Statement of Chairman Heath P. Tarbert Before the December 10, 2019 Open Meeting

Tripling Down On Transparency

 December 10, 2019

As regulators, we must be mindful not only of what we do, but how we do it.  Our shared vision for the CFTC is to be the global standard for sound derivatives regulation.[1]  Soundness is built on transparency: we serve our markets best when we act with the benefit of public input and dialogue.  We also owe it to those who rely on our derivatives markets to regulate in the open.  With this in mind, our agency recently adopted Clarity—which we describe as “[p]roviding transparency to market participants about our rules and processes”—as one of the four core values of the CFTC.[2] 

Importance of Transparency

Given the importance of transparency, I am committed to holding Commission deliberations in public view.  I have long considered the CFTC to be the most important regulator most Americans have never heard of.[3]  We are working to change this: during the last few months of 2019, our current Commission will have held six open meetings—the same number the Commission held during 2015, 2016, 2017, and 2018 combined.[4]  In 2020, I intend to continue to hold open meetings on a monthly or bimonthly basis so we can continue to decide important policy matters before the public. 

While transparency is important for all regulators, it is especially critical for us.  When the Dodd-Frank Act[5] gave the CFTC jurisdiction over the swaps market, we were entrusted with overseeing more than $400 trillion in notion value.[6]  That is a humbling level of responsibility.  It demands that we give the public ample opportunity to see what the Commission is doing and to engage with us.  We will not regulate from behind a curtain.

Reaffirming the value of transparency is vital because the need to “get things done” has not always lent itself to getting them done the right way.  Commentators have argued that in implementing the Dodd-Frank Act, the CFTC sometimes stumbled in its commitment to transparency by focusing too much on the deliverables and not enough on the delivery.[7]  In particular, the CFTC was criticized for regulating through staff no-action letters, policy statements, and enforcement actions rather than “a transparent, notice-and-comment rulemaking process.”[8]  Given the immense demands placed on this agency in the immediate wake of the Dodd-Frank Act, our predecessors surely did not make opacity the goal.  Nevertheless, opacity was the result: the agency too often traded openness for what some have dubbed the quiet expediency of ‘“backroom rulemaking.’”[9]

As we approach the year 2020 and beyond, I am pleased to announce that the CFTC will triple down on transparency by taking action in the following three areas: (1) how we make regulations; (2) how we apply them; and (3) how we enforce them.

1.  Transparency in Rulemaking

First, we will reaffirm the importance of notice-and-comment rulemaking established under the Administrative Procedure Act (APA) as the foundation for providing transparency in how we make regulations.  Today the Commission is voting to approve a final rule to amend Part 13 of our regulations to clarify how we receive, process, and respond to petitions for rulemakings filed under the APA.  Apart from being fully consistent the APA, our Part 13 also retains Section 13.2, which permits any person to petition the Commission for a rulemaking.  This is a unique feature of the CFTC’s rulemaking framework that reinforces transparency and the right of the public to participate in our regulatory process.  Most importantly, we will publish petitions for rulemakings on the CFTC website, facilitating public engagement in our rulemaking process.   

In addition to updating Part 13, we will be publishing a summary of our rulemaking process on the CFTC website.[10]  The summary is written for the general public and is designed to explain in plain English how the CFTC proposes and finalizes regulations.  I believe the summary is an important step in improving the public’s understanding of our regulatory process.

2.  Transparency in No-Action, Interpretive, and Exemptive Relief

Second, I am committed to ensuring our agency is transparent in how we apply our regulations through the use of no-action, interpretive, and exemptive relief letters.  To be sure, the Commission is most transparent when we regulate through public notice-and-comment rulemakings that require a majority vote of presidentially-nominated, Senate-confirmed officials.  We should do so whenever possible.  Staff relief should be a supplement, rather than a substitute, for the APA rulemaking process.  I am therefore pleased to announce that the CFTC is finalizing guidance to ensure staff no-action, interpretive, and exemptive letters are limited only to those situations where they are truly appropriate.[11]  Examples include those situations with unique circumstances not suitable for a general rulemaking or where only temporary relief is contemplated pending either the rulemaking process[12]or one or more market events (e.g., Brexit, SOFR transition, etc.).

We must also increase transparency even where staff relief is appropriate.  Today I am also announcing that as of January 1, 2020, the CFTC will publish all requests for staff no-action, interpretive, and exemptive relief on our website when such relief is granted.[13]  Publishing requests alongside our relief letters will harmonize our agency’s practices with those of other federal financial regulators.  This practice will likewise provide greater public visibility into issues before our Commission.  Publicly disclosing requests for staff relief further demonstrates our commitment to putting transparency into practice.

3. Transparency in Enforcement Settlements

Finally, we must be transparent in how we enforce the law.  One goal of our enforcement program is to change behavior in a positive way by deterring misconduct before it happens.  Deterrence requires clarity about how our laws work.  Long gone are the days when kings would post their edicts high on columns to make the law harder to read and easier to transgress.[14]  Our Founders instead adopted a system in which “the law is king.”[15]  Indeed, it has been said that in our American system, the rule of law is a law of rules.[16]  

Consistent with this mandate, our Division of Enforcement will soon publish an updated Enforcement Manual that will inform the public about a number of changes designed to increase transparency.  We take seriously the need to inform the public about our enforcement priorities and practices. 

In the same vein, the Commission and its staff must be free to speak publicly about enforcement matters.  Beginning January 1, 2020, I will not present to the Commission any enforcement settlement or consent order that restricts the Commission or our staff from publicly stating their views on the case.[17]  Affirming this right to speak ensures the CFTC can inform the public of our enforcement priorities.  It also advances customer protection: the facts of past cases can serve as early warning signs of new types of fraudulent or manipulative activity. 

At the same time, genuine transparency cannot be one-sided.  Just as the Commission should be able to speak freely about enforcement actions, so too should defendants.  Also beginning on January 1, 2020, I will not put before the Commission any settlement agreement or consent order that unduly restricts a defendant’s ability to speak publicly about an enforcement matter.[18]  While the Commission will continue to require that defendants who agree to settle a matter not deny liability, or any fact or statement to which the parties have agreed, the CFTC will not limit any defendant’s ability to discuss his or her case publicly or to criticize our agency.  This approach is good for transparency as well as accountability: defendants may speak freely, but will be unable to hide behind the language of settlements to avoid answering tough questions about their conduct.

Conclusion

Transparency is sometimes avoided because it opens the door to criticism.  But as Aristotle purportedly reminds us, “[c]riticism is something we can avoid easily by saying nothing, doing nothing, and being nothing.”[19]  That has never been of the path of the CFTC during our nearly 45 years of regulating our markets and enforcing our rules.  Nor will it ever be.  Just as we will not shrink from carrying out our duties, calling out wrongdoing, and enforcing the law, so too will we ensure market participants have true insight into the operation of our agency.

Criticism is not always pleasant, but it is a core facet of democracy.  The Commission is an agency of the U.S. Government, and it should be scrutinized when it acts.  When asked what type of government came out of the Constitutional Convention, Benjamin Franklin famously answered, “A Republic, if you can keep it.”  Our Commission will do its part.  

Statement of Commissioner Dan M. Berkovitz:  Transparency and Accountability in Government

December 10, 2019

I strongly support the Chairman’s announcement that he will not put before the Commission for a vote any settlement agreement or other resolution of an enforcement matter that constrains the Commission, individual Commissioners, or Commission staff from making public statements about that matter.

I am, however, disappointed that despite CFTC staff preparing a proposed rule for today’s meeting that would codify a prohibition of confidentiality clauses in settlement agreements, a majority of the Commission is not ready to support even putting the proposal out for comment.  Ensuring the transparency and accountability of the Commission’s operations and enforcement actions should be a priority of this Commission.  It certainly is a priority for me.  During my tenure as a Commissioner, I will never agree to any gag clause with any party settling an enforcement matter with the Commission.  I will continue to exercise my right to speak on all matters before the Commission, a right that recently was affirmed by a United States Court of Appeals.[1]  Neither a majority of the Commission nor any consent order can take away this right.  Under no circumstance will I agree to be silenced by—or agree to let the Commission or staff be silenced by—any person that the Commission believes has violated the Commodity Exchange Act (“CEA”).

It is of paramount importance that the Commission, Commissioners, and agency staff be able to communicate to the public the reasons why enforcement actions are initiated and concluded.  Congress has protected the ability of individual Commissioners to make public statements on matters before the Commission and it is good government to extend this protection to the full Commission, as well as its staff, when the CFTC settles administrative and civil proceedings.

