Keynote Speech of Chairman Timothy Massad before the Commodity Markets Council
February 1, 2016
Thank you so much, Charlie for that warm introduction.
I’m particularly pleased to be here today. For those of you who live on the east coast, I know you are pleased to be here as well. Last week, Washington was hit with one of the worst blizzards in its history. We’re all still digging out, and so it’s nice to be near a beach where you can shovel sand, rather than be at home shoveling snow.
I always enjoy meeting with commercial end-users of the derivatives markets. Most Americans don’t participate in these markets. And as a result, these markets, and the work of the CFTC, is not always well understood.
But you understand the importance of these markets – which help companies such as yours manage routine commercial risk.
You understand that the derivatives markets impact the lives of almost every American – by shaping the prices we all pay for food, energy, and many other goods and services. They enable farmers to lock in a price for their crops, utilities to manage their fuel cost, and manufacturers to hedge the price of industrial metals. They enable exporters to hedge foreign exchange risk and businesses of all types to lock in borrowing costs.
Certain types of derivatives did intensify the global economic crisis, which caused trillions of dollars in losses to our economy and to American families. We must never forget the toll inflicted on millions of individuals during that time. But we also must remember that commercial end-users were not the cause of that crisis, and should not bear the burdens of reforms designed to rein in systemic risk.
As a result, since I took office, I and my colleagues, Commissioners Giancarlo and Bowen, have all expressed our commitment to protecting commercial end-users from overly onerous regulatory burdens. And since that time, we have made significant progress.
So, today I’d like to discuss some of the recent actions we have taken – in areas such as recordkeeping requirements, margin requirements for uncleared swaps and in other areas. Then I’d like to discuss some of the issues on our agenda for the first part of 2016 that may be of interest to you.
Simplifying Recordkeeping Requirements
So let me start with some recent actions. First, the Commission recently acted to help ease reporting burdens for commercial participants. In mid-December, we adopted significant changes to a rule that will reduce recordkeeping obligations for commercial end-users. This final rule, unanimously approved by the Commission, amends recordkeeping requirements set forth under Commission Regulation 1.35. First implemented in 1948, this regulation requires various types of market participants to keep written and oral records of their commodity interest and related cash or forward transactions. It is very important to our efforts to ensure our markets are strong, transparent, and operate free of fraud and manipulation.
Last month, we revised the rule so that members of exchanges and swap execution facilities not registered with the Commission—such as end-users—do not have to keep pre-trade communications or text messages. Further, we have simplified the requirements for keeping records of final transactions. The amended rule also states that commodity trading advisors do not have to record oral communications regarding their transactions.
The rule changes help strike an appropriate balance between the costs of recordkeeping and the benefits to market oversight. It will help ensure that businesses, farmers and ranchers that depend on the derivatives markets are able to continue using them effectively and efficiently. I know these changes are important to many of you. I want to thank all of you who commented on the proposed rule; your input was very helpful.
Margin for Uncleared Swaps
We also kept the interests of commercial end-users top of mind as the Commission finalized its rule setting margin requirements for uncleared swaps.
Our margin rule is one of the most important elements of swaps market regulation set forth in the Dodd-Frank Act. There will always be a large part of the market that is not cleared – many swaps are not suitable for central clearing and our clearinghouses will be stronger if we exercise care in what is required to be cleared. And in the absence of clearing, margin requirements protect against posing excessive risk to the system.
Our rule does not require swap dealers to collect margin from end-users. I know that is important to many of you. The banking regulators also changed their rules, in the course of working with us, to the same standard.
The rule we have adopted is strong and sensible. We’ve focused it on where the primary risk is – the uncleared swaps between large financial institutions, because we want to prevent one default from leading to further defaults, given the interconnectedness of our financial system. It requires swap dealers and major swap participants to post and collect margin with financial entities with whom they have significant exposures. It requires initial margin, which is designed to protect against potential future loss on a default, as well as variation margin, which serves as mark-to-market protection.
Our handling of how our rule should apply to inter-affiliate transactions was in large part to strike the proper balance between benefits and costs. Inter-affiliate transactions are not outward-facing and thus do not increase the overall risk exposure of the consolidated enterprise to third-parties. We were concerned that imposing the exact same standards on these internal activities of consolidated entities is likely to significantly increase costs to end-users without any commensurate benefit.
