Leaders of CFTC, FinCEN, and SEC Issue Joint Statement on Activities Involving Digital Assets

Statement of Heath Tarbert, Chairman, U.S. Commodity Futures Trading Commission (CFTC); Kenneth A. Blanco, Director, Financial Crimes Enforcement Network (FinCEN); and Jay Clayton, Chairman, U.S. Securities and Exchange Commission (SEC)

October 11, 2019

Washington, DC – The leaders of the U.S. Commodity Futures Trading Commission, the Financial Crimes Enforcement Network, and the U.S. Securities and Exchange Commission (the “Agencies”) today issued the following joint statement to remind persons engaged in activities involving digital assets of their anti-money laundering and countering the financing of terrorism (AML/CFT) obligations under the Bank Secrecy Act (BSA).[1]

AML/CFT obligations apply to entities that the BSA defines as “financial institutions,” such as futures commission merchants and introducing brokers obligated to register with the CFTC, money services businesses (MSBs) as defined by FinCEN, and broker-dealers and mutual funds obligated to register with the SEC.  Among those AML/CFT obligations are the requirement to establish and implement an effective anti-money laundering program (AML Program)[2] and recordkeeping and reporting requirements, including suspicious activity reporting (SAR) requirements.[3]

For the purpose of this joint statement, “digital assets” include instruments that may qualify under applicable U.S. laws as securities, commodities, and security-or commodity-based instruments such as futures or swaps.  We are aware that market participants refer to digital assets using many different labels.[4]  The label or terminology used to describe a digital asset or a person engaging in or providing financial activities or services involving a digital asset,[5] however, may not necessarily align with how that asset, activity or service is defined under the BSA, or under the laws and rules administered by the CFTC and the SEC.  For example, something referred to as an “exchange” in a market for digital assets may or may not also qualify as an “exchange” as that term is used under the federal securities laws.  As such, regardless of the label or terminology that market participants may use, or the level or type of technology employed, it is the facts and circumstances underlying an asset, activity or service, including its economic reality and use (whether intended or organically developed or repurposed), that determines the general categorization of an asset, the specific regulatory treatment of the activity involving the asset, and whether the persons involved are “financial institutions” for purposes of the BSA.[6]

The nature of the digital asset-related activities a person engages in is a key factor in determining whether and how that person must register with the CFTC, FinCEN, or the SEC.  For example, certain “commodity”-related activities may trigger registration and other obligations under the Commodity Exchange Act (CEA), while certain activities involving a “security” may trigger registration and other obligations under the federal securities laws.  If a person falls under the definition of a “financial institution,” its AML/CFT activities will be overseen for BSA purposes by one or more of the Agencies (and potentially others).  For example, the AML/CFT activities of a futures commission merchant will be overseen by the CFTC, FinCEN, and the National Futures Association (NFA); those of an MSB will be overseen by FinCEN; and those of a broker-dealer in securities will be overseen by the SEC, FinCEN and a self-regulatory organization, primarily the Financial Industry Regulatory Authority (FINRA).

Certain BSA obligations that apply to a broker-dealer in securities, mutual fund, futures commission merchant, or introducing broker, such as developing an AML Program or reporting suspicious activity, apply very broadly and without regard to whether the particular transaction at issue involves a “security” or a “commodity” as those terms are defined under the federal securities laws or the CEA.

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Additional Comments by the U.S. Commodity Futures Trading Commission Chairman

The mission of the CFTC is to promote the integrity, resilience, and vibrancy of the U.S. derivatives markets through sound regulation.  In advancing that mission, the CFTC regulates key participants in the derivatives markets, including boards of trade, futures commission merchants, introducing brokers, swaps dealers, major swap participants, retail foreign exchange dealers, commodity pool operators, and commodity trading advisors pursuant to the CEA.  An “introducing broker” or “futures commission merchant” is defined in BSA regulations as a person that is registered or required to register as an introducing broker or futures commission merchant under the CEA.[7]  Introducing brokers and futures commission merchants are required to report suspicious activity and implement reasonably-designed AML Programs.[8]  These requirements are not limited in their application to activities in which digital assets qualify as commodities or are used as derivatives.  The rules would also apply to activities that are not subject to regulation under the CEA.

