SPEECHES & TESTIMONY

Keynote Address of Commissioner Dawn D. Stump at the 2019 ISDA Annual Europe Conference

September 19, 2019

From Pittsburgh with Love[1]
Dramatic Reforms, Ten Years Later
September 2009 – September 2019

I am pleased to join you here in London for ISDA’s Annual Europe Conference.  Before we get started, I want to say that the views I express today are my own and may differ from those of the Commission that I am honored to serve upon.  While this is my first trip to the United Kingdom since being sworn in as a CFTC Commissioner, prior professional endeavors enabled me to experience and appreciate not only the city, but also the financial services industry expertise and market infrastructure here in London.  More recently, I have had the privilege to develop working relationships with several fellow market regulators both here in the U.K. and within Continental Europe.  The tremendous responsibility to regulate global derivatives markets in today’s dynamic environment makes fast friends among those who share this charge.

Overview

I believe working together for a common mission yields far better results than duplicating efforts and potentially impeding regulators’ shared goal of effective financial regulation.  We know this based upon experience during our agency’s 45-year history.  Cross-border regulatory coordination is not a new trend.  We have long worked with our fellow regulators to develop international standards such that we can rely upon “mutual recognition” of comparable regulatory regimes.  Mutual recognition – or what today we often refer to as international “deference” – enables us to facilitate compliance with the unique U.S. statutory core principles which we at the CFTC are tasked with implementing by sensibly relying upon home country regulators as our partners to apply a common set of the highest global standards.

The CFTC’s mission requires us to join forces with fellow regulators in what one might liken to the alliance of James Bond of MI6 and Felix Leiter of the CIA.  You may struggle to see the obvious correlation of derivatives regulators to spy film celebrities.  I’ll admit we are far less adventurous and perhaps lack the fan following of 007, and while Robert Ophele does emanate Bond with his French cuffed shirts, Andrew Bailey likely does not have a collection of weapon-grade timepieces, nor do any CFTC Commissioners to my knowledge drive Aston Martin sports cars.  Seriously, though, in our far less glamorous roles there is a lesson to be taken from James, Felix and Rene Mathis - a strong global alliance is essential to achieving our shared pursuit of well-functioning derivatives markets.

Let’s start with the 2008 financial crisis.  At the time, I was serving as professional staff for the U.S. legislative branch and was specifically assigned to work on re-thinking the laws that governed over-the-counter (“OTC”) derivatives.  It was one of the more challenging opportunities of my career because what we knew about the underlying problems in the derivatives markets was continually evolving at the very time we were also trying to design a solution.  Some of you may have experienced a similar challenge.

In the midst of the chaos, the G-20 leaders met in Pittsburgh and correctly recognized that the markets are global and that designing a workable solution, though complicated, demands coordinated policies and cooperation.[2]  To do otherwise would ignore the reality that modern markets are not bound by jurisdictional borders.  While each country agreed to this coordinated approach, our pace of implementation differed, and the CFTC has since wrestled with first mover disadvantage.  Today, however, many of our fellow regulators have implemented commensurate reforms, thus aligning our regulatory principles, just as the G-20 envisioned.

Our regulatory similarities can now be used as a basis to support deference between jurisdictions which, in turn, helps to promote clarity and market stability.  Moving in the opposite direction would undermine the coordination envisioned by the G-20.  While I respect that circumstances in individual jurisdictions shift from time to time and warrant regulatory adjustments, I am hopeful we can approach such instances without forgetting what necessitates our union.  Unilateral actions can lead to retaliatory tactics that are counterproductive to the coordinated approach agreed to at the Pittsburgh Summit.  I offer these points as reminders of why we should build upon, rather than ignore, our progress.  Next week marks ten years since the leaders’ statement in Pittsburgh, and we cannot forget what necessitated global regulatory union both then and now.

License to Cooperate[3]Coordination is Essential for Oversight of Central Counterparties

Given the depth and breadth of the global marketplace and its participants, we must acknowledge that no single regulator is capable of overseeing the markets in every corner of the world.  Therefore, we must respect and rely upon each other’s expertise for intelligence and support.  In this way, we leverage this worldwide coalition of regulators to oversee these global markets efficiently and effectively.  We all have a license to cooperate.

