Remarks of Chairman Timothy Massad before the Exchequer Club of Washington, D.C.
November 18, 2015
Thank you so much, and thank you Jerry for that wonderful introduction. I’m delighted to speak to the Exchequer Club – and add my name to the list of distinguished individuals who have done so in the past. These events are a welcome opportunity for a candid exchange of ideas on critical issues facing our society.
It’s hard to believe that next week we will celebrate Thanksgiving, and the new year will soon be upon us. The holiday season is often a time when people look back – and take stock of the year’s accomplishments.
From my perspective at the CFTC, the past year has seen continued progress in the implementation of the financial reforms agreed to by the G-20 in the aftermath of the financial crisis. In addition, we have been working to make sure our regulatory framework better serves the commercial end-users for whom the derivatives markets are so very important.
We don’t publish a summary of actions taken each year, but we just did publish our annual summary of enforcement actions for the fiscal year ended September 30. In my confirmation hearing, I emphasized that robust enforcement is critical to the integrity of our markets and I pledged to make it a priority. We have done so. Over the past fiscal year, the CFTC’s total monetary sanctions topped more than $3.2 billion dollars. This included an $800 million dollar sanction, the largest in Commission history. The Commission filed 69 new enforcement actions. This year, we brought or resolved actions related to integrity of benchmarks, improper behavior such as spoofing, traditional scams such as Ponzi schemes and precious metal frauds, and failure to comply with reporting obligations.
It’s been a busy year in many other areas as well. CFTC staff also completed hundreds of reviews of new product certifications and rule filings, as well as several foreign security index certifications. We’ve issued orders exempting clearing houses in three major countries from registration: the Japan Securities Clearing Corporation, the Korea Exchange, and ASX Clear of Australia. And in September, we approved a new clearinghouse for registration, marking the 15th to be registered with the Commission.
And the Commission has been working hard on clearinghouse resiliency, which will continue to be a key issue on our agenda.
While I could spend most of my time here today looking back at the work we’ve done, we actually still have a lot on our 2015 agenda. So today I’d like to talk about what I expect you will see from the Commission over the remaining days and weeks of this year.
First, I’d like to tell you about a report we released today on the so-called “de minimis threshold” for swap dealer registration. I’d then like to discuss a proposal related to automated trading that the Commission will consider in an open meeting next week. I’d also like to discuss a few other issues that I expect us to take up before the end of the year, which are proposals on cybersecurity and final rules on margin for uncleared swaps and trade options. Finally, I’ll say a few brief words about some of the work we’ll be focused on next year.
Indeed, the coming weeks will mark the culmination of months of effort by our dedicated and hardworking staff. Let me use this opportunity to thank them for all their efforts.
Report on the De Minimis Threshold
Now, let me talk about the preliminary report CFTC staff released earlier today on what is known as the “de minimis threshold” for swap dealing and major swap participants.
The de minimis limit was set by the CFTC and the Securities and Exchange Commission’s joint rule defining swap dealers. As you may recall, if an entity exceeds that threshold –which is currently $8 billion dollars in notional amount of swaps over the year – it must register as a swap dealer, which triggers oversight by the CFTC as well as disclosure, recordkeeping and documentation requirements. The rule also provides that about two years from now, that level will fall to $3 billion, unless the Commission takes action.
When our two agencies wrote the “de minimis exception” we originally did it without the benefit of much data.
But times have changed – and we now have data to inform the public discussion. And that reflects the great progress we have made since 2008. There was virtually no reporting on swaps at that time. Requiring reporting of swaps has put regulators in a better position to monitor the market, understand potential risks and inform policy. Market participants have better information as well, which contributes to greater competition and better pricing.
So we now have a wealth of information that we can use to have a discussion about what is the appropriate level at which to set the de minimis threshold. And today’s staff report aims to start that conversation, by taking a fresh look at the issue. It gives us a better understanding of impact of setting the level at different thresholds. Now the data isn’t perfect; we’ve had to make some assumptions, as you will see. But we at least have data with which we can estimate the number of participants who might be subject to registration and the percentage of the market that might be covered.
Let me be clear, the staff’s preliminary report does not make a recommendation as to what the level should be. It instead explores these issues, and invites public comment on the data, the methodology and the issues discussed. After receiving feedback, the staff will produce a final report, and then the Commission can decide what, if any, action to take. So we invite your comments as this process moves forward.
Improving Data Reporting. While this report is a reflection of the progress we have made in implementing reporting requirements on swaps, there is still much to do to improve that system. I outlined what we are doing to improve data collection and reporting in a speech earlier this month, which includes improving the consistency of the data. And before the end of the year, I expect that we will take action to that effect.
