Opening Statement of Commissioner Rostin Behnam before the Market Risk Advisory Committee

December 11, 2019

Introduction

Good morning and welcome to the CFTC’s Market Risk Advisory Committee (“MRAC” or “Committee”) meeting.  I want to thank Chairman Tarbert and Commissioners Quintenz and Stump for being here today.  I also want to thank and acknowledge the MRAC members and invited speakers who will participate on the panels today.  

I would like to extend a special thanks to Nadia Zakir, the MRAC Chair for her commitment and leadership.  Finally, and as always, I would like to thank and recognize Alicia Lewis, the Committee’s Designated Federal Officer, for all of her tireless, well executed, and thoughtful work.  There are many individuals who make advisory committee meetings run smoothly, efficiently, and with purpose; but, none deserve more recognition than Alicia. 

Subcommittee Updates

This morning we will receive updates from the MRAC’s three newest subcommittees: Climate-Related Market Risk, Market Structure, and CCP Risk and Governance.  The Commission recently approved each of these three subcommittees.  I appreciate my fellow Commissioners and their support and thank each of the subcommittee members for their willingness to serve and contribute to these critically important market issues.[1]  Although less than a month since Commission approval, I know each of the chairs will have important updates for the MRAC from each subcommittee.  With that, I will take a moment to thank each of the new chairs: Bob Litterman, Stephen Berger, Lisa Shemie, Lee Betsill, and Alicia Crighton for their leadership. 

The Interest Rate Benchmark Reform Subcommittee

Following the morning panels, the MRAC will receive a status report from the Interest Rate Benchmark Reform Subcommittee covering its three work streams: (1) the Initial Margin Working Group, led by Biswarup Chatterjee; (2) the Clearing Working Group, led by Marnie Rosenberg; and (3) the Disclosure Working Group, led by Ann Battle.  Tom Wipf, Chairman of this critically important subcommittee, and Chairman of the Alternative Reference Rate Committee (“ARRC”) of the Board of Governors of the Federal Reserve System (“Federal Reserve Board”) will lead the discussion.

I am proud of the accomplishments and progress made by the MRAC and the Subcommittee’s work and contributions to the larger efforts by our domestic and international counterparts, as we all collectively work to successfully transition away from the London Interbank Offered Rate (“LIBOR”).  As an important first deliverable in September, the MRAC approved plain English disclosures for new derivatives referencing LIBOR and other IBORS.[2]

This standard set of disclosures, prepared by the Interest Rate Benchmark Reform Subcommittee, is intended as a helpful example of “plain English” disclosures that market participants could use, as they deem appropriate, with all clients and counterparties with whom they continue to transact derivatives referencing LIBOR and other IBORs.  The disclosures inform clients and counterparties about the implications of using such products and provide additional transparency to the market.  That said, the “plain English” disclosures are not meant and should not undermine efforts to complete transition in an orderly and timely manner.  More generally, the disclosures provide a tool as we collectively work towards the end of 2021, when the Financial Conduct Authority will no longer sustain LIBOR.[3]

After the Interest Rate Benchmark Reform update, we will hear a discussion of the CFTC’s Office of the Chief Economist’s (OCE) and the Subcommittee’s findings on the uncleared margin impact of transitioning certain legacy IBOR-linked derivatives to risk free rates.  Specifically, Richard Haynes, a CFTC Supervisory Research Analyst will discuss an OCE-published CFTC research paper, “Legacy Swaps under the CFTC’s Uncleared Margin and Clearing Rules”.[4]  The paper provides important data about the landscape for legacy swaps, which are swaps executed prior to the implementation of the CFTC’s Title VII margin and clearing mandate.  I believe the paper’s conclusions cement the important role the CFTC and other regulators should play in providing critical market data and regulatory relief for market participants, where needed and when appropriate, as we collectively stride towards benchmark transition.  On that note, I believe the Chairman has an announcement to make in the near future that will validate the important role the CFTC and other regulators play in the benchmark transition effort.  And I thank the Chairman for working with me on these important issues.

The penultimate discussion will center on ISDA’s fallback consultations, including pre-cessation triggers and the parameters for benchmark fallback adjustments.  These are critically important issues, which have seen great progress in just the past few weeks alone.[5]  Among many other efforts since 2016, ISDA has spearheaded this critical work as part of the larger global benchmark transition effort, and the entire organization deserves recognition for excellent and timely work.

Many challenges remain that demand thoughtful consideration and eventual execution in order to globally harmonize transition away from LIBOR.  Discussions raise several issues, including most generally how to avoid significant market disruption if the Financial Conduct Authority, as the primary regulator of LIBOR, finds it to be non-representative.  Of note, the Financial Stability Board’s Official Sector Steering Group has encouraged consideration of a pre-cessation trigger as a step towards greater market certainty.[6] A second concern involves how non-EU jurisdictions, including the U.S., should respond if there is a determination under the European Benchmark Regulation that LIBOR, although still published, is non-representative of the underlying market.[7]

Finally, we will hear current proposals from the CME and LCH for transitioning price alignment interest and discounting for U.S. dollar over-the-counter cleared swaps to the Secured Overnight Financing Rate (“SOFR”).  I believe the MRAC’s Interest Rate Benchmark Reform Subcommittee can play an important role in hosting critical discussions and potentially table top exercises to game out the possible “big bang” transition.