But we must have appropriate protections to help ensure the safety and soundness of swap dealers. So we require that full variation margin be exchanged for all inter-affiliate swaps. We require initial margin in certain cases, in order to prevent evasion of the requirements to collect margin from third parties and to protect insured depositary institutions. And we require that inter-affiliate swaps be subject to a centralized risk management program appropriate to monitor and to manage these risks.
Centralized Treasury Unit Legislation
Further, we recently worked with lawmakers on Capitol Hill and the Administration on legislation that would assist end-users that use “centralized treasury units” or CTUs.
Specifically, the legislation ensures that an end-user company that uses a CTU to streamline and manage all its derivatives activity would continue to be exempt from margin and clearing requirements that are designed for financial institutions.
The measure recently became law as part of the recent transportation bill. It is important to many American businesses. And now that it has become law, the CFTC is working to implement these Congressional changes.
De Minimis Threshold
In November, the Commission addressed another issue that may have an impact on the derivatives market for commercial entities when staff released a preliminary report 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 know, if an entity engaged in swap dealing exceeds that threshold –which is currently $8 billion dollars in notional amount of swaps over the year – it must register as a swap dealer, in which case capital and margin requirements as well as disclosure, recordkeeping and other requirements apply. The rule also provides that in about two years, 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 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 our staff report aims to start that conversation, by taking a fresh look at the issue. The staff’s preliminary report does not make a recommendation as to what the level should be. It instead explores the issues, and invites public comment on the data, the methodology and the issues discussed.
The comment period on this study recently closed. We will now begin the process of carefully studying the feedback we’ve received, producing a final report, and making a decision on what, if any, action to take.
Relief for Small Banks and CDFIs
Let me mention another recent action that pertains to small banks, which reflects our desire to be attentive to the needs of smaller participants in our markets and to make sure our rules do not impose undue burdens on them. Just a few weeks ago, CFTC staff issued no-action relief from our swap clearing requirement to Community Development Financial Institutions, and small bank holding companies and savings and loan holding companies with consolidated assets of $10 billion dollars or less. Provided these institutions meet our end-user exception and comply with certain other conditions, they may elect not to clear their swap transactions.
Additional Actions for End-Users
Although I just discussed a number of the most recent steps we’ve taken to address the concerns of commercial end-users, they are not the only ones. Since I took office, I -- and the other Commissioners – have been actively listening to market participants and taking a number of actions to address their concerns. And we have made some important changes – in an effort to be responsive to these concerns.
Let me highlight a few from last year, as well as some follow-up steps we are considering.
Customer Protection/Margin Collection. For example, last year the Commission unanimously approved a change to the “residual interest” rule. This is an important aspect of our customer-protection related rules, designed to help prevent future insolvencies like the failure of MF Global – and to protect customers in the event it does happen. To address a concern of many in the agricultural community and many smaller customers regarding the posting of collateral for their trades, we removed a provision that would have automatically changed the deadline for futures commission merchants to post “residual interest,” which, in turn, can affect when customers must post collateral. So the Residual Interest Deadline remains at 6:00 pm on the next day after a customer’s accounts become undermargined.
The rule requires a study on implementation. And I want to make sure we have the benefit of input from you and others who may have views on this. So, we expect to have a staff roundtable sometime in the next few months on the issue of how this rule is working in practice. We welcome your input, and we will have more to say about that roundtable soon.
Volumetric Optionality. The Commission also clarified when certain agreements that include volumetric optionality provisions are forward contracts, rather than swaps. These types of contracts are widely used by a variety of end-users, including electric and natural gas utilities. By clarifying how these agreements will be treated for regulatory purposes, the interpretation is intended to make sure commercial companies can continue to conduct their daily operations efficiently.
Public Utility Companies. We have taken other actions since I took office to make sure these markets work for commercial end-users. These have included amending our rules so that local, publicly-owned utility companies can continue to effectively hedge their risks in 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.
Future Areas of Interest
Now, let me say a brief word about some additional things we are working on that will be of interest to you.
The first is trade options. I am hoping that soon, the Commission will finalize proposed rule changes related to trade options, which are a type of commodity options. Our proposal would eliminate the obligations of commercial participants to report trade options to swap data repositories. This would include eliminating the requirement to file “form TO.”
I strongly support finalizing this proposal. Trade options products are commonly used by commercial participants, and this relief will help them continue to do so efficiently. Many of the comments we received on the proposal were supportive, and several asked us to consider further eliminating some requirements on commercial participants. While I cannot speak for my fellow Commissioners, I am optimistic that we can responsive to some of those requests, and hope this can be completed in the near future.
