Supporting Statement of Commissioner Dan M. Berkovitz on the Proposed Regulation for Registration with Alternative Compliance for Non-U.S. Derivatives Clearing Organizations

July 11, 2019

I support issuing for public comment the proposed rulemaking (“Proposal”) to permit registration with alternative compliance for non-U.S. derivatives clearing organizations (“non-U.S. DCOs”).

Under the Proposal, a non-U.S. DCO that does not pose “substantial risk to the U.S. financial system” would be permitted to elect to comply with certain Commodity Exchange Act (“CEA”) core principles for DCOs through compliance with its home country regulatory regime.[1]  The non-U.S. DCO still would be required to comply with the CFTC’s customer protection and swap data reporting requirements.  This registration alternative would permit U.S. persons to access foreign swap markets while benefitting from customer protections under the U.S. Bankruptcy Code and CFTC regulations without introducing significant new risks into the financial system.

The alternative compliance framework seeks to satisfy both the CFTC interest in protecting U.S. customers accessing a non-U.S. DCO and the interests of the home regulator in overseeing the activities of the non-U.S. DCO within its jurisdiction.  It maintains key U.S. customer protection requirements and U.S. Bankruptcy Code treatment for U.S. customer funds held by CFTC-registered futures commission merchants (“FCMs”).[2]  At the same time, this framework recognizes the interests of the non-U.S. DCO’s home country regulator by relying on its oversight of other DCO activities.  I look forward to comments on whether the Proposal maintains for the Commission an appropriate level of regulatory oversight for non-U.S. DCOs operating within this framework.

The effective regulation of central clearinghouses for derivatives is critical to managing risk throughout global financial markets.  Under the CEA, the Commission may exempt a non-U.S. DCO from the registration requirement if the Commission determines that the non-U.S. DCO is subject to “comparable, comprehensive supervision and regulation” by its home regulator.[3]  The Exempt DCO Proposal, which the Commission also is considering today, would set forth, for the first time, objective standards for determining whether a particular non-U.S. DCO is eligible for such an exemption.[4]  The threshold for permitting non-U.S. DCOs under the Exempt DCO Proposal to be eligible to elect exemption from registration – that the DCO not pose a “substantial risk to the U.S. financial system” – is the same standard for permitting a non-U.S. DCO to be eligible to register with alternative compliance under this Proposal.  Thus, under the set of proposals the Commission is considering today, a non-U.S. DCO that does not pose substantial risk to the U.S. financial system could apply, at its election, either for an exemption from DCO registration, or for registration with alternative compliance.  Of course, it could apply for full DCO registration as well.

I support the Commission’s movement towards objective standards and defined processes for establishing registration alternatives for non-U.S. DCOs.  Non-U.S. DCOs that conduct a substantial amount of U.S. customer-related activity will remain subject to full CFTC registration and regulation and U.S. customers on such DCOs are generally protected under the U.S. Bankruptcy Code and CFTC customer protection regulations.

For a non-U.S. DCO that is below that “substantial risk” threshold, this Proposal creates an “alternative compliance mechanism” that would permit the non-U.S. DCO to register with the Commission and provide clearing for U.S. customers, but also to comply with certain DCO core principles by complying with its home country requirements.  Under this alternative, the non-U.S. DCO would still be subject to some CFTC customer protection regulations and U.S. customers would continue to receive protections under the U.S. Bankruptcy Code for funds held at the FCMs that must be used as intermediaries.[5]

“Substantial Risk” Threshold Issues

As noted above, only those non-U.S. DCOs that do not pose a “substantial risk to the U.S. financial system” would be permitted to register with alternative compliance.  A non-U.S. DCO would be deemed to present a “substantial risk to the U.S. financial system” if: (1) it holds 20% or more of the required initial margin of U.S. members for swaps aggregated across all registered and exempt DCOs; and (2) 20% or more of the initial margin for swaps required at the DCO is attributable to U.S. members.  The 20/20 criteria would not be a bright line test.  If either of the conditions is present, or close to present, the Commission may nonetheless determine that the non-U.S. DCO presents substantial risk to the U.S. financial system and therefore must fully register.

Although I support issuance of this Proposal, I have significant concerns about adopting the 20/20 criteria as a “risk-based” standard.  Although the 20/20 criteria are characterized as a risk-based standard (i.e., “substantial risk to the U.S. financial system”), the criteria would more accurately be described as establishing an activity-based test.  The proposed 20/20 criteria directly measure the level of initial margin deposited at the non-U.S. DCO rather than risk presented to the U.S. financial system.  The Proposal is devoid of reasoned analysis as to the basis for the 20/20 criteria in terms of actual risk presented to the U.S. financial system.  It is not difficult to envision scenarios in which a lesser amount of initial margin at a non-U.S. DCO by U.S. participants may actually represent increased risk to the U.S. financial system, and a greater amount of margin may represent lesser risk.  In the Proposal, the Commission concedes that “a test based solely on initial margin requirements may not fully capture the risk of a given DCO.”[6]

In my view, an activity-related test is, in fact, the more appropriate standard for determining registration requirements.  In effect, the Proposal gets the result right, but for the wrong reasons.  “Substantial risk to the U.S. financial system” is difficult—if not impossible—to measure in a straightforward, objective formula, especially as markets change over time.  The activity-based thresholds in the Dodd-Frank Act for the regulation of swaps markets and entities were adopted largely due to the spectacular failure of the risk-based approach prior to the financial crisis.  Other registration thresholds and registration exemptions in the CEA and the Commission’s regulations, for example for swap dealers, FCMs, commodity pool operators, and commodity trading advisors, are based on activity rather than risk.  Importantly, the standard in CEA Section 2(i) for the application of the swaps provisions to activities outside the U.S. (“direct and significant connection with activities in, or effect on, commerce of the United States”) is activity-based and not risk-based.  The threshold for exemption from registration for non-U.S. DCOs should be activity-based as well.