For example, the Commission, Commissioners, and CFTC staff must be able to speak publicly about the reasons for determining that the law has been violated.  CFTC enforcement actions not only punish parties who violate the law, but also provide guidance to market participants and the public about the agency’s interpretation of the applicable statutes and regulations.[2]  Explaining to the public the legal and factual bases for bringing an action both deters misconduct and avoids chilling legitimate market activity.

In addition, the public has a right to know why the Commission is resolving a case, and whether it is obtaining appropriate remedies when the law is violated.[3]  “The effective functioning of a free government like ours depends largely on the force of an informed public opinion.”[4]  The Commission, Commissioners, and CFTC staff therefore must be able to inform the public about the reasons underlying the settlement of enforcement actions.

Congress has recognized the right of individual Commissioners to speak publicly about matters before the Commission.  CEA Section 2(a)(10)(C) states:

Whenever the Commission issues for official publication any opinion, release, rule, order, interpretation, or other determination on a matter, the Commission shall provide that any dissenting, concurring, or separate opinion by any Commissioner on the matter be published in full along with the Commission opinion, release, rule, order, interpretation, or determination.[5]

The absolute right of Commissioners to make public statements on matters before the Commission—including enforcement matters—was recently affirmed by the U.S. Court of Appeals for the Seventh Circuit.  In In re CFTC, the court explained that Section 2(a)(10)(C) grants every member of the Commission “a right to publish an explanation of his or her vote.”[6]  The court made it clear that the Commission could not enter into any consent order in an enforcement matter that impaired the right of Commissioners to make public statements about the underlying case:

This is a right that the Commission cannot negate.  It could not vote, three to two, to block the two from publishing their views.  So if we understand the consent decree as an effort to silence individual members of the Commission, it is ineffectual, for no litigant may accomplish through a consent decree something it lacks the power to accomplish directly, unless some other statute grants that power—and no one argues that any other statute overrides § 2(a)(10)(C).[7]

But we should go further and formally recognize that these same protections should extend to the Commission and its staff.[8]  The public’s right to know, and the enforcement objectives met by promoting transparency, apply with equal force to the Commission acting as a collective body, and the staff when it speaks on the Commission’s behalf.

Indeed, market participants routinely request CFTC staff to provide information about resolved actions, or make comparisons among actions, to facilitate their compliance with the CEA and Commission regulations.  It is essential that CFTC staff be able to respond to these requests by providing guidance about how the Commission interprets the CEA and its regulations, and how those interpretations have been applied in specific circumstances.  Such guidance facilitates compliance by market participants and supports the Commission’s ability to prosecute enforcement actions.

There is ample precedent and support for federal government agencies prohibiting confidentiality provisions in settlement agreements, whether in the policies of other federal agencies, judicial rulings, or constitutional principles.  For example, the Department of Justice[9] and the Equal Employment Opportunity Commission[10]—similarly comprised of up to five presidentially appointed bipartisan members—prohibit confidentiality provisions in settlement agreements.  Appellate courts have invalidated confidentiality provisions that abrogated statutory disclosure obligations, such as that provided by CEA Section 2(a)(10)(C).[11]  And the Supreme Court has held that federal officials have immunity from suit for public statements made in the performance of official duties.[12]

Transparency in the Commission’s enforcement actions is essential to promoting compliance with the CEA and the Commission’s regulations and public confidence in our markets.  So while I thank the Chairman for making this issue a priority, I am extremely disheartened that we do not yet have support among the Commission to codify this rule.

Remarks of Chairman Heath P. Tarbert at the 2019 Annual Robert Glauber Lecture at Harvard University’s Institute of Politics

October 24, 2019

Remarks as Prepared for Delivery

Thank you so much. It is really terrific to be here tonight. Before the presentation, I’m supposed to say this disclaimer: the opinions, analyses, and conclusions expressed herein are those of the presenter (that’s me), and do not necessarily reflect those of other Commissioners or the Commission itself.  But, one day, I hope they will! So I’ll just put that out there.

One thing I don’t have to disclaim, however, is the admiration I have for Bob Glauber. Bob is truly a legend in both financial regulation as well as public leadership. I could actually spend two hours going through all of Bob’s career accolades, so I’m not going to do that tonight. But one of the things I will say, is that at least throughout my life and many others with whom I’ve spoken have said apart from family and friends one of the things you cherish in life are mentors. And I am privileged to have had Bob as a mentor. It’s not just me by the way. I know for many of you Bob is a current mentor. His mentees include, the Chairman of the Federal Reserve System, the Vice Chair of the Fed for Supervision, a former SEC chairman, and the list goes on and on.  So I will just say that the United States, Bob, is lucky to have had your leadership in government during those years. And this university is particularly, I think, honored to have had over 50 years of your service. So thank you so much, Bob. It’s an honor to be here.

So, tonight I thought, as Bob mentioned, I would talk about two basic types of regulation: what we call principles-based regulation and what we refer to as rules-based regulation, explain what they are, talk about the advantages and disadvantages of each, and then, for the first time in a forum, talk a little bit about how you would choose each approach—what are the factors. In other words, what are the principles for rules and what are the rules for principles?  And then finally, I wanted to share with you some actual real-world applications—things that at the CFTC we are actually working on—where we have to make decisions about do we think about it in a rules-based way or do we think about it in a more principles-based approach.

So why am I here at Harvard? Well, I am here at Harvard because I’m surrounded by some of the brightest minds in the country and throughout the world. And many of you are in this room. And so my hope is that by introducing some ideas here, I might get some feedback from all of you, you might even think about continuing research and discussion about it, so we can learn from all of you. And I will note that the mission of the Kennedy School, which I think is incredibly articulate and eloquent, the very last line of it says this: “The reason the Kennedy School exists is to have an impact on solving public problems that no other institution can match.” So I figured what better place to come and talk about this than right here at the Kennedy School.

So let me set the scene a little bit before we dive in on explaining to you—Bob did a great job of it, but I’ll just talk about it little bit more—who is the CFTC? What I often say is the CFTC is the most important regulator many people have never heard of. The mission of the agency is to promote the integrity, resilience, and vibrancy of the U.S. derivatives markets through sound regulation. Now, I’ve worked with all of the financial regulators in the United States in one form or another. And what makes the CFTC, I think, really unique is because the derivatives markets touch on all of the underlying markets. We effectively regulate everything from corn to crypto. So we have to know about agriculture, about energy, about financial markets, and now we find ourselves learning more and more about digital assets. So that, I think, makes the CFTC really unique because derivatives essentially touch everything.

The vision of the agency is to be the global standard for sound derivatives regulation. So both the mission statement and our vision statement, which we just created only a few weeks ago with the entire staff of the agency, both of them use that term, sound regulation. So what is sound regulation? Well the best I can explain it is sound regulation is about using the right tools at the right time for the right reasons.  And so one of the ways that we’re focused on using the right tools at the right time for the right reason are first distinguishing between how we regulate. Because how we regulate, in many ways, is just as important as what we regulate.

So the CFTC, as Bob noted, has a unique history and tradition of being a principles-based regulator. And this was codified by Congress—Congress recognized its importance—in something called the Commodity Futures Modernization Act back in 2000 where we took a series of core principles—principles that govern our exchanges as well as govern our clearinghouses—and we essentially codified them into law. At the same time, our fellows in the UK were doing something very similar. The Financial Services and Markets Act of 2000 also created a principles-based regime. And the interesting thing about principles-based regulation is that it’s not really ideological. There are a number of former Chairmen (including Chairman Massad, who is a fellow here at the Harvard Kennedy School and he was President Obama’s second CFTC Chairman) who have said principles-based regulation is a really important tool for our markets. In fact, one of the interesting features is that after the financial crisis, the CFTC was the only regulator not to lose jurisdiction and arguably not to be criticized. Indeed, what happened was Congress said the entire swaps market is largely unregulated and we want you take the approach that you’ve been using for futures and options and essentially apply it to swaps.  In many ways it was a validation of the principles-based approach the CFTC had been taking for a number of years. The whole entire point is to stay ahead of the curve. Now, there’s only one thing that is worse than falling behind the curve and that’s getting wiped out by it. There’s a very real chance that can happen if we don’t keep up and we don’t approach new markets. One of my goals is to reinvigorate a principles approach as it is one of the tools that you can use to stay ahead of the curve when things are rapidly changing.

So what is principles-based regulation? Principles-based regulation has a high level of generality. It’s flexible and can be applied broadly. If focuses on outcomes, not specific conduct. It’s also generally qualitative rather than quantitative. It’s also susceptible to elaboration. So when you have very specific rules, they become ossified. They become frozen in time to some extent, whereas a principles-based approach can be allowed to evolve over time as markets and behaviors change. Later in my presentation, I will provide some examples for when principles make sense and for when rules make sense. The other thing to talk about and make clear to everyone is what principles-based isn’t. Principles-based is not “light-touch.” Light-touch regulation is not really regulation in my opinion, it’s more of a monitoring function. Principles-based regulation is also not a euphemism for deregulation.