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Additional Comments by the Financial Crimes Enforcement Network Director

As a bureau of the Department of the Treasury, FinCEN is the administrator of and lead regulator under the BSA -- the nation’s first and most comprehensive AML/ CFT statute.  FinCEN’s mission is to protect our financial system from illicit use, ensure our national security, and protect our people from harm.  FinCEN has supervisory and enforcement authority over U.S. financial institutions to ensure the effectiveness of the AML/CFT regime.  As such FinCEN mandates certain controls, reporting, and recordkeeping obligations for U.S. financial institutions.  The BSA and its implementing regulations set forth the regulatory obligations that generally apply to financial institutions,[9] including AML Program, recordkeeping, and reporting requirements.

FinCEN regulates, among other persons, money transmitters and other MSBs.[10]  FinCEN’s BSA regulations define a “money transmitter” as a person engaged in the business of providing money transmission services or any other person engaged as a business in the transfer of funds. [11]  The term “money transmission services” means “the acceptance of currency,[12] funds, or other value that substitutes for currency from one person and the transmission of currency, funds, or other value that substitutes for currency to another location or person by any means.”[13]

In May 2019, FinCEN issued interpretive guidance (2019 CVC Guidance) to remind persons subject to the BSA how FinCEN regulations relating to MSBs apply to certain business models involving money transmission denominated in value that substitutes for currency, specifically, convertible virtual currencies.[14]  The 2019 CVC Guidance consolidated current FinCEN regulations, and related administrative rulings and guidance issued since 2011, and applied these rules and interpretations to other common business models involving CVC engaging in the same underlying patterns of activity.  Covered persons and institutions are strongly encouraged to review the 2019 CVC Guidance.

As set forth in the 2019 CVC Guidance, a number of digital asset-related activities qualify a person as an MSB that would be regulated by FinCEN.  FinCEN’s BSA regulations also provide that any person “registered with, and functionally regulated or examined by, the SEC or the CFTC,”[15] would not be subject to the BSA obligations applicable to MSBs, but instead would be subject to the BSA obligations of such a type of regulated entity.  Accordingly, even if an introducing broker, futures commission merchant, broker-dealer or mutual fund acts as an exchanger of digital assets and provides money transmission services for the purposes of the BSA, it would not qualify as a money transmitter or any other category of MSB and would not be subject to BSA requirements that are applicable only to MSBs.  Instead, these persons would be subject to FinCEN’s regulations applicable to introducing brokers, futures commission merchants, broker-dealers and mutual funds, respectively.  These obligations include the development of an AML program and suspicious activity reporting requirements, as well as requirements under applicable CFTC or SEC rules.  Furthermore, regardless of federal functional regulator, all financial institutions dealing in digital assets meeting the definition of “securities” under federal law must comply with federal securities law.

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Additional Comments by the U.S. Securities and Exchange Commission Chairman

The statutory mission of the SEC is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.  In general, the SEC has jurisdiction over securities and securities-related conduct.  Persons engaged in activities involving digital assets that are securities have registration or other statutory or regulatory obligations under the federal securities laws.[16]

The SEC oversees the key participants in the securities markets, some of which may engage in digital asset activities.[17]  Key participants in the securities markets include but are not limited to national securities exchanges, securities brokers and dealers, investment advisers, and investment companies.  Market participants receiving payments or engaging in other transactions in digital assets should consider such transactions to present similar or additional risks, including AML/CFT risks, as are presented by transactions in cash and cash equivalents.  With regard to SEC regulated entities, broker-dealers and mutual funds are defined as “financial institutions” in rules implementing the BSA.  A “broker-dealer” is defined in rules implementing the BSA as a person that is registered or required to register as a broker or dealer under the Securities Exchange Act,[18] while a “mutual fund” is defined as an investment company that is an “open-end company” and that is registered or required to register under the Investment Company Act of 1940.[19]

Broker-dealers and mutual funds are required to implement reasonably-designed AML Programs and report suspicious activity.[20]  These rules are not limited in their application to activities involving digital assets that are “securities” under the federal securities laws.[21]

Statement of Commissioner Dawn D. Stump Regarding the CFTC Technology Advisory Committee Meeting

October 3, 2019

Thank you Commissioner Quintenz for convening today’s meeting of the Technology Advisory Committee (TAC).  I also want to extend my appreciation to the Committee members and presenters for their participation and engagement.

