Keynote Remarks of Chairman Timothy Massad at SEFCON VII
January 18, 2017
Thank you for that warm introduction. It’s great to be back at SEFCON.
What a difference elections can make.
Eight years ago on this day I was taking the train to Washington to attend the inauguration of President Obama. Think back for a moment to where we were at that time. Our financial system was teetering on the brink of collapse. Unemployment was at 10 percent and the Dow Jones was at 8,500. We’ve come a long way since then.
Shortly after this speech, I’ll hop on that same train to go back to Washington. Indeed, with two days left as Chairman, I feel a bit like Cinderella—I need to get back to D.C. soon, at least to make sure my train fare is reimbursed.
It’s been a privilege to serve my country over the last eight years. These have been extraordinary times. It has been a tremendous honor to help our nation recover from the crisis, and then chair the CFTC, which is at the forefront of many important issues concerning our financial markets.
Since this is my final speech, I want to offer some reflections on my time as Chairman, and some thoughts for the future.
But I recognize that in the past, I’ve talked a lot about swap execution facilities (SEFs) and swap trading, so let me first say a few words about that. We’ve made additional progress to improve trading on SEFs. But there’s more to do, and I would expect this will be a focus for the next Chair.
The Commission completed its review of SEF registrations early last year, just as I committed we would when I spoke here in November of 2015. At that time, I also said that we would move to codify in a formal rulemaking many of the steps we have taken to improve trading through no-action letters and guidance, and that we would consider changes to the “made available for trade” process. I also said we would work on harmonization with Europe. Well, we’ve been doing all those things and more. The staff provided to all the Commissioners last fall proposed rules to codify many of the actions we have previously taken and to reform the MAT process. The staff also developed an exempt SEF proposal and they have been working with Europe on harmonization generally.
We have not taken action on these matters because the staffs of my colleagues have wanted to explore whether we could combine these with other possible changes to the trading rules. My desire has been first to build consensus. I believe the market would be well served by unanimity here, just as we have achieved in other areas. Second, I have felt we should consider modifications in particular that might facilitate harmonizing our rules with those of other jurisdictions, provided, of course, the congressionally mandated core principles are met and we think the modifications otherwise make sense.
So I leave this to the next Chair and Commission. I know both Commissioner Giancarlo and Commissioner Bowen are keenly interested in these issues. I wish both of them good luck as they take up these matters.
Let me turn now to some reflections on the last 30 months and some thoughts on the future. As I prepared my resignation statement, I thought about what we had accomplished. There’s always more you’d like to achieve in a job like this, and it often seems like things take longer than they should. But the exercise of putting together a list of accomplishments reminded me of all we have done. So we posted the list on the CFTC website. And these accomplishments are a credit to our staff. Their talent and dedication cannot be overstated. While chairs and commissioners come and go, it’s the staff that provide the collective expertise regarding the markets and the business of the Commission. And of course, they do the work—they get things done. It’s been a great privilege to work with them.
Today I will focus on five areas that have been priorities for me. And I’d like to briefly note some of the more important achievements, and also talk about challenges for the future. These areas are the regulatory framework for swaps; clearinghouse strength and resilience; the actions we’ve taken to address the concerns of commercial end-users; international cooperation; and technological change in our markets.
Regulatory Framework for Swaps
First, let me turn to the regulatory framework for over-the-counter swaps. Today, this framework is largely in place.
And if I had to name one swap reform as the most important, it would be the margin requirements for uncleared swaps. This is the first line of defense against a default and against the buildup of excessive risk. I’m very pleased that we got this done last year after much effort. It’s a good, sensible rule. It focuses on the areas of greatest risk—that is, transactions between large financial institutions; commercial end-users are exempted. And we succeeded in harmonizing our rule, the rules of the prudential regulators, and international rules. Yes there are still some differences, but the material terms are the same. That was a big achievement, in light of the many differences in proposals at the time I took office.
I believe one of our most important accomplishments is that we have built a broader consensus that these reforms make sense. We did that by taking actions to fine-tune and improve the rules and being open to further changes. This is true in swap trading and in other areas. We did that by addressing unintended consequences of the rules for commercial end-users, and harmonizing more internationally. We did that by focusing on areas of greatest risk. With regard to clearing, we coordinated with other jurisdictions in mandating additional swaps. We proposed a capital rule that would harmonize our standards with those of the bank regulators and the SEC. We simplified and streamlined the process for reporting cleared swaps. We are leading the efforts to standardize reporting requirements globally. We still have work to do to improve the quality of the data, but anyone who thinks the data isn’t useful should just look at the excellent study our staff did of the swap dealer de minimis threshold.
