Keynote Remarks of Chairman Timothy Massad Before the Futures Industry Association Futures and Options Expo
October 19, 2016
As Prepared for Delivery
Thank you for that introduction. I’m so pleased to be back with you today. I’m also grateful to the Futures Industry Association for the critical role it plays in our industry.
In my remarks last year, I discussed five issues that were among my top priorities at the time, and I laid out what I expected in the months ahead. Today, I’d like to give you brief updates on those areas. And then I would like to discuss the subject of clearinghouse resilience and recovery.
The five issues I discussed last year were: margin requirements for uncleared swaps, automated trading, cybersecurity, swap execution facility trading, and data reporting.
Margin for Uncleared Swaps
Let me begin with margin for uncleared swaps. Last year, I talked about my desire to finalize these rules—and harmonize them with the rules of the prudential regulators and our counterparts internationally. Today, we have achieved that goal: we adopted a strong, sensible rule that is very similar to the rules of the United States banking regulators, and substantially similar to international standards. We also adopted a cross-border approach for the implementation of this rule—which helps protect against the possibility that risks created outside of the United States will flow back into the United States.
Most of you know that on September 1, our rules, and the rules of Japan and Canada, went into effect for the largest swap dealers. The European Commission also adopted EU standards earlier this month. These are likely to be in effect by early next year, assuming there are no objections from the European Parliament and the European Council.
The next implementation date is March 1, 2017, when a larger group of financial firms will be subject to variation margin requirements. Firms subject to that date should be making preparations now. I know the swap dealers worked very hard to comply with the September 1 date. There are over four months until March 1, so there’s plenty of time to get documentation in place. I encourage firms not to wait until the last minute.
In addition, I expect that other jurisdictions will soon finalize their margin rules. We understand Switzerland will follow the EU approach. Australia has just announced their rules. And we are in touch with Hong Kong and Singapore, which are working on finalizing their rules.
Margin requirements represent one of the most—if not the most—important components of the reforms of the swap market that were agreed to by the G20 leaders in response to the 2008 global financial crisis. We must never forget the suffering that occurred as a result of that crisis—the millions of Americans who saw jobs lost, homes foreclosed, and savings destroyed. Our goal as regulators is to enact sensible regulation that makes the system more resilient and reduces the chance that swap activity will cause such an event to happen again.
Another important and related reform is capital requirements for swap dealers and major swap participants. While margin is the front-line defense against default, adequate capital is critical to the ability of swap dealers to absorb losses. This further enhances the resiliency of our financial system.
I will ask my fellow Commissioners to consider a reproposal of our rule in the coming weeks. Because many types of firms are swap dealers, I believe it is important to have a rule that takes into account this diversity of firms while still promoting safety and soundness.
Let me turn to my second topic, automated trading. Automated trading has become the dominant form of trading in our markets. This is true across products. Last year, I discussed my intention to address the risk of market disruption posed by the increased use of automated trading.
Shortly after the FIA Expo, the Commission unanimously proposed “Regulation AT.” This is designed to minimize the risk of disruption and other operational problems by requiring certain pre-trade controls and other measures. Our proposal relies on a principles-based approach that codifies many industry best practices, such as message throttles and maximum order size limits. It requires other measures such as “kill switches,” which facilitate emergency intervention in the case of a malfunctioning algorithm. But it does not prescribe the parameters or limits of such controls, because we believe market participants are the ones who should determine those specifics.
We have received a lot of helpful feedback since our proposal was published. I expect that we will consider a supplemental proposal on certain issues related to it in the near future. And while I will not go into detail today, I do expect we will address some of the concerns we’ve heard about the proposal’s requirements for registration and the preservation of and access to source code. We won’t be doing away with either requirement, but we are considering changes that address some of the concerns while ensuring our regulatory goals are still met.