Today’s meeting topics are of immense interest to me, including custody of crypto assets, real world applications of distributed ledger technology specifically as it relates to data privacy, and cybersecurity.  These issues are timely and provide much for the Commission to consider as we embrace technology in our ever-evolving derivatives markets.  In thinking about the topics, one cannot ignore how far our markets have evolved in terms of technology in a very short period of time.  Today’s markets are almost unrecognizable not just due to (maybe some would argue in spite of) regulation but spurred by tremendous innovation.

Predicting that we would be discussing the matters under consideration today would have been difficult to fathom during the nascent years of the Commodity Futures Trading Commission (CFTC).  The TAC agenda reminds me of an interesting article that appeared in The New Yorker late last year, What 2018 Looked Like Fifty Years Ago.[1]  The article examined the book, Toward the Year 2018[2], a compilation of predictions published in 1968 of what the world would look like in 50 years.  Some predictions were not particularly remarkable, such as that “machines will do more of a man’s work.”[3]  Others were especially clairvoyant:  “The transmission of pictures and texts and the distant manipulation of computers and other machines will be added to the transmission of the human voice on a scale that will eventually approach the universality of telephony.”[4]  Some foreshadowed the privacy concerns of today by predicting that all types of sensitive information, such as “[t]ax returns, social security records . . . a criminal record, hospital records . . . [and] bank statements” would be stored on computers that could communicate with one another over a vast international network.[5]  Thus, as The New Yorker article observed, it was predicted that by 2018, “[y]ou could find out anything about anyone, without ever leaving your desk.”[6]

Another interesting prediction from 1968 was that “political and social institutions in the United States will remain flexible enough to ingest the fruits of science and technology without basic damage to its value systems.”[7]  I hope that the CFTC will always stay true to its underlying spirit and principles-based regulation such that this prediction is fully realized.   The pace, breadth, and depth of technological change should be embraced by regulators and provided with guideposts for development and growth, while also encouraging competition and fostering market integrity.  Regulating by principles will limit the risk of stifling innovation and allow for the ongoing improvements we expect from our markets, lest the next half decade not be as revolutionary as the prior.

Opening Statement of Chairman Heath P. Tarbert Before the Technology Advisory Committee Meeting

October 3, 2019

Good morning, and thank you all for being here.  I would especially like to thank Commissioner Quintenz and his staff for convening this meeting of the Technology Advisory Committee (TAC).  My thanks also to Meghan Tente, the Designated Federal Officer for the TAC, for organizing the meeting.  And of course, thank you to the TAC members for traveling from near and far and taking the time to share your valuable perspectives.

Role of Advisory Committees

Let me start by saying thank you to Commissioner Quintenz for his active engagement with stakeholders on these highly technical issues.  In particular, I applaud Commissioner Quintenz’s drive for actionable, practical advice from the advisory committee and the efforts of the committee members to deliver that advice.

Our advisory committees should be a way for the CFTC to engage with market participants and other stakeholders in our markets.  But the real value of advisory committees is the ability to present concrete recommendations to the Commission.  I look forward to hearing recommendations on how to improve our regulations and our markets at this meeting and future meetings.

Engagement with Industry

This advisory committee has a vital role to play in the operation of our agency.  We regulate markets that are at the cutting edge of technological innovation.  As an agency, we do not always have the technical expertise that our market participants have.  We can keep pace with developments in our markets only through dialogue with people active in those markets and driving those developments.

The topics for today’s TAC meeting reflect the rapid technological transformation taking place in our derivatives markets.  Automated trading systems, stablecoins and digital assets, distributed ledger technology, and cybersecurity—these are exactly the type of issues where we must gain insight from industry.

Innovation in our Markets

Our interest in these issues stems from our larger mission.

Our job is to ensure that our rules protect market integrity while fostering innovation.  To be sure, that requires a bit of a balancing act.  Market integrity is about protecting customer assets, making sure the markets function, and making sure everybody knows the rules.  If our markets are good enough, there is no need to fix anything.  But “good enough” is not the ultimate objective.  Our markets should always be striving to improve.

Fostering innovation, on the other hand, is about letting change happen in order to find a better way.  But innovation can be messy.  Some innovations are a dead end and do not always live up to their promises.  Other innovations create more problems than they solve.  And any innovation can take a long time to realize its potential.  Innovation also sometimes bears risk.  If the new mousetrap is better at catching mice but burns down the house, it is not a better mousetrap.