It is not apparent from the information provided in the Proposal why the 20/20 test should be the appropriate standard for determining whether a non-U.S. DCO need not fully register with the CFTC.  Do the proposed criteria accurately measure the appropriate level of clearing activity?  Are additional or different metrics more appropriate for measuring when clearing activity for U.S. customers becomes substantial and full registration becomes appropriate?  I look forward to reviewing comments addressing these and the other issues regarding the 20/20 test.

No Substituted Compliance Review

I also am concerned that the Proposal may not establish sufficiently clear or adequate standards for the review of a non-U.S. DCO’s application for alternative compliance.  In contrast to the  standard and proposed process for granting a request for exemption from DCO registration,[7] the Proposal would not require the CFTC to make any determination that the home jurisdiction’s requirements for the DCO are comparable to, and as comprehensive as, the core principles for which alternative compliance is being sought.[8]  It is not clear why a vaguer standard should apply to DCOs seeking registration with alternative compliance.  The Proposal establishes what, in essence, appears to be a regime similar to substituted compliance for certain DCO core principles, yet it does not follow the process the CEA requires and the CFTC has implemented in other circumstances for establishing a substituted compliance regime.[9]  Further, the Proposal does not require that the non-U.S. DCO observe the Principles for Financial Market Infrastructure.  I look forward to comments on, and further clarification of, these issues.

Reciprocity

In this rulemaking the Commission proposes to recognize the interests of other jurisdictions in the regulation of non-U.S. DCOs.  To the extent that non-U.S. jurisdictions adopt similar approaches that recognize the interests of the U.S. in the regulation of DCOs located in the U.S., the global marketplace as a whole will benefit.  However, to the extent that another jurisdiction does not appropriately recognize the interests of the U.S. in regulating U.S. DCOs, then U.S. DCOs could be fully regulated by both the U.S. and the other non-U.S. jurisdiction, subjecting the U.S. DCOs to unnecessary additional costs and potentially conflicting requirements.[10]  Prior to granting any applications for alternative compliance for a non-U.S. DCO, the Commission should determine that the home jurisdiction of the non-U.S. DCO has adopted a comparable approach to the regulation (including exemption from regulation) of U.S. DCOs.[11]  I invite comment on whether reciprocity or a similar mechanism should be incorporated into the regulation.

I thank the staff of the Division of Clearing and Risk for their work on this Proposal and appreciate their professional engagement with my office to address many of our comments. 

Dissenting Statement of Commissioner Dan M. Berkovitz on the Supplemental Proposal for Exemption from Derivatives Clearing Organization Registration

July 11, 2019

I dissent from the proposal to exempt certain foreign clearinghouses from the derivatives clearing organization (“DCO”) registration requirements.  The proposal would jeopardize U.S. customers, create systemic risks to the U.S. financial system, promote the use of foreign intermediaries at the expense of U.S. firms, and exceed this agency’s limited exemptive authority.[1]

The Commodity Futures Trading Commission (“Commission”) previously has permitted the clearing of proprietary swap positions at a limited number of foreign clearinghouses that it has exempted from the DCO registration requirement.[2]  The proposed rule before us today (“Exempt DCO Proposal” or “Proposal”) would permit, for the first time, exempt DCOs to clear positions of U.S. customers.[3]  To accomplish this, the Proposal disregards key protections for U.S. customers and the U.S. financial system provided by the U.S. Bankruptcy Code, the CEA, and CFTC regulations.

The Exempt DCO Proposal would permit U.S. customers to clear swaps at exempt non-U.S. DCOs without the protections afforded to swap customers under the Bankruptcy Code or CFTC regulations.  It would enable U.S. customers to trade at these exempt DCOs through non-registered foreign intermediaries who would not be covered by the U.S. Bankruptcy Code or subject to the CFTC’s customer protection requirements.  Enabling U.S. customers to trade swaps and amass large positions in non-U.S. markets without these protections not only poses risks to those customers, but also presents systemic risks to the U.S. financial system.

The Exempt DCO Proposal also would prohibit U.S. FCMs that are registered with the CFTC from providing clearing services at exempt DCOs.  The Exempt DCO Proposal thus requires that which the CEA prohibits (clearing by a non-registered intermediary), and prohibits that which the CEA requires (clearing by a registered FCM).  The Proposal creates a Bizarro World[4] for U.S. swaps customers in which the CFTC does not regulate derivative clearing organizations, only unregistered foreign firms are allowed to serve U.S. customers, and U.S. customers get none of the protections provided by U.S. law.

