Keynote Address of Commissioner Dawn D. Stump at the ISDA Annual Legal Forum, New York, NY 

The Law Is Our Authority and Common Sense Our Judge 

June 11, 2019

Thank you, Katherine, for the kind introduction and to ISDA for the opportunity to be here today at the Annual Legal Forum.

In addressing this collection of global derivatives law experts, I thought it appropriate to heed the principle of “The Law is King” in Thomas Paine’s Common Sense pamphlet from 1776.[1]  Despite the different time and intent of these writings, the concept of the law’s supremacy must remain a critical factor to consider when regulating global derivatives markets today.

That being said, after spending almost a decade as a Congressional policy advisor tasked with drafting legislation, I always like to recall that according to James Madison, the purpose of legislation is to deal with general principles.  Therefore, the law requires a fair bit of interpretation and policy development, and here common sense should be applied to generate the best possible outcomes while adhering to the rule of law.

Our markets are dynamic, and regulatory policies must be reviewed and updated as appropriate.  I feel that the role of our current Commission is just that, reviewing initial implementation of regulations and adjusting course based on data and lessons learned.  Before I continue with the importance of, and this is noteworthy, both law and common sense, let me start with the standard disclaimer that the views I express today are my own and may differ from those of the Commission I am honored to serve upon.

Position Limits

I want to start with an issue that is all too familiar for many of us and acknowledge that there has been much discussion about the status of the position limits rulemaking in recent months.  Position limits certainly feels like a never-ending saga.  I worked on it during my time on Capitol Hill – even before the Dodd-Frank Act – and now, a decade later, I have joined the agency and it is still unresolved.  As this audience knows well, since the passage of the Dodd-Frank Act, position limits have been the subject of a final rule, a court decision vacating that final rule, a new proposal, a supplemental proposal, and a re-proposal.  And, we are currently in the process of trying once again.

With respect to the derivatives reform provisions of Dodd-Frank, I have said that it is important to look back at the objective that a particular provision was designed to achieve,[2] and that applies to position limits as well.  Shortly before the financial crisis hit with full force in September 2008, America endured a period of skyrocketing food and energy prices that peaked during that summer, and it was that experience that influenced Congress to amend the Commodity Exchange Act’s (CEA’s) position limits regime as part of Dodd-Frank.

While the debate has raged on over how the Commission should implement these provisions, and how much discretion the agency has in doing so, I believe we are best suited to consider a new position limits regime during times of less turbulent market conditions than those we faced in the summer of 2008.  Yet, uncertainty over whether, when, and what the Commission will do about position limits is a constant concern for market participants.  And analyzing and commenting on complex and ever-shifting proposals diverts human and financial resources from other business purposes.

As you know, the federal court that vacated the prior final rule remanded the issue back to the Commission to “fill in the gaps and resolve the ambiguities” [3] as to whether the law mandated the agency to impose position limits or required such limits only upon a finding of necessity and appropriateness.[4]  Our staff is working diligently to fulfill that direction from the court.

Beyond that issue, though, I believe there are some common-sense principles that should guide our position limits rulemaking, and on which all should be able to agree.

First, the factors in determining appropriate limits must be current.  Just as we need up-to-date swaps data to inform our policy determinations on implementing the OTC derivatives reforms of Dodd-Frank, we also need current deliverable supply information to inform the methodology for updated position limits.

Second, the Exchanges must play an integral role in the administration of the position limits regime.  The Exchanges know their markets, and they know the hedging practices of traders in their markets.  We must rely on that knowledge and expertise in order to make the position limits regime work effectively.

Third, one size will not fit all.  The Commission has a long history of administering position limits for futures on certain agricultural commodities, but not for futures in the energy or metals sectors.  Not all futures markets are the same.  We cannot impose position limits on energy and metals transactions solely on the basis of how the Commission has imposed limits in agricultural commodities over the years, and we cannot subject our legacy agricultural contracts to a position limits regime that is best suited to the hedging needs of the energy markets.

I must emphasize that the next iteration of the Commission’s position limits rulemaking currently remains at the staff level.  I have not seen a draft.  Nevertheless, I am optimistic that it will be premised on common-sense principles such as those I have mentioned.

Given the vastly disparate viewpoints on this subject, I have no expectation that everybody will be happy with the ultimate product.  But I do believe that, by adhering to common-sense principles, we can adopt position limits rules that finally provide needed clarity and certainty, and that market participants will accept as reasonable to the task of implementing the law.

Swap Execution Facilities (SEFs)

The Commission published a notice of proposed rulemaking on SEFs in November of last year.[5]  I voted to issue the proposal in order to solicit public feedback, consider whether changes to the SEF rules were warranted (and, if yes, what and how), and then ultimately determine appropriate next steps.  I find the notice-and-comment process to be an incredibly informative dialogue that affords regulation the greatest chance of success.  The Commission gets to analyze whether it hit a home run or struck out.

To those who commented, thank you for the walk down memory lane, as I have not heard so many diametrically opposed viewpoints since my time considering the merits of establishing SEFs in legislation while working on Capitol Hill.  The feedback received was mixed in that different folks liked and disliked various aspects of the proposal, but overall consensus concerning some of the more structural changes was not achieved.  Now, the Commission must heed the lessons learned and comments received while adhering to the Rule of Construction in Section 5h(e) of the CEA which reads:  “The goal of this section is to promote the trading of swaps on swap execution facilities and to promote pre-trade price transparency in the swaps market.”[6]  This is clearly a two-part test, and neither aspect can be prioritized at the expense of the other.

In promoting SEF trading we must remember that price transparency is best achieved when market participants are drawn to a trading venue because it provides the most liquidity, best service offering, efficient functionality, or some other added value.  An entire set of cleared products should not be mandated to trade on-platform, in a one-size-fits-all approach, without considering the characteristics and market dynamics at play.  Market participants and products should be drawn to a liquidity pool like moths to a flame rather than repentant children, kicking and screaming.

Developing a new regulated market structure from scratch is challenging and the process will evolve as the market matures, but it should not surprise anyone who was around for the conversations in 2008 and 2009 that there remain vastly different viewpoints as to the best method of execution.  It is safe to say that the law did not contemplate only central-limit-order-book (CLOB) or request-for-quote to three (RFQ-3) market mechanisms, just as it did not mean to speak in absolute terms with any and all types of trading being deemed de facto compliant.  There is more work to be done here, and we welcome the views you have shared on this particular topic.

In the spirit of promoting swap execution on SEFs, I believe a reasonable improvement would be to encourage new types of market participants to transact on-platform without major structural, organizational, or regulatory obstacles that impose substantial costs and barriers to entry.

While advancing a comprehensive SEF overhaul is a tall order, we have learned much through this process and perhaps we have identified some elements ripe for refinement.  We have also recognized elements that are serving market participants well and must be preserved.  While the next steps in this process are unclear, the existing SEF structure, which required considerable time and effort to create, has increased pre-trade price transparency, fostered competition, and allowed SEF trading volumes to display a positive growth trend.  A common sense option at the Commission’s disposal could be to pursue a more limited rulemaking simply to codify the myriad of no-action and guidance letters that were required to operationalize this new market structure and to address a limited subset of the less divisive topics, such as financial resources and registration/examination of SEF professionals.

Non-US Central Counterparties (CCPs)

Just last week, Chairman Giancarlo discussed rule changes under consideration by the Commission concerning the treatment of non-US CCPs. I have long been a proponent of resetting the manner in which global regulatory authorities apply their reach in foreign jurisdictions.

To be clear, I believe the Commission can do more to show the appropriate level of deference to our regulatory colleagues overseas.  Previous Commissions wrestled with first mover disadvantage and deemed it necessary to require registration of foreign CCPs utilized by US persons, maybe due to the fact that other jurisdictions had yet to enact post-crisis, G-20 reforms and the subsequent enhanced CCP resilience measures.  However, many regulators have now implemented commensurate policies in the clearing space, thus aligning our regulatory principles, just as the G-20 envisioned at the Pittsburgh Summit in 2009.

In 2010, Congress recognized the global nature of these markets, and the G-20 commitments made in 2009, when it determined that consistency, rather than regulatory duplication, around the world is the best way to achieve a more secure system.  For this reason, Dodd-Frank amended the CEA to provide:  “The Commission may exempt, conditionally or unconditionally, a derivatives clearing organization from registration… for the clearing of swaps if the Commission 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]

I believe that Congress recognized that a duplicative, confusing web of multiple regulatory agencies around the world asserting their overlapping regulation and supervision of global clearinghouses could serve to complicate, rather than improve, the system.  Assuming we all remain committed to our shared goals from Pittsburgh, I believe we are best served by allowing a fair bit of deference to our global regulatory partners.

While the particulars of the non-US CCP rule amendments we are considering remain in flux, I wish to share my hopes for what these policy changes should accomplish.  Market participants involved in swaps should be given a choice regarding how and where to conduct clearing business rather than having limited clearing services at their disposal.  Sophisticated, institutional investors should be allowed a degree of flexibility in making a business-driven decision with an understanding of the risks involved based on information (including disclosures) regarding jurisdictional insolvency regimes, the role of intermediaries, registration status of entities in the clearing workflow, and protection of customer funds.