So how can a regulator strike the right balance between maintaining the integrity of the system while fostering innovation?  Fortunately for us, the best way to strike this balance is through a principles-based approach to regulation—a hallmark and unique feature of the CFTC’s regulatory regime.  We can set the destination but leave it to our registrants to find the best path to get there.  This approach allows flexibility for our markets to take advantage of new technology and other advances but still retains fundamental regulatory mandates so everyone knows what is expected of them.

If we the regulator better understand the innovations in our markets, we can make sure we have the right mix of principles and rules to strike that balance.

Conclusion

I look forward to hearing the TAC members’ views on these important issues.  Your perspectives are likely to be invaluable to the Commission and staff as we continue to work to refine our regulatory framework as to 21^st century commodities.

Opening Statement of Commissioner Dan M. Berkovitz Before the CFTC Technology Advisory Committee Meeting

October 3, 2019

Today the TAC will address a number of advanced issues regarding cryptocurrencies, distributed ledger and cybersecurity.  I look forward to hearing from the panels on these important topics.

I would like to take this opportunity to briefly discuss another technology topic: using infrastructure technology to make regulatory compliance more effective and efficient.

Ten years ago, the G20 leaders met in Pittsburgh and agreed on policies for reforming the global financial system.[1]  Regulators and market participants have accomplished a great deal in the interim implementing new regulatory systems resulting in a safer, more robust financial system.  However, we can improve on our accomplishments and I believe technology will be an important driver in our efforts. 

Compliance with the new regulations has not been perfect.  Just this week the Commission announced numerous swap reporting violation enforcement actions.  Aggregate penalties for swap reporting violations are now in the tens of millions of dollars (over $30 million) and counting.  This does not include the millions of dollars spent on lawyers and consultants to address these violations, many of which could have been avoided with better technology solutions.

It is my belief that fintech solutions that digitize and automate swap transactions and life cycle events[2] will lead to compliance that is both more complete and more cost-effective. 

The benefits of automation are realized when repetitive processes are standardized, digitized and automated.  Consistency will reduce errors and human input improving the level of compliance over millions of swaps.  In addition, integrating compliance features into the transaction infrastructure will increase compliance rates and the public benefits of regulation are more likely to be realized. While much of the substantial cost savings from digitization, automation, and standardization will relate to transaction costs generally,[3] savings in compliance costs can also be expected.

The CFTC can and should play a significant role working with market participants and fintech providers to help them build automated solutions that are effective in fulfilling regulatory requirements.  To the extent feasible, the CFTC should also be more mindful of the role of technology in compliance, and take further steps to integrate technology considerations into its approach to regulation. 

Engaging with fintech developers and market participants on integrating compliance into technology solutions should be a routine part of the CFTC’s work.  If we can do this successfully, the CFTC will have helped the industry achieve more effective and efficient compliance.  That’s a win-win for the CFTC and the derivatives industry.  

I look forward to working with my fellow Commissioners, CFTC staff, and market participants in facilitating greater compliance using technology.

Opening Statement of Commissioner Brian D. Quintenz Before the CFTC Technology Advisory Committee

October 3, 2019

Good morning and welcome to our fourth meeting of the Technology Advisory Committee (TAC or Committee). Before we begin, I would like extend a warm welcome to Chairman Tarbert.  This is Chairman Tarbert’s first TAC meeting at the Commission and I hope he finds them as informative and engaging as I have. I would also like to take a moment to recognize Meghan Tente, the Committee’s new Designated Federal Officer. Thank you, Meghan, for seamlessly assuming the leadership role for the Committee and for working so diligently to ensure today goes off without a hitch.

As always, I would also like to express my deep gratitude to all of the Committee members for so generously giving their time to participate today.  As I have noted before, the agency is fortunate to have such a talented and esteemed group advising us, but the flip side of that coin is you all undoubtedly have many demands on your time, so I appreciate you making this Committee’s work a priority.

We have a packed agenda for today. We have presentations from each of the TAC subcommittees highlighting relevant issues for the full Committee’s consideration, as well as several guest presenters.