I think there’s a general consensus that we’ve had a little bit of an information overload in terms of rules. I think there’s also a consensus among everyone that for risk and other types of features involving our financial system, we shouldn’t treat Main Street institutions the same way we treat Wall Street institutions. So things have gotten a little bit out of hand. Regulation has grown quite enormous—a ten-fold increase since 1950. Winston Churchill of course said, “if you make ten thousand regulations, you destroy all respect for the law.” A principles-based approach sort of dispenses in some ways with the need for detailed rules and regulations that dictate every aspect of a firm’s possible behavior. So again, I’m not saying that rules-based doesn’t necessarily make sense, but what I am going to try to articulate is when it makes sense and when principles makes sense.

So what are the key advantages of a principles-based approach? Well number one, obviously, simplicity. A few principles can cover a lot more ground and reduce complexity. Flexibility – it’s much more adaptable. It avoids over and under inclusion. The moment you write a specific rule you’re excluding things and including things that maybe you didn’t want to include. It promotes innovation because it allows flexibility. And this is an important one: it discourages loophole behavior. We’ve had a number of situations where accounting rules and types of tax laws have been very, very specific and the overarching point of why we have these things is often lost. So people quote unquote “comply,” but they undermine the whole reason the regime is there to begin with. It also creates a better supervisory model. If something is principles-based, it actually creates much more work for the regulator. So you’re constantly working with the regulated firm to understand how they’re complying with your principles. The other thing it does, particularly in a globally interconnected world is it facilitates international cooperation. Higher-level principles can be agreed upon in a much more easier way than detailed, specific rules.

That said, principles-based regulation has some downsides and there are some advantages to rules-based regulation. In fact, many people on both the Libertarian Right and I’d say the far Progressive Left have actually criticized principles-based regulation and said you should go with rules-based regulation and there are some points we need to take into account.

So what are the key advantages of a rules-based approach? Well obviously, greater clarity. Being more specific leads to more consistency because everybody knows what you expect of them. It avoids retrospectivity. So in other words, it’s a lot easier to know when you’re about to violate a specific rule than whether or not you’re going to violate a principle. And you only find out the regulator disagreed with you and you violated the principle later on in time. This is what I call the “dark side of flexibility.” You know in advance whether or not you’re going to violate the regulations. It also protects against some private lawsuits. So you have a situation that if you have private lawsuits for certain financial behavior, and there are no clear regulations, but they are principles-based, you end up with the problem that lawsuits can effectively create the regime for you. So if you actually have a detailed rule book and someone accuses you of wrongdoing you can point to it and say, “no, we did follow the rules.” The other interesting thing, and this is really important, people have said one of the potential issues with principles-based regulation is not a race to the bottom, but rather a race to the top. That if you use principles-based regulation in a certain set of circumstances, it tends to sometimes blur minimum standards with best practices. And so you end up with people saying, “in order to comply with the principle, I need to use the gold standard.” So that’s really interesting. So those are some key advantages of a rules-based approach.

So how do we choose which approach to use? We’ve reviewed some of the academic literature, some of the other literature, and no one has given us a set menu and said, “here’s how you do it, Mr. Regulator.” So what we have done and what I have thought about is to propose to all of you tonight a framework for starting to think about how you choose rules versus principles. The first thing to mention is it’s not a false dichotomy; it’s not mutually exclusive. In many places you’ll see a hybrid approach where you choose some principles, you articulate what those principles mean, and a certain set of circumstances with rules, but you have both.  But I think at the end of the day, a regulator still has to decide are we going to have an emphasis on principles, are we going to have an emphasis on rules?

Well, I’d propose to you there are at least four categories you should look at. The first category are your regulatory objectives. Second, the nature of the market and actually the subject—what you are regulating. Third would be the attributes of market participants—who is in your market? And finally, you’ve got to look at yourself if you’re the regulator. Using these categories, what are the factors that lead us to choose principles-based regulation—where it makes more sense to choose principles?

So let’s take the first, regulatory objectives. Number one, you are more likely to choose a principles-based approach if a chief objective is prudential supervision. So prudential supervision is where you’re looking at the safety and soundness of institutions. You’re looking at things like capital, margin, and risk management where one-size-fits all approaches don’t necessarily work. Second, a situation where you need quick action. Quick action is needed for standards or guidelines for market behavior. You’ve got to get out there with something. Rules take time; specific rules take a lot of time. Principles can be fashioned much more quickly. A third factor would be: do you want the direct involvement of senior management in compliance? No CEO, CFO, or even a general counsel is going to read 13,000 pages of regulation. But I’ll tell you what, for our clearinghouses, we have 17 core principles. They’re pretty easy. You can read them in about five minutes. I’m almost certain that every CEO, every member of the board, as well as senior management of all of our clearinghouses have read these core principles. So it’s important. Also, another factor is if there are several different ways to achieve the desired regulatory outcome. So if we’re talking about something like cybersecurity where there’s various ways where you can set up defenses, if we’re talking about something like value at risk and various calculations and there are a number of scientifically and analytically validated approaches, then you may a apply a principle that at least requires them to do one or more of those.

The second category would be the nature of the market—the subject matter. You want to use principles in a situation where detailed rules could be easily gamed. Remember the accounting example or the tax code. If you have a check-the-box situation and it could lead to disaster, you want some principles in there to guide the overarching behavior. You also want principles where you have specific governing rules or processes would require frequent updates. Think about things that require mathematical models and economic data—if you’re continuing to have to change them. The average regulation probably lasts about 15 years. So once we come out with a detailed rule if it’s going to be useless a year from now, we probably want to go with principles. Similar point: if the area of regulation deals with rapidly changing technology, again we’re more likely to use principles. And finally, if the regulated market and its products are in the nascent phase. So in our area, we look at something like crypto assets versus hard red spring wheat—very different. It’s been around for at least 30 years, the same type of contract; you compare that to some of the new cryptocurrencies. Again, in that instance, principles-based probably makes more sense for rapidly changing nascent industries. We also want to look at the market participants. So if the participants are more sophisticated, you’re dealing with institutional markets. That’s one of the big reasons the CFTC has largely been principles-based. Closely related to that point is information asymmetry between the participants. Again, if people can look out for themselves largely, then you can go more with principles-based. If there’s a natural asymmetry between certain groups in the market, then you may need more detailed rules. Also, consider whether participants have extensive internal compliance functions. If they’re pretty sophisticated, they have internal compliance functions, you can rely more on principles. And then finally, ask if participants are subject to a self-regulatory regime. If there’s an SRO there, like the one Bob Glauber ran, where they are close to the industry participants and everybody agrees that there are certain standards of behavior, then the regulator doesn’t need to necessarily dictate the rules.

Last, we look at ourselves. If there is a high level of trust and frequent interaction between the regulator and the regulated entity, and we’re constantly interacting with them, that’s a place where you’re more likely to use principles. Consider whether there’s information asymmetry between the regulators and the regulated entity. So here what we’re talking about is when the regulator can’t possibly know as much as the people they’re regulating.  We don’t want to have specific rules in that case, we want to have more general principles. The private litigation point—if there’s not a lot of private litigation, then we’re more likely to use a principles-based approach. And then finally, if it’s an area where we’re coordinating—these are cross border markets—and we need to coordinate with our overseas counterparts, we’re more likely to use principles-based because they’re more like international standards.

So those are the instances where I’d say you want to use principles. We would use the same categories in thinking about when you’d use rules. Many of these are simply the reverse, though there are a couple that are unique. So first off, if your objective is market conduct or disclosure, you’re more likely to use rules-based regulation. If clarity is really important, you want to use rules-based. If the regulation targets behavior that is generally malum in se—that’s just Latin for bad in and of itself—you’re more likely to use a rules-based approach. Everybody agrees we don’t want falsifying documents; we don’t want unlicensed people. Well, there, you can write rules. You can clearly write rules to address those situations. And finally, if there’s just one way to comply with it, why not write a rule like a registration requirement, for example?

Looking at the second category, the nature of the market, the subject matter, you’re more likely to use rules if, number one, broad principles would just lead to confusion. There are some areas where it’s just going to be confusing. The market really needs clarity. Secondly, we look to see whether specific rules governing behavior or processes would likely stand the test of time. Okay, so here we’re not worried about things rapidly changing. Anytime you’re dealing with disclosures or standard forms—any kind of standardization—we want to use rules. And then finally, if you’ve got mature markets, they’re more likely a candidate for a rules-based approach.