The CFTC does not have the superpowers to fashion its own de-regulatory planet.  It must stay within the orbit of the laws prescribed by the Congress.  It cannot bypass any provision of the CEA that it considers an impediment to a global swaps market.  Congress has not provided the CFTC’s with unlimited exemptive authority.  In particular, the CFTC’s limited exemptive authority under CEA section 4(c) does not extend to instruments that are not subject to the exchange-trading requirement of section 4(a), such as non-U.S. swaps traded in markets located outside the United States.[5]  By seeking to exempt non-U.S. intermediaries who provide clearing services to U.S. swap customers in overseas markets from the registration requirement for FCMs,[6] the Proposal exceeds the Commission’s authority.

No Customer Protections

The Exempt DCO Proposal would eliminate the important protections afforded to U.S. swaps customers provided by Congress and the CFTC’s regulations.[7]  Many of these protections result from the provisions in the Bankruptcy Code applicable to FCMs and the regulatory requirements imposed on the FCMs regarding the handling of customer funds.  Section 4d(f) of the Act, which was added by the Dodd-Frank Act, provides that only registered FCMs may accept customer monies to margin cleared swaps.  It also requires FCMs to segregate customer cleared swaps funds, and prohibits the comingling of customer and proprietary funds.[8]  In addition, all FCMs must implement systems and procedures to address conflicts of interest, and they must each designate a chief compliance officer to fulfill specified duties and responsibilities.

In the event that a registered FCM becomes insolvent, swaps customers are protected if their funds reside in segregated accounts as required by the Act and Commission regulations,[9] are carried by an FCM, and are deposited with a registered DCO.  Segregation helps to ensure that swaps customer funds are not comingled with an FCM’s proprietary funds, while registration helps ensure that they meet applicable definitions in the Bankruptcy Code to fall under its protections.

Customer protections under the Bankruptcy Code include safe harbors for certain derivatives contracts that allow non-defaulting counterparties in a bankruptcy proceeding to quickly terminate and net their swaps.  The safe harbors override the Bankruptcy Code’s automatic stays that would otherwise foreclose any action to liquidate collateral and collect debts from a defaulting party.[10]  Swap customer funds are given priority treatment and not included in the bankruptcy estate that is subject to other creditors of the bankrupt firm.  These protections facilitate the prompt transfer of customer positions away from an insolvent FCM, which can avoid a forced liquidation at potentially depressed valuations.  In the event that an FCM becomes insolvent, the Bankruptcy Code also entitles the FCM’s customers to a pro rata distribution of customer assets ahead of any other creditors of the FCM.

The Exempt DCO Proposal would circumvent these fundamental swaps customer protections by permitting foreign intermediaries to accept U.S. customer funds to margin cleared swaps at exempt DCOs without registering as an FCM.  It would free foreign intermediaries from all of the regulatory requirements that apply to U.S. FCMs, including requirements providing for the protection of customer funds, financial safeguards, and operational soundness.  At the same time, it would prohibit CFTC-registered FCMs—the entities which are subject to these customer protection requirements—from acting as FCMs for U.S. customers at exempt DCOs.  The Proposal thus legally ensures that U.S. customers will not receive the customer protections required by the CEA, CFTC regulations for swap transactions, and the Bankruptcy Code.

Absent these protections, U.S. swaps customers potentially face a range of financial and market risks.  U.S. customers may find that foreign bankruptcy laws fail to provide priority treatment for derivatives and could include their funds in the general bankruptcy estate for all creditors of the insolvent firm.  Uncertainty over the treatment of customer funds held at an exempt DCO or a foreign intermediary, as well as over the portability of open positions at the DCO could also lead counterparties to quickly terminate their swaps.  The cascading effects on market prices, liquidity, the value of open positions, and perceived counterparty credit risk could quickly become a systemic event.

Systemic Risks

In the U.S., the segregation requirements for margin funds held at an FCM protect the funds of the customer in the event that the FCM becomes insolvent.  If there are no similar segregation requirements, then the failure of the clearing intermediary could result in significant losses to the intermediary’s customers.  These losses could impair one or more customers’ ability to maintain its trades with its other counterparties, not just those at the affected non-U.S. DCO.  Such other counterparties may seek to terminate their trades with the affected U.S. persons to avoid potential losses that could arise in these circumstances.  The losses of one or more U.S. entities due to the bankruptcy of another entity or intermediary in a non-U.S. jurisdiction without equivalent bankruptcy laws thus could rapidly escalate into a more widespread market event involving numerous other persons within the U.S.[11]

The Proposal contains no discussion or analysis of the potential systemic consequences if a foreign intermediary holding significant assets from large U.S. swaps customers were to fail.  Similarly, it fails to examine the impact to the U.S. financial system if the overseas assets of large U.S. swaps customers were to become entangled – or potentially entangled – in foreign bankruptcy proceedings.

Exclusion of U.S. FCMs

The Exempt DCO Proposal would prohibit U.S. FCMs from providing clearing services to U.S. swaps customers at exempt DCOs.[12]  By itself, this prohibition would not be problematic, as it is consistent with the Commission’s interpretation of the CEA and longstanding policy.  The Proposal veers off course by coupling this prohibition with permitting non-registered foreign intermediaries to provide those same services without any protections for U.S. customers.