As we kick on the heels of 2020, much work remains to be done in two short years.  The ARRC’s paced transition plan assumes significant transition to SOFR in 2020.  Operational readiness becomes crucial to ensure organizations have set a solid foundation internally to begin transition in earnest.  I remain committed to supporting this entire effort, working with market participants and my official sector colleagues to ensure the MRAC continues to play an additive role in addressing challenges in a thoughtful, measured way to ensure market continuity and stability. 

I look forward to today’s important discussion.

Statement of Chairman Heath P. Tarbert on LIBOR Transition Before the Market Risk Advisory Committee Meeting

December 11, 2019

Good morning, and thank you all for being here.  I want to thank Commissioner Behnam in particular for his tireless work on the LIBOR transition.  Through his sponsorship of the Market Risk Advisory Committee (MRAC), he has helped drive a very productive dialogue among industry and the U.S. regulators.  With all of your help as MRAC members, this dialogue has led us to what I believe will be a workable path forward.

Helping the LIBOR-to-SOFR Transition

As we all are acutely aware, the benchmark interest rates underpinning much of our markets will be sunsetting by the end of 2021.  The UK Financial Conduct Authority (FCA) has been unequivocal that it expects LIBOR as we know it to cease within two years.  Because of this, I have a word of caution to anyone hoping that LIBOR will continue into 2022.  It is simply this:  failing to transition away from LIBOR is source of risk to your individual firm as well as the global financial system.

The CFTC agrees with our fellow regulators here and abroad that it is time for global financial markets to move away from LIBOR.  We want to encourage and facilitate that transition.  For our part, we want to facilitate the conversion of U.S. Dollar LIBOR-based swaps to SOFR.

This agency has worked with the Alternative Reference Rate Committee (ARRC), of which we are an ex officio member.  The ARRC has submitted requests to the relevant U.S. financial regulators for regulatory relief that will ease the transition away from LIBOR. In our case, the ARRC has requested no-action relief from CFTC staff.  The ARRC’s request covers a number of issues addressed in our swaps regulations—including trade execution, clearing, margin for uncleared swaps, business conduct standards, and confirmations.  In effect, the ARRC is asking us treat amendments to legacy LIBOR swaps the same way we treated the original swaps.  That makes perfect sense to me. Providing such relief will ensure we do not penalize market participants as they make this critical transition in good faith.[1]

I am therefore pleased to announce that the CFTC will likely be the first out of the gate to provide LIBOR-transition related relief. Specifically, the CFTC staff is working to publish a series of relevant no-action letters by December 20, 2019.  This relief will remove many of the barriers to converting legacy LIBOR swaps to SOFR.  The relief will cover amendments to existing swaps that either add a fallback provision or change the reference rate to SOFR or another risk-free rate.

I want to express support for the collaborative efforts of our clearinghouses, in particular CME and LCH, and ISDA in developing fallback language for LIBOR swaps.  These fallback provisions can help smooth the transition to SOFR.

Avoiding Zombie LIBOR

I also want to highlight another lurking threat: the so-called “zombie LIBOR.”  If LIBOR is still published for some limited period but not enough panel banks submit daily rates, then LIBOR would exist yet not be representative of a real rate.  We would face a situation where swaps would be priced against a seemly alive rate whose is integrity as a benchmark is completely dead.

To avoid a potential zombie LIBOR apocalypse, various proposals are currently being discussed.  One possibility is that swaps referencing LIBOR could have pre-cessation triggers to change the referenced rate.[2]  We are monitoring these discussions and look forward to responding to any proposals in due course.

Regulators are also discussing how a period of non-representative LIBOR might work.  I certainly do not think this is the ideal outcome, but I appreciate that it is necessary to plan for all eventualities.

Looking ahead, 2020 is going to be crucial for our collective efforts to transition away from LIBOR.  The CFTC remains committed to working with market participants and our fellow regulators on this critical issue.

Statement of Commissioner Dan M. Berkovitz on Final Rule to Amend the Rulemaking Procedures in Part 13 of the Commission’s Regulations

December 10, 2019

I support the final rule to eliminate the obsolete provisions in part 13 of the Commission’s regulations that specify procedures for Commission rulemakings.  Part 13, adopted by the Commission more than 40 years ago, does not conform fully to the rulemaking procedures required by the Administrative Procedure Act (“APA”) and followed today by the Commission. The repeal of these procedures will avoid potential confusion regarding the Commission’s rulemaking process.

Notice and comment rulemaking pursuant to the APA relies on a transparent process and an informed public that is able to participate in agency rulemakings.  In conjunction with today’s final rule, the Commission is posting on its website a plain-English summary of its rulemaking process. 

I am particularly pleased to see that in response to public comments, the preamble to the final rule affirms the Commission’s commitment to transparency during the rulemaking process.[1]  Specifically, the Commission affirms its policy to post on its website notice of all ex parte meetings held on proposed rules, as well as any significant material information received in such communications.  I strongly support these policies, which promote transparency, and aid the public’s understanding of, and participation in, the Commission’s rulemakings.   

In addition, the final rule also preserves the public’s right to petition the Commission for the issuance, amendment, or repeal of a rule.  It incorporates comments received in response to the proposed rule by allowing for the electronic submission of such petitions through the Commission’s website.  The preamble to the final rule also establishes a Commission policy of posting petitions for rulemaking on the Commission’s website.  Each of these measures is a valuable addition to the transparency and accessibility that the public deserves when interacting with the Commission.