In December, CFTC staff expects to issue a request for comment regarding the reporting standards for a list of priority swap fields. The staff has made a dedicated effort to identify these priority areas where we believe standardization or clarification is needed. And we will use this input to develop proposals that specify the form, manner and allowable values that each data element can have. We will invite public comment on these proposals, and we encourage market participants to get together and come up with common suggestions and other ideas.
This is just one of many actions we are working on to enhance data reporting. We will take further actions in 2016.
Upcoming CFTC Open Meeting on Automated Trading
Yesterday, we announced that the Commission will hold an open meeting next Tuesday to consider a proposal related to algorithmic or automated trading. In the futures markets, almost all trading is electronic in some form. And automated trading accounts for more than 70 percent of all trading over the last few years.
Electronic trading has brought many benefits to market participants, such as more efficient execution and lower spreads. But the extensive use of automated trading in particular raises important policy and supervisory questions and concerns, including those related to operational risks, fairness and potential effects on liquidity.
We have already taken a number of steps to respond to the development of automated trading in our markets, as have the exchanges.
These included requiring exchanges to establish risk control mechanisms to prevent market disruptions, including mechanisms that pause or halt trading. We required clearing members to establish risk-based limits for all accounts based on factors such as position size or order size. We also required automatic screening of orders for compliance with risk limits if they are automatically executed.
Automated trading has also raised market integrity concerns. And we have – and will continue to – aggressively bring enforcement actions against those who engage in activities such as spoofing and other forms of manipulation.
The proposal we will consider next week focuses on mitigating operational risks, and minimizing the potential for disruptions or other operational problems. These risks may arise from the automation of order origination, transmission or execution. These risks can come about due to malfunctioning algorithms, inadequate testing of algorithms, errors and similar problems. We are concerned about the potential for disruptive events and whether there are adequate measures to ensure effective compliance with risk controls and other requirements.
I expect that our proposal will include requirements for pre-trade risk controls and other measures with respect to automated trading. These will apply regardless of whether the automated trading is high- or low-frequency. We will not attempt to define high-frequency trading specifically.
I anticipate that our proposal will be largely consistent with the best practices followed by many firms already, and they will build on what the exchanges have already done. While we would, in some cases, propose the types of controls necessary, we will not prescribe the parameters or limits of such controls.
For example, we are considering requiring message throttles and maximum order size limits. But we will not prescribe how those limits should be set. We may also propose requirements pertaining to the design, testing and supervision of automated trading systems. We’re considering measures such as “kill switches,” which facilitate emergency intervention in the case of malfunctioning algorithms.
We are considering requirements at the exchange level as well as at the clearing member and trading firm levels. We are considering whether to require proprietary traders who access the market directly and who are using automated trading – to register with the CFTC. This would ensure that all those with so-called “direct electronic access” to our markets are complying with pre-trade risk controls, testing and other requirements.
And we are also looking at whether to require measures to limit the practice of self-trading. I would also distinguish unintentional self-trading from wash trading, which is illegal. And I expect we will focus on increased transparency for market maker and trading incentive programs, which have become more significant as automated trading has increased.
Other Actions Expected in December
In addition to the automated trading proposal we will consider at next week’s open meeting, I expect that we will consider three other major issues in December.
Cybersecurity. One is on the issue of cybersecurity, or what we call “system safeguards.” In today’s markets, the disruptions that can be caused by automated trading are only one type of operational or technological risk. Of even greater concern is the risk of cyberattacks, including in particular by those looking to intentionally disrupt our financial system.
The impact an incident can have on businesses and the economy underscores the need to strengthen the security and resilience of our financial markets against cyber-attacks and technological failures. We’ve seen too many examples of how this can go wrong. And we know the interconnectedness of our financial institutions and markets means that a problem at one institution can quickly affect many others.
System safeguards are already part of the core principles and regulations with which trading platforms and clearinghouses must comply. And we focus on these issues in our examinations of clearinghouses, exchanges and other institutions. We look at whether an institution is following good practices and paying adequate attention to these risks from the board level on down.
Recently, the Commission approved the National Futures Association’s cybersecurity guidance that will require members to adopt – and enforce –policies and procedures to secure customer data and protect their electronic systems. This is an important step forward.
But I believe we should enhance this. I expect that in December, we will consider a proposal to make sure the private companies that run the core infrastructure under our jurisdiction – such as the major exchanges, clearinghouses, and swap data repositories – are doing adequate evaluation of these risks and testing of their own cybersecurity and operational risk protections.
