Keynote Address by Chairman Timothy G. Massad before the Monetary Authority of Singapore
The Future of Financial Market Regulation
January 23, 2015
As Prepared For Delivery
Good morning. I want to thank Lucien for that kind introduction. I also want to thank Ravi Menon and the MAS and the Singapore Academy of Law for inviting me and for organizing this excellent conference. It is a privilege and a pleasure to be here. I am also very pleased to be here with Masa Kono, with whom I spent some time in Tokyo earlier this week, and I look forward to our panel shortly with Ong Chong Tee.
While this is my first trip here as Chairman of the CFTC, I am no stranger to Singapore. I spent five years living in Hong Kong and working in the region as a lawyer in private practice.
It’s great to have the opportunity to visit Asia again. I began my trip in Beijing and was also in Hong Kong earlier this week.
My five years in Asia were some of the best years in my life. The work was interesting, and getting to know the various countries and cultures in Asia was fascinating. I met my wife here—though she happens to be from St. Paul, Minnesota. She is a fluent Mandarin speaker who spent many years in Beijing and Taipei. She fell in love with the language and wanted to have a legal career that revolved around Asia. I, on the other hand, was a complete novice to the region. I fell in love both with her and with Asia.
I have many fond memories of my time in Asia, including many fond memories of Singapore. During those years, I came here many times, and made many good friends. As I learned more about your history, my respect and admiration grew. In 200 days you will celebrate the 50th anniversary of your independence. What you have built and accomplished over the last fifty years is simply staggering. Lee Kuan Yue said, “Some countries are born independent. Some achieve independence. Singapore had independence thrust upon it.” You certainly seized the mantle once it was thrust upon you. The relationship between our countries has also become very important over those years, another reason why I am pleased to be here today.
I want to talk today about where we are in the process of global financial regulatory reform. I want to talk about Singapore’s role in that effort and why that effort is important to the prospects for growth here and throughout Asia. But I want to first say a few more words about my path to standing in front of you today, and how it shapes my perspective on these issues.
My Experience in Asia
During my time in Asia, I had the privilege to work with the MAS, Temasek, and many fine corporate leaders, bankers, and lawyers here on a variety of transactions. I had the honor of being the United States counsel for the initial public offering of SGX, and the merger of the cash equities and derivatives exchanges. I had done a lot of public offering and securities work throughout my career. And my derivatives work began as a young lawyer, when I represented the International Swaps and Derivatives Association (or ISDA), and helped lay the groundwork for the modern financial derivatives industry. I was one of a handful of lawyers who worked for over a year to draft the first master agreements for swaps; before that, swaps were documented on 50 page agreements.
The SGX offering was a landmark transaction for Singapore. It was a pleasure to work with Joe Pillay, who was then chairman, the MAS, Lucien Wong, and many others on this important transaction.
But my stay in Asia began at a difficult time. It was in June of 1997 that I agreed with my firm that I would move to Hong Kong. It was right before the handover by the British. Things were booming in Hong Kong, China, and throughout Southeast Asia at the time. There was lots of work for bankers and lawyers.
But a few weeks after I agreed to move, the Thai baht collapsed. By the time I arrived in January 1998, the baht had lost over 50% of its value, and the crisis had spread throughout Southeast Asia. Singapore suffered, though not nearly as badly as others. I know you all remember this period well.
I spent much of the first year or so I was in Asia on transactions involving sales of distressed debt by Thailand and Korea.
I recount all this because, while it’s hard to predict or plan out your career or your life, when you look back, you can often see how one experience led to another, and how those experiences shape your views.
When I was working on distressed debt sales by the governments of Thailand and Korea during the Asian financial crisis, I never would have guessed that ten years later I would oversee the Troubled Asset Relief Program, the key U.S. response to the 2008 global financial crisis.
When I was helping to standardize the swaps market through the writing of the first master agreements in the late 1980s, I never would have guessed that twenty five years later I would have the responsibility to lead the efforts of the United States to bring much greater transparency and cross-border harmonization to the swaps market.
And similarly, when I was meeting just down the road at the offices of SGX to prepare them for an initial public offering, I never would have guessed that, fifteen years later, I would be back here to meet with SGX as chairman of the CFTC.
But I have drawn on these experiences in this job and at Treasury, when I was helping the United States recover from the worst financial crisis we have experienced since the Great Depression.
Learning from the Past Crises
Looking back not only reminds us of how we got here; the perspective can inform our way forward. That is true for nations as well as individuals. It is particularly relevant when we think about the next steps in financial regulatory reform.