Statement of Commissioner Dan M. Berkovitz on Proposed Rule to Make Permanent Certain Anti-Evasion Measures for Inter-Affiliate Swaps

December 10, 2019

I support the proposed rule to make permanent the alternative compliance frameworks for certain swaps between the foreign affiliates of U.S. firms and their non-U.S. counterparties.[1]  The proposed rule would make permanent, with modifications, anti-evasion provisions for inter-affiliate swaps that the Commission originally adopted in 2013, and then extended through staff no-action letters that remain in effect today.  The no-action letters require U.S. firms and their foreign affiliates to exchange variation margin in connection with swaps entered into by the foreign affiliate with non-U.S. counterparties, where such swaps are subject to the Commission’s clearing requirement and there is no comparable and comprehensive clearing regime in the foreign jurisdiction.  The proposed rule upholds the Dodd-Frank Act’s clearing mandate, deters evasion, and helps to protect against systemic risk to the U.S. from swaps executed overseas by foreign affiliates. 

The Commission’s rules provide a limited, conditional exemption from clearing for swaps between certain affiliate counterparties, including U.S. firms and their foreign affiliates (“Inter-Affiliate Exemption”).[2]  At the same time, through both regulation and no-action relief, the Commission has implemented measures designed to prevent U.S. firms from routing swaps through their foreign affiliates to evade the Commission’s clearing requirement for such swaps.  These anti-evasion provisions condition the Inter-Affiliate Exemption such that foreign affiliates of U.S. firms must clear their outward-facing swaps if such swaps are: (1) subject to the Commission’s clearing requirement and (2) entered into with unaffiliated counterparties in foreign jurisdictions (“Outward-Facing Swaps Condition”).  The Outward-Facing Swaps Condition allows outward-facing swaps to be cleared pursuant to a comparable and comprehensive foreign clearing regime, if available. 

In jurisdictions where the Commission has not made a comparability determination, the alternative compliance frameworks permit the foreign affiliate to exchange full, daily variation margin for the swap with its U.S. affiliate or its non-U.S. counterparty, rather than clearing the outward-facing swap.  The alternative compliance frameworks permit the foreign affiliate to enter into swaps with non-U.S. counterparties in foreign jurisdictions under the same terms and conditions as other non-U.S. persons in those jurisdictions.  They preserve the competitiveness of the foreign affiliates of U.S. firms without presenting significant risks to the U.S. affiliate or importing significant risks into the U.S.  Today’s proposed rule would make the alternative compliance frameworks permanent, with certain modifications.[3]      

I support the proposed rule’s emphasis on clearing, anti-evasion, and systemic risk by preserving the Outward-Facing Swaps Condition and making permanent the alternative compliance frameworks.  The proposed rule would also expand the jurisdictions subject to one of the alternative compliance frameworks to include additional jurisdictions that have adopted and implemented their respective domestic clearing mandates.[4]  By extending and making permanent the alternative compliance frameworks, the proposed rule would address the lack of comparability determinations for foreign clearing regimes, while ensuring the continued operation of anti-evasion and anti-systemic risk provisions in the Commission’s rules.

The proposed rule seeks public comment on whether the alternative compliance frameworks are sufficient to address potential systemic risk to the U.S. and whether they may produce a permanent residual class of swaps that are not cleared but instead result in the exchange of variation margin between eligible affiliate counterparties (and the risks associated with those swaps).  I look forward to public comments on these questions and other aspects of the proposal.       

Statement of Commissioner Dawn D. Stump for CFTC Open Meeting

Proposed Rule: Capital Requirements for Swap Dealers and Major Swap Participants – Reopening the Comment Period and Requesting Additional Comment

December 10, 2019

I would like to thank the staff of DSIO, OGC, and OCE for their efforts on further refining the capital rules that would apply to those swap dealers who are not otherwise prudentially regulated.  I realize that everyone at the Commission is juggling multiple concurrent priorities and I am grateful for the considerable amount of time you all devoted to our questions and the modifications in the document that were accepted based on our recommendations.

I believe that adequate regulatory capital for swap dealers is an important component of the post-crisis reforms, and I am pleased that the CFTC is advancing this effort.  Swap Dealers and other market participants that rely on their services need regulatory certainty and a logical implementation schedule.  I hope that we will ultimately be able to provide both.

When it comes to regulatory certainty, capital remains the last substantive Dodd-Frank Act rulemaking yet to be finalized by the CFTC.  The Commission has mandated the provisional registration of Swap Dealers for years and imposed all of the associated regulatory obligations.  Today we seek to advance the regulatory certainty as to capital requirements under our authority, which will enable Swap Dealers to more comprehensively ascertain the cost of continuing to provide such services.

Equally important is a transparent and reasonable schedule for the implementation of capital requirements.  Businesses need accurate and timely information to make sound decisions and plan for the allocation of resources.  I think the Commission would be well-served from commenters speaking to the effective date and implementation timeframe for the CFTC’s rule, especially as it relates to cooperation with other regulators and the impact of substituted compliance determinations.