We are concerned about information security, physical security, business continuity and disaster recovery. And the necessary testing should include control testing, vulnerability testing, and penetration testing. Such efforts are vital to mitigate risk and preserve the ability to detect, respond to, and recover from a cyber attack or other type of operational problem.
Now of course, undertaking this type of testing takes resources – resources we do not have. But these companies do. In fact, many major financial institutions have cyber budgets that are greater than our entire budget. So we will consider proposing principles-based standards on testing – to make sure these companies are following best practices.
Margin for Uncleared Swaps. We also hope to finalize our rule setting margin for uncleared swaps before the end of the year.
An important reform agreed to by the G-20 leaders was to mandate the clearing of standardized swaps. In the United States, our framework is in place – and approximately 75 percent of swap transactions are being cleared, as compared to only about 15 percent in 2007.
But there will always be a large part of the swaps market that is not centrally cleared. Some products are not suitable for clearing mandates because of liquidity concerns or other risk characteristics. And clearinghouses will be stronger if we exercise care in what is centrally cleared.
This reality underscores the importance of setting margin for uncleared swaps. Our proposed rule requires swap dealers to post and collect margin on uncleared swaps with one another – and with certain financial counterparties. It will help reduce the risk of those trades, and thus reduce the risk to our financial system as a whole.
Over the last year, we have focused on working with the prudential regulators, as well as with our international colleagues in Europe and Japan, to harmonize our margin rules as much as possible. I am pleased to say that much progress has been made. As you may know, the prudential regulators recently finalized their versions of the margin rules. And on many issues, there is far greater similarity with the current European and Japanese proposals – than compared to a year ago.
I expect that our forthcoming rules will be similar to the final rules of the prudential regulators and to those rules being considered by Europe and Japan. I expect this on a number of core issues, such as the material swaps exposure threshold – which triggers margin requirements for financial counterparties; the timetable of implementation; the acceptable types of collateral, including for variation margin; the currency of payment; and other matters. This reflects the work of our respective staffs to achieve greater harmonization.
Of course, there will be some differences. Domestically, the missions and regulatory frameworks of the CFTC and the prudential regulators are distinct – and that may lead to some differences. And there will be some differences internationally—the European proposals, for example, apply to a much larger group of institutions than do ours. But we remain committed to harmonizing with our international and domestic colleagues as much as possible.
Trade Options. I expect the Commission to also consider finalizing our proposed rule changes related to trade options, which are a subset of commodity options. In April, the Commission proposed to eliminate some obligations of commercial participants to report trade options to swap data repositories, including by eliminating the requirement to file “form TO.”
Trade options products are commonly used by commercial participants, and such relief would help them continue to do so efficiently. I believe strongly that we must continually assess the costs of reporting obligations and eliminate those reporting obligations that do not provide sufficient benefit.
These are the key areas where I expect we will see action before the end of the year. Let me make it clear that the Commission is still considering these issues, and has not yet decided to take any of the actions that are to be considered at next week’s open meeting or in December. So my comments reflect my own views. And of course, any proposals will be subject to public comment. We always look forward to public input.
Of course, there is a lot of other work going on today that will lead to action in 2016. Clearinghouse resiliency is a big issue, and there are considerable efforts going on domestically and internationally to look at a range of issues to make sure clearinghouses are strong and safe.
Our staff is also working hard on swap execution facility registrations. Twenty-two platforms are temporarily registered. And for the platforms that have provided complete information to us, we expect to make determinations of permanent registrations by early 2016.
In the area of swaps trading, I expect we will also consider formalizing a number of the “no action” letters and guidance we have issued over the past 18 months through rulemaking proposals. We will also consider some additional issues, such as the “made available to trade” determination process.
And now that ESMA has published the MiFiD II technical standards, we are also working to understand differences in our respective rules – in order to make progress toward harmonization and mutual recognition.
Our staff is working hard to finalize rules related to position limits, and once margin requirements for uncleared swaps are finalized, we will turn to capital for swap dealers.
These are just a few highlights; there is work going on in other areas. But regardless of the area, a key focus that cuts across all of our work has – and will continue to be – to ask ourselves: are these markets working well for the commercial end users who depend on them to hedge routine commercial risk? And what can we do to further that objective? We have taken a number of actions over the last year to fine tune rules and make other changes in support of that objective, and we will continue to do so.
Thank you again for allowing me to give my version of our holiday list. As you can see, we have a lot we hope to do before the holidays come, and plenty to look forward to in the new year.
Thank you for inviting me here today. I’d be pleased to take some of your questions.
Last Updated: November 18, 2015