Guarding Against Cyber Threats
Last year, I also discussed our plans to propose rules that would bolster protections against cyberattacks and other types of operational risk in our markets. The risk of cyberattack probably represents the single greatest threat to the stability and integrity of our markets we face today.
Just a few weeks ago, we finalized these important rules. They require the core infrastructure in our markets—that is, the exchanges, clearinghouses, trading platforms, and trade repositories—to regularly evaluate cyber risks and test their cybersecurity and operational risk defenses. The rules require specific types of testing, but do not prescribe how the tests should be done. Instead, the standards are principles-based and rely on best practices. We are also continuing to make cybersecurity a priority in our examinations.
Let me also update you on our efforts to fully implement and enhance swap trading on regulated facilities. Since last year, we have approved permanent registration of 23 swap execution facilities—or SEFs. And we continue to see strong participation and a high volume of trading on these platforms. In the course of approving registrations, we addressed some concerns that had been raised by market participants. This included, for example, approving facilities that used various execution methods—such as certain streaming protocols and certain types of auction or volume match methods of execution, so long as there is sufficient transparency regarding the process for setting the price.
In addition, Commission staff has taken steps to fine-tune our rules to improve SEF trading in a number of areas through several no-action letters. These have pertained to issues such as error trades and simplifying procedures regarding confirmations, among others.
We are also considering some additional changes, such as a review of the “made available to trade” determination process. This process identifies products that must be traded on SEFs, and some market participants have suggested that the CFTC play a larger role in it.
Finally, we are working with our European colleagues on the process of how we recognize each other’s trading platforms. I am hopeful that we can work together to achieve greater harmonization.
Improving Data Reporting
The final topic on which I want to give you an update from last year is swap data reporting. You may recall that last year, I reviewed a number of the actions we are taking to improve the data we collect, make sure it’s consistent, and clarify the reporting obligations of market participants. In this area, we have taken a number of actions.
First, we adopted a rule to create a simple, consistent process for reporting cleared swaps. The rule streamlines the reporting process so there are not duplicate records of a swap, which can lead to double counting that can distort the data. It makes sure that accurate valuations of swaps are provided on an ongoing basis. And it eliminates some needless reporting requirements for swap dealers and major swap participants. This rule goes into effect in December.
Second, we’ve been working to standardize reporting to swap data repositories (SDRs). In December, our staff published draft technical specifications for the reporting of 120 priority data elements. These describe the form, manner and the allowable values that each data element can have. We have asked for comment on this. We are also co-chairing the working group tackling this issue internationally. It has also published a document for comment. We have decided to hold off on finalizing domestic standards until this international work is complete. This will allow us to harmonize our standards and achieve consistency in reporting across-borders.
Third, we will soon consider a proposal to change our rules to give swap data repositories (SDRs) greater ability to make sure the data they receive is complete and conforms to required standards. In that way, the data will be of higher quality when it arrives at the CFTC.
Fourth, we are implementing a change to Dodd-Frank that will make it easier for us to share swap data with other regulators, both domestic and foreign. Late last year, Congress removed a requirement that another regulator provide an indemnity before we could share data. This requirement is also in our rules, so we are working on a proposal to implement rule changes to remove this requirement and facilitate sharing of appropriate data between regulators.
And finally, we remain focused on ensuring market participants are complying with reporting obligations. We want to bring firms into compliance. But where firms fail repeatedly to take these obligations seriously or invest sufficient resources to meet them, we have taken, and will continue to take, enforcement action. This includes a recent action where we are seeking the appointment of a monitor because an institution had been unable for some time to meet its obligations.
Clearinghouse Resilience Recovery and Resolution Planning
Now let me turn to a very important area: clearing and clearinghouse resilience.
As you know, in 2009 the G20 leaders made a decision to expand the use of central clearing. We’ve been doing that—including by expanding our swaps clearing mandate last month, so as to include swaps that have been or will soon be mandated for clearing in nine other jurisdictions. In doing so, we also coordinated the timing of our mandates with those of the other jurisdictions.