Even while acknowledging that this piece of our swaps regulatory assignment has taken a bit longer compared to the other changes mandated by the Dodd-Frank Act, I am supportive of the Commission again engaging with the public to receive more timely feedback from affected parties.  Much has changed since the 2011 and 2016 proposals concerning capital. We need to solicit a more contemporary snapshot of the issues.  The matter before us today provides us with an opportunity to rethink our approach to capital and allows us to be more consistent with what other regulators have accomplished.  I agree with the need to re-open the comment period and also ask additional questions, but I do that with an open mind and am not presupposing the outcome.  I encourage commenters to not limit their potential answers to the examples provided but instead view the request for comment as a non-exhaustive list of options.  Bottom line, it is time to get this right. To help us do that, this release has explicitly requested data driven responses that illustrate examples of the impact of various capital choices. Any such information commenters can share will help formulate the highest quality rulemaking possible.  I look forward to seeing the comments and getting this rule across the finish line.

Statement of Concurrence by Commissioner Rostin Behnam

Amendments to the Exemption from the Swap Clearing Requirement for Certain Affiliated Entities

December 10, 2019

I respectfully concur with the Commodity Futures Trading Commission’s (the “Commission” or “CFTC”) decision today to issue proposed amendments to the exemption from the swap clearing requirement for certain affiliated entities.  The original inter-affiliate exemption rule was issued by the Commission in 2013.[1]  Today’s proposal reminds us both of how forward thinking the Commission was in implementing the Dodd-Frank Act and the goals envisioned at the 2009 G20 Pittsburgh Summit, and of how we need to be thoughtful and willing to update our rule set when reality differs from what we envisioned.

The impetus for today’s proposal boils down to this.  In some respects, the world hasn’t turned out quite the way the Commission envisioned.  When the Commission promulgated the inter-affiliate exemption rule in 2013, the perhaps overly hopeful expectation was that other jurisdictions would quickly follow our lead and adopt swap clearing requirements in short order.  While a number of jurisdictions now have clearing mandates for certain swaps, some non-U.S. jurisdictions are still in the process of adopting clearing regimes, and some non-U.S. jurisdictions vary significantly from the Commission’s clearing requirement.  While the expectation in 2013 was that the Commission would issue comparability determinations for non-U.S. jurisdictions with respect to the clearing requirement, to date the Commission has not issued any comparability determinations.

Because the Commission in 2013 expected the world to quickly follow with clearing mandates, it established a temporary Alternative Compliance Framework for compliance with the Outward-Facing Swaps Condition of the Inter-Affiliate Exemption.[2]  Since that temporary Alternative Compliance Framework expired in 2014, the Division of Clearing and Risk staff has issued a series of no-action letters extending the Alternative Compliance Framework to provide more time for global harmonization.[3]  Today, because the global regulatory landscape has not turned out quite like we expected, the Commission proposes to codify and make permanent the Alternative Compliance Framework.

While I support today’s proposal and believe that it represents the best path forward to provide legal certainty to market participants regarding the Outward-Facing Swaps Condition of the Inter-Affiliate Exemption, there is one significant aspect of the proposal that gives me pause.  In the preamble to the 2013 rule, the Commission stated that the Alternative Compliance Framework provided for the Outward-Facing Swaps Condition is “not equivalent to clearing and would not mitigate potential losses between swap counterparties in the same manner that clearing would.”[4]  We reiterate this in today’s preamble, stating that “[a]lthough paying and collecting variation margin daily does not mitigate counterparty credit risk to the same extent that central clearing does, the Commission believes, as stated in the 2013 adopting release for the Inter-Affiliate Exemption, that variation margin is an essential risk management tool.”  Despite clearly stating that variation margin does not mitigate counterparty credit risk to the same extent as central clearing, we nonetheless are proposing to exempt certain transactions from central clearing under the theory that variation margin mitigates counterparty credit risk.  This may be the right result, but I want to be absolutely certain that we are not injecting unnecessary risk into the system by exempting these transactions from central clearing in the name of focusing on the easiest, cheapest risk management tool.  I encourage interested parties to comment on whether the alternative compliance framework that we propose to codify effectively mitigates counterparty credit risk, and the differences in risk mitigation between the alternative compliance framework and central clearing.

In part, I am comfortable with the proposal because the existing rule provides the Commission with the ability to monitor how the exemption is working.  Under Regulation 50.52(c)-(d), the election of the Inter-Affiliate Exemption, as well as how the requirements of the exemption are met, must be reported to a Commission-registered swap data repository.[5]  Accordingly, the Commission will have a window into which entities elect the exemption, how many swaps are exempted, and how the requirements of the exemption are met.  In addition, the Commission retains its special call, anti-fraud, and anti-evasion authorities, which should enable it to discharge its regulatory responsibilities under the CEA.  I believe that the Commission should closely monitor SDR data regarding the Inter-Affiliate Exemption going forward in order to be certain that the exemption is not being used to evade central clearing, and to ensure that the exemption is not adding unnecessary and preventable risk to the system.

I thank staff for their thoughtful responses to my questions, and for making edits that reflected comments and suggestions made by me and my staff.