At the same time, CCPs should focus on managing risk rather than diverting resources to prepare for another set of exams, maintaining a duplicate set of books and records, and building reporting work flows to respond to different questions, different formats, and different timeframes, while still aiming to achieve the common policy outcome of a foreign jurisdiction and their home-country regulator.  The likely result of such a system could be an exacerbation of risk and a threat to the stability of the CCP directly, and to the financial system overall.

I firmly believe that deference is the right answer for the Commission’s oversight of CCPs not located in the United States, just as I firmly believe that deference cannot be a one-way street.  Other jurisdictions must share in the commitment.  The alternative is counterproductive to the coordinated approach agreed to at the height of the financial crisis.  If the Commission acts to right-size its cross-border footprint, then there is no excuse for other jurisdictions to disregard our efforts by moving in the opposite direction at the very time we are demonstrating greater respect for their regulatory oversight. The Commission would not portray commons sense principles if it applied less stringent regulations and oversight of third-country CCPs as a baseline whereas others refused to comport to deference.

We must refocus on the original mission, and the subject of this debate.  Regulated CCP infrastructure was hailed as a means to alleviate problems presented by a previously undesirable web of interconnected bilateral OTC transactions.  CCPs were not determined to be a contributing factor, but rather a potential solution, in responding to the financial crisis.

I have made my views on cross-border CCP matters known early and often in various ways during my time as Commissioner.  I have always supported the legal powers that the U.S.  Congress afforded the Commission to exempt certain CCPs when appropriate.  I also want to ensure that the proposals represent the true meaning of deference and provide significant respect to fellow regulators that have rules and a supervisory system that are sufficiently robust.  I struggle how to best achieve international harmony at this juncture with the publication of the ESMA consultation papers on EMIR 2.2 and the oversight of third-country CCPs on May 28th.  I query whether exhibiting deference to other authorities will help or hinder the end result – should we hit the pause button, allow the European process to run its course, examine the approach finalized in Europe, and then decide what actions are appropriate?  Or should we forge ahead by proposing a more deferential approach for public comment now, and then resurvey the entire landscape at a later date?

Cross-Border Swap Dealer

A cross-border swap dealer rule proposal has also been mentioned publicly as being on the near-term horizon for the Commission to consider.  While I am still reviewing such and will therefore not speak to the specifics, generally I would like to note that the 2013 guidance was just that, guidance, whereas what the Commission might soon consider would be actual regulations.  I have long believed that the guidance was designed to be temporary and that actual regulation is the more prudent course.

I also believe that CEA Section 2(i) limits the international reach of CFTC swaps 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.”[8]  A common sense reading of this section, aptly titled “Applicability”, is that there is a limited reach of U.S. law and it does not stretch to infringe upon other rule sets unless the criteria are met.

The legal intent is to start with U.S. law not applying, and then continue to the limited conditions where extraterritoriality would be deemed appropriate. To the contrary, the law does not say that CFTC rules govern derivatives market activities around the world’s financial markets 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 warranted to ensure that the law is followed both to the letter and in spirit.

Swap Data Reporting

Swap data reporting is another area of interest where a good dose of common sense would benefit the situation.  The Commission recently published a rule proposal outlining ideas on how to confirm the accuracy of swap data reported to swap data repositories (SDRs).  In issuing the proposal, I also shared some thoughts for public consideration related to potential areas of improvement, and I hope that you all will respond accordingly when you supply comments.[9]

In addition, I expect that subsequent proposals of other rules will provide market participants with a holistic view into what the Commission is thinking for the entire swap data reporting ecosystem.  I hope this includes reasonable streamlining of obligations, such as a significant harmonization with both the SEC and international regulators, a considerable decrease in the number of required reportable data elements, extending the time delay for part 45 regulatory reporting to 24 hours, and a reduction in the regulatory burden placed on end-users.

The lack of global harmonization in swap data reporting is an ongoing and substantial burden.  Distinct reporting rules across jurisdictions increase costs and promote inefficiency by forcing trade repositories and counterparties to build and maintain different reporting mechanisms.  International bodies, such as the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO), have achieved considerable progress with the development of technical standards.  International regulators should cooperate to implement these standards in a coordinated manner expeditiously.

Phase V Initial Margin for Uncleared Swaps

Finally, I want to address the looming implementation of phase V initial margin (IM) for uncleared swaps.  While the deadline for this last phase is September 2020, a tremendous amount of time and resources must be committed in preparation, and time is fleeting. By some estimates, around 700 counterparties are likely in scope and would need to execute documentation for potentially 10 times that number of custodial arrangements. The implicated market participants together account for only 11% of the Average Aggregate Notional Amount (AANA) across all phases of implementation of the margin requirements.[10]   Also, by some estimates, almost three-quarters of these phase V firms will not even be required to exchange IM for a significant period of time following the compliance date, if at all, further making this an exercise in futility, at least in the near term.

At the very least, the U.S. financial regulatory community should provide guidance to market participants relieving them of an obligation to put in place documentation and systems that they may never use, and rather require such only when entities reach the required $50 million threshold at which they are actually obligated to exchange IM.  This type of action would provide some clarity and allow for resources to be directed towards counterparties that are more likely to exchange IM.

Conclusion

Let me conclude by saying that I applaud the current Japanese presidency of the G-20 for proposing that the Financial Stability Board (FSB) examine signs of market fragmentation.  I also commend IOSCO for establishing a Follow-Up Group to the 2015 Task Force on Cross Border Regulation to better understand regulatory driven market fragmentation, where it occurs, and why.  I hope to explore these issues further via my sponsorship of the CFTC’s Global Markets Advisory Committee.

Luckily, the challenges we face in designing the new market structure for swaps are not quite as daunting as those faced by the colonials as they sought to set up a new independent nation during the time of Thomas Paine and James Madison.  However, as all of these topics illustrate, common sense can help us address the unique and complex challenges presented by our derivatives markets.  While the law is always supreme, I expect the Commission to be nimble and leverage common sense wherever possible to generate the best regulatory framework for the global derivatives markets.

CFTC Chairman Giancarlo Statement on the Senate Confirmation of Heath Tarbert as CFTC Chairman

June 5, 2019

CFTC Chairman J. Christopher Giancarlo issued the following statement on the U.S. Senate’s confirmation of Heath Tarbert to become Chairman of the CFTC:

“I would like to extend enthusiastic congratulations to Dr. Heath Tarbert on the Senate passage of his nomination to be the next Chairman of the Commodity Futures Trading Commission. He is highly qualified to lead the agency.

“During my time of service, it has been a priority to transform the CFTC into a 21st Century regulator for today’s digital markets.  With Dr. Tarbert’s confirmation, I know the agency is in safe hands to continue this transition.  As he completes his current obligations as Acting Under Secretary of the U.S. Treasury, I have committed to stay on as Chairman until Monday, July 15, 2019 when Dr. Tarbert will take up the Chairmanship.

“With the end date for my service in sight, there is still much to do on important matters before the agency. I want to thank my fellow Commissioners and our Commission staff for their support and attention to the many complex matters affecting trading markets overseen by the CFTC.”

Remarks of Chairman J. Christopher Giancarlo at the Futures Industry Association 12th Annual International Derivatives Expo, London, United Kingdom

“Recalibrating the CFTC’s Cross-Border Regulation:  Current Status and Next Steps”

June 5, 2019

Introduction

Good morning.  Thank you for your kind welcome.  It is great to be here at the FIA’s International Derivatives Expo in London, at what will be my final speech to the FIA.  I expect to be stepping down as Chairman in mid-July and handing the baton to Heath Tarbert.

I am particularly pleased to have this opportunity to speak to you today here at The Brewery.  As some of you may remember, last September, a short walk from here at Guildhall, I gave a speech setting forth my proposal to recalibrate the CFTC’s cross-border swaps framework.[i]  A month later, I published a white paper on cross-border swaps regulation that proposed updating the agency’s current cross-border application of its swaps regime with a rule-based framework based on regulatory deference to third-country jurisdictions that have adopted comparable G20 swaps reforms.[ii]  Accordingly, returning to London to discuss cross-border issues feels a bit like coming home.

What I would like to do today is discuss what has been happening at the CFTC on the cross-border front and what you can expect to see happen in the future, especially before I leave the CFTC.  I will discuss three rulemakings that are currently being considered by the Commission and then lay out a plan for the remaining rulemakings that I expect to be taken up by the Commission under my successor.

I also want to discuss some of the progress that the CFTC has made with respect to comparability determinations for non-U.S. jurisdictions and discuss an approach to addressing cross-border issues relating to non-U.S. trading platforms.

First Principles

Before diving into the substance, let’s take a step back and consider the first principles that inform my approach to cross-border regulation.

First, the CFTC is tasked with implementing Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act” or “Dodd-Frank”).  Dodd-Frank was enacted to reduce systemic risk (including risk to the U.S. financial system created by interconnections in the swaps market), increase transparency, and promote market integrity within the financial system.  Dodd-Frank is clear in its approach to the extraterritorial application of CFTC rules.  The CFTC’s swaps authority “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….”[iii]

Notice that Dodd-Frank addresses the CFTC’s extraterritorial jurisdiction by stating in the negative that the CFTC has no authority outside the United States unless ….  Unless what?  Unless the activity has a “direct and significant” connection with the United States.  Accordingly, determining what is “direct and significant” to the U.S. financial system should be at the heart of the CFTC’s approach to cross-border issues.

