CFTC helped lead. IOSCO’s Principles for Oil Price Reporting Agencies (PRA Principles) and Principles for Financial Benchmarks set forth standards that address methodology, governance, conflicts of interest, and disclosure. The oil price reporting agencies have been voluntarily complying with these standards.
I have also encouraged European officials to consider focusing their standards on those benchmarks that are most widely used, so that smaller contracts are not subject to costs of compliance that could be prohibitive. It is especially important that we do not inhibit innovation in our markets by imposing upfront, significant costs for regulatory compliance regarding benchmarks before a contract has even developed significant liquidity.
The integrity of benchmarks and indices is vital to our financial system. I hope that we can continue to work with our international counterparts to ensure benchmark integrity in a way that recognizes that most benchmarks are not administered by, or regulated by, a government agency.
We had another recent and very important enforcement case that also raises important policy concerns. Last month, the Commission and the Department of Justice brought civil and criminal charges against an individual for spoofing in and manipulating, and attempting to manipulate, the E-mini S&P 500 futures contract on repeated occasions, at times successfully. His activity contributed to the order imbalance in trading in E-mini S&P 500 futures that contributed to market conditions that led to the flash crash of 2010. This is a complex case. We coordinated closely with the Justice Department, the FBI, and the U.K. Financial Conduct Authority on this case.
The Commission is also looking at automated trading from a policy perspective. Almost all of the trading in our markets today is electronic, and much of it is by automated trading. This is true not just for financial derivatives, but for many commodity products. For example, over 80% of the traded volumes in the Henry Hub Natural Gas futures contracts are from high speed, automated trading systems.
The Commission has taken a number of actions in response to the growth of electronic and automated trading in CFTC-regulated markets that address key steps in the order placement and trade execution process, and we are currently considering whether additional actions are necessary. In particular, we are considering comments received in response to the Concept Release on Risk Controls and System Safeguards for Automated Trading Environments that we issued in September 2013. We will make a determination in the near future on what additional measures, if any, might be necessary to address automated trading.
One of the biggest challenges we face is simply that there is more we should be doing, but the CFTC’s current budget has simply not kept up with the growth of the markets and our responsibilities. I remind our staff of the Teddy Roosevelt adage: we will do all we can, with what we have, where we are.
But without additional resources, it is difficult for us to do the job that I believe our markets need and the American people deserve.
The energy commodity markets are global and complex. Prices in these markets are important metrics that can profoundly impact the world economy. I know you face daily, difficult challenges managing risk in these often volatile markets. I believe our job at the CFTC is to create a regulatory framework that helps you manage risk, by promoting transparency, integrity, and regulatory certainty. I look forward to working with you toward those goals.
Thank you for inviting me. I would be happy to take some questions.
Last Updated: May 12, 2015