Virtual Currencies Subcommittee Presentation

Our Virtual Currency subcommittee will hear a presentation from Gary DeWaal, Special Counsel at Katten, and Lee Schneider, General Counsel of Block.one, on the key characteristics and legal treatment of stablecoins.  Although the definition of a “stablecoin” is evolving, they are commonly thought of as a class of virtual currencies that seek to offer price stability, frequently by being “backed” by assets on reserve, like fiat currency(ies) or physical commodities (e.g., gold).  Because they strive for price stability, stablecoins have the potential, through tokenization, to function as viable, liquid mediums of exchange and to be powerful enablers of smart contracts.  Depending upon their mechanics and structure, a particular stablecoin may qualify as a commodity, security, derivative, or some other regulatory category.  Given the nascency of this class of digital assets, I think it is important to approach any stablecoin as we have other products that have similar characteristics, mechanics and structure.  I look forward to hearing from Mr. DeWaal and Mr. Schneider on the defining characteristics of stablecoins and their potential regulatory implications.

Next, the subcommittee will hear from Chris Brummer, Professor and Director of the Institute of International Economic Law at Georgetown University Law Center, and Tom Chippas, Chief Executive Officer of ErisX, to discuss some of the unique challenges associated with crypto-custody.  The protection of private keys by crypto-trading platforms, trust companies, and clearinghouses is an evolving landscape of best practices which has quickly become very robust.

Distributed Ledger Technology and Market Infrastructure Subcommittee Presentation

The Distributed Ledger Technology (DLT) subcommittee will then present on some of the potential real world applications of DLT, including with respect to custody and collateral management.  DLT also holds great promise to safeguard individuals’ privacy, promote data integrity, and ensure confidentiality.  As the technology matures, I also think it will be interesting to explore whether there is a role for DLT to play with respect to firms demonstrating their compliance with CFTC record retention requirements. Specifically, one day the agency may be able to verify over the blockchain, through something like a zero-knowledge proof, that certain records exist within a firm and are being maintained appropriately.  Such a process could significantly enhance customer protection and promote regulatory compliance, while not requiring enormous regulatory resources or exposing sensitive data to cyber risk through electronic transfers.

Automated and Modern Trading Markets Subcommittee Presentation

The Automated and Modern Trading Markets subcommittee will continue its examination of the true risks inherent in the modern trading environment and whether, and how, those risks are currently being mitigated.  In my view, many of the risks posed by automated and algorithmic trading are already being addressed through market incentives, including exchanges’ and firms’ own self-interest to limit a significant operational risk to their businesses.  But to the extent gaps may exist, it has been my hope that the work of this subcommittee can illuminate them and begin a conversation about how those risks can be best alleviated.

Prior TAC meeting presentations and discussions have already added significant clarity to that landscape.  To refresh everyone’s recollections, in prior TAC meetings, Bryan Durkin of the CME Group has presented how CME has implemented trading and volatility controls that complement, and in some cases exceed, eight recommendations published by the International Organization of Securities Commissions (IOSCO) regarding practices to manage volatility and preserve orderly trading.

More recently, the CFTC’s Market Intelligence Branch presented its own research report entitled, Impact of Automated Orders in Futures Markets, that analyzed manual and automated trading’s impact on the commodity futures markets.[1]  The report contained several significant findings, including that the increase in automated order activity seen across all commodity futures markets has not correlated to increases in end-of-day price volatility and, in some cases, showed that the volatility declined as automation increased.

Building upon that work, today we will hear from Alicia Crighton, Managing Director at Goldman Sachs, who will discuss FIA’s best practices for exchange and firm risk controls. FIA has played a critical role in advancing risk management and trading controls through development of its best practices and its subsequent industry surveys regarding their adoption.

Ms. Crighton will discuss current pre- and post-trade risk controls being implemented by exchanges and firms today.  Taking into account the dynamic, ever evolving nature of these controls, she will also give us a preview of some of the next generation controls and best practices currently being developed by exchanges and firms to further refine and improve electronic trading systems and protect the integrity of our markets.

Next, and directly supplementing the prior TAC meeting’s presentation by CME, Mayur Kapani, Chief Technology Officer for the Intercontinental Exchange (ICE), will present on the risk controls ICE currently implements across all of its exchanges.  Mr. Kapani will also walk us through a real life example illustrating how these risk controls worked during the recent volatility spike in Brent crude.

Both of today’s presentations demonstrate how trading and risk management controls continue to evolve with the trading technology itself.  Controls are constantly being updated and improved to respond to market developments.  Given how quickly advancements in risk controls are occurring, I would also be curious to hear from the subcommittee and the full TAC if it would be informative to have an updated industry survey to determine what best practices look like in 2019 and how widely they have been adopted.