Second, a key distinction that informs my cross-border approach is the difference between swaps reforms that are designed to mitigate systemic risk, on the one hand, and swaps reforms that address market and trading practices, on the other.  The former includes swaps clearing, margin for uncleared swaps, dealer capital, and recordkeeping and regulatory reporting.  These reforms seek to mitigate the type of risk that may have a “direct and significant” connection with the United States.  By contrast, swaps reforms that are focused on market and trading practices, such as public trade reporting and price transparency, trading platform design, trade execution methodologies and mechanics, and personnel qualifications, examinations, and regulatory oversight, do not go to systemic risk but to how the markets operate.  While certainly important, these reforms generally do not have as great a “direct and significant” connection with the United States as the swaps reforms that are specifically designed to address systemic risk.  Such reforms may be legitimately different across jurisdictions depending on local market conditions and characteristics.

Third, the CFTC should act with deference to non-U.S. regulators in jurisdictions that have adopted comparable G20 swaps reforms.  In doing so, the CFTC should seek stricter comparability for substituted compliance with requirements intended to address systemic risk and afford more flexible comparability for substituted compliance with requirements intended to address market and trading practices.  Mutual commitment to cross-border regulatory deference ideally should mean that market participants can rely on one set of rules – in their totality – without fear that another jurisdiction will seek to selectively impose an additional layer of particular regulatory obligations that reflect differences in policy emphasis, or application of local market-driven policy choices beyond the local market.  This approach is essential to ensuring strong and stable derivatives markets that support economic growth both in the United States and around the globe.  I will return to this idea in a few minutes when I discuss the progress the CFTC has made in making comparability determinations for non-U.S. jurisdictions.

These first principles are the core of my cross-border approach and inform the CFTC’s new cross-border rulemaking, to which I will now turn.

Current Rulemaking Initiatives

The CFTC staff has prepared three rulemakings that are now being considered by the Commission.  The first two deal with issues relating to the regulation and supervision of central counterparties or CCPs.  The third deals with swap dealer and major swap participants’ registration and regulation.

DCO Registration with Alternative Compliance Proposal

The first clearing proposal addresses the registration of non-U.S. derivatives CCPs, which we call derivatives clearing organizations or DCOs, that clear swaps for U.S. persons.  The CFTC has almost two decades of experience overseeing non-U.S. DCOs engaging in activity in U.S. derivatives markets.  LCH Ltd was the first non-U.S. DCO to register with the CFTC 18 years ago.  Other CCPs became registered after the enactment of Dodd-Frank in 2010.  Through its supervisory powers, the CFTC has informally calibrated its day-to-day oversight of these registered DCOs based on the core principle of deference to the oversight of primary regulators, while taking into account the specific circumstances of a particular non-U.S. DCO.

I would like to address the current informality of our approach and, in doing so, introduce significant additional areas where we can defer, appropriately and consistent with our risk oversight responsibilities, to non-U.S. DCOs’ home country supervisors.  Among other things, this first proposal sets forth a framework under which non-U.S. DCOs that do not pose a substantial risk to the U.S. financial system would have the option of being fully registered with the CFTC as a DCO but meet their registration requirements through compliance with their home country requirements.  These DCOs that are “fully registered with alternative compliance” would still be able to offer customer clearing through futures commission merchants (“FCMs”), just like other fully registered DCOs.  Consistent with the commitment to apply supervisory deference under Title VII of the Dodd-Frank Act where appropriate, the home country regulator would have supervisory primacy over these DCOs with the CFTC much more narrowly focused than is currently the case, from both a legal and practical perspective, on U.S. customer funds protection at these DCOs.

This narrow focus on customer funds protection is appropriate to help ensure the legal requirements relating to segregation at both the FCM and DCO level are met, and that, if necessary, the bankruptcy protections afforded to customers under the CFTC’s FCM model work as intended.  I would note in this regard that many non-U.S. customers choose the FCM model at non-U.S. DCOs to clear their swaps transactions even though there is no legal requirement to do so.  For example, to date this year over three quarters of non-U.S. customer business at LCH Ltd’s SwapClear, on a gross notional basis, is cleared via the FCM model.  I believe this “voting with their feet” is a testament to the efficacy of the customer funds protection regime under U.S. law and CFTC regulations, and the efforts of the CFTC and its staff over many years to help ensure the ongoing effectiveness of this regime.

Most importantly, it is critical to use objective criteria to determine whether a non-U.S. CCP potentially poses “substantial risk to the U.S. financial system” and to provide transparency about such criteria.  The proposed definition of substantial risk to the U.S. financial system consists of two 20 percent tests.  The first focuses on the percentage of initial margin from a “U.S. origin” (i.e., initial margin posted by clearing members ultimately owned by U.S.-domiciled holding companies, regardless of the domicile of the clearing member) at a specific non-U.S. DCO.  The second focuses on the “U.S. origin” business of the non-U.S. DCO as a percentage of the overall U.S. cleared swaps market.  Where both of these “20/20” thresholds are close to 20 percent, the Commission would be able to exercise discretion in determining whether the DCO poses substantial risk to the U.S. financial system.  I believe that objective and transparent criteria, such as the ones being considered by the Commission in this forthcoming rulemaking, are what all regulators around the world should strive for to provide appropriate predictability and stability to the markets.

Exempt DCO Proposal

At the same time, the Commission is considering whether to provide non-U.S. DCOs that do not pose a substantial risk to the United States, and that are subject to “comparable, comprehensive supervision and regulation” by appropriate regulators in the DCO’s home jurisdiction, the option to be exempt DCOs under an enhanced framework.  Unlike the current CFTC approach to exempt DCOs, this option would permit exempt DCOs to offer customer clearing to U.S. eligible contract participants (i.e., other than U.S. retail customers) through foreign clearing members that are not registered as FCMs, provided that the DCO and the FCM offer clear and succinct disclosure to U.S. eligible contract participants on the bankruptcy protections that would be afforded to them under relevant non-U.S. law.

This approach is similar to the CFTC’s long-standing approach to foreign futures clearing, which provides U.S. customers, including retail customers, with the ability to opt out of the bankruptcy protections offered under U.S. law to foreign futures funds.  In this regard, I believe it is wholly appropriate to permit U.S. eligible contract participants – particularly small- and medium-sized institutional investors that do not have the heft of their larger-sized brethren to access foreign cleared swaps markets indirectly through non-U.S.-based operations – to exercise their own business judgment in this area.  In other words, I believe it is appropriate to afford these institutional investors the opportunity to weigh the potential economic benefits of accessing products cleared at a non-U.S. CCP through a non-U.S. intermediary that would otherwise not be available to them, with the attendant potential risks relating to the use of a non-FCM intermediary, i.e., risks that institutional – and potentially retail – investors in those non-U.S. markets take every day when they choose to clear swaps through those non-U.S. intermediaries at non-U.S. CCPs.

Some non-U.S. DCOs that are currently exempt from registration may elect to remain exempt or register under the full registration regime with alternative compliance that I just described.  In either case, they would be able to offer customer clearing, but in different ways.  Exempt DCOs would be able to offer customer clearing to U.S. eligible contract participants through non-U.S. intermediaries operating in their markets, while fully registered DCOs subject to alternative compliance would be able to permit customer clearing through U.S. FCMs.  In both cases, in terms of regulatory oversight of the DCO, the CFTC would defer to the primary regulator or regulators of the DCO.

Swap Entity Cross-Border Proposal

The Commission is also considering a rule proposal to address the registration and regulation of non-U.S. swap dealers and major swap participants, as well as foreign branches of U.S. banks.  Specifically, the proposal addresses the cross-border application of the swap dealer and major swap participant (collectively referred to as “swap entities”) registration thresholds.  It also addresses compliance with certain swap regulations applicable to swap entities in the cross-border context, including by establishing a formal process for registered swap entities to request comparability determinations from the Commission.  If adopted, the proposal would replace the related portions of the cross-border guidance issued by the CFTC in 2013,[iv] the cross-border rules proposed by the CFTC in 2016,[v] and certain related staff no-action letters and guidance.[vi]

Among the issues that are addressed in this proposal are the treatment of “foreign consolidated subsidiaries” (“FCSs”) and swaps between non-U.S. counterparties that are arranged, negotiated, or executed by personnel in the United States (“ANE Transactions”).  The proposal addresses the risk that non-U.S. swap dealing activity poses to the United States.  It does so in a way that does not restrict the ability of U.S.-related entities to access foreign markets or apply the swap dealer rules extraterritorially unless the activity truly poses a “direct and significant” risk to the U.S. financial system, as Dodd-Frank requires.  Further, the proposal will not unnecessarily limit the ability of U.S. participants, including foreign branches of U.S. banks, to access foreign markets or the ability of non-U.S. persons to use U.S. personnel in an incidental manner to support non-U.S. swap activity.

The Commission is currently considering these three proposals.  I intend to call them for a vote before I leave the CFTC.