In last year’s initial proposal to establish a framework for exempt DCOs, the Commission proposed to prohibit FCMs from clearing customer swaps at exempt DCOs.  At that time, the Commission explained:

Section 4d(f)(1) of the CEA makes it unlawful for any person to accept money, securities, or property (i.e., funds) from a swaps customer to margin a swap cleared through a DCO unless the person is registered as an FCM.  Any swaps customer funds held by a DCO are also subject to the segregation requirements of section 4df(2) of the CEA, and in order for a customer to receive protection under this regime, particularly in an insolvency context, its funds must be carried by an FCM, and deposited with a registered DCO.  Absent that chain of registration, the swaps customer’s funds may not be treated as customer property under the U.S. Bankruptcy Code and the Commission’s regulations.  Because of this, it has been the Commission’s policy to allow exempt DCOs to clear only proprietary positions of U.S. persons and FCMs.[13]

In its zeal to enable U.S. customers to access non-U.S. swap markets, the Commission seeks to sidestep these issues with the Bankruptcy Code by jettisoning the entire bankruptcy regime as it applies to U.S. swaps.  It would accomplish this by permitting non-registered, non-U.S. intermediaries to clear swaps through exempt DCOs.  But this approach leaves U.S. customers without any bankruptcy protection and competitively disadvantages U.S. FCMs with respect to clearing in non-U.S. swaps markets.  In the cost/benefit considerations, the Commission acknowledges, “FCMs may . . . face a competitive disadvantage as a result of this proposal, as they would not be permitted to clear customer trades at an exempt DCO.  To the extent that their customers shift their clearing activity at registered DCOs to exempt DCOs, or otherwise reduce their clearing activity at registered DCOs as a result of this proposal, FCMs would lose business.”[14]

Not only would the Proposal place FCMs at a competitive disadvantage, the Proposal recognizes that this also would place registered DCOs at a competitive disadvantage.  The Commission states in the cost/benefit considerations that it “anticipates that some non-U.S. clearing organizations that are currently registered DCOs, or that would otherwise apply to register in the future, may choose to apply to become exempt an DCO, thus lowering their ongoing compliance costs.”[15]

A better approach would be to prohibit exempt DCOs from providing clearing services to U.S. customers—as the Commission proposed last year—and permit customer clearing only at registered DCOs, through registered FCMs.   This would preserve the competitiveness of U.S. FCMs in the global swaps markets and maintain the bankruptcy and other protections for U.S. customers.  Today’s companion proposed rule, providing for registration with alternative compliance for DCOs that would be eligible for an exemption, would provide a second mechanism—in addition to full DCO registration—for non-U.S. DCOs to provide for clearing services to U.S. customers.  The Commission does not explain why either the existing option for full registration, or the proposed alternative compliance mechanism, are insufficient to enable U.S. customers to access clearing services as non-U.S. DCOs.[16]

The Commission asserts that by expanding the pool of available intermediaries and clearinghouses to include unregistered or exempt non-U.S. entities, the Proposal may “reduc[e] the concentration of U.S. customer funds in a small number of FCMs,”[17] and may also “reduc[e] the concentration risk among registered and exempt DCOs.”[18]  The exclusion of registered FCMs from non-U.S. swap markets, however, will in no way reduce the currently high levels of concentration amongst registered FCMs at registered DCOs serving the U.S. market.  It is the high levels of concentration of registered FCMs at registered DCOs that pose potentially systemic risks to the U.S. financial system.  The Commission should be working to enable greater FCM competition in U.S. swap markets, not precluding U.S. FCMs from competing in non-U.S. markets.

I strongly support efforts to increase competition and reduce concentration amongst registered, U.S. FCMs in the U.S. swaps markets.  It is a topsy-turvy argument that this is best accomplished by prohibiting U.S. FCMs from participating in non-U.S. markets and enabling non-registered non-U.S. FCMs to take this business away from those U.S. FCMs.

Absence of Exemptive Authority

The Proposal relies on CEA Section 4(c) for authority to exempt non-U.S. intermediaries that provide customer clearing at exempt DCOs from the FCM registration requirement and the regulations applicable to registered FCMs.[19]  Section 4(c), however, provides the Commission with limited exemptive authority, applicable to specified classes of instruments and markets.  It does not provide the Commission with the ability to waive any provision of the CEA that it deems inconvenient.[20]  The Commission’s limited authority does not extend to the non-U.S. cleared swaps markets that are the subject of this rulemaking.

Section 4(c) provides that the Commission may exempt any agreement, contract, or transaction from the requirements of section 4(a) (which requires that contracts for future delivery be traded on a designated contract market) or any other provision of the Act if such agreement, contract, or transaction is, in the first instance, subject to section 4(a).[21]  Notably, however, section 4(a) does not apply to contracts “made on or subject to the rules of a board of trade, exchange, or market located outside the United States . . .”[22]

Swaps traded on a non-U.S. trading facility and cleared at a non-U.S. DCO appear to fall into the category of contracts “made on or subject to the rules of a board of trade, exchange, or market located outside the United States.”  The Commission provides no justification or analysis for asserting that section 4(c) provides exemptive authority for transactions in non-U.S. markets involving these contracts.

Conclusion

The Exempt DCO Proposal deprives U.S. customers of bankruptcy protection under U.S. law, creates systemic risks for the U.S. financial system, and promotes the use of foreign intermediaries at the expense of U.S. FCMs.  It also exceeds the Commission’s exemptive authority under section 4(c) of the Act.  If the Commission desires to facilitate greater access by U.S. persons to foreign cleared swaps markets, it should do so within the framework of registered DCOs, registered FCMs, and the customer protections provided by the U.S. bankruptcy laws and CFTC regulations.  It should not do so at the expense of protections for U.S. customers and the U.S. financial system.  Accordingly, I dissent.