It is my view that these continuous enhancements are made possible because exchanges and firms have the flexibility and incentives to mitigate evolving risks through an ever-higher set of standards, rather than through prescriptive regulatory requirements which can quickly become obsolete, redundant, or create unintended consequences, and even new risks.

Cybersecurity Subcommittee Presentation

Finally, the Cybersecurity subcommittee will present on the Financial Services Sector Coordinating Council’s (FSSCC) Cybersecurity Profile, building upon the overview provided at our last meeting.  Following the presentation, the subcommittee would like to discuss with the full Committee whether the TAC should vote to recommend that the Commission issue a statement of support for the FSSCC Cybersecurity Profile at the next TAC meeting.  I am interested to hear feedback from the full Committee regarding this possibility.

We will also hear from Jason Harrell, Executive Director and Head of Business and Government Cybersecurity Partnerships at DTCC, regarding vendor risk management.  Mr. Harrell will discuss some of the challenges of effective vendor risk management and some potential alternative approaches that may address those challenges.

Conclusion

Before I conclude my remarks, I would also like to recognize Jorge Herrada, John Coughlan, Scott Sloan, and Phil Raimondi for their tireless efforts to make this meeting a success.

With that, I would now like to recognize Chairman Tarbert and my fellow Commissioners to make their opening remarks.

Remarks of DSIO Director Joshua B. Sterling Before the ABA Securities Association

What’s Going On: Our Division’s Measured Approach to Key Derivatives Market Issues for Bank-Affiliated CFTC Registrants

September 26, 2019

Introduction

Good afternoon.  I wish to thank the ABA Securities Association for inviting me to participate in this important conversation, and for the thoughtfulness displayed by its excellent staff in organizing today’s program.

It’s no great insight to say that bank-affiliated firms that are registered with the CFTC operate in a complex, multi-dimensional environment.  They operate what are often global businesses under different, and often competing, regulatory requirements.  Those requirements can change quite a bit, which can have a cascading effect on systems, personnel, and other resources, all of which can drive up the cost of doing business.  And, while all the rigorous efforts to comply with the law are continuing, your firms remain focused – as they should – on the important imperative of serving your customers, counterparties, and clients.

We recognize these challenges, while you equally recognize our unique role in being singularly‑focused on your firms’ derivatives markets activities.  There are limitations to thinking about those activities in isolation from your other businesses, which makes it all the more imperative that we work together to see the full picture.

Our role in overseeing your businesses is vital, both given the scale of your derivatives market activities and because of the deep connection between derivatives markets and the broader economy.  Through smart, focused and effective regulation, we aim to do our part in helping your firms maintain the remarkable comparative advantage that our strong financial system affords the United States.

Before I continue, please note that these remarks reflect solely my personal views and not those of the Commission or its staff.

With our time together today, I’d like to touch on a few key areas that I believe are top of mind for bank-affiliated registrants.

Capital Requirements – Harmonization with the SEC and Moving to Final Rules

The Commodity Exchange Act (CEA) requires that we both meet with the Securities and Exchange Commission (SEC) on capital (and margin) requirements and, to the maximum extent practicable, establish comparable capital and margin requirements.[1]  This made great sense, of course.  We had a very productive consultative process with the SEC leading up to their adopting final capital rules for security-based swap dealers.[2]

In this regard, I wish to thank personally the efforts of Commissioner Quintenz and his terrific staff in facilitating this critical interagency dialogue.  The results achieved speak for the positive effect that he and his team had on the process.

Their final rules reflect the fruits of these efforts, as they attempted to align their rules with ours to a great extent.  Some differences will clearly remain, however, given the differences in the dealing activities under our regimes and the differences among firms dealing in swaps on the one hand and security-based swaps on the other.

So, what then about the CFTC’s swap dealer capital and financial reporting rule?

The Commission originally issued a proposal in 2011, which was followed by a comprehensive re‑proposal in 2016 based on important feedback that we received.[3]  The 2016 proposal is focused on three core concepts:

• First, recognize existing capital structures and frameworks;
• Second, permit the use of capital models for market and credit risk; and
• Third, recognize foreign domiciled swap dealers.

We have carefully reviewed the comments filed on this latest proposal.  On the whole, the Commission’s overall approach has been well-received.  So, as we develop a final set of rules for the Commission’s consideration, we expect to build on these concepts.