Comparability and Substituted Compliance

The rulemaking proposals I just discussed are complemented by a series of comparability determinations that the CFTC has issued and plans to consider in the near future.[vii]  A commitment to deference must be a fundamental component of the Commission’s cross-border framework.  The use of deference tools, like substituted compliance and exemptions, is intended to promote the benefits of integrated global markets by reducing the degree to which market participants will be subject to duplicative regulations.[viii]  Deference also fosters international harmonization by encouraging U.S. and foreign regulators to seek to adopt consistent and comparable regulatory regimes.  When properly calibrated, deference promotes open, transparent, and competitive markets without compromising market integrity while mitigating the risk of fragmentation in global cross-border markets.[ix]

The CFTC recently granted substituted compliance to Australia with respect to margin requirements for uncleared swaps.[x]  It also amended a previous substituted compliance determination for Japan with respect to the uncleared margin requirements.[xi]  Previously the CFTC granted substituted compliance for the European Union (“EU”) with respect to the uncleared margin requirements.[xii]

Further, in March, the CFTC and the Monetary Authority of Singapore (“MAS”) announced the mutual recognition of certain derivatives trading venues in the United States and Singapore.[xiii]  Specifically, the CFTC issued an order exempting certain derivatives trading facilities regulated by MAS from the requirement to register with the CFTC as swap execution facilities (“SEFs”).[xiv]  Previously, the CFTC issued an order exempting certain multilateral trading facilities and organized trading facilities authorized within the EU from the requirement to register with the CFTC as SEFs.[xv]  A comparability assessment for Japanese trading venues should also be completed soon.[xvi]

This is all a good start, and I am pleased that many of these comparability determinations came under my Chairmanship.  However, I believe the CFTC should continue to make additional comparability determinations wherever appropriate.

Remaining Implementation Plan

Now I want to briefly discuss the remaining implementation plan for the CFTC’s cross-border recalibration.  In addition to the releases and comparability determinations discussed above, CFTC staff is also working on a number of additional cross-border rulemakings.  These additional rulemakings will address the remaining aspects of the CFTC’s cross-border approach, including application of the clearing, trade execution, and reporting requirements to cross-border swap transactions.  The goal is ultimately to replace CFTC guidance and staff advisories and no-action letters with formal rulemakings.

Approach to Non-U.S. Swaps Trading Venues

Non-U.S. swaps trading venues is the last topic I want to touch on today.  The CFTC recently proposed amendments to its rules relating to SEFs.[xvii]  However, this proposal deliberately did not address the cross-border application of the SEF rules.

Currently market participants look to guidance published by the CFTC staff in 2013 that addressed when multilateral swaps trading platform located outside the United States may have to register with the Commission.[xviii]  The staff guidance took the view that a non-U.S. swaps trading venue should register as a SEF (or designated contract market) if it provides U.S. persons or persons located in the United States (including personnel and agents of non-U.S. persons located in the United States) with the ability to trade or execute swaps on or pursuant to the rules of the platform, either directly or indirectly through an intermediary.[xix]  At the same time, the staff guidance stated that among the factors that would be relevant in evaluating the SEF registration requirement for non-U.S. swaps trading platforms is whether a significant portion of the market participants that a multilateral swaps trading platform permits to effect transactions are U.S. persons or U.S.-located persons.[xx]  This has led to some uncertainty regarding when non-U.S. swaps trading venues may have to register as SEFs.  Rightly or wrongly, the staff guidance has generally been interpreted by non-U.S. trading venues to require SEF registration if the trading venue has even one U.S. person that has the ability to trade on the platform.

The CFTC should be committed to trying to make comparability determinations for trading venues in all the major swaps jurisdictions where the vast majority of over 90% of global swaps activity takes place.  As I noted above, the CFTC already has exempted trading venues from registration as SEFs in the EU and Singapore, and a comparability assessment for trading venues in Japan is close to completion.  In case of Brexit, the CFTC already announced the intention to extend the exemption from registration as SEFs to UK trading venues consistent with our arrangement with the EU.[xxi]  This leaves Hong Kong, Australia, Canada, and Switzerland to account for most of the world’s non-U.S. swap activity.

In all remaining jurisdictions where implementation of comparable G20 reforms remains generally incomplete, much less than 10% of global swaps activity takes place.  For these jurisdictions, I believe that the CFTC should take a more risk-based approach to the registration of non-U.S. trading venues.  Unlike CCPs, trading venues do not pose significant risk to the United States.  The CFTC should allow U.S. persons to access the trading venue directly or indirectly through a non-U.S. intermediary, subject to an appropriate materiality threshold.  The materiality threshold should be based on a level of trading involving U.S. persons that does not meet the Section 2(i) “direct and significant” standard.  The precise standard would be set by the CFTC based on appropriate criteria.

I believe the combination of comparability determinations and a rulemaking for non-major markets that establishes an appropriate materiality threshold should address the concerns that U.S. persons have about accessing foreign markets.

Conclusion

Let me close by reiterating a point I made in the past:  the CFTC must remain a leader in global swaps reform.[xxii]  I am convinced that this is best achieved if the CFTC’s approach to cross-border swaps reform is not viewed as unilateralist and dismissive of the capacity and interests of non-U.S. jurisdictions.  Instead, it should be risk-based and committed to deference to competent regulatory authorities.

To not adopt an approach of regulatory deference would lead us down a very different course, one of overlapping and confounding cross-border regulation and market fragmentation, high regulatory cost and constraints on economic growth.  That course would lead us in the wrong direction, one that hazards systemic risk.  We should avoid that course.

We must have the confidence of our convictions.  Global swaps market participants seek access to deep pools of trading liquidity in global markets.  We must not divide the global market into artificially separate and less resilient liquidity pools based on the nationality of trading participants.  That will fragment markets into individual trading pools of liquidity that are shallower, more brittle, and less resilient to market shocks, thereby increasing systemic risk rather than diminishing it.  Instead, the approach of deference is intended to thwart such fragmentation, so as not to impede hedging of financial risk that is necessary for global economic growth.

I personally hope that we can renew faith in regulatory deference. With the proper balance of sound policy, regulatory oversight, outcomes-based regulatory deference and a little bit of courage, world derivatives markets will continue to evolve in responsible ways and continue to help grow the global economy, creating a future of untethered aspiration where creativity and economic expression is a social good in its own right, and a source of human growth and human advancement.

Thank you for your time and attention.  Farewell.

 

---

 

Remarks of  Chairman J. Christopher Giancarlo at Guildhall, London

“The Future of the City of London: Global, European Financial Center”

June 4, 2019
 

INTRODUCTION: Freedom of the City

My Lord Mayor, Aldermen, Sheriffs, Chief Commoner, and very distinguished guests, it is a distinct privilege to speak to you this evening.  I thank Catherine McGuiness and the City of London Corporation for inviting me to speak here again in the magnificent setting of Guildhall.
 

I am deeply honored, indeed “chuffed”, to have received a short while ago the Freedom of the City.  It is quite a distinct honor. I accept it as Chairman of the US Commodity Futures Trading Commission with compliments to my fine fellow Commissioners and the agency’s dedicated public servants.
 

I can’t wait to enjoy its unique privileges.  I plan to wear a naked sword in public - that is as soon as I can get one through airport security.  I want to drive sheep across London Bridge, just as soon as I can gather a flock.  And, I look forward to being bundled into a taxi home by London’s constabulary rather than be thrown in jail if that ever became necessary. 
 

As for the comfort of a silken rope around my neck on the gallows, if you don’t mind I’m going to save that privilege as long as I can!
 

I understand that the Freedom was first awarded in 1237, almost 800 years ago.  It arises from the medieval practice of granting worthy citizens freedom from serfdom.  That is particularly meaningful.  I descend from a diverse group of Nineteenth and Twentieth Century émigrés from Italy, Germany, Poland and Ireland. They generally had one historical trait in common – European peasantry.  Away from their homelands, in America, Ireland and France, and here in Britain[1] and elsewhere, they found the opportunity to apply their brains, determination and industriousness to succeed.  No one granted them their liberty; like all free men and women, they chose it for themselves.
 

But, now I have one thing that they never had: the Freedom of the City of London and the velum to go with it.  I am indeed truly honored and grateful.  Thank you.
 

The Future of London
 

This evening, I want to share with you some thoughts on the future of the City of London.  By the City of London, I mean the global trading and financial services industry conducted in the greater London Metropolitan area that is centered here in the Square Mile.
 

I do not wish to discuss the merits or disappointments of Brexit.  As a public official of a non-European country, it is not my place to opine on a European political decision.  Nor will I try to handicap how or when the matter will resolve itself.  Many others, including many of you, have far better information and perspectives on how Brexit might evolve.
 

My purpose this evening is to provide a longer-term perspective, much longer.  In fact, I want to offer a vision of the future of the City of London that applies no matter the outcome of Brexit.  It is a vision for the City that, I believe, will manifest itself whether or not Great Britain actually leaves the EU.  And, I will extend that vision with some perspective on economic freedom that I feel is more determinative of London’s future than any political deal can be.
 

For now it is clear that London is shedding, and will continue to shed, a not insignificant amount of its financial service offerings and specialties to other European financial centers as a result of Brexit.[2]  Accordingly, several European capitals will likely increase their share of financial services activities that are currently conducted out of London.[3] 
 

Yet, despite this, I believe that London will remain one of the world’s major financial centers and Europe’s largest.  The final disposition of Brexit will not change that.  However, what Brexit will do is determine the degree of London’s focus on global, wholesale markets.
 