Opening Statement of Commissioner Brian D Quintenz before the Open Commission Meeting on July 11, 2019

Open Meeting on Proposed Rule on Registration with Alternative Compliance for Non-U.S. Derivatives Clearing Organizations and Supplemental Proposal on Exemption from Derivatives Clearing Organization Registration

July 11, 2019

Mr. Chairman, thank you for calling this meeting and thank you for lending your invaluable leadership and voice to this agency during your tenure here, first as Commissioner and then as Chairman.  I have consistently been impressed and inspired by your commitment to thoughtful public policy, willingness to consider alternative viewpoints, and unwavering dedication to the success and well-being of the CFTC and all of its employees. You will be greatly missed.

I am pleased to support both of today’s proposals, which embrace a view of global swaps market regulation based on open competition and choice, deference to comparable foreign jurisdictions, and cooperation with the CFTC’s foreign counterparts.

I would also like to note that today’s two rules are part of a three-pronged approach to right-size the CFTC’s extraterritorial application of its regulations.  The third piece, on the regulation of foreign entities’ swaps activities, is still being considered and actively discussed.  I very much look forward to the Commission considering a proposal on this important topic that takes a similar view towards foreign deference in the near future.  That vision of deference was fully laid out almost one whole year ago with the Chairman’s release of his Cross Border White Paper.  It should come as no surprise to anyone who follows this Commission that actual rule proposals to effectuate that white paper would be forthcoming.  I’m very pleased with the work of the staff to put these two pieces of that vision before us today.

Proposed Rule on Registration with Alternative Compliance for Non-U.S. Derivatives Clearing Organizations

The first proposed rule considered by the Commission today would reduce the degree to which CFTC-registered foreign derivatives clearing organizations (DCO) are subject to duplicative regulation by the CFTC and their home country regulator.  The proposal would permit a foreign DCO that does not pose “substantial risk to the U.S. financial system” to comply with its home country authorities’ regulations instead of most CFTC regulations.  To satisfy CFTC regulations, the foreign DCO would only need to comply with certain of our customer protection and swap data reporting requirements.

The proposal recognizes that foreign regulators have a substantial interest and expertise in supervising DCOs located in their home jurisdictions.  Deference to their oversight is appropriate when compliance with the home country regulatory regime would achieve compliance with DCO core principles.  This proposal is consistent with, and in many ways an expansion of, the CFTC’s 2016 Equivalence Agreement with the European Commission, pursuant to which the CFTC granted substituted compliance to dually-registered DCOs based in the European Union.[1]

I also strongly support the proposal’s transparent, fact-based procedure for determining when a foreign DCO poses “substantial risk to the U.S. financial system.”  The proposal defines “substantial risk” to mean two simple criteria: (i) the foreign DCO holds 20 percent or more of the required initial margin of U.S. clearing members for swaps across all registered and exempt DCOs; and (ii) 20 percent or more of the initial margin requirements for swaps at that foreign DCO is attributable to U.S. clearing members.  I think this two-prong test correctly assesses the DCO’s focus on U.S. firms and impact on the U.S. marketplace.

Today’s proposal contrasts starkly with the European Securities and Markets Authority’s (ESMA) recent proposal to determine the systemic importance of a foreign DCO to the European Union and thereby apply the European Market Infrastructure Regulation (EMIR) and ESMA oversight.  Unlike today’s CFTC proposal, ESMA has not proposed any quantitative thresholds for assessing systemic importance.  Instead, ESMA proposed 14 “indicators” for determining systemic importance that would grant it considerable discretion and raise serious questions about the judgement and consistency of the indicators’ application.  I hope that, through its consultative process, ESMA decides to revise its criteria and ultimately adopts a predictable, transparent, and appropriately calibrated threshold regime for such an important and extraterritorial regulatory determination.

I welcome comments and suggestions from market participants and foreign jurisdictions about all aspects of the Commission’s proposed alternative compliance regime for non-U.S. DCOs. It is also my hope that incoming Chairman Tarbert will prioritize finalizing a version of this proposal. Lastly, I look forward to discussing this proposal, and advocating for its deference-based approach, with our regulatory colleagues around the globe.

Supplemental Proposal on Exemption from Derivatives Clearing Organization Registration

Today’s supplemental proposal to permit exempt DCOs to clear swaps for U.S. customers will provide greater choice and flexibility to market participants.  Currently, an exempt DCO is only authorized to clear the proprietary positions of its U.S. clearing members.  Today’s proposal will provide U.S. customers, like U.S. asset managers, insurance companies, and others, with increased access to foreign markets and an enhanced ability to hedge their risk.

I strongly support this proposal’s inclusion of specific criteria that the Commission will use to determine whether a foreign DCO poses a “substantial risk to the U.S. financial system,” and would therefore be ineligible for an exemption from registration.  Today’s rulemaking also appropriately streamlines exempt DCO reporting requirements to focus solely on the information necessary to evaluate “substantial risk” and to assess the extent to which the foreign DCO is clearing U.S. business.