Trust and deference are particularly critical in the mission to regulate and supervise cross-border central counterparties (“CCPs”).  A duplicative, confusing web of multiple regulatory agencies around the world asserting overlapping but jurisdictionally distinct regulation and supervision of global CCPs would undermine, not enhance, the safety of our clearing system.  Instead, we need a strong alliance of regulators executing a common set of principles, each with a clear delineation of roles and a willingness to defer to its counterparts in the home country of a CCP.

This summer, the CFTC proposed regulations addressing such an alliance.[4]  The CFTC’s proposals recognize that a jurisdiction may have a legitimate interest in regulating a third country CCP under certain circumstances.  The CFTC has proposed that such an interest exists when a third country CCP poses a substantial risk to the U.S. financial system.  On the other hand, the European Commission and the European Securities and Markets Authority (“ESMA”) have expressed an interest in a third country CCP that is systemically important.  Regulators must be clear about when such an interest exists.

The CFTC has put forward a transparent, objective, quantitative metric for determining whether a third country CCP poses substantial risk to the U.S. financial system.[5]  The proposed substantial risk test focuses on the amount of initial margin required at the CCP.  The first part of the proposed test is whether required initial margin from U.S. clearing members at the CCP constitutes twenty percent or more of the required initial margin for U.S. clearing members at all registered and exempt derivatives clearing organizations (“DCOs”).  This part of the test focuses on the CCP’s share of the total global required initial margin from U.S. clearing members.  The second part of the proposed test is whether twenty percent or more of the required initial margin at the CCP is attributable to U.S. clearing members.  This part of the test focuses on the percentage of the required initial margin at the CCP that comes from U.S. clearing members.

To be sure, the CFTC is not proposing that these twenty percent numbers be fixed lines.  Where one or both of the thresholds is close to twenty percent, the proposals would afford the CFTC discretion in determining whether the CCP poses substantial risk to the U.S. financial system.  But the CFTC’s proposed substantial risk test would take the guesswork out of the determination.  While I am interested to hear what commenters have to say about the CFTC’s proposed test, as well as other aspects of the recently proposed rules, I support using a metric that is transparent, objective, and quantitative.

By contrast, ESMA has proposed fourteen “indicators” that it would use to assess whether a third country CCP is systemically important or likely to become systemically important for the financial stability of the European Union or one or more of its Member States.[6]  I am concerned that these indicators are subjective, qualitative, and confer overly broad discretion on ESMA.  These indicators would make it difficult for market participants and regulators alike to anticipate which third country CCPs will fall within ESMA’s remit.  I understand that commenters have raised similar concerns, and I hope that ESMA works with all relevant stakeholders to clarify how it will determine that a third country CCP is systemically important or likely to become systemically important for the financial stability of the European Union or one or more of its Member States.

With respect to third country CCPs that do not present a substantial risk to the U.S. financial system, the CFTC has proposed two approaches: the Exempt DCO Proposal and the Alternative Compliance Proposal.  Both proposals set forth principles-based standards for determining whether and to what extent the CFTC should defer to a CCP’s home country regulator.

In this context, we have proposed an option for non-U.S. CCPs offering clearing services to U.S. persons to request an exemption from registration with the CFTC.  Congress in the Commodity Exchange Act (“CEA”) explicitly authorized the CFTC to issue such registration exemptions in deference to a CCP’s home country regulator.  The CFTC may “exempt, conditionally or unconditionally, a derivatives clearing organization from registration…for the clearing of swaps if the [CFTC] determines that the derivatives clearing organization is subject to comparable, comprehensive supervision and regulation by … the appropriate government authorities in the home country of the organization.”[7]  In determining whether a CCP is subject to comparable, comprehensive supervision and regulation by its home country regulator, the CFTC’s proposal would rely on the home country’s adoption of, and the CCP’s observation of, the Principles for Financial Market Infrastructures.[8]