To that end, we are nearly finished thinking through the SEC’s final rules.  We will wrap up this process shortly in the coming weeks.  Given the passage of time since our 2016 release, we anticipate recommending that the Commission re-open the comment period to ask some very directed questions focused on getting our rules right.  We will be very pleased if these coming next steps lead to final rules being adopted next year.

To keep to this ball moving down the proverbial field, I encourage you to respond quickly and comprehensively to the request for comment once it is released.

The Supplemental Leverage Ratio – Taking a Coordinated Approach to Basel Developments

For several years now, the Commission’s leadership has taken a strong and helpful position in highlighting the impact that the supplemental leverage ratio has had on the derivatives markets – specifically, the cleared markets.  I think those efforts were well-worth the candle, and it was right for a derivatives market regulator to focus on this particular issue given our unique focus.

The BCBS’s June release is certainly a testament to the Commission’s work, which recognizes the exposure‑reducing impact that client cleared margin has on banking entities and the financial system as a whole.[4]  The Committee’s decision is a clear indication that they are committed to fine-tuning bank capital requirements appropriately, while re-affirming the G20’s commitment to encourage the further growth of cleared products as a response to failings in uncleared markets during the financial crisis.[5]

As always, we will continue to work with our counterparts at the federal banking regulators to assist them as they consider making revisions to their rules and the impact that any changes may have on the derivatives markets and its participants.  From my perspective, it will be very important to consider, with respect to futures and cleared swap transactions, the potential cushioning effect of customer margin deposits in estimating the scope of possible losses to a futures commission merchant (FCM) resulting from a customer default.

Uncleared Margin: Thinking Through Phase 5 Implementation Carefully, from all Perspectives

The Commission’s uncleared margin rule implements the initial margin requirements in five separate phases, from September 1, 2016, through September 1, 2020, depending on the size of the swap dealer’s portfolio of non-cleared swaps and the counterparty’s portfolio of non-cleared swaps.[6]  This schedule is consistent with an internationally agreed‑upon framework promulgated by the BCBS and IOSCO.

The swaps industry has raised concerns about certain operational difficulties associated with the exchange of initial margin, given the large number of relatively small counterparties encompassed in the rule’s fifth phase.  In recognition of these difficulties, and consistent with work being taken at the international level to revise the existing framework, the Commission has already undertaken certain measures to address possible “congestion” when Phase 5 begins in September 2020, and is contemplating further efforts as well.

I would like to highlight a few particular examples of these efforts:

Practical Approach to the $50 Million Threshold.

In July 2019, CFTC staff issued an Advisory to clarify that documentation requirements pertaining to uncleared swaps will not apply until a firm exceeds a $50 million IM threshold for uncleared swaps between a particular SD and counterparty.[7]

Without this guidance, some firms would have incurred the expense of preparing to exchange initial margin even though they would never actually be required to do so, since their initial margin amounts would remain below the $50 million threshold.  Even for firms that will eventually cross the $50 million threshold, the Advisory provides partial relief as they may avoid having to document during the 2020 “congestion” period.

Extension of the Compliance Date for Uncleared Margin Requirements.

The Commission is considering whether to allow swaps involving certain smaller counterparties an additional year to implement initial margin requirements.  In recognition of developments with our colleagues at the banking regulators, we expect to recommend that the Commission amend its compliance schedule to add a sixth phase of compliance for certain smaller entities that are currently subject to the Phase 5 compliance deadline.

Smaller entities would be those, in each case, with an average aggregate notional amount (AANA) of swaps from $8 billion up to $50 billion.  The existing requirement, by contrast, would require compliance by all counterparties with an AANA from $8 billion to $750 billion no later than September 1, 2020.  The deadline for this additional phase, if proposed and adopted, would be September 1, 2021.

Brexit, Legacy Contracts, and Libor.