I look forward to receiving comments on additional possibilities for U.S. customers to clear on exempt DCOs.  In particular, I am interested to hear from commenters about whether U.S. futures commission merchants (FCMs) should be permitted to provide their U.S. customers with access to exempt DCOs, and, if so, how the protection of U.S. customer funds should be addressed.  I also welcome comment about whether a foreign DCO, neither registered with the CFTC nor exempted from CFTC registration, should be permitted to clear for a foreign branch of a U.S. bank that is registered with the CFTC as a swap dealer.  Finally, I look forward to hearing from market participants about whether a foreign clearing member of a foreign DCO should be permitted to sponsor a U.S. FCM’s membership to the foreign DCO in order to facilitate access by U.S. customers.

In conclusion, I would like to once again thank Chairman Giancarlo for his exemplary service to the CFTC and the United States.  We will all benefit from his long fight to promote deference culminating with today’s two rule proposals.

Opening Statement of Chairman J. Christopher Giancarlo before the Open Commission Meeting

July 11, 2019

Good morning.  This meeting will come to order.  This is a public meeting of the Commodity Futures Trading Commission (CFTC).

Let me welcome my fellow Commissioners, their staffs, agency staff, and interested members of the public.  Thank you for your engagement in this important process.

We have two matters before us today.  I look forward to the staff presentations on each of them and their thorough consideration and disposition.  Another matter that was noticed for this meeting, a joint proposal with the SEC to align the minimum margin required on security futures with other similar financial products, has been unanimously actioned by seriatim and was announced earlier this week.  I thank the Commissioners and their staffs for its timely handling.

Before we take up the two remaining matters, I want to briefly address some idle speculation of late in the London press regarding my supposed candidacy for the position of Governor of the Bank of England, the United Kingdom’s central bank and prudential regulator.  As I have informed my fellow Commissioners, I have neither sought nor applied for the position, for which I understand the application process formally closed some time ago. 

More broadly, I confirm that I have not and will not, discuss, consider, apply for, or pursue any professional engagement or employment of any kind whatsoever here or abroad until after the completion of my service on the Commission. 

I mention this only to dispel any concerns that such press chatter may suggest about my engagement in today’s proceedings or, for that matter, any other subject now before the Commission.

Now for the matters at hand.  

The CFTC has been a consistent leader of the world’s major market regulators in enacting effective derivatives regulation and oversight.  By 2014, it was the first regulatory agency to implement most of the internationally agreed upon swaps market reforms. 

As a result, the CFTC now has more than five years of experience with its current regulatory framework, including the approach to its cross-border application.   This puts us in a position to appreciate that application’s different strengths and deficiencies.  Based on a careful analysis of that data and experience, it is possible to recognize successes, address flaws, recalibrate imprecision, and optimize measures.  This is particularly important with respect to the CFTC’s approach to regulating cross-border activities.

Last October, I published a white paper[1] on cross-border swaps regulation.  It proposed updating the agency’s current cross-border approach with an objective and risk-focused framework based on regulatory deference to third-country jurisdictions with comparable regulation and supervision, including those that have adopted the core G20 swaps reforms.

Stemming from that white paper, the staff has put into seriatim over the past several months four proposals on the cross-border reach of CFTC regulation.  The first proposal was unanimously approved by the Commission several weeks ago.  It establishes amendments to certain provisions of CFTC regulations governing the offer and sale of foreign futures and options to customers located in the United States.[2]  The proposed amendments would codify the process by which the Commission may terminate exemptive relief issued pursuant to those regulations.[3] 

The next two proposals deal with issues related to the registration of derivatives clearing organizations (DCOs) and are the subject of today’s open meeting, which we will turn to shortly. 

The fourth proposal concerns the registration and regulation of swap dealers and major swap participants.  This proposal continues to be the subject of constructive dialogue with the Commissioners and their staffs.   It remains before the Commission for consideration in seriatim.  I commend the proposal to my fellow Commissioners and my successor for their thoughtful consideration and advancement. 

I want to note that these proposals have absorbed enormous time and attention from my fellow Commissioners and their staffs.  The Divisions have received excellent comments and engaged in extensive dialogue with each Commissioner office.  Whatever the final disposition of today’s proposals, I want to acknowledge that each of the proposals has benefited from the intelligence and bipartisan attention of my colleagues and their thoughtful staffs.

I also want to thank the agency staff for their fine work and input, especially the Division of Clearing and Risk and the Office of International Affairs.  These hearings require extensive preparation by them, for which we are grateful. 

Finally, I thank my own staff, especially Matt Daigler, who has devoted much of his time to seeing these proposals through.  I also want to publicly acknowledge my gratitude to Michael Gill, who is simply the finest, most capable and effective Chief of Staff and Agency COO in the federal government.  Mike managed my transition to the Chairman’s Office and will assist Dr. Tarbert with his.  I am deeply indebted to Mike for his matchless savoir faire.

Proposed Rule on Registration with Alternative Compliance for Non-U.S. Derivatives Clearing Organizations

I turn first to the proposed rule on registration with alternative compliance for non-U.S. DCOs.

This proposal addresses the registration of non-U.S. DCOs that clear swaps for U.S. persons.  The CFTC has almost two decades of experience overseeing non-U.S. DCOs engaging in activity in U.S. derivatives markets.  LCH Ltd was the first non-U.S. DCO to register with the CFTC 18 years ago.  Other CCPs became registered after the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act).[4]  Through its supervisory powers, the CFTC has informally calibrated its day-to-day oversight of these registered DCOs based on the principle of deference to the oversight of primary regulators, while taking into account the specific circumstances of a particular non-U.S. DCO.