So my thoughts for the future are simple: don’t dismantle the framework. But let’s continue to refine and improve it.
Clearinghouse Strength and Resilience
My second area is clearinghouse strength and resilience. This has been a priority of mine since taking office. Derivatives clearinghouses were important in the global financial system before the crisis, but they are obviously much more critical today. As an illustration, total initial margin at the five largest clearinghouses registered with us increased from $90 billion dollars in 2008 to $300 billion last year. So we must make sure clearinghouses are strong and stable.
We have done a lot in this area. We reached an accord with the European Union last year that resolved longstanding issues regarding the recognition and oversight of clearinghouses. It has brought our two regulatory regimes closer together and kept the derivatives market global. This contributes to financial stability and the potential for growth.
We have also enhanced our clearinghouse oversight and risk surveillance. A good illustration of this is the report we released last November on the supervisory stress tests our staff conducted. These tests assessed the impact of stressful market scenarios across the five largest clearinghouses under our jurisdiction—CME, LCH and three ICE entities--and across the largest clearing members.
The results were positive. They showed that the clearinghouses had ample pre-funded resources to withstand extremely stressful market scenarios. And they further showed that risk was diversified across clearing members — a clearing member that had a loss at one clearinghouse might actually have gains at others.
I’m very proud of this pathbreaking study. We are the only regulator in the world who is in a position to do this type of analysis on clearinghouses here and abroad. But this is just one set of tests, and it is very important that work like this be continued.
As a result of the initiative of our staff and the assistance of the Federal Reserve, the pre-funded resources held by systemically important clearinghouses can now be deposited and held at Federal Reserve Banks. This is good for customer protection and for financial stability.
We have also worked with the major clearinghouses to develop recovery and wind down plans and related rules. These are now done. And we are working with the FDIC, the resolution authority, on clearinghouse resolution planning.
We are also helping to lead a global effort among regulators to examine clearinghouse resilience standards, as well as recovery and resolution planning, and we are forming cross-border crisis management groups with other regulators for the major clearinghouses.
I hope the Commission continues to make all of this work a priority.
A couple thoughts for the future: our clearinghouses are only as strong as our clearing members, and we need to continue to think about how we make sure the clearing industry is robust. This is critical to making sure all customers have access, and it’s critical if we ever need to transfer accounts in a default situation. We need to focus in particular on making sure clearing services are available to smaller, traditional hedgers. I hear a lot of concern in this regard from agricultural users, and it deserves attention.
There are many factors that affect the economics of clearing, and therefore the extent to which firms choose to be in this business, not the least of which is interest rates. But insofar as regulation is relevant, we should certainly look at it and make sure we have struck the right balance. I’ve spoken before about my concerns regarding the effect of the supplemental leverage ratio on incentives to clear, and I hope this gets further attention. We must make sure we have properly balanced the objective of strengthening bank capital with the goal of mandating central clearing.
In due course, I believe the Commission should also look at whether the regulatory framework is properly balanced when it comes to cleared and uncleared swaps. Congress did not direct us to clear all swaps, and our clearinghouses will be stronger if we do not. As long as we have adequate margin and capital requirements, the uncleared market can continue to be an important component of a healthy derivatives market. Among other things, it is an important source of innovation. Therefore, in addition to being judicious in mandating clearing, we should make sure that margin, capital and other requirements are not pushing more swaps into clearinghouses than is desirable.
My third area: one of my top priorities since taking office has been to reduce unintended consequences, eliminate unnecessary requirements, and strengthen protections for commercial end-users. Commercial businesses did not cause the global financial crisis, and we need to make sure they can continue to use the derivatives markets efficiently and effectively.
On this front, we made lot of progress. We reduced reporting and recordkeeping obligations generally for commercial end-users. We exempted commercial end-users from our rule on margin for uncleared swaps. We clarified when certain agreements that include volumetric optionality provisions are forward contracts, rather than swaps. We made changes to our rules on trade options, to recognize that they are different from the swaps that were the focus of Dodd-Frank reforms. And we changed our customer protection rules to address concerns, particularly of smaller futures customers, regarding the timing of posting collateral.
These are just some of the actions we have taken to make sure these markets work for commercial end-users. I appreciate the input that many businesses have given us throughout my tenure. And I hope addressing end-user concerns remains a priority for the Commission going forward.