We next look at the market participants, the third category. Well, if we’ve got a situation where we’ve got consumers, retail investors, and other unsophisticated participants and there’s asymmetry that’s natural, we’re going to use rules. And these two points may be the very reason why we have a difference between the CFTC and the SEC historically. Also again, sometimes participants say, “I don’t want flexibility, I don’t want to have to choose; I just want consistency and I want transparency.” In those instances, when you can, you’d use rules-based regulation. And then finally, you would go with a rules-based approach when there’s no self-regulatory regime.

And then lastly, look at the qualities of the regulator. If we the regulator don’t interact with market participants regularly, we see them once every few years—we’re probably going to rely more on rules because we can’t check up on them and have interactions to determine whether or not they’re complying with our principles. This one’s a bit counterintuitive: if the regulator must coordinate its regime with one or more domestic regulators, you’re more likely to use a rules-based approach. Any idea why that is? Well, number one, our fellow regulators like the SEC are pretty rules-based. So if they have a rules-based regime and we have a principles-based regime, we have the potential for regulatory arbitrage right here in our own country with very similar products. So, generally speaking, we should actually be able to do detailed rules in that case. Finally, the private litigation point—if private litigation is used, we don’t want an odd situation where rather than the expert financial regulator setting the rules, we have a patchwork of courts around the country that are deciding them. It needs to be the regulator themselves making the rules. So the private litigation aspect plays a role. And then finally, rules are more appropriate where the regulated market has little connection with overseas markets—so we’re not worried as much about regulatory arbitrage overseas. With things like consumer finance, where there’s not going to be a lot of spillage overseas; buying houses, mortgages, and things of that domestic nature.  So that in a nutshell, are some principles for rules and rules for principles.

And now, we have the pop quiz: real life situations in the derivatives markets. And so I’ll give you an area, and I’d like you guys to think about whether you’d choose a principles-based approach or a rules-based approach. And I’ll explain to you what the area is if you’re not familiar with it.

So, in closing, I would like to say earlier in the presentation I mentioned that the mission of the CFTC is to promote the integrity, resilience, and vibrancy of the U.S. derivatives markets through sound regulation. And I told you that, at least from my standpoint, I thought sound regulation was about doing the right things, using the right tools, at the right time, for the right reasons. And so I thought I would end with one of my favorite quotes by JFK, after whom the school is named as well as the forum here. And it is this:

“Let us not seek the Republican answer or the Democratic answer, but the right answer. Let us not seek to fix the blame for the past. Let us accept our own responsibility for the future.”

While I hope today that at least articulating some principles for rules and some rules for principles, I’ve at least gone a step in the right direction in focusing on that right answer. And I hope that in so doing, I’ve perhaps shed a little light in making a little sense of financial regulation. Thank you very much.

Statement of CFTC Chairman Heath P. Tarbert on the New Activities-Based Approach to Systemic Risk

December 6, 2019

The Financial Stability Oversight Council (“FSOC”) has approved interpretive guidance (“Guidance”) on the designation of non-bank financial companies as systemically important financial institutions (“SIFIs”). I was pleased to vote for the Guidance for two reasons: because of what it does, and because of what it does not do.

The Guidance sets forth the activities-based approach that the FSOC intends to prioritize in addressing risks to financial stability. Under this approach, the FSOC will actively monitor financial markets to identify activities that could pose risks to U.S. financial stability. The FSOC will then work closely with the relevant financial regulatory agencies to mitigate any such risks.

Until now, the FSOC has focused on entity-based—rather than activities-based—systemic risk determinations. In its formative years, this approach made sense. The U.S. Government had recently bailed out several large, non-bank financial institutions. American taxpayers had borne the downside risk but none of the upside enjoyed by those firms.

But now we face new challenges. It is an axiom of financial markets that products move to the path of least regulation. A singular focus on particular entities inevitably leads to a “whack-a-mole” scenario in which risky activities are transferred out of highly-regulated entities and into less-regulated ones. In short, an approach that focuses solely on entity-by-entity designations virtually guarantees the FSOC will fail in its important mission to identify and mitigate threats to U.S. financial stability.

Although the 2008 financial crisis demonstrated the usefulness of entity-based designations, it also revealed a more acute need for an activities-based regulatory approach to systemic risk. Widespread loan issuance and securitization without adequate incentives for proper underwriting provides one example. Highly relevant to my own agency was the lack of margin held on over-the-counter (“OTC”) swaps—including swaps providing credit protection for the securitized loans I just mentioned. Indeed, a firm such as AIG would likely not have presented a systemic risk if it had held sufficient initial and variation margin at a third-party custodian.[1] The futures markets experienced none of the dislocation that concurrently occurred in the OTC swaps markets, as futures trading activity was then subject to a comprehensive regulatory regime, including central clearing and minimum margin requirements.[2] 

Recognizing this, the Dodd-Frank Act swaps reforms that addressed systemic risk were largely activities-based rather than entity-based.[3] Title VII of the Act required on-platform trading, clearing and/or margin, and transaction reporting for various categories of swaps-trading activity. In addition, Title VIII of the Act recognized the importance of employing activities-based designations alongside entity-based designations, specifically charging the FSOC to identify as systemically important “financial market utility” entities as well as “payment, clearing, or settlement activities.”[4]

The Guidance reflects not only a consensus among FSOC members, but also an international consensus in favor of an activities-based approach to systemic risk. The Financial Stability Board (“FSB”), International Organization of Securities Commissions (“IOSCO”), and International Association of Insurance Supervisors (“IAIS”) have prioritized activities-based regulatory approaches in the insurance and asset management sectors.[5] Like the Guidance, international approaches initially focus on activities-based policy recommendations but will ultimately address any residual entity-based sources of systemic risk, to the extent that such risks “cannot be effectively addressed by market-wide activities-based policies.”[6]

This brings me to what the Guidance does not do. The Guidance does not eliminate entity-based designations. If it did, I would have voted against it. The FSOC’s power to designate non-banks as SIFIs will remain an important backstop for addressing systemic risk. Contrary to concerns voiced about the Guidance, the systemic risk analysis will not “always end” after an assessment of activity risk.[7] Nor does the Guidance constitute a “doctrinal commitment that no non-bank intermediary can ever be ‘systemic.’”[8] If an activities-based approach is inadequate to address the risk posed by a particular institution, then the option of SIFI designation remains fully available.[9]  

Too often in Washington, common sense does not translate into common practice. That disconnect has led to American taxpayers bearing a heavy financial burden. I therefore support the Guidance,[10] which allows the FSOC to focus first on potential systemic risks of activities that span financial sectors, while also considering the risk posed by individual institutions.

Remarks of CFTC Chairman Heath P. Tarbert to the 35th Annual FIA Expo 2019

October 30, 2019

(Chairman Tarbert’s remarks begin at 1:08:19)

Remarks as Prepared for Delivery

Well, good morning everyone.  It is great to be here at FIA, the leading association for the futures industry—not only in the United States, but around the world.  It’s also terrific to be here in Chicago.  As Walt said, this city has so much history and has made the United States a leader in this field and has helped underpin our system of free enterprise for the last century and a half.  So it’s wonderful to be here because I think one of the key messages I want to convey is that I care as much about these markets as all of you do.  And so it’s a great honor to stand here before you as the fourteenth Chairman of the CFTC, with that charge to keep.

I finished my first 100 days a few days ago, so I will just give you an overview of what I have done, and ultimately, what I hope to do, not only in the near term, but also in the farther term as well.  So I’m going to cover today what we have done, and that includes picking the right team of executive leadership that I want to introduce to all of you. Some of them are here today.  I also want to talk about our new mission, vision, and values.  That is very important for setting the right tone as the CFTC goes into close to fifty years of being a leader in derivatives regulation.  Most importantly, I want to give you an idea of where we are going.  I am going to outline five strategic goals that the CFTC has come up with in the past 100 days and then an action plan for what I would like to pursue as Chairman.  And then finally, some tangible next steps that you will see in relatively short order coming out of the agency.

One of the things they say in Washington is that “personnel is policy.”  So even before I set foot at the CFTC, I started thinking about the leadership team.  I can’t do the job alone.  I have an absolutely phenomenal Commission.  Some of our Commissioners are here today.  I think Commissioner Behnam, Commissioner Quintenz, if you could stand up.  I just want to say I have an outstanding set of colleagues.  And so while they are absolutely critical to setting the agenda, I also rely on our executive team, which runs the agency day-to-day.  I will just run down who they are: Jaime Klima, Dan Davis, Dorothy DeWitt, Clark Hutchison—some of them sat in this very room in years past—Jamie McDonald, Summer Mersinger, Suyash Paliwal, Michael Short, Josh Sterling, Sarah Summerville, Tony Thompson, and Bruce Tuckman.  These truly are in my opinion, a best-in-class team who care about these markets as much as I do.  And I looked for people who would be good leaders, who have natural ability, but who are also very thoughtful.  I also looked for people who truly understand the industry.  I don’t think you can be a responsible regulator if you don’t understand the industry.  So I looked for people with those qualities.  You will also notice that is—if not the most diverse—one of the most diverse leadership teams in CFTC history.  It’s really important to me that our leadership reflects the diversity of those in our markets—all of you.  And I know FIA shares that view based on what Walt just said.