Looking back teaches us more than a little humility. When the Asian financial crisis occurred, many in the West were quick to point out why the West would not catch what was sometimes referred to as the “Asian flu.” Some people said our markets and financial regulatory system were more mature, more transparent, and better supervised. They said that all of those things made us more resilient to shocks. Well, not resilient enough. Those things didn’t mean we wouldn’t have our own crisis. They didn’t inoculate us from the dangers that can occur when risks are not properly understood, when authorities believe markets are fully self-policing.
By the same token, recall some of the things that were said after Asia had recovered from its crisis, and in the years before the financial crisis, about “decoupling”. People began to suggest that the Asian economies had “decoupled” from the economies of the West. No longer were they dependent on what happened in the West. Slow growth or even more serious problems in the West would not affect the dynamic growth in Asia.
Well, that didn’t prove true either. The Asian economies did not escape the collateral damage of the 2008 financial crisis. And that should not surprise us, given the severity of the shocks. In the United States, we lost eight million jobs and millions lost their homes in foreclosure. Our economy was in free-fall. And with markets so interconnected, the shock waves reverberated worldwide.
Looking back on these crises is helpful as we think about the way forward when it comes to financial regulatory reform today.
The Asian financial crisis and the global financial crisis illustrate the speed with which capital can move, and the speed with which markets can fall, when problems hit. And these crises remind us that the economies of the United States and Asia are strongly intertwined. What we do affects you. What happens here affects us. We are all in this together.
The Importance of Asia’s Role in Financial Regulatory Reform
Simply put, that is why I am here. I am here because Singapore and other countries in Asia are critically important in building a new global regulatory framework for derivatives. Our effort to build that framework can only fully succeed if we act together.
Building this new regulatory framework is important for Asia because well-developed derivatives markets can propel growth in the real economy.
The Asian derivatives markets are growing rapidly. Today the Asian derivatives markets represent nearly a third of global futures and options volume measured by number of contracts, and continued growth is to be expected. China is liberalizing its markets, which will bring further opportunity. The commencement of the HK – Shanghai Stock Connect is very important, as are their plans to introduce an oil futures contract that would be open to foreign participation. And I know you have had success in growing the Singapore market, a subject to which I will return in a moment.
Let me turn then to discuss where we are in the process of building the global regulatory framework with respect to derivatives, and the importance of your role in that process.
In 2008, we learned how over-the-counter swaps could accelerate and intensify the financial crisis. Of course, in normal times, the derivatives markets provide significant benefits to our economies. They enable airlines to hedge the costs of fuel, manufacturers to hedge the price of industrial metals, exporters to manage fluctuations in foreign currencies, and businesses of all types to lock in borrowing costs.
But in 2008, swaps worsened the crisis. The swaps market had grown to be a massive, global market that was unregulated. Participants had taken on risk that they didn’t always fully understand, and that was opaque to regulators. The interconnectedness of large institutions meant that trouble at one firm could easily cascade through the system.
In response, the leaders of the G-20 nations agreed to bring the swaps market out of the shadows and achieve greater transparency. They agreed to implement four fundamental reforms: require central clearing of standardized swaps through regulated clearinghouses; require regular reporting so that regulators and the public can have a view of what is happening in the market; require oversight of the largest market participants; and require transparent trading of swaps on regulated platforms.
Let’s pause just to reflect on the fact that the nations comprising the G-20 agreed on how to reform the swap market. That illustrates how far we have come. At the time of the Asian financial crisis, there was no G-20, nor was there a Financial Stability Board. There was no simple way to agree to global reforms.
A G-20 communique only goes so far, however. The task of actually writing laws and developing rules remains with individual nation states.
What makes this reform effort unique and especially challenging is that we must regulate what is already a global market, but we can only do so through the actions of individual countries, each of which has its own legal traditions, regulatory philosophies, political processes, and market concerns. That can lead to differences.
Now in most areas of financial regulation, the fact that there are differences between national laws wouldn’t be news. Consider the laws that govern how corporations sell securities, which vary significantly among jurisdictions. When we did the SGX offering, for example, it was structured legally as a public offering in Singapore, but that did not entitle us to sell securities publicly in other countries. Whether we could sell, and how, depended on the laws in those jurisdictions. The fact is the U.S. and many other countries established their securities laws long before there was a global securities market, and we are not trying to make all those laws the same.
But the swaps industry grew to be a global market before there was any regulation. So today, many participants expect harmonization. They expect it in timing of implementation as well as in the substance of the reforms. Indeed, they are critical that we haven’t achieved it yet.
I would say that those who are critical are looking at the glass as half empty; I see it as half full.
The fact is the G-20 nations have agreed on necessary reforms and are moving in the same direction. We have made great progress, and we will continue to do so, but it will take time.