International Coordination and Cooperation
Let me turn to the issue of international coordination and cooperation. When I took office, there were loud complaints about the lack of international coordination and harmonization, and our relationships with other regulators were strained. We made tremendous progress, as evidenced by many of the things I’ve already mentioned—the harmonization of margin rules, the clearinghouse equivalence accord with the European Union, the coordination of swap clearing mandates, the clearinghouse resilience efforts, and the work on swap reporting standardization. We also accelerated the review of applications by foreign exchanges to register with the Commission. There was quite a backlog when I took office, and we approved 13 of them. We also created a process to exempt foreign clearinghouses from our registration requirements in certain circumstances. We approved four exemption applications and are reviewing others. And we are working with jurisdictions all over the world on other matters such as automated trading, cybersecurity and surveillance and enforcement.
I want to emphasize that our international efforts aren’t just with traditional partners—such as the European Union or Canada. We have also strengthened relationships and have important initiatives going on with Australia, China, Hong Kong, India, Japan, Mexico, Singapore and many others.
There is more to do in this area as well, of course. This includes the swap trading issues, and additional comparability determinations as other jurisdictions adopt their rules.
The broader point is this: extensive international coordination and cooperation is essential in today’s global financial system, not just in swaps but generally. A lot was said in last year’s election questioning whether global trade—or at least recent global trade agreements—are in our best interest as a nation. Whatever the merits of that criticism, we should not view international cooperation in the regulation of the global financial marketplace with the same skepticism. On the contrary, we saw in the crisis just how necessary it is, because the global financial marketplace had outstripped the ability of national regulators to oversee it. That’s the lesson of AIG. And since the crisis, regulators have worked together to plug the holes in that regulatory framework and make the system more resilient. You may argue about—or indeed, wish to change—some of the details of the reforms that have been implemented, but to pull back from such cooperation would be to send us toward a path of regulatory inconsistency, or even competition, that can only be destructive.
Technological Changes in our Markets
Finally, the last several years have been a period of profound technological change in our markets. I made it a priority to focus on many of the implications of this, but there is more that we need to do.
Cybersecurity. There is the challenge of cybersecurity, first and foremost. We made great progress here. We unanimously adopted rules to bolster protections in our markets. They require the core infrastructure companies in our markets—the clearinghouses, exchanges and others—to engage in regular and thorough testing of cyber defenses. Equally important are the steps we have taken to focus on this issue in our examinations, and to facilitate sharing of information between industry and government on potential threats, defenses and responses. And I’m pleased that the CFTC has one of the highest cybersecurity ratings among U.S. government agencies. But we know this is a constant arms race. There needs to be a constant focus on this issue in all its aspects.
Automated Trading and Market Liquidity. A second critical area is the effects of automated trading. Automated trading has brought benefits to our markets, such as faster execution and tighter spreads. But it poses challenges and risks also.
You know about our proposed rule. I hope the Commission finalizes it soon, however they choose to resolve the issue of the Commission’s access to source code. A huge percentage of the volume in our markets today comes from traders who aren’t subject to any oversight, because they don’t handle customer funds and don’t hold large positions. We need to make sure there are baseline risk controls, and that appropriate records are preserved, in case we ever need to reconstruct what happened in a market breakdown.
We’ve been at the forefront in bringing actions against spoofing and other forms of manipulation resulting from automated trading. And we’ve enhanced our own technological capabilities to oversee these markets. But we need to do more.
We need to continue to examine how automation and technology has changed our markets, and in particular the nature of market liquidity today. In the days ahead, I expect we may hear more statements that regulation has harmed liquidity. While I have no objection to studying that issue, I think the headline is that liquidity is simply fundamentally different today.
Consider what happened after Brexit, the most stressful moment in our market since Dodd-Frank was enacted. Despite predictions that because of regulation, liquidity would disappear in stressful conditions, there was a lot of liquidity. Spreads were tight and trading was continuous. But the speed, style and composition of trading was quite different from what I would call the classic or perhaps iconic model—that is, bank dealers using their balance sheets to make markets for their customers, regardless of price. Today it is all about smaller sizes, rapid changes in bids and offers, and all the other attributes of modern trading that you are familiar with.
Today, in our markets, proprietary trading firms generally represent 50 to 60 percent of the volume in many key futures contracts, sometimes even more, but a very small percentage of the open interest, often only 5 percent.
Repealing regulations won’t reverse market evolution. If we allow banks to trade more, I don’t think it will change the fundamental nature of liquidity. Fine-tuning circuit breakers and similar limits might do a lot more to address volatility spikes, if that is the concern. And let’s not forget the financial stability reasons why we chose to limit the trading of banks that benefit from government insurance programs.