When I came to the CFTC, I came from Treasury and I had a pretty deep background in financial regulation more generally.  But it was much more in the banking and securities side.  I am always reminded by Benjamin Franklin’s saying that “the doorstep to the temple of wisdom is knowledge of our own ignorance.”  So for the first thirty days, I said, “I’m not going to make key decisions that I don’t have to make.  I’m just going to try to listen and understand.”  And so I had over 26 meetings with virtually all of the 700 employees at the CFTC to get a sense of what they were working on, what they cared about, and where we can take the agency.  What became very clear to me is I would go into a room of 30 to 40 people in Chicago, New York, Washington, Kansas City, and I would say “alright could anyone tell me the mission of the CFTC?”  Not a single hand would go up.  And that wasn’t really talking about them as much as talking about our mission.  It was very clear it was sort of copied out of some statutory language.  It wasn’t inspirational.  And so one of the things that we did early on, was to ask the entire agency to propose a mission, vision, and set of core values.  We then took all of the submissions, we selected what we thought were the best and then we voted on them.  So I’m pleased to announce that the CFTC—a few hundred of our employees as well as those in our leadership—voted on the following mission statement, which is the new mission of the CFTC:  To promote the integrity, resilience, and vibrancy of the U.S. derivatives markets through sound regulation.  And you’ll hear me talk about integrity, resilience, and vibrancy—very important traits.  And so this is the new mission statement of the CFTC.

The other thing the CFTC did not have in our 45-year history was a vision statement.  And so we also created a new vision statement, which is: To be the global standard for sound derivatives regulation.  And again, you see sound regulation in both of those statements, and it’s really key to us get it right.  Sound regulation is doing the right things, using the right tools, at the right time, for the right reasons.  And it’s really important that we consider that.

We also chose four key values.  And I think all of you will like these values, and keep in mind these were chosen by people at the CFTC, your day-to-day regulators in many cases.  The first core value is Commitment—bringing our best to work every day and holding ourselves to the highest professional standard, just as many of you do.  Second, was Forward-thinking.  Really important for this industry in particular.  It’s constantly changing.  And so we need to challenge ourselves to stay ahead of the curve, and that is necessarily going to mean an important, constructive relationship with all of you.  Next, Teamwork.  The CFTC is really a community.  It’s a place where people value each other.  There are many CFTC alums in the audience today, and you know that it’s a special place, and I want to reinforce that.  So we value our diverse skillsets and backgrounds to achieve our mission.  And that’s so important simply because many of the issues that Walt outlined in his introduction don’t fall within any single division of the CFTC.  It requires the entire organization to work together on cross-cutting issues.  So emphasizing teamwork is critical.  And then finally, and again, the agency’s employees chose this, so it is very important, this came from inside the agency, but is arguably going to be the most important of these values for all of you out there: Clarity—providing transparency to market participants about our rules and processes.

So now that we have come up with our mission, vision, and core values, we were then able to construct five strategic goals.  So I’ll spend the rest of the time talking a little bit about those goals and tangible things that you can expect from the agency over the next short-term period.

So what are the strategic goals?  Well, the very first one is taken directly from our mission statement. That’s to strengthen the resilience and integrity of our derivatives markets while fostering their vibrancy.  And the formulation of this goal I think is really important because it is subtle, but it’s critical.  And that’s the idea that resilience and integrity are of critical importance, but sometimes there can be a trade-off with vibrancy.  So we want to make sure we balance that.  Making sure our markets are strong, they have integrity, but not over-regulating in such a manner that they no longer are innovative.

Second, is to regulate our derivatives markets to promote the interests of all Americans.  I think Walt said it best, and this is something that I’ve been focused on: most Americans have no idea how important the derivatives markets are to their daily lives.  From the price of gasoline that people pay at the pump to the price of the food on the kitchen table, derivatives markets are the underpinning of our free enterprise system, not only in this country, but around the world.

Third—and this is one I think everyone in this room will appreciate—is to encourage market innovation and enhance the regulatory experience for market participants at home and abroad.   It’s really important to me that this market—while being well regulated, while being soundly regulated—continues to thrive and that this industry continues to grow.  And so we want to make sure that the regulatory experience for all of you is one that is enhanced.

Number four is to be tough on those who break the rules.  I know everyone in this room, members of FIA, care about these markets, you care about the integrity of these markets, but there are bad actors out there.  And to ensure we have confidence in our markets, we’re committed to weeding out those bad actors and being tough.

And then finally, this is sort of internal, but it’s so important that the agency, which has gone through a tremendous amount of change in the last ten years: to focus on our unique mission and improves our operational effectiveness.  Because while these are primarily internal, they will have external ramifications as over the years you interact with our agency.

So how will we implement this?  Well, goal number one:  to strengthen the resilience and integrity of our markets while fostering their vibrancy.  First big bucket of things is CCP supervision.  And in this room, everyone knows the importance of clearinghouses and central counterparties.  They really are at the center of our system and the Dodd-Frank Act made them all the more important, where we are centralizing risk in our clearinghouses.   One of my key goals is to enhance and build out our Division of Clearing and Risk.  So we have the people and personnel we need to continue to keep pace with the industry on issues like cybersecurity, margin, and capital, which we will talk about in a little bit.  Also, we will be introducing in short order in the next couple of months our final rules to Part 39, our core principles for derivative clearing organizations.  It’s also critically important that the CFTC remains the primary regulator and supervisor of our clearinghouses.

And this goes to the second key area which is international cooperation.  Everything Walt said is absolutely on point.  Regulators think about jurisdiction and borders, but markets do not.  Markets are fluid.  And international cooperation is more important now than it has ever been.  EMIR 2.2 poses a potential challenge to that.  We have been in a very good dialogue with the European Commission and with ESMA.  We want to get to a place where we have regulatory cooperation that retains the authority of the CFTC and America to regulate and supervise our own clearinghouses.  So we are committed to that result.  And part of international cooperation, as Walt said, is about deference.  But let me be very clear on this, deference is a two-way street.  So we will grant deference if deference is granted in return.  And so we are committed to doing that.  One of the areas that we’re going to introduce in the next few months is our cross-border swaps proposal.  And the cross-border swaps proposal basically addresses the situation where you have a foreign counterparty and a foreign counterparty, so non-US persons.  At what point does that become a direct and significant issue for the United States?  Does it have a direct and significant impact?  A lot of foreign regulators around the world have told us there was a potential overreach back in the day.  So we are considering that point, and are also considering the point about risk to the United States.  So you will see, I think, a proposal in short order that focuses on capturing risk to the U.S. and to U.S. taxpayers.  In my view, something that is arranged, negotiated, and executed in the United States, but ultimately not booked in the United States—booked abroad—does not pose a direct and significant risk, such that we would need them to register them as a swap dealer.  I want to be very clear, we will apply our fraud and manipulation standards for U.S. activity. But as far as requiring the registration, I am focused on eventual risk that could come back to the United States and would hit American taxpayers potentially.

Margin and capital, another huge area that you care a lot about.  We are going to be continuing to look at margin models, to think about that to ensure there is enough margin in the system.  That will also play a role in our swap dealer capital rule, which we will re-propose or re-open in short order.  Also talking about capital, that many of you I think have brought to our attention over the years, are the Basel rules and their impact on our markets.  We have started a constructive dialogue with our banking regulators to make sure that our risks are not mispriced and that we don’t take away these markets or undermine them through bank capital rules.

And then finally, market structure.  Here we’re looking at things particularly in markets that let’s say, have not existed for a hundred years, like our swap execution facilities.  We want to make sure these markets are liquid, vibrant, and resilient.  And so for example, we will be putting out a proposal to restrict or eliminate the name-give-up practice to ensure that everyone has a fair shot.  And now that we have centralized clearing, we don’t necessarily need to share this kind of critical information, which some people argue will reduce liquidity in the markets.  And so everyone will have a chance to comment on that proposal in short order.

We’re also looking at some other changes: codifying some no action relief in the SEF space as well as in the SDR space, swap data reporting.  It is really important we get those rules right—Part 43, Part 45, and Part 49—and that we have a semi-uniformed standard.