Dissenting Statement of Commissioner Dan M. Berkovitz

“Proposed Rule” and “Request for Additional Comment” on Capital Requirements of Swap Dealers and Major Swap Participants

December 10, 2019

I dissent from the document that is called a “Proposed Rule” on the Capital Requirements of Swap Dealers and Major Swap Participants (the “Document”).  My objections are both procedural and substantive.  Procedurally, the Document asks many open ended questions, is vague about what is being proposed, and lacks sufficient supporting data to serve as the basis for a final rule under the Administrative Procedure Act (“APA”).[1]  The Document as structured is not a proposal that can lead to a final rule; rather it appears to be more in the nature of an advance notice of proposed rulemaking.

Substantively, I dissent because the Document encourages mostly changes that only weaken what the Commission had previously proposed.  The path forward suggested by the proposed changes would undermine the statutory purpose of requiring swap dealers to retain an appropriate minimum level of capital to serve as a buffer of last resort after all other sources of credit support (e.g. initial and variation margin) have been exhausted.

The Document is not a Proposal that can Lead to a Final Rule

The Document asks over 140 questions regarding capital requirements that the Commission proposed in 2011 and again in 2016.  We received numerous public comments on both prior proposals.  The Document briefly discusses these comments, most of which were critical of the proposals, and then asks open-ended questions about various alternatives to the initial proposals.  The discussion of the rationale behind the general alternatives posed in the questions is often superficial.

For the most part, the Document does not propose any new rule text or amendments to previously proposed rule text, but rather summarizes comments and asks for further comments, data, and analysis to support suggested alternatives to the previously proposed regulations.  In many cases, a wide range of alternatives are suggested, such as capital levels ranging from 0 to 8% of risk margin.  In a number of places, the Document asks commenters to propose new rule text for the Commission.  The Document states “[t]he Commission notes that comments are of the greatest assistance to rulemaking initiatives when accompanied by supporting data and analysis, and, if appropriate, accompanied by alternative approaches and suggested rule text language.”[2]  As an illustrative example, the Document asks commenters to, “Please provide data and analysis in support of any suggested modified percentage of the risk margin amount.”[3]

To the extent that some commenters provide significant new information or data that the Commission intends to rely upon in formulating or justifying a final rule, the public must be afforded notice of and an opportunity to comment on the new information.  Under the APA it is not permissible for an agency to ask a wide range of questions about potential approaches, and then proceed to promulgate a final rule supported by new reasons and data sourced from the comments received.  Data that is relied on by an agency to support its final rule and that is not merely supplemental or confirming data must be subjected to the notice and comment process.[4]

Under the APA, an agency has a “duty to identify and make available technical studies and data that it has employed in reaching the decisions to propose particular rules. . . .  An agency commits serious procedural error when it fails to reveal portions of the technical basis for a proposed rule in time to allow meaningful commentary.”[5]

I have stated many times that when practical, the Commission should be guided by objective data in writing regulations.  An excellent example is our rule setting the minimum swap dealer registration threshold at $8 billion.  The CFTC staff undertook an exhaustive, objective data analysis that, when completed, showed that the $8 billion level captured the vast majority of swap dealing activity.  I voted for the rule based on that analysis.  However, we cannot rely on data submitted by commenters in the final rule without first allowing the public to comment on that data.

A Weaker Capital Rule is the Purpose

After reading the140-plus questions in the Document, it is clear that the Commission is headed in the wrong direction.  The Document does not pursue the goal stated by Congress for the capital requirements to help assure the safety and soundness of the swap dealers.[6]  In virtually every instance, the questions and accompanying discussion seek alternatives that would reduce the level of capital required or create greater flexibility for the swap dealers to comply.[7]  The Document reads like an extensive diner menu offering up every type of rule reduction that a hungry swap dealer might desire.

Let’s consider two significant examples.  Under one approach proposed in the prior proposals, a swap dealer would be required to hold capital equal to or exceeding 8% of uncleared swap margin and initial margin for certain swaps and futures positions of the swap dealer.  As explained in the Document, the 8% level is drawn from the Commission’s experience with its risk-based capital requirements for futures commission merchants.[8]

Based on comments received on the prior proposals, and in an effort to harmonize with the SEC, the Document now proposes dropping that level to 2% (or 4% or perhaps another level that a commenter may propose) and allowing swap dealers to “exclude any particular asset classes or positions from the computation of risk margin amount.”  No data is offered in the Document to explain why 2% would be a sufficient level.  Maybe 8% is not the right number, but how does 2% in a formula that potentially excludes more asset classes or swap positions from the calculation even enter the realm of possibility when FCMs are held to much higher levels?  The Document provides no clear rationale related to the statutory purpose of the rule.  The rationale in the Document boils down to saying 2% would harmonize our rule with the SEC’s security-based swap dealer capital rule.  But the security-based swap market is very small and relatively narrow in scope.  The Document includes virtually no analysis of whether a 2% level makes sense in the much larger, complex, and varied swap market.  An individual swap dealer may maintain a portfolio of hundreds of different swap products with a notional amount in excess of a trillion dollars and thousands of counterparties.  The dealer may enter into over a million swaps a year.  Asking generic questions about the differences in these two markets is helpful.  However, it is apparent that any significant new data or analysis provided by commenters in response to this Document that the Commission uses to support the final rule will need to be presented to the public for consideration and comment.