Finally, as we think about liquidity, automation, and related issues, I hope the Commission keeps the concerns of traditional, commercial end-users foremost in mind. We need to make sure that commercial businesses can continue to use these markets effectively to hedge risk and engage in price discovery.
Fintech. The innovations that may be created through financial technology such as blockchain represent another form of change that deserves our attention. Now, we are probably still a ways away from meaningful applications of this technology in our markets. But we need to make sure our rules don’t stand in the way of innovation and that the regulatory framework can adapt to new innovations. So we formed an internal cross-divisional group to monitor these developments and think about the intersection with our rules and requirements.
And these developments are also one reason why we issued a proposal last week to update our recordkeeping requirements so that they are technologically neutral. I’ve told private sector participants to let us know if they see other obstacles.
We have seen incredible innovations in the United States derivatives markets, and I have great confidence that there will be more. Frankly, I was surprised to hear that there was a report that claimed the U.K. was ahead of the U.S. in facilitating fintech developments, until I read the report. Commissioned by the Bank of England, it reached that conclusion by ranking California and New York separately because of the distance between them. The report conceded that if California and New York were grouped together, the U.S. would clearly be first. I wouldn’t have thought the distance between California and New York was a reason to not treat the U.S. as one country; after all, we’re talking about building fintech here, not building a transcontinental railroad.
The Future of Reform
That’s five areas, but I must briefly add a sixth, which is enforcement. I said at my confirmation hearing that enforcement would be a priority, and it was. We’ve been at the cutting edge of issues like spoofing and benchmark manipulation, we’ve protected retail investors, and brought fraudulent actors to justice. And we’ve imposed penalties that were seven times our aggregate budgets during this period.
So there you have it. The 25 minute summary of key accomplishments of the last two and a half years. The full version is available online at no additional cost.
Will this progress be undone by the next Administration? It’s not my place to make predictions—I’ll leave that to next speaker. But let me address it this way: it’s clear that many of the people who voted for the President-elect did so out of economic concern, not out of a desire to dismantle reforms that improve oversight of the financial sector. Certainly, that’s true for the Trump supporters I know. The details of derivatives reform are not familiar to them, but the devastation of the financial crisis is—and its memory will remain, just as the memories of the Great Depression influenced how my parents acted throughout their lives.
We are unlikely to predict the cause of the next financial crisis. But we’ve done a lot to make the financial system more resilient. And that reduces the likelihood that the pain and suffering experienced during the last crisis will happen again.
There is more we need to do to make sure our economy delivers opportunity for all. But repealing or reversing the progress we’ve made in reforming the financial system will not address that need. On the contrary, it will only increase the chances that those who suffered during the crisis may suffer again.
Let me conclude with this. My principles throughout my tenure were the following: focus rules on the areas of greatest risk. Don’t be overly prescriptive. Eliminate or reduce the unintended consequences of regulation, particularly on commercial end-users. They, after all, are the reasons these markets were created. Work with your fellow regulators, domestically and internationally. Harmonize wherever possible. Don’t let minor differences—or egos—get in the way, but don’t sacrifice critical principles either. Engage in robust enforcement but don’t play “gotcha” games. Focus on the truly bad actors—and the violations that really matter.
Throughout my tenure, I also sought to build consensus. We’ve taken over 600 votes as a commission during that time. I’m proud to say that over 95 percent of them were unanimous.
There is a lot we didn’t get to. But what we did accomplish is a credit to the staff, as I noted earlier, and to my colleagues on the Commission. I had the good fortune to serve with several terrific colleagues—from my beginning days with Scott O’Malia and Mark Wetjen, to the end with Sharon Bowen and Chris Giancarlo.
Sharon, Chris and I have been colleagues for my entire tenure, and we have been a Commission of three for most of that time. I couldn’t ask for finer colleagues. We have relationships of mutual respect, and each of us has had the same agenda: do what is best for the markets. We have not always agreed on what that was, but our purpose was the same. That’s not always the case in government. Of course, being a Commission of three posed some challenges under the Sunshine Act, which prevents a majority of Commissioners from discussing policy in private. Just imagine what we might have accomplished had we been able to talk to one another more.
I wish them both the best of luck as they carry on. And I congratulate Chris, who will soon become the acting Chairman.
Finally, I thank you very much for your engagement in the work of the CFTC. I always enjoyed listening to the thoughts of market participants, even when you were critical. The regular input of people like you is a necessary element for anyone to succeed in this job.
The United States has the greatest financial markets in the world. Continued sensible regulation is vital to ensuring that our markets remain strong, dynamic, and innovative. I am grateful to have contributed to that important objective in even a small way.
Thank you very much for your time today.
Last Updated: January 18, 2017