The second goal, as I mentioned, is to regulate our derivatives markets to promote the interests of all Americans.  As Walt said, in many ways I feel like we are the most important financial regulator most Americans have never heard of.  We need to make sure that Americans understand the importance of our markets, and there are specific ways we are going to do that.  First and foremost, agriculture.  Agriculture is the very cornerstone of the Commodity Exchange Act.  If we don’t make these markets work for farmers and ranchers, then in my view, they’re not working.  So you will see we are focused on agriculture and some things we can do there.  In April 2020, we’re planning on having our very first meeting outside of Washington.  One of the most important things that I think the Commission can do is to actually go out to the communities that are effected by our derivatives markets.  So we will have our first open meeting out in the Mid-West at some point because I think the regulator that is the closest to the people, is the best form of regulation.

End users.  These markets exist to ensure that end users can use them for risk management and price discovery.  And all of you know that because either you are end users or many of your clients are end users.  We will propose a position limits rule in the next few months that addresses the concerns of end users, that ensures that bona fide hedging is not restricted, and that risk management is there.  But we will provide some prophylactic, clear, and usable rules so market participants such as yourself will know what the limits are.

Smaller financial institutions.  It’s really important that we don’t treat Main Street institutions the same way we treat Wall Street institutions.  And by Main Street institutions, I’m also talking about smaller FCMs.  So there are some things we are thinking about doing in that space and would like an ongoing dialogue with FIA and others about that.

Customer protection.  I know everyone in this room cares a great deal about customer protection, it’s one of the reasons my agency exists.  Next week we are going to be proposing some changes to our Part 160 rules on protecting customer information that will enhance that.  And early next year, I expect we will release a proposal that codifies thirty years of important bankruptcy standards in our Part 190 rules to ensure that customers are protected and we don’t have another MF Global.

And then finally, education.  Again, making sure that all Americans understand the derivatives markets and the critical role that they play.  And we would hope to partner with FIA, with NFA, and some of the other institutions on your great classes in that regard.

Goal 3: encourage innovation and enhance the regulatory experience for market participants at home and abroad.  Well first and foremost, the CFTC has a long history of principles based regulation.  And the CFTC, even unlike other financial regulators, and the futures markets in particular, not only survived the financial crisis, but thrived during it.  And as a result, the Dodd-Frank Act codified much of what this industry has been doing for close to a hundred years.  Maybe over a hundred years.  Yet, the interesting thing was it didn’t actually codify the principles based approach that has led to the thriving of this industry and the sound regulation of this industry.  So I would like to renew our principles-based tradition in areas where it makes sense.  Last week I gave a speech at Harvard where I articulated some rules for principles and some principles for rules, as to when we would apply one or the other.  So you will be seeing some principles-based approaches again, in the near term.

CFTC-SEC coordination.  How many people in this room are also subject to some kind of regulation or reporting by the SEC?  Can I see a show of hands?  Okay, quite a bit, quite a bit.  We want to make sure that we are not duplicating or overlapping regulations.  We want to coordinate well with the SEC on a number of fronts.  If the SEC is regulating something and has information, then we have to ask ourselves the question: do we really need to ask for similar information in a totally different reporting form?  So we are focused on coordinating with the SEC.  We are also focused on coordinating with them on issues regarding margin and cross-margining.

Eliminating red tape.  That’s pretty clear.  I think the issue there is we have some things that have lasted for decades.  Do we really need to be doing them?  Do the rules that we have represent any current regulatory purpose?  If not, then maybe we should consider removing them.

Transparency.  Transparency is absolutely critical.  We just amended, or are about to finalize Part 13, which imports the APA into our rulemaking process.  We’re going to do more open meetings.  As I said, I have a tremendous set of fellow Commissioners, and I think it’s important that the Commission meet publicly.  And you’ll be seeing a lot more of that.  We are not going to be doing a lot of rulemaking or other things by no action letters.  We are actually going to go through the APA process where important and, we will restrict no action letters to those instances where we need a temporary fix or there’s something very specific that doesn’t lend itself to a general rule.  It’s very important that our organization is transparent.

And then finally, 21st century commodities.  Thinking about digital assets.  Coming up with an approach that allows this country to lead—allows America to lead.  Because if America doesn’t lead in this area, other countries will end up writing the rules.  So it’s really important and part of the way we do this, in my opinion, is linked to that first topic I mentioned, a principles-based approach.

Be tough on those who break the rules.  I don’t want to spend a lot of detail on this, but it’s really important, again, that these markets have integrity.  You rely on them for integrity.  You rely on the SROs as well as the CFTC to promote the integrity of these markets.  That said, we’re going to be fair and consistent.  It’s really important that we lay out what our expectations are.  Self-reporting, cooperation, and remediation will be met with reduced fines.  We will recognize that because it’s so important.  My focus is not on punishing people as much as getting people to follow the rules.  We will also increase our coordination with other regulatory authorities: the DOJ, the FBI, the SEC as well as with the exchanges, and NFA.  And then finally we will focus our surveillance efforts.  So, on those areas where we really do think there is a potential risk to market integrity, we will use quantitative methods and we’ll also target certain areas that I think are particularly important, like agriculture.

Finally, focusing on our unique mission and improving our operational effectiveness.  I spoke earlier about mission, vision, and values.  This is an organization that has gone through a lot of change and I think you guys have experienced that in dealing with this agency.  Just to give you an objective number here: In 2007, the CFTC was rated by the Partnership for Public Service as one of the best places in government to work.  By 2016, the CFTC was one of the worst three places to work in the government of agencies our size.  We have a tremendous work force.  If regulators feel good about what they do, they are committed, and they feel like they’ve got the resources they need, they will be better regulators for all of you.  I care about the people in the agency, and I am focused on making it a better place.

Efficiency and cost effectiveness.  Every private sector firm in here has to make tough decisions when it comes to money, budgets, and allocation.  We should be doing the same in the government.  In fact, I would argue it’s even more important that the government have the discipline because, ultimately, we are custodians of tax payer dollars.

Attracting and retaining diverse talent.  I’ve already spoke about that.  It’s not only for the executive team, it’s throughout the entire organization.

And then finally, data analysis and protection.  We need to think about as an agency, how we get, how we use, and how we protect data.  Under my watch, we’re not going to be taking any source code, unless there is a very specific reason for it and it’s subject to a subpoena.  I can assure you of that.  I’ve spent the last couple of years at Treasury trying to do what I could on the trade front and on the CFIUS front to protect American intellectual property and that’s something I will bring to this job. 

So where do we go from here?  Well, this is a quote I like by Thomas Edison, “vision without execution is hallucination.”  In fact, I had this plaque made, I ordered it, and I showed it to the entire agency.  And now it hangs on my wall in my conference room.  We’re going to be focused now on getting things done.  We have a mission, we have a vision, we have strategic goals, core values, but nothing’s going to get done unless we focus on results.  “Never mistake activity for achievement,” said John Wooden of UCLA, and that’s something that is really important to us.

So what you can expect over the next short period, six months or so let’s say, all of these things: a framework of principle-based regulation, I already introduced that last week; CPO/CTA amendments to our Part 4—will be coming out pretty shortly; enforcement penalty guidance, again to ensure that there is fairness and consistency and market participants know; a swap dealer capital rule; cross-border rule for swap dealers, I mentioned earlier; the position limits rule that all of you I know are eagerly awaiting; name-give-up for SEFs; provisions to our bankruptcy rules; further SEF refinements—particularly I’m interested in not undoing ten years of industry practice, but if there are changes in the SEF world that enhance the liquidity and the resiliency of these markets, I’m certainly open to them if we can get a consensus on them; swap data reporting, that’s really important that we get that right, that we streamline that; revisions to Form PQR, that goes to SEC and CFTC; and finally, principles guidance for digital assets—so we can allow this industry to innovate and grow, but at the same time regulate responsibly.  So that is what you can expect from the CFTC.  I think if we do all of these things in the strategic plan—having listed out the core categories, I counted—there are about 195 tangible, focused actions that the agency can do over the next several years to achieve these.  I think if we do this and we work constructively with all of you, we will work to ensure that our markets have integrity, have resilience, and have vibrancy.  And I know it’s important to all of you, to your clients, to your companies, and to your livelihood.  And I want you to know I am very much committed to that.  Thank you very much.

Statement of Commissioner Dan M. Berkovitz

Amendments to Registration and Compliance Requirements for CPOs and CTAs: Registered Investment Companies, Business Development Companies, and Regulation 4.27

November 25, 2019

I am voting in favor of today’s rule adopting three amendments to Regulations 4.5 and 4.27, addressing certain exemptions for commodity pool operators (CPOs) and filing requirements for CPOs and commodity trading advisors (CTAs).  These three amendments are in largely identical form to those proposed last fall, which I voted for because they codify no-action and exemptive letters and simplify our registration framework, without compromising customer protection or the integrity of our derivatives markets.