As a further example, the Document asks questions about permitting expanded use of netting of offsetting positions when calculating the exposures against which minimum capital must be held.  Netting of offsetting positions is an important function for intermediaries like swap dealers for day-to-day cash flow, liquidity, and risk management.  In some respects, netting is the basis on which certain types of intermediaries build their business by dealing derivatives to different parties that want or need long positions when other parties need or want corresponding short positions.

However, when it comes to minimum capital requirements, which are intended to serve as a source of funding of last resort at all times, we must be very careful when proposing netting offsets.  Should a large swap dealer with a complex dealing book only be required to hold some minimum amount of collateral simply because it is able to net out its book?  That would not appear to serve the statutory purpose for a minimum capital requirement of helping to assure the safety and soundness of the swap dealer.[9]  While I am not suggesting that netting should play no role in the capital requirement calculations, my concern is that the Document provides little in the way of data, analysis, or rationale as to how the netting provisions discussed, which could net significant portions of the requirement down to nothing, would serve the intended purpose.  That is a concerning approach to take for a capital requirement and it is difficult to see how a final rule could be built on such questions in the Document.

Harmonization and Cost Reduction Alone are not Valid Policy Goals

In the Document, the costs of compliance and harmonization with the SEC’s capital rule are repeatedly mentioned as reasons for various possible changes.  Compliance cost reduction and rule harmonization, when feasible without undermining the policy goals of the regulations, are certainly important considerations in writing regulations.  However, as I have stated in other contexts, these are secondary considerations and should not supplant achieving the policy goals stated by Congress in the Commodity Exchange Act.  While the Document acknowledges that safety and soundness of each swap dealer is the stated purpose of the capital rule, and asks generic questions about the impact on swap dealer safety and soundness, that purpose is not mentioned as the reason for any of the proposed changes to the capital requirements.  This odd omission belies the purported goals of the Document.

The Document also exposes the one-sided nature of the “harmonization” rationale.  In several instances it relies almost completely on harmonizing the CFTC regulation with the comparable SEC regulation.  In each of those instances, the result is always a weaker regulatory requirement.  And yet in a other instances,[10] the Document acknowledges that a change to the existing capital rule proposals would conflict with the SEC’s rules, but then goes on to support implementing a different rule.  It seems that harmonization is used as a rationale for action only when it is convenient for reducing regulation and therefore obfuscates the real reason for the action.

Conclusion

For the reasons stated above, I dissent. 

Notwithstanding my dissent, I want to acknowledge the hard work of the staff in trying to address my many questions and comments in the limited time we had to consider the Document.  Capital requirements are one of the most complex and highly technical areas in our regulations.  We had a little less than a month to review the Document, which was not enough time given the heavy schedule currently set for the Commission and the complexity and history behind the Document and the two prior capital rule proposals.  Notwithstanding this short time frame, I appreciate the staff’s efforts to incorporate a number of my requested changes and address several complicated issues.

Statement of Dissent by Commissioner Rostin Behnam

Capital Requirements of Swap Dealers and Major Swap Participants: Proposed rule; reopening of comment period; request for additional comment

December 10, 2019

I respectfully dissent from the Commodity Futures Trading Commission’s (the “Commission” or “CFTC”) decision today to reopen the comment period and request additional comment on proposed regulations and amendments to implement section 731 of the Wall Street Reform and Consumer Protection Act,[1] which requires the CFTC to establish capital rules for all registered swap dealers (“SDs”) and major swap participants (“MSPs”) that are not banks, including nonbank subsidiaries of bank holding companies, as well as associated financial recordkeeping and reporting requirements (the “Reopening”).  While I would have been comfortable supporting the Reopening as a matter of moving this critical Dodd-Frank Act rule forward to finalization, to the extent it introduces supplementary avenues for future rulemaking such as a leverage ratio requirement, it is a deception.  Impulsively inviting comment on matters tangential to the 2016 Capital Proposal[2], but perhaps relevant to determining appropriate capital standards and methodologies, as opposed to a thoughtful re-proposal sacrifices discipline for expediency, and runs afoul of proper process for notice and comment.  I will not be complicit in supporting Commission action that I believe could invite backdoor rationalization when finalization is before us.  The public deserves--and our integrity demands--that we play by the rules.

Today’s action is a reopening of the comment period and a request for comment, rather than a true proposal, and thus the 2016 Capital Proposal remains the only concrete indicator to the public of the Commission’s intentions.  If the 2016 Capital Proposal is an extreme overshoot, the appropriate way to provide the public with an opportunity to comment is to issue a reproposal.  Asking further questions, without a clear signal as to where the Commission is going, at the minimum risks further slowing this nearly ten-year effort to finalize a capital rule by adding an unnecessary step to the process in the form of a reproposal at some time in the future; and at the worst, incites the agency towards an exercise in creative reasoning outside the bounds of process.

Too often over the last couple of years, I believe this agency has slowed its own progress by snaking outside clear Administrative Procedure Act (“APA”) trajectories and adding unnecessary steps to the rulemaking process.  In part, I fear that we are doing the same thing today.  The competing threads throughout the Reopening make it harder for the public to discern what the Commission is proposing to do, and will make it more difficult to effectively comment on the existing proposal from 2016.   This creates undue risk under the APA, and arguably poisons the well in regard to the reachable goals of this new request for comment.

