Public Statements & Remarks

Objection of Commissioner Christy Goldsmith Romero to No-Action Letter that Rolls Back Dodd-Frank Act Reforms and Removes Counterparty Protections

February 22, 2024

I object to the CFTC staff issuing a no-action letter rolling back critical Dodd-Frank Act reforms intended to address causes of the 2008 financial crisis. The Dodd-Frank Act directed the Commission to impose business conduct standards on swap dealers to reverse the caveat emptor nature of pre-crisis swaps markets. These business conduct rules promulgated by the Commission in 2012 include that swap dealers shall disclose to a potential counterparty material information that reasonably allows the counterparty to assess “the material incentives and conflicts of interest” the swap dealer may have before entering into a swap.  Those disclosures “shall include…the mid-market mark of the swap.”[1]

The rule contains no exceptions to these disclosure requirements, despite strenuous objections to the requirements by some in the industry. But the no-action letter creates an exception to swap dealers disclosing their conflicts of interest and material incentives through the pre-trade mid-market mark for certain products as long as there is some transparency in pricing of those products.[2] The no-action letter inappropriately shifts the burden of understanding swap dealer’s conflicts and incentives back onto counterparties, upending the Dodd-Frank Act’s intent.

The No-Action Letter Removes an Important Dodd-Frank Act Counterparty Protection Adopted by the Commission

Through this no-action letter the staff is removing for certain products an important counterparty protection adopted by the Commission. Regulation 23.431(d)(2) instructs swap dealers that mid-market marks “shall not include amounts for profit, credit reserve, hedging, funding, liquidity, or any other costs or adjustments.” As described in a relevant CFTC enforcement case: “By making such disclosures, swap dealers inform their counterparties of an approximate measure of the objective value of a swap prior to markup being added by the swap dealer.”[3] These disclosure rules “are intended to level the information playing field . . . to enable counterparties to make their own informed decisions about the appropriateness of entering into the swap.”[4]

I understand that banks and other swap dealers might prefer to not disclose this type of information, but it is not an appropriate use of a no-action letter for the staff to create an exception for all swap dealers from clear and well-established Dodd Frank Act reforms. As the Commission said during the post-crisis era while implementing the Dodd-Frank Act, the no-action process is “generally better suited for discrete, unique factual circumstances and for situations where neither the CEA nor the Commission's regulations address the issue presented.”[5] Here, there is no discrete or unique factual circumstances as the relief applies to all swap dealers and to a heavily traded product, and the CEA and Commission regulations squarely address the issue presented.

The no-action letter disturbs a carefully considered Commission rule. In developing the 2012 rule, the Commission held over two dozen external consultations, consulted with the SEC, prudential regulators, and foreign authorities, and considered over 120 comments from a wide range of interested parties, including public interest groups. Commenters made arguments both for and against a pre-trade mid-market mark. In contrast, this no-action letter is based only on a request of a working group representing some of the largest swap dealer banks. The letter repeats the perspective of large banks who have opposed this reform since the 2012 rulemaking and says that the relief is in part based on the working group’s representations, without including any independent CFTC analysis.

The no-action letter is particularly concerning because it rolls back an important Dodd Frank Act reform designed to reverse the caveat emptor nature of swaps markets that contributed to the 2008 financial crisis.[6] Even if there is some transparency in pricing (which is not clear as no independent analysis has been provided), the primary purpose of the Dodd Frank Act reforms for this rule was to establish business conduct rules for swap dealers, and provide counterparties with protections. There is no exception in the rule to those protections if there is some transparency in pricing.

Then-Chairman Gensler in the open meeting on the final rule said,

Congress really wanted to address protections for counterparties, and in particular, special entities—municipal governments, pension funds that are entrusted with trillions of dollars of assets on behalf of people's retirements, and I think this rule takes a balanced approach to it. I'm just going to mention three things. One is I think it's very important. It was a Congressional mandate, but I think we've got it right in the rule. The counterparties will get a daily what's the value of this outstanding swap, and I think that's particularly important for a lot of municipals and pension funds, but also small banks, small end users, midmarket companies that would not necessarily know what's the value of that—or at least what does their dealer think the value is on those bilateral swaps. And they'll get it midmarket before the profits or the charges that would be there. I think it's very critical. Two, I think it does help protect against fraud and other abuses in the market…[7]

The No-Action Letter Inappropriately Shifts the Burden of Understanding Swap Dealer’s Conflicts and Incentives Back onto Counterparties, Upending the Dodd-Frank Act’s Intent

Consumer Federation of America’s (“CFA”) comment letter to the 2012 rule said, “Getting the disclosures right is central to preventing the types of abuses that prompted Congress to provide the Commission with such broad authority to set business conduct standards.”[8] CFA commented that the business conduct rules would significantly enhance the integrity of the swaps markets and “better ensure that this market benefits rather than exploits the many commercial end users, government entities, endowments, and pension funds that reply on swaps to hedge risks.”[9]