The first amendment is to Regulation 4.5(a)(1), which currently excludes an investment company (RIC) registered under the Investment Company Act of 1940 (1940 Act) from the definition of a CPO.  Today’s amendment confirms the Commission’s understanding that an investment adviser registered under the Investment Advisers Act of 1940 is the entity that operates the RIC and therefore is the appropriate person to claim the CPO exclusion for the RIC.  I note that this revision neither broadens the category of persons currently claiming the RIC exclusion, nor changes the current requirements that qualifying entities claiming the exclusion must file annual notices with the CFTC and make disclosures to pool participants.

Today’s final rule also amends Regulation 4.5(b)(1) to include business development companies (BDCs), defined in the 1940 Act, as persons excluded from the CPO definition.[1]  BDCs are a type of closed-end investment company, but are exempt from registering as a RIC under the securities laws.  A BDC therefore is not a “qualified entity” under 4.5(a)(1).  On this basis, in 2012 CFTC staff provided no action relief to BDCs that meet the conditions of Regulation 4.5(c), which include significant caps on the BDC’s use of derivatives and require notice to the CFTC and disclosures to investors.[2]  To date, 65 entities have claimed this relief.  By codifying the exclusion through this amendment, we also harmonize our regulations relating to BDCs with those of the Securities and Exchange Commission (SEC).

Finally, today’s rule amends the definition of “Reporting Person” in Regulation 4.27 to exempt certain classes of CPOs and CTAs, consistent with exemptive relief currently provided at the request of the National Futures Association (NFA).[3]  Under these amendments, certain CPOs and CTAs are not required to file Forms CPO-PQR and CTA-PR, respectively, where such filing would provide limited additional information about the reporting person beyond what is already available to the Commission.  Notice and filing requirements are critical to performing effective market oversight, but where the information received by the Commission is largely duplicative, these requirements do not materially advance the interests of the Commission or its registrants and are therefore unnecessary.

It is good government to periodically asses our regulations and make improvements where appropriate.  In this context, improving the clarity and transparency of our rules and harmonizing them with those of the SEC are worthy objectives, but without more, do not justify a change.[4]  The primary objective in evaluating and considering amendments to our regulations is whether and how they will improve the Commission’s ability to protect customers and police our markets.

Here, the NFA—the front-line self-regulatory organization responsible for member registration—has noted that these amendments will bring transparency to the CPO registration framework by incorporating CPO and CTA no-action and exemptive relief into the Commission’s regulations.  I agree with the NFA that today’s proposed amendments will benefit both the Commission and its registrants, and in my view, they will not impact our mission to safeguard the markets and its participants.  I therefore support these narrow revisions to Regulations 4.5 and 4.27 and thank the staff of the Division of Swap Dealer and Intermediary Oversight for their work on this rule.

Dissenting Statement of Commissioner Dan M. Berkovitz

Rulemaking to Provide Exemptive Relief for Family Office CPOs:
Customer Protection Should be More Important than Relief for Billionaires

November 25, 2019

I dissent from today’s final rule to provide registration exemptions for operators of commodity pools in large investment management structures euphemistically called “family offices.”  These investment management structures typically manage hundreds of millions, sometimes billions, of dollars, in private wealth.  The regulations that we proposed last year (Proposal) balanced the family office exemption with an annual notice filing requirement and a prohibition on persons who were statutorily disqualified from operating commodity pools from claiming the exemption.[1]  Today’s final rule provides a blanket exemption for the operators of commodity pools (CPOs) in family offices without either of these minimal checks and balances.  It is absurd that the Commission is excusing billionaires from the notice-filing requirement that generally applies to other persons—who have a fraction of that immense wealth—who claim exemptions from CPO registration.[2]  And persons that are statutorily disqualified from registering should not be permitted to operate under an exemption from registration.  Disqualified persons should be disqualified.

Family Office Registration Exemption

The final rule exempts CPOs and commodity trading advisors (CTAs) from registration requirements in connection with commodity pools that are solely for the use of entities that are called “family offices.”

 “Family Offices” Are Very Large Enterprises

According to the Securities and Exchange Commission (“SEC”), whose definition of “family office” is used in today’s rulemaking, “‘Family offices’ are entities established by wealthy families to manage their wealth and provide other services to family members, such as tax and estate planning services.”[3]  Family offices, however, are not and have never been used by ordinary families who may have a modest degree of wealth, but rather by the extraordinarily wealthy—including royalty, aristocrats, and wealthy entrepreneurs, bankers and hedge fund operators—who create these organizations to preserve, grow, and pass on their wealth to their descendants.[4]  Under the SEC’s definition, family offices are not limited to managing the wealth of the related members of a family, but may also include “family clients,” which includes key employees of the family office, any non-profit or charitable organization funded exclusively by family members, certain family client trusts, and any company wholly-owned by and operated for the sole benefit of family clients.[5]

By any measure, family offices today manage extremely large amounts of wealth.  According to the Global Family Office Report 2019, “[t]he average family wealth of those surveyed for this report stands at USD 1.2 billion, while the average family office has USD 917 million in [assets under management].”[6]  Another source reports that, as of 2014, “of the 34 family offices surveyed, the financial size of the office ranged from $42 million to well over $1.5 billion, with a median of $275 million assets under supervision and a mean of $516 million.”[7]  Although there remain family offices with tens of millions of dollars in assets under management, over the past decade the costs of running a family office have increased significantly.  It is now estimated “that the operating costs to build out a fully functioning family office typically require a minimum in the range of $500 million to $1 billion.”[8]

The aggregate amount of wealth managed by family offices is staggering.  By one estimate, the total assets under management by family offices is over $4 trillion, and the number of family offices has grown ten-fold in the last decade.[9]  A recent Forbes article noted that “[f]amily offices are now capable of making transactions that were traditionally reserved for big companies or private-equity firms and therefore are becoming a disruptive force in the market-place.”[10]

The Family Office Exemption

As explained in both the Proposal and today’s final rule, family offices typically have been exempt from CPO registration.  When the previous regulation that family offices relied upon for an exemption was repealed in 2012, the Commission provided no-action relief to enable family offices to continue to be exempt from registration.  Family offices are currently operating on an exempt basis under this no-action relief.

The rationale for providing registration relief to pools investing the money of family members has merit.  The commodity pool regulatory regime is in significant part directed at those who solicit funds for the pools and preventing investor fraud and misuse of customer funds.  Presumably, these concerns are less likely to arise if a pool is an investment vehicle for investors who are related to each other and do not solicit funds from the general public.[11]  I voted for the Proposal to seek comments on making permanent the no-action relief from registration currently available to family office pool operators.

Family Offices Are Currently Required to Provide Notice for a CPO Exemption

But whereas the Proposal included sensible initial and annual notice filing requirements for an exempt CPO that would notify the Commission that it is electing the exemption, the final rule eliminates that requirement.  To date, family office CPOs claiming an exemption from registration has been required to provide notice to the CFTC of their claim for exemption.  The current no-action relief imposes a notice requirement,[12] as did the previous regulatory exemption that was relied upon by family office CPOs prior to its repeal in 2012.[13]  Neither of these notice requirements placed any significant burdens or costs upon family office CPOs.[14]

The Proposal would have subjected persons claiming an exemption from CPO registration to the same notice requirements that apply to other types of CPOs claiming an exemption from registration under Regulation 4.13.  Under Regulation 4.13, a person claiming any of the enumerated exemptions from CPO registration is required to provide his or her name, address, telephone number, fax number, and email address, and the name of the pool for which it is claiming the exemption.[15]  In the Proposal the Commission estimated that the notice filing would cost approximately $28.50 per pool annually.[16]

The estimated $28.50 annual cost of filing a notice of claim of exemption is trivial compared to the hundreds of millions of dollars managed by the average family office CPO.  All other types of CPOs claiming an exemption under Regulation 4.13, such as operators of single pools without compensation, or operators of small pools with less than $400,000 in capital, are required to file the same notice of a claim of exemption.  There is no rational justification for exempting large family office pools with hundreds of millions of dollars, or in many cases billions of dollars, under management from the minimal notice requirements that apply to other, less wealthy persons claiming exemptions from CPO registration.