The main purpose of this rulemaking is to address the current informality of the CFTC’s approach and, in doing so, introduce significant additional areas where the CFTC can defer, appropriately and consistent with its risk oversight responsibilities, to non-U.S. DCOs’ home country supervisors.  Among other things, this proposal sets forth a framework under which non-U.S. DCOs that do not pose a substantial risk to the U.S. financial system would have the option of being fully registered with the CFTC as a DCO but meet their registration requirements through compliance with their home country requirements. 

These DCOs that are “fully registered with alternative compliance” would still be able to offer customer clearing through futures commission merchants (FCMs), just like other fully registered DCOs.  Consistent with the commitment to apply supervisory deference under Title VII of the Dodd-Frank Act where appropriate, the home country regulator would have supervisory primacy over these DCOs with the CFTC much more narrowly focused than is currently the case, from both a legal and practical perspective, on U.S. customer funds protection at these DCOs.  This narrow focus on customer funds protection is appropriate to help ensure the legal requirements relating to segregation at both the FCM and DCO level are met, and that, if necessary, the bankruptcy protections afforded to customers under the CFTC’s FCM model work as intended. 

In determining whether a non-U.S. CCP potentially poses “substantial risk to the U.S. financial system,” the proposal would use objective criteria and provide transparency about such criteria.  The proposed definition of substantial risk to the U.S. financial system consists of two 20 percent tests.  The first focuses on the percentage of initial margin from a “U.S. origin” (i.e., initial margin posted by U.S.-domiciled clearing members and clearing members ultimately owned by U.S.-domiciled holding companies, regardless of the domicile of the clearing member) at a specific non-U.S. DCO.  The second focuses on the “U.S. origin” business of the non-U.S. DCO as a percentage of the overall U.S. cleared swaps market.  Where both of these “20/20” thresholds are close to 20 percent, the Commission would be able to exercise discretion in determining whether the DCO poses substantial risk to the U.S. financial system. 

I believe that objective and transparent criteria, such as the ones set forth in the proposal, are what all regulators around the world should strive for to provide appropriate predictability and stability to the markets.

Supplemental Proposal on Exemption from Derivatives Clearing Organization Registration

I next turn to the proposed rule addressing exemptions from registration for non-U.S. DCOs. 

The proposal would provide a non-U.S. DCO that does not pose a substantial risk to the United States, and that is subject to “comparable, comprehensive supervision and regulation” by appropriate regulators in the DCO’s home jurisdiction, the option to be an exempt DCO.  This proposal supplements regulations proposed by the Commission in August 2018 that would codify the policies and procedures that the Commission is currently following with respect to granting exemptions from registration as a DCO.[5]  The proposal is grounded in section 5b(h) of the Commodity Exchange Act,[6] which provides that non-U.S. clearing organizations that are subject to “comparable, comprehensive supervision and regulation” by a home country regulator are eligible for an exemption from DCO registration.[7]

Unlike the current CFTC approach to exempt DCOs, the proposal would permit exempt DCOs to offer customer clearing to U.S. eligible contract participants – i.e., non-retail customers – through foreign clearing members that are not registered as FCMs.  To be eligible for this exemption, the DCO and the FCM would be required, among other things, to provide clear and succinct disclosure to U.S. eligible contract participants on the bankruptcy protections that would be afforded to them under relevant non-U.S. law.  To facilitate this proposal, the Commission also is proposing to allow persons located outside of the United States to accept funds from U.S. persons to margin swaps cleared at an exempt DCO, without registering as FCMs.

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

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

I thank CFTC staff for their fine work that resulted in today’s proposal.  I look forward to reviewing comments from the public.

Conclusion

My thanks to my colleagues, Commissioners Brian Quintenz, Rostin Benham, Dawn Stump, and Dan Berkovitz.  Today’s rule proposals, as with most everything we have done together, have benefitted from your thoughtfulness and intelligence. 

This will be our last public meeting together as a Commission.  I thank each of you for your dedication and commitment to the CFTC mission.  It has truly been a pleasure to serve with you.

I have had the profound honor to lead this fine agency for thirty months now.  In my time as skipper, I have strived to set the agency off in a smooth course toward a clear horizon under an honest and capable crew. 

I hope that my time at the helm will be known for intellectual depth, paradigm resetting, and policy recalibration.  I hope it will be considered a time for winning of hearts and minds among market participants in both agriculture and financial communities and with other regulators here in America and on the global stage.  I hope it will be seen as a time of international cooperation while championing American markets and upholding U.S. regulatory sovereignty.

Perhaps more importantly, I trust our work will be recognized for its human touch and professionalism and the building of trust among the Chairman, the Commissioners, and our fine agency employees, as well as with our stakeholders in Congress and the markets we oversee.  I believe that today the CFTC is known widely to act in a forthright and candid manner, displaying leadership when appropriate and thoughtfulness and due consideration at all times.  I know that the CFTC’s reputation as a trusted and worthy counterparty will be reinforced by the pivotal actions taken today.

If I have been consistent in anything in my time on deck, it has been in asserting the value proposition of free market capitalism.  The proposition that broad and sustained prosperity generally occurs here in America and, in fact, anywhere in the world where there are open and competitive markets, free of political interference, combined with free enterprise, personal choice, voluntary exchange and legal protection of person and property.