I agree with Peter Allen who said that, as a financial center, London has always had an “offshore” feel about it – a sense of some detachment from the EU mainland, a focus on sophisticated wholesale markets and a transatlantic orientation.[4]  He says that with Brexit those “offshore characteristics are likely to strengthen.”[5]  I think that Mr. Allen is right.
 

Yet, I am convinced that London will remain a major global financial center.  That is because of its incomparable strengths, but also because it is ultimately not in the EU’s interest to restrict financial activities to the Eurozone.  The EU needs access to markets for global capital and financial expertise that no EU city is capable of assembling any time soon.  And, at the same time, London’s financial services industry needs to serve the broader European economy.  In short, the EU needs the City of London, and the City of London needs the EU.  I expect that sooner or later that is going to become apparent to the political classes on both sides of the Channel.
 

Reversion to the mean
 

London was founded almost two millennia ago as a center of trade and commerce. Over the centuries, London’s role as a financial center expanded from supporting regional and national interests to financing global commerce.  The expansion of the British Empire in the 18^th, 19^th and 20^th centuries made London one of Europe’s largest and most international financial capitals.  In this new century, London has consistently ranked as the world’s premier financial center.[6]  It has only recently fallen to number two behind New York.[7]
 

In fact, London’s current financial prominence in Europe is unusually pronounced.  Of other EU cities, only 10^th place Frankfurt is in the global top 20.[8]  Paris is ranked 27^th, Luxembourg is ranked 30^th, Madrid is 37^th, Dublin is 38^th and Amsterdam is 41^st.[9]  The concentration of EU financial services in London is inordinate by international standards.  Of the three most economically developed global regions of North America, Europe and Asian Pacific Rim, only Europe is so lopsided.  North America’s six largest financial centers are all in the global top 20.[10]  Asia’s financial centers are even more prominent with its top six being ranked third (Hong Kong), fourth (Singapore), fifth (Shanghai), sixth (Tokyo), ninth (Beijing) and eleventh (Sydney).[11]
 

 

It seems that even without Brexit, some degree of rebalancing and reversion to the global mean of financial center regional dispersal is appropriate.  This may be especially so as the EU is engaged in furthering its economic union, enabling the provision of a broad set of financial services for local, national and continental EU retail and commercial customers.
 

The opportunity is at hand to further develop several prominent cities as EU centers of expertise and service concentration.  Based on current trends, it appears that hedge funds and asset management and private equity firms are coalescing in Dublin.[12]  Commercial and investment banks are locating to Frankfurt while trading platforms, exchanges and broking operations are setting up in Amsterdam.[13]  Meanwhile, Paris is emerging as an EU center for start-ups in Fintech, RegTech and Insurance.[14]
 

Nevertheless, London remains unique as a global financial center.  It is the essential processing point for global wholesale markets for foreign exchange, interest rate swaps and other instruments for financial risk mitigation and transfer, which it accommodates with a unique concentration of skilled legal, accounting, broking, clearing and other professional services.  Few cities in the world, let alone in Europe, are competitive with London in these activities.
 

Moreover, London has strong competitive advantages over other EU cities.  They range from a successful underlying economy, strong human capital base and effective infrastructures for share trading, clearing and settlement.  These advantages exist alongside a cosmopolitan city with a large housing and educational capability as well as well functioning transport, telecommunications and educational infrastructures.
 

While these advantages are often acknowledged, I wish to mention a few other advantages that are less often recognized, but just as important.  They are the native use of the English language and common law, politically independent market and prudential regulation, and support for free market capitalism and hospitality to US Dollar economics.
 

It is a fact that today the language of global finance is English and the law of global finance is common law, either English or New York.  The top four global financial centers – New York, London, Hong Kong and Singapore – all transact in English and under common law legal systems.  Common law systems are generally seen to be fair, foreseeable and efficient.  They readily adapt to changing commercial demands and cases, facts, and situations that were not anticipated or foreseen.  Their courts reliably uphold commercial property rights.  Common law systems are broadly considered more flexible, faster, and responsive than civil law frameworks.
 

British regulation of London’s financial services industry is also recognized as being pragmatic, sophisticated, evidence rather than policy-based and nationality-blind.  It is seen to be independent of political interference, acting in the best interest of markets.  This recognized integrity and independence from particular government social, monetary, industrial or political policies underlie London’s ability to attract global capital and investment.
 

British prudential and market regulators also have decades of constructive engagement with their international regulatory counterparts, especially those in the United States, which has the world’s largest financial markets and most important reserve currency.  British market oversight and prudential regulation is hospitable to markets for US Dollar-based instruments and the activities of US banks and market makers who support an increasing preponderance of EU-wide share trading.  London business culture also has been consistently sympathetic to free market capitalism, the oxygen that global financial centers breathe and in which they thrive.
 

Notwithstanding the development of Dublin, Amsterdam, Paris, Frankfurt, Milan and Madrid as regional and specialized financial centers, none of these cities is presently poised to replace London as a global financial center.  None of them can currently provide the range of sophisticated services necessary to connect the EU to the global financial system.  None of them alone can replicate in sufficient scale London’s rich and diverse ecosystem of financial capability, talent and experience.  I agree with Colm Kelleher that EU capital markets are too small and fragmented to justify assembling the extensive eco-system of transaction advisors, asset managers, lawyers and accountants that a global financial center requires.[15] 
 

Moreover, no European city outside of London combines such extensive financial infrastructure with the commercial practicality of common law, independent and practical regulation and consistent and sympathetic hospitality to wholesale finance and free market capitalism.  The cultural habits of legal pragmatism, wholesale market sophistication and regulatory independence will not blossom overnight in continental EU jurisdictions, even if they were faithfully emulated.
 

Undoubtedly, it is appropriate for an increased amount of retail and commercial financial services in the EU to be conducted in regional financial centers, in the local language and under local law.  On the other hand, institutional participants in global wholesale financial markets expect their transactions to be conducted in English, using common law in truly global financial centers like London.  Any loss of London’s wholesale financial service capabilities is likely to be of greater benefit to New York, Singapore or Hong Kong, than for Paris or Frankfurt.
 

The EU needs The City of London
 

If the EU and its commercial institutions are to play a role in the global financial markets, then they must have free access to a premier global financial center.  This is necessary to serve larger EU corporate institutions and sovereigns with investment capital and wholesale financial services.  The EU needs to develop its capital markets, which fuel only a quarter of its commercial enterprises (as compared to three-quarters in the US).  Restricting EU entities to trade only with other EU entities in the Eurozone will limit their access to global pools of capital and thwart their growth and development.  Without active participation in robust wholesale financial markets, the EU risks become a largely regional economy.  Without Euro-denominated instruments transacted in London’s premier trading markets alongside the US Dollar, the Euro will remain predominantly a regional currency with limited global influence.
 

The City of London Needs the EU
 

Each of the world’s major financial centers is anchored in one of the most developed economic regions of North America, Europe and Asia. The City of London needs the EU in order to remain an integral part of the European economy and avoid being largely an “offshore” European financial operation.  London needs the continued ability to host the trading and servicing of Euro-denominated instruments and retain some form of “passporting rights” for its headquartered firms to provide services in the EU.  Further, London needs to continue to underwrite securities offerings by EU firms and sovereign entities.  Moreover, London needs continued access to a large pool of human talent and creativity to operate its financial services infrastructure.  Finally, London needs to continue the business of financial services that generates over seven percent (7%) of the UK GDP.[16]
 

A Deal on UK-EU Financial Services Must be Reached
 

So this is my message this evening:  the EU needs the City, and the City needs the EU. The EU needs access to a global financial capital and expertise that no other EU location is capable of assembling any time soon.  London’s financial service industry needs to serve the broader European economy.
 

“Fortress Europe” cannot muster enough investment capital to grow its economy and generate broad based prosperity necessary for social harmony.  “Offshore island London” cannot sustain the critical contribution to the UK economy of its extensive financial services infrastructure.
 

What needs to be done?
 

Well, it seems that the starting point is a common realization on both sides of the Channel that maintaining London as a premier, global financial center tethered to Europe is of vital importance for both the EU and for Britain. 
 

This is too important to ignore any longer.  A win/win solution must be found.  The current course of political fighting, brinkmanship and regulatory and legislative non-action are not helpful.  It just means a flow of activity away from London to New York, Hong Kong or Singapore.  It means financial regionalization of the EU and slowing of the European economy.
 

Leaders of business and finance from both sides of the Channel need to get together and persuasively explain to their respective political representatives why the EU and the City need each other.  They need to show that European prosperity is jeopardized if the City and the EU are sundered apart.  They need to encourage putting national political interests aside for the economic good of the whole of Europe and the welfare of its inhabitants.
 

It is time to pull out a fresh sheet of paper and draw up the right arrangement between the EU and a post Brexit London.  Draw it up and then work backwards to embody it in a bespoke legal and political arrangement either alongside or separate from any final Brexit deal.  The arrangement must be flexible enough to allow for the continued development of EU cities as regional and specialist financial centers, while allowing London to continue providing Europe with the services that only a global financial center can provide.  Anything less, is a failure of vision and imagination.
 