Related to trade options, we have heard industry comments regarding peaking supply and capacity contracts. I know many of you have raised concerns about the appropriate treatment of these products, which many end-users rely on to ensure they have the appropriate supply of commodities needed to run a business, manufacture a product, or generate electricity. I have asked the staff to look at this. And while again, I cannot speak for my fellow Commissioners, I would support the Commission providing guidance or otherwise addressing this issue.
Second is position limits. We continue to work on finalizing these important rules.
I know all of you are very interested in these rules and have expressed some concerns about them. None of us currently on the Commission were in office when these rules were proposed, and therefore we are taking time to listen to you and other market participants and consider the proposals very carefully. In particular, we’re listening closely to your concerns about bona fide hedging. We understand the significance of these rules to the ability of commercial end-users to continue to use the markets efficiently for risk management and price discovery.
We recently proposed to modify the aggregation provisions of the rules. These changes are designed to streamline the process for waiving aggregation requirements when one entity does not control another’s trading, even if they are under common ownership.
We are also considering the possibility of further modifications, which would have the exchanges play a greater role in granting exemptions for non-enumerated hedges. We have discussed this at our advisory committee meetings, which many of you have attended, and we are continuing to study it.
We’re also continuing to gather information on deliverable supply estimates so that limits are set accordingly.
I’m not going to announce a timetable for finalizing the rule but I can assure you we are working hard.
Finally, we will continue to work to prevent excessive risk and promote stability in the financial system, something which benefits all market participants.
A primary focus here will remain clearinghouse strength and resiliency generally. There are considerable efforts going on domestically and internationally to look at a range of issues to make sure clearinghouses are strong and safe. It’s very important to do this in a manner that supports the liquidity of these markets. The issues include developing standards for stress-testing, and working on recovery and resolution planning.
On the subject of clearinghouses, let me note that that today we are announcing the approval of the registration of Eurex Clearing as a clearinghouse. Eurex Clearing is one of the largest clearinghouses in Europe, and we are pleased they have registered with the CFTC. This is an important step forward to enhance global trading.
Let me also note that we have been continuing to work with the European Commission on the issue of “equivalence,” so that European firms can continue to do business with our clearinghouses. I have always believed there is an ample basis for the European Commission to declare us equivalent.
It is important that a determination of equivalence happen soon, particularly because the European clearing mandate is scheduled to take effect in a few months, and it’s important that we avoid market disruption. I know Commissioner Jonathan Hill of the European Commission shares that concern and wants to bring this to closure. So I’m hopeful they will act and a determination will be issued soon.
Let me turn to some other matters on our agenda. Late last year the Commission unanimously proposed two new rules that, once implemented, will help make our markets more stable and secure. The first would enhance cybersecurity protections. This is one of our top priorities. The risk of cyberattacks is one of the greatest threats to the orderly functioning of our markets. Our proposal seeks to make sure that the critical market infrastructure that we oversee--the exchanges, swap execution facilities, clearinghouses and swap data repositories—have adequate protections against cyberattacks and similar technological risks.
The second is a proposal to address the increased use of automated trading in our markets, which has dramatically expanded in recent years. Our proposal seeks to minimize the risk that automated trading will result in disruptions in the markets by requiring adequate risk controls, monitoring and other measures. Both of these are significant proposals – and both are still open for comment. We hope to process this feedback and finalize these rules later this year, which will help ensure our markets remain strong, resilient and poised for growth.
Finally, let me just say that with the many things on our agenda, and our desire to be responsive to market participants and in particular end-users, I was disappointed that, as a part of last year’s federal spending bill, the CFTC received no budgetary increase. As you know, our responsibilities were greatly expanded after the crisis, and our markets have grown enormously in size, importance and technological complexity.
But the CFTC’s appropriation simply doesn’t match our responsibilities. The markets we oversee are critical to commercial businesses, and profoundly affect the prices all Americans pay for many goods and services in our daily lives. Sensible regulation requires adequate resources, and is a good investment for our economy. So we’ll continue working to ensure Congress understands the important work we do.
Thank you so much for inviting me here today to discuss what we’re working on at the CFTC. These are just some of the actions we have taken – or are planning to take – to make sure these markets work for commercial end-users. We will continue to focus on that goal. And I want to underscore that my door is open, and that we are always willing to hear your views and concerns.
Thank you and I’d be happy to take your questions.
Last Updated: February 1, 2016