Another challenge in regulating this global swaps market is the fact that a country’s financial stability can be threatened by offshore swaps activity. In the U.S., we experienced this first-hand with AIG, which nearly failed because it took on excessive swap risk through operations located in London. The failure of AIG, at that time, in those circumstances, could have triggered another Great Depression. As a result, U.S. taxpayers were required to commit $182 billion to prevent this one company’s collapse. I spent a significant part of my time at Treasury working to recover those monies on behalf of American taxpayers, and so I am very aware of the need to address cross-border risk.
But we also know that there are limits to the reach of any one country’s laws. We recognize the importance of harmonizing our rules with those of other nations where possible. And, at the CFTC, I have made it a priority to work with my international counterparts on these issues.
I am pleased that Singapore and other countries in Asia have taken many steps to implement these reforms. I think that’s good for you, and for us.
I talked earlier about the growth generally of the Asian derivatives markets and the prospects for future growth. Let me say a few more words about growth here in Singapore. What you have done to date is quite impressive. You have developed a wide range of products since the time I was here for the IPO. Your success with equity derivatives is particularly notable, including those based on China’s and Japan’s markets. The Wall Street Journal ran a feature story on derivatives innovation at SGX last month. And more generally, you have built a very successful financial services industry, and no doubt you are looking at the best ways to continue to grow your financial markets and the industry generally in the future.
Part of the answer is surely a sound regulatory framework. History demonstrates that markets are strongest when they are built on a firm foundation of transparency and sensible oversight. Consider how successful was the framework for securities regulation that the U.S. implemented in response to securities scandals in the Great Depression. And you have focused on creating a strong regulatory structure to date.
The goal of the reforms we are adopting today should be to create a framework in which the derivatives markets can continue to thrive and develop, here, and throughout Asia, and throughout the world.
The framework must bring transparency, integrity, and oversight, but, at the same time, provide predictability to market participants, and encourage innovation and competition.
So let me turn to discuss where we are on the four key areas of reform—clearing and clearinghouse regulation, market data, oversight of market participants and trading.
Clearing and Clearinghouse Oversight
Clearing is perhaps the most important reform in terms of reducing systemic risk. But we must remember that central clearing does not eliminate risk.
We are making substantial progress in requiring clearing of standardized swaps. The percentage of transactions that are centrally cleared in the markets we oversee has gone from 15% in December 2007 to about 75% today. Globally, the FSB reports that the percentage is close to half, again up substantially over the last few years. Some countries in Asia have implemented mandates, such as Japan, which did so in 2013, thanks in part to Masa’s leadership. Other countries are still working on theirs.
But now that we are requiring more clearing, we must make clearinghouse supervision a top priority. We must make sure that clearinghouses themselves do not pose risk to the stability of the financial system.
Doing so requires regulators from different countries to work together effectively. The fact is that a small number of clearinghouses are becoming increasingly important single points of risk in the global financial system. Their importance transcends national borders. Their importance transcends swaps—they handle clearing for many products.
And here, I want to congratulate the MAS and SGX for implementing and adhering to high standards. In December 2013, SGX became the first Asian clearinghouse registered with the U.S., which means it can clear swaps for U.S. participants. And just last week, I understand Mizuho Securities became the first clearing member on SGX registered with us.
Our dual registration system came about originally because we took a very non-territorial view as to where clearing must occur. The U.S. did not mandate that clearing of futures traded on U.S. exchanges must take place in the U.S.; we simply required that it take place through clearinghouses that are registered with us and that meet certain standards.
This dual registration system has been the foundation on which the swaps market grew to be a global market. The clearinghouse LCH, which now handles 85% of swaps clearing, is based in Europe, and has been registered with us since 2001.
Today, we are also continuing to work with Europe on harmonizing our rules with theirs as much as possible with respect to clearinghouse supervision. And we are working out cooperative supervision arrangements with them.
We do not take the view that every clearinghouse in the world must register with us. The CFTC previously granted temporary relief from registration to several clearinghouses where the clearing for U.S. persons is limited to clearing members and their affiliates. We did this for clearinghouses in Hong Kong, South Korea, India, and Australia. We are currently working with those four clearinghouses on permanent exemptions, and we hope to have those in place later this year. They can also apply to register with us should they wish at a later date to engage in clearing for U.S. customers.
I believe cooperation among regulators with respect to clearinghouse supervision will be increasingly critical given the increasing importance that major clearinghouses play in the global financial system. I expect that there will be significant dialogue among regulators about clearinghouse standards and strength. Margining standards will be a critical piece of this discussion. So will stress testing. We will need to make sure that the financial, managerial, and operational resources of major clearinghouses are adequate, and in particular that liquidity is adequate. We will need to focus on clearinghouse recovery and resolution. And we will also be very focused on cybersecurity, which is perhaps the most important single risk to global financial stability today.