Conclusion
 

It is fitting that we are here this evening in the glorious Guildhall, the heart of one of Europe’s oldest incorporated cities and trading centers.
 

Scholar Tom G. Palmer explains how the concept of liberty and the rule of law had their origins in Europe’ medieval trading centers and self-governing cities like this one.[17]  These domains provided their citizens with the liberty to come and go, a power not enjoyed by many.  It included the freedom to sell goods and engage in commerce – indeed, the freedom to herd one’s sheep to London market. 
 

Medieval cities granted freedom to make trade possible. They knew that without trade cities declined and life was wretched.  They knew that liberty and freedom were a pre-requisite for prosperity.  Eventually, so too were individual rights of limited government, freedom of thought, religion, speech, trade, production, and travel.  Eventually these freedoms liberated the serfs of Europe, including my ancestors.
 

So it has always been.  Cities and countries that afford their inhabitants the greatest amount of ordered freedom and the least amount of political interference attract the world’s entrepreneurs, innovators and job creators and the trade and commerce they generate.  So it also remains true that broad and sustained prosperity generally occurs wherever in the world there are open and competitive markets, free of undue political interference, combined with free enterprise, personal choice, voluntary exchange and legal protection of person and property.  Free markets and prosperity are natural partners in this respect.
 

So it remains true in contemporary Europe.  Prosperity and human thriving are built upon free trade and commerce.  The future prospect for the European continent, whatever the composition of the EU, remains dependent on economic growth and dynamism.  This will be difficult without a premier global financial center in Europe.
 

The EU needs the City, and the City needs the EU.  Whatever the political disposition of Brexit, we must encourage both sides to reach a suitable arrangement for the conduct of financial services between the European Union and the City of London.  We must not be intimidated, but be confident.
 

With courage and determination, the peoples of the European continent may continue to grow their economy and create a future of untethered aspiration, a future where creativity and economic activity are a source of human growth and advancement for all of us – Europeans and your American cousins alike.
 

Thank you.

Remarks of Chairman J. Christopher Giancarlo at Commissione Nazionale per le Societa e la Borsa (CONSOB), Rome, Italy

“The New Futurism:  21st Century Financial Markets, Technology and Regulation”

June 3, 2019

 

Introduction

 

I am delighted to join all of you today.  My thanks to [Chairman Paolo Savona,] Dottore Carmine Di Noia and Condirectore Nicoletta Giusto.

 

It is great to be part of this program put on by CONSOB, with which the CFTC has a long and cooperative relationship.  Here, I am amongst friends and colleagues.

 

I want to talk today about a time of sweeping changes in technology and culture that create distinctive new modes of thought and experience of time and space, an era of ever-increasing changes seemingly faster and faster breaking down the slow linear course of the past.

 

No, I am not talking about 2019.  I am referring to 1909.  Then, Italy was still a very young country, but with a booming and volatile economy.  Its people were on the move, including my great grandfather, Onorio Greco, who with his young bride left southern Lazio for the coalmines of southern Colorado and afterwards the industrial factories of New Jersey.

 

That same year gave birth to the Italian Futurist movement in art and literature.  It grew out of Italy’s encounter with fast developing technology like the automobile, airplane and machine engines.  It glorified modernity and youth and sought to free Italian society from the past.

 

Futurists used art and literature to express the increasing pace of technological and social change.  Pannaggi’s Speeding Train (1922) shows a powerful locomotive shattering through the canvas and pounding the viewer’s senses with a cacophony of hissing steam, thunderous rumbling and ear-splitting whistles.

 

I think about Pannaggi and the Futurists and their artistic efforts to represent the quickening pace of change and its impact on our lives.  I think about them today, more than a century after their emergence, at a time of even greater change, an era when analog mechanics have yielded to digital electronics, when human action has turned to virtual reality, and the pace of change has gone from linear to exponential.

 

I think about this from the perspective of a financial market regulator.  I think that what makes this era of financial technology innovation so challenging for us is that the development of new digital technologies and business models is intertwined with the existence of much older regulatory frameworks.  Like the Futurists we struggle with old regulatory forms and mechanisms to represent and accommodate the modern pace of change, innovation and technological advancement.  Yet, we strive undauntedly to keep up.

 

Today I want to share my thoughts on technology, regulation, and markets, and the relationship between the three – what we might call Digital “Futurism”.

 

The Blockchain – Taking Stock

 

In the past few years, I have had numerous opportunities to discuss one prominent application of blockchain technology – cryptocurrencies – especially given the CFTC’s oversight of crypto-related futures and derivatives markets.[1]

 

Today I want to take stock of the current state of blockchain technology and renew a focus on how it can impact – and improve – our markets.  To begin, I want to take you back for a moment to September 2008.[2]  That was a perilous time in global financial markets.  An enormous housing bubble had burst triggering a cascading global credit crisis.  Concern was rife about imminent investment and commercial bank failure.

 

I was on Wall Street, serving as a senior executive of one of the world’s major trading platforms for credit default swaps (CDS), then the epicenter of systemic risk.  Panic was in the air and tension was on our broking floor trying to maintain orderly markets.  I remember a call from a U.S. bank regulator asking about CDS trading exposure of several major banks, including Lehman Brothers.  In fact, trading conditions were deteriorating by the hour.  It was clear that the regulator had little means, short of telephone calls, to read all the danger signals that the CDS markets were broadcasting.

 

But imagine what a difference it would have made a decade ago on the eve of the financial crisis if regulators had access to the real-time trading ledgers of large Wall Street banks, rather than trying to assemble piecemeal data to recreate complex, individual trading portfolios.

 

Imagine if, instead of having to call around to brokerage firms like mine searching for market information, prudential regulators had access then to a “golden record” of the real-time ledgers of all regulated trading participants.

 

And imagine if in 2008 regulators could have viewed a real-time distributed ledger, and, perhaps, been able to utilize modern cognitive computing capabilities to recognize anomalies in market-wide trade activity and diverging counterparty exposures indicating heightened risk of bank failure.  And imagine if, that insight would have shown that the $400 billion notional of outstanding credit default swaps written on Lehman Brothers represented under $8 billion in net market exposure to failure of the firm.[3]

 

In short, what a difference it would have made a decade ago if blockchain technology on a private distributed ledger accessible to regulators had been the informational foundation of Wall Street’s derivatives exposures.  At a minimum, it would certainly have allowed for far faster, better-informed, and more calibrated regulatory intervention instead of the disorganized response that unfortunately ensued.

 

Now, let’s fast forward to today.  Bitcoin has refocused attention on topics of back-office infrastructure, interoperable databases, and shared ledgers – and this is a good thing.  It means that efforts to upgrade data infrastructure with blockchain and Distributed Ledger Technology (DLT)-inspired systems is getting the attention required to drive broader adoption.[4]  And these systems could enhance efficiencies and transparency not just in our financial markets, but also across the real-economy.

 

With respect to financial markets, DLT and its inspired systems is likely to have a broad and lasting impact in payments, banking, securities settlement, title recording, cyber security and trade reporting and analysis.[5]

 

Additionally, as our recent LabCFTC primer on smart contracts makes clear,[6] DLT will likely develop hand-in-hand with smart contracts that can value themselves in real-time, report themselves to data repositories, automatically calculate and perform margin payments and even terminate themselves in the event of counterparty default.[7]

 

DLT may further enable financial market participants to manage the significant operational, transactional and capital complexities brought about by the many mandates, regulations and capital requirements promulgated by regulators here and abroad in the wake of the financial crisis.[8]  In fact, one study estimates that DLT could eventually allow financial institutions to save as much as $20 billion by 2022 in infrastructure and operational costs each year.[9]  Another study reportedly estimates that the technology could cut trading settlement costs by a third, or $16 billion a year, and cut capital requirements by $120 billion.[10]  Moving from systems-of-record at the level of a firm to an authoritative system-of-record at the level of a market is an enormous opportunity to improve existing market infrastructure.[11]

 

Outside of the financial services industry, many use cases for DLT are being posited from international trade to charitable endeavors and social services.  International agricultural commodities merchant, Louis Dreyfus, and a group of financing banks last year completed the first agricultural deal using DLT for the sale of 60,000 tons of U.S. soybeans to China.[12]  Other potential DLT use cases include: legal records management, inventory control and logistics, charitable donation tracking and confirmation, voting security, and human refugee identification and relocation.[13]

 

Clearly, DLT development and adoption will not be easy, and challenges remain around scalability, governance, security, and value.  Indeed, as I have observed over the past few years, some advances will seem slow, until they hit a tipping point.

 

Yet it is undeniable that DLT and interoperable database systems hold enormous commercial promise.  It may provide critical assistance to financial market regulators in meeting their mission to oversee healthy markets and mitigate financial risk. And, that is just one of the reasons why I am excited about the promise and prospects of DLT.

 

Regulatory Response to Exponential Technologies: the CFTC Approach

 

Let’s shift gears, however, to the broader discussion of regulation in the face of exponential technologies.  A threshold question that frequently arises when we talk about fintech is whether or why is this time different when it comes to innovation as compared to historical periods?  After all, one could fairly argue the ATM in the 1960s was a landmark financial technology innovation, as was the establishment of electronic trading venues in the 1980s and 90s.