To reiterate sentiments made in my first speech as a CFTC Commissioner,[3] capital is a cornerstone financial crisis reform[4] that is critical to protecting our financial institutions and our financial system as a whole, specifically from systemic risk and contagion, but also from unintended consequences if capital (and margin) levels are applied and set without due regard to the uniqueness of our financial markets and market participants.  I appreciate that in moving forward, we must heed our directive to establish capital standards appropriately and in due consideration of other activities engaged in by SDs and MSPs such that we ensure that we do not penalize commercial end-users who need choices and benefit from competition in our markets.

The Reopening’s overarching premise is that the chosen response to certain uncertainties at the time of the Commission’s prior proposals[5] resulted in recommending standards that, in application, could in no way be justified as appropriate to offset the greater risk to SDs, MSPs, and the financial system,[6] such that the only solution for the potentially extreme overshoot is to dial it back.  With the passage of time comes a nagging amnesia to the pain that the financial crisis brought on American households and the global economy.  We cannot forget that undercapitalization was at the heart of the crisis.

The overall changes to the derivatives market over the last several years, the Commission’s adoption and implementation of margin rules for uncleared swaps and growing knowledge and experience with SDs, and recent movement by the Securities and Exchange Commission in finalizing capital, margin, and segregation requirements as well as financial reporting requirements for security-based swap dealers and major security-based swap participants,[7] provide a reasonable basis for affording the public an opportunity to reevaluate the 2016 Capital Proposal.  However, to the extent the Reopening seeks additional comment on both broader issues of harmonization and more targeted proposals regarding what amount of capital is appropriate and what methodology is used, its focus on solidifying a data-driven approach should send a strong signal that the Commission must justify its final determinations with respect to capital standards.

To reiterate, I would have liked to support today’s Commission action.  To the extent it would move us toward a final rule on a matter that is critical to the safety and resiliency of our markets, the supplemental concepts for consideration and overarching premise that we overshot the mark badly in the 2016 Capital Proposal raise concerns.  If the 2016 Capital Proposal is an extreme overshoot, and if there are alternative methodologies and concepts to consider because of new market data, the appropriate way to provide the public with an opportunity to comment is to issue a reproposal.  While I would have liked to stand with my fellow Commissioners today in supporting this first step towards a final capital rule, I cannot justify it under these circumstances.

Opening Statement of Commissioner Brian D. Quintenz before the Open Commission Meeting

December 10, 2019

Good morning. Mr. Chairman, thank you for calling this meeting.  I support all three rulemakings before the Commission today.

Proposed Rule: Capital Requirements for Swap Dealers and Major Swap Participants – Reopening the Comment Period and Requesting Additional Comment

I have long said that finalizing capital requirements for swap dealers (SDs) and futures commission merchants (FCMs) is perhaps the most consequential rulemaking of the post-crisis reforms to get right.

The financial crisis exposed serious vulnerabilities in the financial system – uncollateralized, opaque, bilateral exposures which, under the right circumstances could have, and did, cause a panic and liquidity freeze due to concerns around that counterparty credit risk.  This panic, in my opinion, transformed a significant recessionary event into the crisis as we know it.  Importantly, since the financial crisis, global regulators and certainly those in the U.S. have implemented many policy reforms, like central clearing requirements and margin for uncleared swaps, designed to bring transparency to those exposures.

I have long lamented prior regulators’ implementation of the important swaps market regulatory reforms by viewing them in isolation of each other – calibrating each to try to think it alone could have prevented the crisis.  In fact, the elegance of the reforms is that they work together and build upon each other.

Therefore, in my view, it is wrong to think of capital in terms of what levels should have existed during the financial crisis that could have prevented it.  Very few capital regimes could have provided the market with enough certainty, given the size, nature, and opacity of these exposures, to remove the possibility of the panic, and the capital levels which could have done so would have rendered the entire swaps market obsolete and uneconomic.  Therefore, regulatory capital regimes implemented to respond to the last crisis need to respect the increased transparency and certainty which other reforms have already brought to the market.  I believe we are asking the right questions in this reopening to respect that progress in calibrating our own capital regime appropriately.

The final pillar of our Dodd-Frank Act reforms, capital ensures that firms are able to continue to operate during times of economic and financial stress by providing an adequate cushion to protect them from losses.  Just as important as the safety and soundness of individual firms, capital is designed to give the marketplace confidence that any given firm has a high probability of surviving the next crisis.

Capital requirements also create important incentives that drive market behavior.  The cost of capital may be the most determinative factor in a firm’s decision to remain, or become, a swap dealer, or to continue to provide clearing services to clients, in the case of an FCM.  If capital costs are too expensive, firms will restrict certain business activities, end unprofitable business lines, or, in some cases, exit the swaps or futures markets altogether.  As a result, over time, the swaps and futures markets would become less liquid, less accessible to end users, more heavily concentrated, and less competitive.  These are not the hallmarks of a healthy financial system.

Therefore, appropriate capital levels are directly linked to both the health and vibrancy of the derivatives markets and to the sustainability of the entire financial system more broadly.