The no-action letter removes the counterparty protection and shifts responsibility back to counterparties to inform themselves about swap dealers’ conflicts and incentives. The letter includes no independent analysis of the consequences of this shift in burden and removing this counterparty protection, and no discussion of engagement with other stakeholders such as counterparties or public interest groups who commented on the 2012 rule. For example, Better Markets described in their comment letter to the 2012 rule:

With grossly distorted compensation incentives, dealers create ever more complex products ostensibly customized to meet client needs, but are, in fact, designed not to be understandable by anyone other than a derivatives expert. As a result, the history of the derivatives market is littered with disasters and scandals arising from transactions sold by dealers to customers who never knew or understood the ramifications of the complex financial instruments they were sold. From industrial companies like Proctor and Gamble and Metallgeselschaft to financial entities like AIG, Long-Term Capital Management and Barings, enormous sums have evaporated from the balance sheets of major businesses through these instruments. And the losses to governmental entities like Orange County, California, Jefferson County, Alabama, the State of Wisconsin Investment Board, the State of West Virginia and the Denver school district have directly cost taxpayers tens of billions of dollars….The Dodd Frank Act established business conduct standards for SDs [swap dealers] and MSPs [major swap participants] in large part to protect the public from this mayhem. This provision and the proposed rules will greatly reduce the potential that customers will enter into arrangements without the full appreciation of the extraordinary risks associated with derivatives.[10]

Consumer Federation of America’s comment letter to the 2012 rule said,

Although the swaps market is theoretically closed to all but sophisticated parties, the reality is that the complexity and opacity of these transactions has made old notions of financial sophistication obsolete. All too often, corporations and government entities alike have failed to understand the magnitude of the risks they are taking on—a particularly egregious failing in a market the most important and valuable function of which is to help counterparties hedge risks.[11]

These comments highlight the importance of the rule through the viewpoint of the counterparties and the public—a viewpoint that is not reflected in the no-action letter.

The No-Action Letter Undermines the CFTC’s Enforcement Program

Additionally, the no-action letter undermines the CFTC’s enforcement program. The Commission has consistently voted to approve civil charges against swap dealers that failed to provide mid-market marks or provided inaccurate marks. In 2017, the Commission charged Cargill for providing inaccurate mid-market marks to counterparties that concealed up to ninety percent of Cargill’s markup out of concern that disclosing Cargill’s full markup would reduce Cargill’s earnings.[12] The Commission also brought charges for failure to provide accurate marks or to provide marks at all in every recent year:

2020 against the Bank of Nova Scotia for violations over nearly eight years,[13]

2021 against Société Générale for violations over seven years,[14]

2022 against ED&F Man Capital Markets for violations over seven years,[15]

2023 twice against Goldman Sachs for violations over nearly a decade involving one million marks, and charges against Stone X for violations over five years.[16]

These charges highlight the importance of the CFTC’s enforcement program in this area. The current Director of Enforcement has said, “The CFTC is committed to ensuring that swap dealers abide by these standards, so that swap counterparties receive disclosures allowing them to assess material aspects of the swaps before entering into them. As today’s penalty against Goldman demonstrates, the CFTC will aggressively pursue swap dealers that violate these business conduct standards.”[17] Given the fact that the Commission has aggressively gone after violations of pre-trade mid-market marks based on their importance to counterparties, the no-action letter undermines the CFTC enforcement program.

This Policy Decision Should Be Made by the Commission, not the Staff

The rationale of the no-action letter reflects a policy decision that should be made by the Commission, rather than the staff, and in fact has already been made by the Commission. It is inappropriate for the staff to create exceptions to Commission promulgated rules through a no-action letter in this area, particularly given our enforcement cases.

I caution against rolling back Dodd Frank Act reforms through this or another action. As Chairman Sherrod Brown and Senators John Fetterman and Tina Smith recently wrote in a letter to the CFTC Chairman, “The CFTC already faces significant resource constraints in its vital position regulating the derivatives market and should not increase risks to market stability. Now is not the time to peel back the important protections under Dodd-Frank. We urge the Commission to continue to focus on its vital work, preserving market integrity and protecting the public, uphold the letter and spirit of the Dodd-Frank Act….[18] I agree, and therefore, I object to the no-action letter.

[1]17 C.F.R. 23.431(a)(3).

[2] In 2012, the staff issued a no-action letter based on an industry representation that the swaps at issue were “highly liquid narrow bid-ask spreads” and “widely quoted.” Fast forward 12 years later, the current no-action letter is based “among other things” on industry representations that the swaps at issue are “highly liquid, narrow bid and offer spreads” and there is “significant amount of publicly available information.” The rule voted on by the Commission as a Dodd Frank Act reform has no exception for “highly liquid, narrow bid and offer spreads” or where there is “significant amount of publicly available information.”

[3] See In the Matter of Bank of Nova Scotia, Order Instituting Proceedings Pursuant To Section 6(C) And (D) Of The Commodity Exchange Act, Making Findings, And Imposing Remedial Sanctions (Aug, 19, 2020).