 

I would suggest, however, that there a number of characteristics of the current period of innovation, that are – in fact – different and require a new, differentiated regulatory response.[14]  Allow me to discuss each in turn.

 

The first is that we live in a period of exponential technological change.  That is, the sheer speed of innovation has increased exponentially, both in terms of production of new models and products and their subsequent public adoption.  The former dynamic is driven by increases in the power of computing coupled with decreases in computing costs, and the latter is a function of how the internet and mobile allow for rapid public adoption and scalability.  These dynamics put pressure on regulators to keep pace with rapidly changing markets, especially given the potential for new technologies to impact markets in short order.

 

The second characteristic is the disintermediation of traditional actors or business models, which can challenge regulators and existing regulatory frameworks.  Consider, for example, how the digitization of everything, including music, travel, trading, and even farming have furthered the decentralization of traditional intermediaries.  Such decentralization of key economic actors is an enormous challenge to most regulatory approaches and frameworks, which tend to focus on key intermediaries through registration of major market participants and designation of self-regulatory organizations comprised of such participants.

 

Consider cryptocurrencies, for example, which seek to offer alternative means and rails to execute payment transactions, power self-executing software, or drive capital raising activity.  In many instances crypto-related activity may occur outside of traditional intermediaries – indeed frequently by intentional design in order to offer an alternative model – and include new economic actors not covered by existing regulatory frameworks or covering them in an ill-fitted manner.

 

The third characteristic is that the pace and nature of technology-driven innovation requires heightened technological literacy across leaders in business and government.  How many today truly understand the technologies that power underlying business models?  And from a government perspective, how can regulators be expected to mitigate risks and formulate sound policies that foster market-enhancing innovation without requisite technology literacy?

 

Given these characteristics, how is a regulator to respond and keep pace with rapidly changing markets?

 

During my tenure as Chairman of the CFTC we have taken affirmative steps to evolve into a 21^st century regulator and craft a modern regulatory approach.  Our formula for this evolution is quite straightforward and is predicated on four key elements:

 

1. Adopting an Exponential Growth Mind-set.
2. Creating an Internal Fintech Stakeholder.
3. Becoming a Quantitative Regulator.
4. Embracing Market-Based Solutions.

Let’s look at these ingredients in more detail:

 

First, it is critical to train our minds to anticipate the pace of exponential growth.  Specifically, this means expecting rapid change not just in technological innovation, but also in market adoption and utilization of new and disruptive digital technologies.  This mindset must inform and serve as the lens through which we approach our markets.

 

The second ingredient is really a natural outgrowth of the first: that is, the creation of a permanent stakeholder within regulatory agencies to understand and address the opportunities, challenges, and risks posed by innovation.  Absent this stakeholder there is no other constituent tasked with thinking about the direction of emerging technology, considering the impact on existing rules and regulations, exploring ways to internalize such new technologies, and working to mitigate emerging risks.

 

The stakeholder should have both an external and internal focus.  Externally, the stakeholder engages with innovators – whether start-ups or existing market participants – and can help save them time and resources by providing feedback on new concepts or identifying regulatory friction.  By serving as a liaison to the innovator, the stakeholder also benefits by gleaning key insights into technological change and market evolution.

 

Internally, this stakeholder helps to educate and inform the regulatory agency and its staff on new developments.  It can help manage the tension of innovation against existing regulatory frameworks, advocate and inform internal technology and procurement strategies, and serve as a liaison to other domestic and international regulators, as well as political bodies.

 

If this stakeholder sounds familiar and like a good idea, I am glad to say that it is the description of our very own LabCFTC.

 

Launched in 2017 on the floor of the New York Stock Exchange,[15] LabCFTC has engaged with more than 275 entities in cities and regions around the world, including NYC, Chicago, Silicon Valley, Austin, Singapore, London, Boston, and Washington, D.C.[16]  LabCFTC has published timely primers on emerging technologies, including virtual currencies and smart contracts, embarked on an innovation competition, informed policy at the Commission, participated in numerous external events, operationalized bilateral fintech cooperation arrangements with international regulators, and engaged with the US Congress and other governmental bodies.

 

The work of LabCFTC has highlighted an important challenge for regulators – the need to test, demo, and generate proof of concepts around emerging technologies and systems.  Despite certain limitations and constraints we face in this realm, we are currently working on a LabCFTC effort whereby we would use a variety of tools, including internal pilots and tests, market research, and innovation competitions in order to drive better understanding of emerging technologies.  This enhanced understanding, in turn, can help inform policy and internal technology and procurement strategies.

 

We will have more to say soon on this front, and we look forward to the next phase of LabCFTC as we look to deploy our increased agency budget in support of modernization and capacity building.  And, I am pleased that at this point in time every federal financial regulator in the U.S. either has or is creating an innovation program or office similar to LabCFTC as we all seek to develop a blue print for regulatory modernization.

 

The third ingredient is for the CFTC to become what I have previously called a “Quantitative Regulator.”[17]  Commercial trade execution and strategy in CFTC regulated markets is increasingly driven by quantitative data analysis of highly granular market data.  We are beginning to chart a parallel course for the CFTC to become a Quantitative Regulator, which means an effective and up-to-date big data organization capable of engaging in robust data collection, automated data analytics, and artificial intelligence deployment.  The transformation I describe here will be necessary to ensure we can glean critical market intelligence, conduct effective trade surveillance and oversight, calibrate policy prescriptions, and capably regulate our markets.

 

In many respects, this quantitative capability is the necessary antidote to systemic disintermediation.  It makes the regulator competent to conduct independent market data analysis across disparate data sources, less reliant on delegation to SROs and major market intermediaries, and a potential node capable of accessing information found in decentralized economic blockchains and networks.

 

Embracing Market-Based Solutions

 

The fourth ingredient in creating a 21^st century regulator deserves its own discussion and consideration, as it is more of a foundational principle rather than a CFTC activity.  The ingredient is to embrace market-based solutions – a concept that should be assumed and readily accepted but that perhaps today requires some reminders.

 

Markets are in CFTC regulatory DNA, and are the basis for our regulatory mandate.  In the US, market-based capital and risk transfer have allowed for unparalleled industrial and technological innovation.  Indeed, markets are adept at valuing innovation and managing enterprise risk, can be more nimble than bank finance, and are more comfortable with handling intangible collateral.

 

Through the interaction of hundreds, if not thousands, of individual economic actors, markets further drive price and value discovery, allow for the efficient allocation of resources, and permit risk transfer that drives stability and certainty in real-world economic activity.  While markets are not always perfect, they have proven time and again to be the most effective means humans have to drive economic productivity and prosperity.  For today’s younger generations, you can think of markets as the ultimate in crowd-sourced and decentralized decision making.[18]

 

Indeed, that is the central value proposition of free market capitalism.  The proposition that broad and sustained prosperity generally occurs wherever in the world there are open and competitive markets, free of political interference, combined with free enterprise, personal choice, voluntary exchange and legal protection of person and property.  This value proposition is a source of human expression, aspiration and creativity.  Freedom of choice is a social good in its own right, a moral and economic imperative.

 

Nevertheless, it is frequently tempting to apply a paternalistic hand on markets in order to steer them in desired directions or eliminate all risk – a truly futile exercise. This temptation is understandable, but must be constrained, as efforts to tip the scale are more likely to drive unintended and undesirable outcomes.

 

This is not to say that careful oversight, targeted enforcement, and proper guardrails are not appropriate, but our individual concerns or judgments should not override the availability of markets for others to make their own determinations or to pursue their own goals.

 

We at the CFTC believe in the power of markets to be the best determinate of the value of technology-driven innovation.  To this end, a case study can help illustrate the above concepts.

 

At the end of 2017 two CFTC exchanges – CME and CBOE – sought to self-certify and list futures products based on the value of Bitcoin.  CFTC regulatory practice is for exchanges to self-certify that new contracts meet CFTC core principles before listing.  This approach has allowed for robust and dynamic risk transfer markets to develop and test new products without a time-consuming application process.  Indeed, over 12,000 new futures products have come to market in the US since 2000, far more than in any other national marketplace.

 

With respect to the bitcoin products, because they were novel and based on a unique crypto-asset, the exchanges did engage in substantial prior discussions with CFTC staff before launch; this allowed for incorporation of risk mitigating elements, including around higher margin requirements and contract sizes.[19]

 

Some have questioned the decision to allow bitcoin futures to be self-certified by the exchanges.  But in my view risk transfer markets comprised of sophisticated institutional investors were in the best place to make individual determinations regarding the value of Bitcoin and the need to offset price or volatility risk.  And I think a strong case can be made that the results of the past year confirm this view.

 

Indeed, at the time of the launch of Bitcoin futures many observed a potential bubble in the price of Bitcoin, which had exceed $19,000.  That price was reduced to less than $10,000 within months of the futures product offerings.  Some have speculated that this price decrease reflected a reversion to Bitcoin fundamentals: namely the cost of production.  Economists from the San Francisco Fed noted in a 2018 economic letter[20] that the launch of bitcoin futures products coincided with the subsequent and precipitous drop in the price of bitcoin, perhaps because futures allowed for the first accessible way to speculate against the price of the asset.