But part and parcel of that work is making sure our clearinghouses are strong and resilient. There are a number of efforts going on domestically and internationally that I’d like to discuss.
Many of you know that clearinghouses engage in stress testing. In fact, our rules require them to conduct stress tests on a daily basis. This type of testing is used to estimate potential losses under extreme but plausible market events. Stress tests help to evaluate the sufficiency of financial resources available for the clearinghouse to meet its obligations, and to evaluate exposures to individual clearing members.
The CFTC staff is also working on additional stress tests—what are known as supervisory or regulatory stress tests. These tests have a different objective. It is to assess the impact of stressful market scenarios across multiple clearinghouses and clearing members on the same date. Thus, while we look at the impact of certain stressful scenarios on individual clearinghouses, what we are focused on is analyzing the impact across clearinghouses and across firms that hold clearing memberships at more than one clearinghouse.
We expect to finish this work and issue a public report on it before the end of the year. But let me tell you a little bit about the scope of it today.
We are focusing on the five largest clearinghouses that are registered with us: CME Clearing; ICE Clear Credit; ICE Clear Europe; ICE Clear U.S.; and LCH Clearnet Limited. We developed a set of stressful scenarios based on a number of factors, including price changes and correlations across markets that occurred on specific dates when there was extreme volatility. For example, in constructing the hypothetical scenarios, staff looked at what happened on the day of Lehman Brothers’ collapse and in the aftermath of the “Brexit” vote.
We then are applying these scenarios to actual positions of clearinghouses as of a specific date. We are basing this on the data regularly submitted to us by these clearinghouses – such as reporting of position, margin, and guarantee fund information. This allows us to look at impacts across clearinghouses and clearing member firms.
The exercise encompasses futures, options on futures, and swaps that are cleared at these five clearinghouses. It includes contracts based on financial products – such as interest rate swaps and credit default swaps – and those based on physical commodities. The clearinghouses covered by the exercise account for almost all cleared futures and cleared swaps subject to CFTC jurisdiction, as measured by initial margin.
We are also looking at the actual positions of the largest clearing members. We are including a firm if the amount of initial margin required for that firm was among the largest of clearing firms at any of the five clearinghouses. And we are using a common set of clearing members for the exercise across all clearinghouses. In this way, the exercise will focus on firms that account for most of the total initial margin in cleared products in our markets.
So we hope to conclude our work and issue this report in the near future. We believe it will complement other work going on in this area. For example, the European Securities and Markets Authority issued a report on the results of its stress test exercise earlier this year. We have been discussing these issues with them, so that we can each learn from one another. And there is work going on internationally to develop guidance on supervisory stress testing of clearinghouses, which should be very useful.
So we view this work as a first phase. There will be a need for cooperation among regulators and more work in this area in the future.
Of course, there is more going on in the area of clearinghouse resilience, recovery and resolution planning. We are working to ensure our systemically important clearinghouses complete their recovery and wind down plans. In July, staff released some detailed guidance that describes how we are looking at these issues, and what must be part of these plans and rules. Both our systemically important clearinghouses have filed their recovery-related rules, and we want to get those finalized by the end of the year.
We also are working closely with staff of the Federal Deposit Insurance Corporation (FDIC) on resolution planning for U.S. systemically important clearinghouses.
In addition to these domestic efforts, we are helping to lead an international work plan on clearinghouses that has four major elements. We are involved in all four.
First, we are co-chairing a working group looking at clearinghouse resilience and recovery issues, including whether the international regulatory standards—the Principles for Financial Market Infrastructures or PFMIs—have sufficient granularity. This group recently issued a consultative report on this work, and we welcome your input. In fact, CFTC staff recently held a public roundtable on the issues raised in the report, and we received some very helpful feedback.
Second, another working group assessed the implementation of the PFMIs at ten representative clearinghouses. They also released a report in August.
A third group is examining resolution planning for clearinghouses, including international coordination. This group also released a Discussion Note for public comment in August.