[4] See Business Conduct Standards for Swap Dealers and Major Swap Participants with Counterparties, 77 Fed. Reg. 9734, 9759 (February 17, 2012); see also In the Matter of Goldman Sachs & Co., Order Instituting Proceedings Pursuant To Section 6(C) And (D) Of The Commodity Exchange Act, Making Findings, And Imposing Remedial Sanctions (Apr. 10, 2023) (citing same).

[5] Registration of Foreign Boards of Trade, 76 Fed. Reg. 80674, 80675 (Dec. 23, 2011).

[6] See Business Conduct Standards for Swap Dealers and Major Swap Participants with Counterparties, 77 Fed. Reg. 9734, 9805 (Feb. 17, 2012).

[8] See Business Conduct Standards for Swap Dealers and Major Swap Participants with Counterparties, 77 Fed. Reg. 9734, 9805 (Feb. 17, 2012) (Comment of CFA / AFR).

[9] Id. (CFA described J.P. Morgan Chase’s sale of derivatives to Jefferson County, Alabama, as part of financing a new sewer system. During the financial crisis, the annual payments on the county’s debt jumped nearly $600 million in one year. When the county could not make the swap payment, JP Morgan cancelled the deal, charging a $647 million termination fee. Jefferson County’s credit rating was slashed, and it had to lay off workers and increase sewer bills by 400 percent).

[10] Id. (Comment of Better Markets).

[11] Id. (Comment of CFA / AFR).

[12] See CFTC Orders Cargill, Inc. to Pay a $10 MN Penalty for Providing Inaccurate Mid-Market Marks on Swaps, Which Concealed Cargill’s Full Mark-up, in Violation of Swap Dealer Business Conduct & Reporting Requirements, & for Supervision Failures | CFTC (Nov. 6, 2017) (“ The CFTC Order finds that from 2013 to the present Cargill, a provisionally registered swap dealer, provided hundreds of counterparties and its SDR with mid-market marks on thousands of complex swaps that failed to comply with the CEA and Commission Regulations. Specifically, Cargill chose to provide counterparties a mid-market mark that failed to disclose Cargill’s full mark-up, as it was required to do. Instead, Cargill provided a mid-market mark that recognized only ten percent of its mark-up on the first day of the swap and amortized the remaining mark-up equally over the next sixty days. The result was that Cargill provided mid-market marks to counterparties that concealed up to ninety percent of Cargill’s mark-up. The CFTC Order further finds that Cargill used this non-compliant mark methodology because of its concern that providing counterparties marks that disclosed Cargill’s full mark-up would reduce Cargill’s earnings. The CFTC Order also finds that Cargill undertook this course of conduct despite concerns within Cargill that this mark methodology did not comply with the requirements of the CEA and Commission Regulations. And the CFTC Order finds that Cargill deliberately avoided raising questions about the mid-market mark with the Commission to avoid “tip[ing Cargill’s] hand.”)

[13] See CFTC Orders The Bank of Nova Scotia to Pay $50 Million for Swap Dealer Compliance and Supervision Failures and False Statements | CFTC (Aug. 19, 2020) (“The order finds, specifically, that at various times from at least December 31, 2012 to the present, BNS failed to comply with swap dealer business conduct standards requirements for pre-trade mid-market marks (PTMMMs) by providing counterparties with PTMMMs that were inaccurate, untimely, or both, or failing to provide PTMMMs entirely. The order finds that this conduct had the effect of concealing BNS’s full markup from its swaps counterparties.”)

[14] See CFTC Orders Société Générale S.A. to Pay $1.5 Million for Mid-Market Mark, Swap Valuation Data and Supervision Failures | CFTC (Sept. 29, 2021) (finding that “between 2013 and until approximately July 2021, Société Générale failed to meet its mid-market mark disclosure requirements with respect to numerous swaps, including failing to disclose pre-trade and/or daily mid-market marks entirely….”)

[15]> See CFTC Orders London-Based Swap Dealer to Pay $3.25 Million for Swap-Data Reporting, Conflicts of Interest, Mid-Market Mark, and Supervision Failures | CFTC (March 15, 2022) (“From February 2014 to April 2021, ED&F Man failed to disclose mid-market marks to some of its counterparties as required for numerous metals and FX swaps.”)

[16] See <CFTC Orders Three Financial Institutions to Pay Over $50 Million for Swap Reporting Failures and Other Violations | CFTC (Sept. 29, 2023) (“on more than one million occasions since 2013, Goldman provided counterparties with PTMMMs that were inaccurate or failed to provide a PTMMM entirely.”) see also CFTC Orders Goldman Sachs to Pay $15,000,000 for Violations of Swap Business Conduct Standards | CFTC (April 10, 2023); see also CFTC Orders StoneX Markets LLC to Pay $650,000 for Violations of Swap Business Conduct Standards | CFTC (Sept. 20, 2023) (“StoneX admits and the order finds that for numerous transactions between 2016 and 2022, StoneX failed to diligently supervise its PTMMM disclosure process, resulting in StoneX’s failure to comply with PTMMM disclosure requirements for thousands of swap transactions.”)