 

Notwithstanding the arguments made for Bitcoin’s price declines, it remains true that markets allow actors to meet and reach price equilibrium on the value of an asset and/or transfer risk.  In the case of Bitcoin, I would posit that the decrease in prices has helped end a speculative bubble and perhaps allow this novel technology and asset class quieter time to continue to develop from a technological and adoption sense.

 

The key takeaway, however, is that markets work even if in ways we do not expect.  And the expression of a market is a healthier forum for such information discovery than the mere opinion or perspective of a few.

 

Solving for a Digital Economy

 

So there you have it -- the CFTC response to fintech innovation and modern market regulation – having an exponential growth mind-set, creating an internal fintech stakeholder, becoming a quantitative regulator, and embracing market-based solutions.  You might call this a 21^st Century regulatory expression of Futurism in response to today’s digital technology, algorithmic markets, and public policy.

 

When I talk to audiences of technology innovators steeped in the language of computer protocols, I like to point out law and regulation are also protocols.  At the CFTC, we work on a really old protocol – in our case it’s over 80 years old.  It’s voluminous, it’s thousands of pages of regulations and it’s very detailed.

 

Yet, while our regulatory frameworks were designed for environments that have been transformed, the principles underlying our regulations remain relevant – and remain enforceable.

 

I am so pleased that the CFTC and CONSOB will engage together on this new, fast paced journey.  We hope to learn about your own unique responses to these remarkable challenges.  No doubt, just like the Italian Futurists, you will find your own special way of keeping pace with a rapidly changing world and ensuring a dynamic and successful future for modern trading markets.

 

Thank you.

Statement of Commissioner Dan M. Berkovitz Regarding the ICE Futures U.S., Inc.[1] Passive Order Protection Functionality Rule

May 15, 2019

I disagree with the self-certification of ICE’s new Rule 4.26(c), and its associated passive order protection (“POP”) functionality for the Exchange’s Gold Daily and Silver Daily futures markets.[2]  POP is an issue of first impression in Commission-regulated markets: an asymmetric speed bump specifically designed to alter the competitive balance between market participants and trading strategies.  Asymmetric speed bumps, such as POP, that purposely disadvantage particular trading entities, strategies, or technologies, are discriminatory, anti-competitive, and facially inconsistent with the fundamental objectives of the Commodity Exchange Act (“Act”) to promote “responsible innovation and fair competition . . . among market participants.”  In these circumstances a compelling “explanation and analysis” of the proposed rule’s compliance with applicable provisions of the Act and the Commission’s regulations must be provided for the Commission not to find the rule inconsistent with the Act.[3]  As discussed below, no such compelling explanation and analysis has been provided with respect to the POP rule.

Under Section 5c of the Act, the Commission shall approve a rule submitted for approval by a registered entity, including a designated contract market (“DCM”), “unless the Commission finds that the new rule, or rule amendment, is inconsistent with [the Act or the Commission’s regulations].”[4]  Significantly, the Commission’s review is not limited to determining whether the rule is inconsistent with only the core principles for a registered entity, but rather the review encompasses consistency with the entirety of the Act.  The broad scope of review that the Commission must undertake is made clear by Regulation 40.6, which governs the submission and review of rule self-certifications.  Under Regulation 40.6(a)(7)(v), a rule submitted by a registered entity for approval must include a “concise explanation and analysis” of the proposed rule’s “compliance with the Act, including core principles, and the Commission’s regulations thereunder.”[5]  Regulation 40.6 thus requires the submission to include information regarding compliance with the entire Act, not just the core principles for the registered entity.

In this context, Section 15(b) of the Act also governs the Commission’s review of rule submissions by a DCM.  Section 15(b) states:

The Commission shall take into consideration the public interest to be protected by the antitrust laws and endeavor to take the least anticompetitive means of achieving the objectives of the Act, as well as the policies and purposes of this Act, in issuing any order or adopting any Commission rule or regulation . . . , or in requiring or approving any bylaw, rule, or regulation of a contract market . . . .[6]

Accordingly, in reviewing a rule submission, the Commission must take into account the protection of competition under the antitrust laws, and endeavor to take the least anticompetitive means to achieve the policies and purposes of the Act.  Under Section 3 of the Act, these purposes include promoting “responsible innovation and fair competition among boards of trade, other markets, and market participants.”[7]  When conducting the review mandated by Section 15(b), the Commission may “exercis[e] its independent judgment” in considering the issues presented.[8]

The Act and Commission regulations evidence a clear preference for open, transparent, and competitive derivatives markets where participants can bring and fully utilize their expertise and resources.  Congress enunciated strong principles of fair-trading[9] in Section 3 of the Act, and specifically identified “responsible innovation and fair competition” in derivatives markets as fundamental purposes underlying the entire statutory regime.[10]  In Sections 5(d)(19) and 5h(11) of the Act,[11] Congress also instructed DCMs and swap execution facilities (“SEFs”), respectively, to not “impose any material anticompetitive burden on trading [on the DCM or SEF]” unless “necessary or appropriate to” achieve the purposes of the Act.  As noted, the record before the Commission includes no compelling explanation and analysis as to why an asymmetric speed bump such as POP—clearly a “material anticompetitive burden” for some market participants—is necessary or appropriate to achieve the purposes of the Act.  Conclusory assertions that the asymmetric speed bump will reduce latency arbitrage and “attract additional participants and liquidity to the screen” are not sufficient to justify such material anticompetitive burdens.[12]

The Commission has implemented Congress’s competition directives through, for example, regulations that codify Sections 5(d)(19) and 5h(11) into Commission rules.[13]  The Commission has also adopted impartial access rules that require DCMs to provide their market participants with impartial access to the DCMs’ “markets and services,” including “[a]ccess criteria that are impartial, transparent, and applied in a non-discriminatory manner.”[14]  DCMs are also required under the Act and the Commission’s regulation to “promote fair and equitable trading” on their facilities.[15]

Practices that serve to preclude legitimate methods of competition or protect incumbents from challenges by new entrants are facially incompatible with the principle of fair competition embodied in the Act and Commission regulations.

In the case of POP, the Commission is faced with an asymmetric speed bump that penalizes certain order types (aggressing orders) and trading strategies (cross-market arbitrage), while also discriminating against market participants that have developed the skill and invested in the technology to thrive in modern markets.  ICE’s public comments in support of POP express the Exchange’s aim of “reducing the importance of latency advantages which are only available to a small subset of the fastest firms engaged in arbitrage . . . .”[16]  When presented with a proposed rule such as an asymmetric speed bump that is discriminatory by design, the Commission must be provided with sufficient explanation and analysis to enable it to conclude that the proposed rule is not inconsistent with the purpose of promoting fair competition and doing so using the “least anti-competitive means” as specified in the Act and the Commission’s regulations.

The record before the Commission does not provide sufficient explanation and analysis to conclude that the proposed rule is not inconsistent with the Act and Commission regulations.  Although I agree with the staff’s interpretation that “notwithstanding the broad language of the ICE Rule, the future implementation of the POP functionality for any ICE contract other than the Gold Daily and Silver Daily contracts, or a change to the three millisecond delay period, among other changes to the POP functionality, would require ICE to file a new rule submission in accordance with CEA Section 5c(c) and part 40 of the Commission’s regulations,” the fact is, as the staff noted, the Rule submitted by ICE is not limited.[17]  By its terms, the ICE rule applies to any futures contract traded on the ICE DCM, as ICE determines “in its discretion.”  Although the ICE rule as drafted is not limited to Gold Daily and Silver Daily contracts, and it does not appear that ICE intended for the rule to be so limited, no justification was provided regarding the rationale for the application of the rule to any contract other than the Gold Daily and Silver Daily contracts.  Based on the record before it, the Commission should have determined that the broad rule is inconsistent with the Act and Commission regulations.

However, even if the submission were limited to Gold Daily and Silver Daily contracts, I do not find the proffered rationale for the application of this asymmetric speed bump sufficiently compelling to justify the anticompetitive burden it places on classes of market participants.  In my view, the promotion of liquidity does not justify the imposition of a material anti-competitive discriminatory burden on a particular segment of the market.  The Commission should not ignore a fundamental purpose of the CEA—to promote fair competition—in a speculative attempt to generate liquidity.

Today’s statement by staff of the Division of Market Oversight (“DMO”) notes that this is the first instance of an asymmetric speed bump being proposed for a CFTC-regulated market and there is no data as to the effectiveness of this type of rule in our markets.  In the event that the CFTC may be requested to consider additional rules imposing speed bumps or other measures to discriminate against particular classes of market participants, I urge the Commission to gather additional information and data about speed bumps, for example by examining the effectiveness and fairness of speed bumps in non-CFTC markets, requesting the Office of Chief Economist to assist in the review of this issue, and seeking input from other outside experts, through, for example, a CFTC Advisory Committee.  Additionally, I urge the Commission to develop some criteria for measuring the effectiveness of speed bumps.

I agree with the statement by DMO staff that today’s non-action by the Commission sets no legal or policy precedent.  DMO staff also correctly states that ICE must submit a new rule filing pursuant to Part 40 of the Commission’s regulations if it in any way intends to modify its current POP functionality, expand it to new products, or adjust the time delay period.   

I thank the staff of DMO for being responsive to questions from my office during the consideration of this matter.