Additionally, for those third country CCPs that want to be registered with the CFTC as DCOs, the CFTC has proposed an “alternative compliance” mechanism for the CCP to comply with U.S. regulatory obligations that similarly defers to the CCP’s home country regulator.  That is, a third country CCP wishing to be a registered DCO can comply with the core principles set forth in the CEA by adhering to applicable legal requirements in its home country.[9]  While the CCP would still be required to comply with certain CFTC regulations in the areas of customer protection safeguards and swap data reporting requirements, the home country regulatory regime would not need to satisfy all of the CFTC’s regulations applicable to registered DCOs.[10]

I believe that the CFTC’s proposals are a step in the right direction when it comes to demonstrating our willingness to defer to our international colleagues that are administering comparable regulatory regimes.  The two proposals – the Exempt DCO Proposal and the Alternative Compliance Proposal – recognize that no regulator can unilaterally supervise the world.  Instead, we should evaluate whether other countries’ regimes reflect our shared goals.  If they do, we should offer greater deference to their regulatory authorities.  Likewise, I expect other jurisdictions to rely on the CFTC’s abilities and respect our expertise.  Such a two-way street will best fulfill the mission the G-20 leaders agreed to in Pittsburgh almost ten years ago.

You Only Live Twice[11] – Rescuing Swap Data Reporting

Turning now to swap data reporting, perhaps we as regulators should heed Ian Fleming’s warning that You Only Live Twice:  New regulatory reporting requirements, though operationalized, are deficient for achieving their intended purpose, and the authorities to which regulators are accountable will likely be unsympathetic should a future challenge arise absent functional data.  I am not sure, in such a circumstance, that we would be afforded another chance to design a workable system.  For this reason, a commitment to improving and standardizing the reporting elements envisioned by the reform agenda requires our immediate attention.

At the onset of the financial crisis, the most obvious regulatory predicament for OTC derivatives was the lack of information, and it was quickly concluded that regulators need a consistent set of data points from which to conduct market oversight and respond to looming challenges.  I have long believed that lacking information was among the most fundamental issues to be addressed post-crisis, and yet we continue to struggle to effectuate this reform measure.  If another challenge or crisis arises without a coordinated data system in place, I doubt there will be much empathy for any explanation or excuse as to why we have failed to achieve our global regulatory charge.

The lack of global harmonization in swap data reporting continues to hinder implementation of post-crisis reforms, and divergent requirements across jurisdictions are an ongoing and substantial burden on market participants.  Distinct reporting rules and disjointed implementation across jurisdictions increase costs and promote inefficiency by forcing trade repositories and reporting counterparties to build and maintain different reporting mechanisms, and they fail to advance a harmonized global system in which regulators can effectively utilize the data for coordinated supervision efforts.

The Pittsburgh accords were predicated upon the global regulatory community procuring data to inform decision makers about the opaque OTC swap markets.  The next crisis will not be the same as the last, nor will it be resolved any better or faster without harmonized data sets.  The regulatory response will be sorely lacking if the CFTC and its international regulatory colleagues have to first assemble their disparate data sets in an emergency situation.  Despite the substantial costs imposed upon market participants to report swap data, the different data elements, formatting, and technical specifications utilized by individual jurisdictions make it extremely difficult to aggregate data across global markets and thus limit the data’s utility.

Earlier this year, the CFTC published a rule proposal outlining ideas on how to confirm the accuracy of swap data reported to trade repositories.[12]  I hope that future proposals regarding our other reporting rules will provide market participants with a holistic view into what the CFTC is thinking for the entire swap data reporting ecosystem.  In my opinion, this should include significant harmonization with other regulators around the world, a reasonable and substantive streamlining of obligations, a considerable adjustment in the number of required reportable elements, extended time for regulatory reporting to 24 hours to ensure accuracy, and a reduction in the regulatory burden placed on end-users.

Data has no nationality and knows no borders.  It presents a tremendous opportunity to demonstrate effective international regulatory cooperation.  Coordination among regulators is essential to the improvement of swap data reporting and the implementation of standardized identifiers and technical guidance on data elements published by international working groups such as the Committee on Payments and Market Infrastructures (“CPMI”), the International Organization of Securities Commissions (“IOSCO”), and the Financial Stability Board (“FSB”).