To promote a vibrant derivatives market, I believe it is critically important that the CFTC finalize a capital rule that is appropriately calibrated to the true risks posed by an SD’s or FCM’s business.  I am pleased to support the re-opening and request for comment before us today.  This document solicits comment on the key issues the Commission must get right in the final rule to ensure that capital requirements are appropriate and commensurate to a firm’s risk.  I appreciate that market participants have commented on two prior capital proposals and the Commission will continue to consider all past comments in moving forward with a final rule.  Nevertheless, I hope commenters use this opportunity to provide the Commission with much needed data and quantitative analysis demonstrating the impact that various choices contemplated in this proposal would have on a firm’s minimum capital level – and, by extension, on that firm’s ability to participate in the market and adequately service clients.  Data will be vital to the Commission’s ability to evaluate various capital alternatives and identify those alternatives that would render certain business lines or activities uneconomic.  It will also be vital to the Commission’s assessment that the capital requirements established ensure the safety and soundness of the firm.

I welcome comments on all aspects of the reopening, but there are a few areas I am particularly interested in hearing from commenters.

The eight percent risk margin amount.  We heard from many commenters that, of all the alternatives, the eight percent risk margin amount would act not as a capital floor as intended, but rather as the primary driver of firms’ capital requirements and as a potential binding constraint on their businesses.  Whereas FCMs are currently required to include in their minimum capital requirement eight percent of the margin required for their futures and cleared swaps customer positions, the 2016 proposal expanded the eight percent risk margin amount to include proprietary futures, swaps and security-based swap (SBS) positions for FCMs and for SDs electing the net liquid asset capital approach.  In addition to these proprietary positions being included in the risk margin amount, these FCMs and SDs would also be subject to capital charges on these proprietary positions.  I hope commenters can provide us with data showing the capital costs of including proprietary positions, for the first time, in an FCM’s risk margin amount.  To the extent possible, it also would be helpful to see how different risk margin percentages, or a different scope of products included in the margin amount, impacts the minimum capital requirements for an actual or hypothetical portfolio of positions.  I would also be interested to hear from commenters about whether it makes sense to remove the risk margin amount altogether for standalone SDs electing the net liquid asset approach or bank-based approach, given the other minimum capital level requirements in the proposal.

Model approval process.  The Commission must have a workable model approval process.  I am interested to hear commenters’ views on how the Commission or NFA should review or accept capital models that have already been approved by another regulator.  Should such models be granted automatic or temporary approval, while the Commission or NFA conducts its own review?

In closing, I have often worried that the accepted mantra on regulatory capital requirements has become “the higher, the better.”  Respectfully, I disagree.  There is a direct tradeoff between the amount of capital regulators require firms to hold to ensure firms’ resilience and viability, and the amount of available capital firms have to deploy in financial markets to support the market’s ongoing liquidity and health.  There is a balance necessary between capital levels that protect firms from losses on certain products, and capital levels that allow firms an economic benefit in servicing their customers’ risk management needs through those products.  I hope the feedback we receive from commenters on this reopening helps the Commission establish appropriate capital requirements that are commensurate to a firm’s risk and not detrimental to its clients.  I would also like to thank the staff of the Division of Swap Dealer and Intermediary Oversight for answering my questions and incorporating many of my comments into this document.

Proposed Rule:  Amendments to the Exemption from the Swap Clearing Requirement for Certain Affiliated Entities Regarding Alternative Compliance Frameworks for Anti-Evasionary Measures

I support today’s proposal to codify how affiliated swap counterparties have, for the past six years, complied with an important provision of one of the Commission’s exemptions from the swap clearing requirement.  The Commission’s swap clearing requirement has accomplished the important task of requiring financial institutions to centrally clear the overwhelming majority of the most commonly-traded interest rate swaps and credit default swaps through CFTC-supervised clearing organizations.  According to a Financial Stability Board (FSB) report published in October, at least 80% of interest rate swaps and credit default swaps executed in the U.S. are now cleared.[1]  Central clearing, through the posting of initial and variation margin with a clearinghouse, has greatly reduced counterparty credit risk in the swaps market, helping to support confidence in the financial markets.  However, carefully considered exceptions should ensure that uncleared products remain economically viable to provide market participants with flexibility in managing risks.  For example, entities belonging to the same corporate group regularly execute swaps for internal risk management purposes, and these swaps do not incur the same risks as those executed with unaffiliated counterparties.[2]  The Commission has also created exceptions to the swap clearing requirement for commercial end-users, financial institutions organized as cooperatives, and banks with assets of $10 billion or less.  As an additional point, I look forward to the Commission finalizing last year’s proposed exemptions for bank holding companies and savings and loan companies having consolidated assets of $10 billion or less and for community development financial institutions.

I believe the proposal before the Commission today strikes an appropriate balance between guarding against evasion, on the one hand, and providing flexibility for cross-border swaps activity on the other.  When affiliated financial counterparties exchange variation margin on all of their swaps with one another, on a worldwide basis, the risk that a U.S. firm can amass a critical amount of uncollateralized exposure abroad is greatly reduced.  At the same time, the proposal does not disadvantage U.S.-based institutions competing with foreign institutions located in jurisdictions whose swap clearing requirements are narrower in scope than the Commission’s.  I believe that today’s proposal functions rationally with the Commission’s rules for margining uncleared swaps on a cross-border basis, including in the context of inter-affiliate transactions, and I look forward to comments on this topic.

In addition, I note that today’s proposal would simplify the existing inter-affiliate exemption to reflect current market practices and eliminate complicated provisions that may never have been relied upon.  I hope the Commission’s next rulemakings similarly rationalize rules so that industry’s compliance becomes less burdensome and costly.