A final group is examining the interdependencies among global clearinghouses and major clearing members.
Let me also note that last week, I joined with senior officials from the U.S., UK, and Europe to hold the second in series of planned exercises to enhance coordination on cross-border resolution of global systemically important financial institutions. While clearinghouses were not the focus of this exercise, the resolution of such a global systemically important bank would have implications for our clearinghouses, so it is important to consider those implications.
When it comes to recovery and resolution planning for clearinghouses, we must always keep in mind that a clearinghouse is very different from a bank. And we must make sure resolution planning for a clearinghouse does not undermine the ability to engage in a successful recovery. For example, we do not want to create incentives that discourage market participants from taking actions that would otherwise contribute to achieving recovery because they think they can get a better deal if recovery fails and resolution is required.
As in the exercise I just noted, much of the focus in the planning for the resolution of a global systemically important bank is how one might recapitalize the good parts of the entity and sell off the bad parts, and what resources would be used for that purpose. This can be especially challenging given that a large systemically important bank is likely to have a complex global footprint with many different lines of business and typically many complex inter-affiliate guarantees and other financial relationships.
A clearinghouse is very different. The business model is relatively simple by comparison. And perhaps most important, a clearinghouse has both the obligation and the ability to address fully any individual or combined default among its members. Clearinghouses already have a lot of resources to deal with a default—starting with the initial margin posted by all clearing members; the clearinghouse’s capital contribution; the guaranty fund, which is pre-funded by all members; and the ability to make specified assessments on members for further funds. Moreover, there are additional tools the clearinghouse can use if these resources are not sufficient. These include variation margin haircuts and partial tear-ups of contracts. With these resources and tools, the clearinghouse has the assured ability to allocate all losses and restore a matched book.
So when should resolution be triggered? Do we create special resources and tools for the resolution authority? And how do we ensure that the resolution plan does not undermine the ability to execute successfully on a recovery plan—because success would allow us to avoid the need for resolution altogether? These are the questions that we must answer.
Finally, let me just say, as I have said before, while this work on recovery and resolution planning is critical, our goal is to never have a situation where recovery and resolution are needed. And that is why daily risk management continues to be critically important—as does oversight of that function.
There is a lot of other work going on. Most of our work consists not of rule-making but other matters, such as ongoing examinations of firms to ensure compliance with rules, surveillance of markets to detect and deter fraud and manipulation, and enforcement activities to prosecute wrongdoing. But I know the rule-making agenda is always of interest, so let me note one other critical issue. And that is, we are working hard to finalize our position limits rule. For example, we have been working to make sure the limits are set based on the most current available data on deliverable supply. We have had extensive discussions with the exchanges on this issue. We have been considering the various comments received on bona fide hedge exemptions. We have proposed that the Commission work with the exchanges to create a new process to grant non-enumerated bona fide hedge exemptions. We have received a lot of helpful comments on that, and I support incorporating it into the final rule. And we issued proposed changes to our aggregation rules that I also support incorporating into the final rule. So I hope we can get this done before the end of the year.
Thank you so much for your attention. As you can see, we’re working hard on a number of fronts. Keeping up with markets that are growing in size, complexity, and sophistication is a significant challenge—and it’s one that takes resources. Last year, Congress failed to provide us even a modest increase in our budget. And without additional resources, it is difficult for us to do the job that I believe our markets need and the American people deserve.
Let me close by again thanking the hardworking CFTC staff for all their efforts. The men and women of the CFTC bring tremendous expertise and dedication to our work, and I am very grateful for their dedication. I’d also like to thank my fellow Commissioners, Chris Giancarlo and Sharon Bowen, for their attention to and support on these issues, and for their commitment to working together constructively and collaboratively. And thank you to the staff of the National Futures Association for all their hard work, especially with respect to the implementation of margin rules.
Thank you again for inviting me today.
Last Updated: October 19, 2016