The World is Not Enough[13]Rethinking the “Intergalactic” Application of Cross-Border Guidance[14]

Over the years, there has been talk about the possibility that the CFTC might re-examine its cross-border approach to swap dealer regulation in a rulemaking.  After all, the agency’s 2013 guidance was just that, guidance, which the CFTC might want to replace with actual regulations.  I have long believed that the guidance was designed to be temporary and that, all other things being equal, regulation to provide certainty and reliability is the more prudent course.

I also believe that Section 2(i) of the CEA limits the international reach of CFTC swap regulations by affirmatively stating that they “shall not apply to activities outside the United States unless those activities . . . have a direct and significant connection with activities in, or effect on, commerce of the United States.”[15]  A common sense reading of this section, aptly titled “Applicability” in the statute, is that there is a limited reach of U.S. law, and to stretch it beyond the stated criteria impermissibly infringes upon the rule sets of other countries.

That is, the legal intent is to start with U.S. law not applying beyond our borders, and then continue to the limited conditions where extraterritoriality would be deemed appropriate.  The law does not say that CFTC rules govern derivatives market activities around the world if there is any linkage or tie to the United States and should not be interpreted and abused as such.  Rigorous analysis of the Section 2(i) test is necessary to ensure that the law is followed both to the letter and in spirit.

Tomorrow Never Dies[16] - Initial Margin for Non-Centrally Cleared Derivatives

I would now like to discuss two recent measures addressing the application of initial margin (“IM”) for non-centrally cleared derivatives.  In July, regulators recognized that market participants in the final phase of implementation require more time to comply with margin rules, and separately the CFTC clarified when documentation requirements are triggered.

The Basel Committee on Banking Supervision (“BCBS”) and IOSCO agreed to an interim phase and an extension for some of the smallest firms by one year until September 2021.[17]  This delay in implementation for the smallest of in-scope firms, essentially a “Phase 6,” is meant to address the enormous task facing smaller counterparties in their compliance efforts.  Also, CFTC staff issued an advisory clarifying for its registrants that documentation requirements for uncleared swaps would not apply until a firm exceeds a $50 million IM threshold with a particular swap dealer.[18]  Both of these actions are positive developments that will ease the potential compliance bottleneck from an unprecedented number of counterparties and provide greater clarity for documentation expectations.  That said, much still remains to be accomplished to achieve readiness and I would remind everyone that Tomorrow Never Dies, and market participants should commit to this exercise sooner rather than later.

Firms captured by the final phases of uncleared margin will be entering unfamiliar territory, negotiating with trading counterparties and custodians, and interacting with new intermediaries where they do not have pre-existing relationships.  The required documentation challenges might not seem insurmountable from an individual firm perspective, but it is expected that the final phases of IM implementation will impact several thousand bilateral relationships.  Further complicating matters, each of these bilateral relationships will require multiple legal agreements addressing the various parts of the margin workflow.  Swap counterparties will be expected to establish separate segregated accounts for the posting and receiving of collateral, and reach agreements with each counterparty and their respective, chosen custodian.  As anyone who has ever negotiated documentation related to swaps knows all too well, negotiating the details of such agreements is time-consuming and tedious, thus extending the process.

In addition to documentation and negotiations, firms will need to monitor their Average Aggregate Notional Amount (“AANA”) and IM amounts proactively to have as much lead time as possible before exceeding various thresholds.  Firms need to adopt the methodology to calculate IM requirements and acquire the necessary infrastructure.  Also, firms controlling separately managed accounts on behalf of underlying investors that employ multiple asset managers face an even greater challenge that must be addressed in an orderly manner.

That is a considerable amount of work, and the reality is that there are a limited number of custodians and law firms available for these negotiations.  The industry overall will be capacity constrained to deliver and negotiate with all these various entities.  Deadlines have a knack for surprising folks sooner than expected.  At some point, prolonging the finish is no longer an option for these margin requirements.  The CFTC’s Global Markets Advisory Committee (“GMAC”) that I sponsor will be meeting on September 24th to advise the CFTC regarding these various documentation and preparation challenges.  Participants who have already engaged on these fronts need to persevere and continue, while those that have yet to commence need to start making progress.