The CFTC’s interest in commodity pool operators is not limited to the protection of investors in the pool.  The Commission has a significant interest in how the activities of these pool operators may affect the commodity markets.  Congress has declared in section 4l of the Commodity Exchange Act (CEA) that “the activities of commodity trading advisors and commodity pool operators are affected with a national public interest in that, among other things . . .  their operations are directed toward and cause the purchase and sale of commodities for future delivery . . . and the foregoing transactions occur in such volume as to affect substantially transactions on contract markets  . . . .”[17]   The Commission has a significant interest in knowing the identity of the persons that operate these pools, including those that are exempt from registration.  This significant interest is manifested in the Commission’s requirement that all other exempt CPOs provide the Commission with annual notices claiming or affirming their exemption from registration.  The Commission’s interest in the activities of large, multimillion dollar family pool CPOs is certainly no less than the Commission’s interest in the activities of smaller CPOs, all of which are required to provide annual notice when they claim an exemption from registration.

The Commission eliminates the notice requirement largely on the basis that this will harmonize the Commission’s regulations with those of the SEC.  Harmonization for harmonization’s sake is not a rational basis for agency action.  The question for the CFTC is not whether the SEC has determined whether a notice requirement is appropriate, but rather whether the CFTC would benefit from a notice requirement under the CFTC’s system of regulations.  To the extent that the Commission believes it has no regulatory interest in the operation of commodity pools beyond the protection of investors in the pool, such a belief is manifestly wrong and inconsistent with Congress’s finding in CEA section 4l.  The Commission has a significant regulatory interest in knowing the identity of CPOs that may be “a disruptive force in the market-place.”[18]   The Commission’s mission would be better served by harmonizing the family pool CPO exemption process with its own regulations for exempt CPOs rather than the SEC’s regulations.

Disqualification of Disqualified Persons

The Proposal would have prohibited any person who was subject to a statutory disqualification from registration from claiming an exemption from registration.  The logic underlying this provision is simple: a person who is disqualified from operating a commodity pool in a registered capacity should also be disqualified from operating a pool in an unregistered capacity.  Disqualified persons should be disqualified.  In the Proposal the Commission stated:

The Commission is concerned that it poses undue risk from a customer protection standpoint for its regulations in their current form to permit statutorily disqualified persons or entities to legally operate exempt commodity pools, especially when those same persons would not be permitted to register with the Commission.  The Commission preliminarily believes that preserving the prohibition on statutory disqualifications from Advisory 18-96 and applying it to exemptions under §4.13 would provide a substantial customer protection benefit by prohibiting statutorily disqualified persons from operating and soliciting participants for investment in exempt commodity pools.[19]

The National Futures Association (NFA) submitted a comment letter “fully support[ing]” the disqualification of disqualified persons.  NFA stated:

[T]he Commission aptly states in the Federal Register release that the proposed prohibition would provide a substantial customer protection benefit.  In particular, the proposed change addresses a significant regulatory gap in the Commission's exemption framework and will certainly strengthen customer protection by ensuring that a person who may be prohibited from registering as a CPO is not able to operate an exempt fund outside of the Commission’s and NFA’s regulatory oversight.[20]

In today’s final rule the Commission states that commenters raised a number of issues regarding the statutory disqualification proposal that require further consideration.  I agree that the Commission should address these comments. But it should have done so prior to granting today’s exemptions from registration.  Customer protection should be our first priority, and not deferred indefinitely.  The Commission should have addressed these comments and finalized the disqualification rule prior to granting today’s exemption for family offices.  Customer protection should not take a back seat to exemptions from regulations for billionaires.

The approval of this rule without any checks and balances on exempt family office CPOs will increase risks to our markets and market participants.  I therefore dissent.

Statement of Commissioner Dan M. Berkovitz Regarding the Commission’s Settlement with Kraft Foods Group, Inc. and Mondelēz Global LLC

August 15, 2019

I am voting for this settlement because I believe that Kraft Foods Group, Inc. (“Kraft”) manipulated the wheat market.[1]  The $16 million penalty and injunctive relief that the Commission has obtained in this consent order is as much as the Commission could reasonably expect to obtain if it were to prevail at trial.  This action demonstrates the CFTC’s resolve to aggressively prosecute and punish those who manipulate or attemept to manipulate our nation’s commodity markets.

The settlement agreement in this case has two unusual features that merit further explanation and comment.  First, the consent order agreed to by the Commission does not contain factual findings or conclusions of law.  Second, the order limits the Commission’s statements in this matter to information already in the public record.  As the Commission observes, however, the consent order only limits the statements of the Commission as a collective body.[2]  Individual Commissioners, speaking in their own capacities, retain their right and ability to speak fully and truthfully about this matter.

Commissioners, as public officials, must be able to explain to Congress and the public the basis for the sanctions obtained, as well as the rationale for entering into a settlement agreement rather than pursuing litigation.  Although I disagree with any provision restricting the five-member Commission’s capacity to make public statements, this provision does not impede my ability to provide information about this case to the public in light of each Commissioner’s right to discuss this case freely.[3]

The Commission typically requires factual findings and conclusions of law in consent orders.  CFTC enforcement actions not only punish violations of the law and deter future misconduct by the party to the action, but also provide guidance to the public about the agency’s interpretation of its laws, thereby deterring similar misconduct by others.[4]  Explaining to the public the factual basis for imposing a penalty not only serves to deter similar conduct in the future, but also is essential to avoid chilling legitimate market activity.  “General deterrence is an exercise in communication.  That is, for a sanctions regime to deter, the potential wrongdoer must be able to apprehend what conduct might give rise to a particular level of pain, in the form of a sanction.”[5]

Federal agencies often decide to settle enforcement matters without further litigation for pragmatic reasons, including the avoidance of the costs and risks associated with a trial.[6]  The Commission, like other federal agencies, may determine that resolving a case without evidentiary findings is appropriate, where the Commission believes that the settlement agreement, viewed in its entirety under the circumstances, is in the public interest.[7]  I support entering into the consent order with Kraft, despite the absence of findings of fact, because the penalty and injunctive relief imposed reflect, in my view, the gravity of Kraft’s conduct.

However, particularly in settlements where there are no evidentiary findings, it is critical that a Commissioner be able to speak publicly about his or her reasons for determining that the law has been violated, why the agreed penalties are appropriate, and why the agency did not obtain findings of fact or proceed to trial.  The public has a right to know whether federal agencies are obtaining appropriate remedies when the law is violated.[8]

More generally, CFTC Commissioners must be able to freely and openly express their views on public matters.  Congress has recognized the importance of such unrestrained communications by providing Commissioners with a statutory right to publicly state their views on matters before the Commission.  Section 2(a)(10)(C) of the Commodity Exchange Act (“CEA”) states:

Whenever the Commission issues for official publication any opinion, release, rule, order, interpretation, or other determination on a matter, the Commission shall provide that any dissenting, concurring, or separate opinion by any Commissioner on the matter be published in full along with the Commission opinion, release, rule, order, interpretation, or determination.[9]

The Commission cannot bargain this right away in settlement negotiations.  The courts are obligated to recognize it when crafting consent orders.[10]

Other federal agencies expressly prohibit consent or settlement agreements that restrict the agency’s ability to speak about settlements or the underlying action.  For example, the Department of Justice has adopted a regulation that prohibits it from entering into settlement agreements or consent decrees that are subject to a confidentiality provision in any civil matter in which the Department is representing the interests of the United States or its agencies.[11]   The Department of Justice regulation is based upon “the public’s strong interest in knowing about the conduct of its Government.”[12]

In my view, in future situations, the Commission should not accept any confidentiality provisions or restrictions on the Commission’s ability to make public statements.

Even where a court does not make any evidentiary findings or conclusions of law, the fact that a U.S. district court, through a consent order, imposes a civil monetary penalty demonstrates that the Commission has provided sufficient evidence to find that the defendants violated the law.  Section 6c(d)(1) of the Act provides courts with “jurisdiction to impose [a civil monetary penalty], on a proper showing, on any person found in the action to have committed any violation . . . .”[13]  Because the court can only impose civil monetary penalties in instances where the government has made a “proper showing,”  it must be presumed that the Commission has provided sufficient evidence to find a violation—even where the order itself does not explicitly say so.  “As part of its review, the district court will necessarily establish that a factual basis exists for the proposed decree.”[14]

Judge Rakoff has put it more bluntly.  In approving a settlement agreement where the defendant neither admitted nor denied the allegations, yet paid the penalty for the violation, Judge Rakoff cogently noted:

No reasonable observer of these events could doubt that the company has effectively admitted the allegations of the complaint in the way that, for a company, is particularly appropriate:  by letting its money do the talking.[15]

In this case, it is not only Kraft’s $16 million payment that is doing the talking.  The Commission is speaking loudly and clearly as well: those who manipulate or attempt to manipulate our commodity markets will be prosecuted and punished.

I thank the Division of Enforcement staff for their diligent prosecution of this matter.

I support the Commission’s action today.