Uncleared swaps that were entered into before the relevant compliance dates under the CFTC’s uncleared margin rules are not subject to margin rules for the life of the swap.  However, where a swap is amended or replaced for either regulatory or business reasons, a formerly “grandfathered” swap could become an in-scope swap where margin rules would apply, absent any CFTC action.  This issue has come up in a number of different contexts, including the following:

• Brexit.  In the event of a “no-deal” Brexit, affected swap dealers will likely need to effect legal transfers of uncleared swaps that were entered into before the relevant compliance dates under the CFTC margin rules.  In April 2019, the CFTC published an interim final rule that maintains the “legacy status” of swaps that were executed prior to the relevant compliance dates if those swaps are legally transferred solely as a result of a no-deal Brexit.[8]
• Legacy Swaps.  In June 2019, the CFTC issued no-action relief that permits certain amendments to legacy swaps, including amendments to reduce notionals and participate in compression exercises.[9]
• LIBOR.  LIBOR is being supported by a voluntary agreement through 2021, but as you are all aware, there is an ongoing industry effort to transition to an alternative reference rate.  In March 2019, BCBS and IOSCO issued a statement explaining that amendments to legacy derivative contracts pursued solely for the purpose of addressing interest rate benchmark reforms do not require the application of margin requirements.[10]  Industry participants have requested that the CFTC and the U.S. banking regulators, consistent with the views already expressed by the international regulatory bodies, propose changes to the uncleared margin rules to ensure that changes to legacy swaps to address benchmark reform would not affect the legacy status of those swaps under U.S. margin rules.  My staff is working with the banking regulators to address this concern.

Investment of FCM Customer Funds

My staff is considering an industry request to permit FCMs to invest customer margin funds in an expanded list of permitted investments.[11]  The requested relief would expand on a 2018 Commission Order that granted derivatives clearing organizations (DCOs) an exemption from CFTC Rule 1.25 to allow them to invest customer funds in foreign sovereign debt, but did not extend the relief to FCMs.[12]  At the time that the DCO relief was granted, the Commission noted that FCMs are a separate class of registrants with different regulatory obligations and that the Commission would need to consider relief for FCMs on its own terms.  We are undertaking that review presently, in light of the request that we do so.  I think it makes great sense to align FCM and DCO requirements in this regard.

DSIO Update: Using Our Five Building Blocks to Enhance Operational Effectiveness

In my remarks to the DC Bar Association yesterday, I laid out in detail the goals and plans for DSIO during my tenure.[13]  While I commend that speech to you for further consideration, I wish to flag a few highlights for you.

The organizing principles for DSIO are to be purposeful in our actions and to provide certainty in the law to all market participants.  These principles are important, because they promote some important values of the CFTC – namely:

• to strengthen the resilience and integrity of our markets,
• to enhance the regulatory experience for market participants, and
• to be tough on those who break our rules.

Our Five Building Blocks provide the mechanisms for carrying out our mission.  Each building block reflects a core piece of a complete regulatory program that will further these values.  The building blocks are our Examination Program, Reporting Program, Guidance Program, Enforcement Referral Program, and Rulemaking Program.  These Programs are linked, and interact with each other, toward the common goal of making better use of facts to produce better law.

Of particular note:

• Our Examination Program will commence in the first quarter of 2020 with targeted thematic reviews of select large swap dealers and commodity pool operators (CPOs), to understand better how the big shops approach key compliance issues like risk management and risk reporting.  The thematic reviews will not duplicate or replace NFA’s ongoing efforts.
• Our Reporting Program will seek to streamline the use of data to produce more effective results.  In this spirit, we fully support the efforts of Commissioner Stump under her Data Protection Initiative and expect to coordinate closely with her and her staff moving forward.[14]
• Our Guidance Program will take the facts we gather and provide more general guidance to registrants on a more frequent basis than in the past.  The trade-off is an expected reduction in our issuance of one-off letter relief, as a matter of good government and regulatory economy.
• Our Enforcement Referral Program will see us take a more focused approach to referrals, so that our coordination efforts with the Division of Enforcement become more programmatic.  Our colleagues in Enforcement should reinforce our oversight function by holding registrants accountable, and we should support Enforcement by flagging potential problems that we encounter.
• Our Rulemaking Program will take facts gathered under our other high-functioning programs and use them to evaluate whether to propose rule amendments based on what we see in the markets.  We are also improving our rulemaking process to ensure that we take a linear path to get to the end result.

It is a new day rising in DSIO.  We look forward to improving our processes, so that we can be more effective in helping to strengthen our markets and broader financial system in which your firms operate.

* * * * *

In closing, I invite you to come talk to us.  Tell us what you see and what you think.  Every data point and anecdote you offer will help. Leave nothing out. 

And, please, invite us to come speak with you.  We need to be out in the world if we are to have any chance to do our best work.

My world-class staff and I look forward to working with you.

Thank you for your time.