Closing

In closing, we should be reminded to Never Say Never Again,[19] but rather prepare for the inevitable challenges ahead through a constant willingness to re-evaluate and reset as appropriate.  The G-20 agreement included a directive to “assess regularly implementation and whether it is sufficient to improve transparency in the derivatives markets, mitigate systemic risk, and protect against market abuse.”[20]  None of the resulting regulatory responses to Pittsburgh are stagnant, and rules should be updated based on changing circumstances.

That said, I want to be clear that I am not suggesting wholesale transformation but rather prudent regulatory adjustments based upon ten years of progress.  Those who rely upon our markets deserve the benefit of regulatory certainty, and regulators must respect and assist one another in order to achieve stability.  It is time to lessen the drama surrounding global derivatives policy-making which, unlike Bond’s signature cocktail, has been both shaken and then stirred in recent years.

 

[1] Cf. Broccoli, A., Saltzman, H. (Producers), & Young, T. (Director), From Russia with Love (1964).

[2] See Leaders’ Statement from the 2009 G-20 Summit in Pittsburgh, Pa. (“G-20 Pittsburgh Leaders’ Statement”) at 7 (Sept. 24-25, 2009) (“We are committed to take action at the national and international level to raise standards together so that our national authorities implement global standards consistently in a way that ensures a level playing field and avoids fragmentation of markets, protectionism, and regulatory arbitrage”), available at https://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf.

[3] Cf. Broccoli, A., Wilson, M. (Producers), & Glen, J. (Director), License to Kill (1989).

[4] Registration with Alternative Compliance for Non-U.S. Derivatives Clearing Organizations, 84 Fed. Reg. 34819 (proposed July 19, 2019) (“Alternative Compliance Proposal”), and Exemption from Derivatives Clearing Organization Registration, 84 Fed. Reg. 35456 (proposed July 23, 2019) (“Exempt DCO Proposal”).

[5] See proposed § 39.2, 84 Fed. Reg. at 34832 (Alternative Compliance Proposal) and 84 Fed. Reg. at 35472 (Exempt DCO Proposal) (defining “substantial risk to the U.S. financial system”).

[6] See European Securities and Markets Authority, Consultation Paper, Draft Technical Advice on Criteria for Tiering under Article 25(2a) of EMIR 2.2 (May 28, 2019), available at https://www.esma.europa.eu/press-news/consultations/technical-advice-comparable-compliance-under-article-25a-emir.

[7] CEA Section 5b(h), 7 U.S.C. § 7a-1(h).

[8] See proposed § 39.6(a)(1), 84 Fed. Reg. at 35472 (Exempt DCO Proposal).

[9] See proposed § 39.51(a)(1)(i), 84 Fed. Reg. at 34833 (Alternative Compliance Proposal).

[10] See 84 Fed. Reg. at 34821, n.14 (Alternative Compliance Proposal).

[11] Broccoli, A., Saltzman, H. (Producers), & Gilbert, L. (Director), You Only Live Twice (1967).

[12] Certain Swap Data Repository and Data Reporting Requirements, 84 Fed. Reg. 21044 (proposed May 13, 2019).

[13] Wilson, M., Broccoli, B. (Producers), & Apted, M. (Director), The World Is Not Enough (1999).

[14] See Cross-Border Application of Certain Swaps Provisions of the Commodity Exchange Act, 77 Fed. Reg. 41214, 41239 (proposed July 12, 2012) (Statement of Commissioner Sommers, expressing the view that in drafting the CFTC’s proposed cross-border interpretive guidance, “staff had been guided by what could only be called the ‘Intergalactic Commerce Clause’ of the Unites States Constitution . . .”).

[15] CEA Section 2(i), 7 U.S.C. § 2(i).

[16] Wilson, M., Broccoli, B. (Producers), & Spottiswoode, R. (Director), Tomorrow Never Dies (1997).

[17] BCBS/IOSCO statement on the final implementation phases of the Margin requirements for non-centrally cleared derivatives (March 5, 2019), available at https://www.bis.org/press/p190305a.htm.

[18] Initial Margin Documentation Requirements, CFTC Letter No. 19-16 (DSIO July 9, 2019).

[19] Schwartzman, J. (Producer), & Kershner, I. (Director), Never Say Never Again (1983).

[20] G-20 Pittsburgh Leaders’ Statement at 9.