The second area of reform is the collection and analysis of data. The establishment of swap data repositories in the U.S., and trade repositories abroad, is bringing unprecedented transparency to the swaps market.
Data enables regulatory authorities to engage in meaningful oversight. Robust surveillance and enforcement, so critical to maintaining market integrity, depends on the availability of accurate market data. And increased transparency helps market participants by increasing competition, facilitating the price discovery process, and enhancing confidence in the integrity of the market. It also enables participants and regulatory authorities to understand systemic risk exposures.
We have come a long way from 2008, when we knew very little about the exposures in this market. Today we have real-time information on prices and volumes of traded swaps, and we are in a much better position to monitor risk. But we have a considerable amount of work still to do to collect and use derivatives market data effectively. We must harmonize data reporting standards and make sure that market participants fulfill their obligations to provide accurate and timely reports. There are four data repositories in the U.S. and more than 20 others internationally, plus thousands of participants who must report data. This is a challenging task that will take time.
Important work is going on today. We and the European Central Bank currently co-chair a global task force that is seeking to standardize data standards internationally. While much of this work is highly technical, it is vitally important to international cooperation and transparency. Japan, Singapore, and Hong Kong are all participating in that process, but I encourage you to become even more active in helping to lead this effort. We need your involvement.
Oversight of Market Participants
Let me turn to a third reform area agreed to by the G-20, which is oversight of major market players. I want to focus on two aspects in particular. The first is margin requirements for uncleared swaps. And I want to focus on this for two reasons—one is its importance, and the second is what it says about international harmonization. This rule is important because uncleared, bilateral swap transactions will continue to be a large part of the derivatives market. And setting margin requirements for the largest players in this market will be a significant tool to mitigate risk to the financial system as a whole.
This is also an opportunity to make the rules in the U.S., Asia, and Europe substantially similar from the outset. The CFTC recently proposed margin rules for uncleared swaps, which are similar to those being developed in Japan and Europe. Collectively, the rules reflect a set of standards agreed to by a broader international consensus. There are some differences, and I hope that we can minimize those in the months ahead. I also hope similar reforms will be adopted by Singapore.
Another important area is risk mitigation standards, such as confirmation, documentation, portfolio reconciliation, compression, and valuation. These risk mitigation techniques are essential for addressing operational and other risks faced by market participants, and are based on industry best practices that were developed over many years. I congratulate Singapore for having co-chaired an international committee in this area. That committee is producing international standards, and the U.S. has implemented rules consistent with those standards.
Finally, let me say a word about swaps trading as well as futures trading. The CFTC has implemented a trading mandate for swaps as well as rules for swap execution facilities. Today we are looking at ways to fine tune those rules, so that we enhance transparency and market integrity, but also allow market participants the freedom to innovate and compete as much as possible. It is challenging to be the first mover with swaps trading in a market that has been global, unregulated and highly mobile. So we look forward to other jurisdictions implementing their trading mandates. My impression is there is still some work to be done in most Asian countries on this issue. As you consider this, we are open to your ideas and happy to work with you.
I also want to talk about trading of futures. We generally do not regulate the trading of futures on offshore exchanges. U.S. citizens are free to trade futures on exchanges located in other countries. However, we have in the past required foreign exchanges to apply for relief from our registration requirements if they wish to provide direct electronic access to U.S. citizens. We have now formalized that process so that foreign exchanges, which we refer to as foreign boards of trade or FBOTs, can be officially registered with us.
Today I am pleased to announce that we have approved the foreign board of trade registration application for the SGX derivatives exchange. I congratulate you and look forward to working with you.
I would also like to announce that we have approved the application for Bursa Malaysia, and two days ago, while in Tokyo, I announced we approved the application for the Tokyo Commodities Exchange (or TOCOM). These approvals recognize the increasing interconnectedness of the global derivatives markets and the importance of Asia in that development. The approvals also demonstrate our commitment to a coordinated regulatory approach that relies on foreign supervisory authorities and ongoing cooperation. I am delighted that these exchanges have this status, and we look forward to continuing to work with them as well as any other Asian exchanges that intend to register.
Let me conclude with this: markets thrive where there is confidence and integrity. You saw how quickly markets lost confidence when the Asian financial crisis hit. And we all saw how quickly that happened in 2008.
Market confidence requires transparency, which in turn requires good regulation. Since 2008, the global community has made significant progress implementing reform. We are all stronger and more resilient as a result.
But there is much more to do, and it requires action by all of us—the U.S., Asia, and Europe.
We in the U.S. stand ready to work with you to implement the G-20 commitments. We look forward to creating a foundation that will enable all of our markets to thrive, and economies to grow into the future.
Thank you again for inviting me today.
Last Updated: January 22, 2015