This value proposition is a source of human expression, aspiration, and creativity. Freedom of choice is a social good in its own right, a moral and economic imperative.  Life, liberty, and the pursuit of happiness are about the freedom of the individual – not just moral or political freedom – but economic freedom as well, freedom to live in a self-directed manner and conduct honest commerce as one may determine.

Under free market capitalism, well-regulated and well-ordered trading activity is a forum of human self-expression and economic advancement.  Freedom to act in the marketplace is a part of freedom itself.  Billions of market actors, following their own self-interests and individual needs, make the decisions that direct the future, not have it directed for them.

It is not the role of the federal government to restrict liberty, but to safeguard it.  It is not the role of market regulation to constrain the free market, but to enhance it. 

Regulators enhance free markets through greater market intelligence, sound and data-driven policy prescriptions, and determined enforcement against fraud, manipulation, and misbehavior.  They also do so through an approach to cross-border market regulation that is risk-based and committed to deference to competent regulatory authorities.  It is this vision of market regulation that we have striven to embody and proclaim at the CFTC.

As I leave you today, I unabashedly encourage staying the course of free market capitalism – a course that is unmatched in reducing global poverty, sustaining prosperity and unlocking human potential.  No other system else even comes close to elevating the human condition.

Let us be not afraid.  Rather, let us set sail to a future of human aspiration.  A future where economic expression and market participation are of social value all by themselves – and good for us all.

It is a bright future, indeed.  The course is set.

Now, with a spirit of gratitude and heart full of affection, I thank you and say…

Farewell.

Statement of Commissioner Dawn D. Stump for the CFTC Open Meeting, July 11, 2019

Open Meeting on: 1) Proposed Rule – Registration with Alternative Compliance for Non-U.S. Derivatives Clearing Organizations; and 2) Supplemental Proposal – Exemption from Derivatives Clearing Organization Registration

July 11, 2019

Overview

In responding to the financial crisis, both the Group of 20 Nations (G-20) and the U.S. Congress recognized that the derivatives markets are global and in doing so provided for international coordination and a practical application of regulatory deference.  I want to commend the Chairman for his leadership in reminding us of the global commitments made in 2009 and the subsequent efforts Congress made to encourage global regulatory harmonization.  Specifically, the G-20 leaders stated the clear responsibility we have “to take action at the national and international level to raise standards together so that our national authorities implement global standards consistently in a way that ensures a level playing field and avoids fragmentation of markets, protectionism, and regulatory arbitrage.”[1]  More directly related to the subjects before us today, Congress, in the Dodd-Frank Act, amended the Commodity Exchange Act to provide: “The Commission may exempt, conditionally or unconditionally, a derivatives clearing organization from registration … for the clearing of swaps if the Commission determines that the derivatives clearing organization is subject to comparable, comprehensive supervision and regulation by… the appropriate government authorities in the home country of the organization.”[2]

I believe deference to comparable regulatory regimes is essential.  Historically, such deference has been the guiding principle of the CFTC’s approach to regulating cross-border derivatives.  We cannot effectively supervise central counterparties (CCPs) in every corner of the world.  We can, however, evaluate the regulatory requirements in a CCP’s home country to determine if they are sufficiently commensurate to our own.  We will never have the exact same rules around the globe.  We should rather strive to minimize the frequency and impact of duplicative regulatory oversight while also demanding high comparable standards, just as Congress intended.

Had we previously established a more comprehensive structure for those comparably-regulated, foreign CCPs seeking to offer swaps clearing to U.S. customers, then CCPs wishing to seek an exemption would have been able to do so under a regime that Congress provided for in the Dodd-Frank Act.  Alternatively, those that wanted to register as a DCO would have done so voluntarily in response to a business rationale demanded by their clearing members and customers.  However, by not having previously established an exemption process, the CFTC left only one path for customer clearing on non-U.S. DCOs, which resulted in compelling several non-U.S. CCPs to become dually registered with both their home country regulator and the CFTC.

As a result, relationships with our global regulatory counterparts became strained, and there have been many unfortunate consequences such that now we must provide new ground rules.  So today, we are advancing an overdue conversation on applying international regulatory deference through the establishment of a test to identify non-U.S. CCPs that pose substantial risk to the U.S. financial system.  To be clear, neither of the proposals we are considering today would be available to DCOs that pose such risk.  I fear that this point may be lost or confused by the fact that we are presenting these as two separate rulemakings.  While I would have preferred a single rulemaking to alleviate any confusion, I want to make clear that we are simply proposing two regulatory options, each of which is only available to those DCOs that do NOT pose substantial risk to the U.S. financial system under the proposed test.  I encourage commenters to provide input on the proposals as if they are a single package, particularly where the request for comments in one proposal may be relevant or more applicable to consideration of the other proposal.

These proposals are a step towards achieving the goals established in 2009 – an effort I wholeheartedly support.  However, I have concerns that these proposals may be a bit too rigid to pragmatically facilitate increased swaps clearing by U.S. customers, as we are committed to do by the original G-20 and Congressional directives.  Under the Alternative Compliance proposal, non-U.S. DCOs can permit customer access only if a futures commission merchant (FCM) is directly facilitating the clearing while the other available option -- provided for in the Exempt DCO proposal -- completely disallows the FCM from being involved in customer clearing.  While I recognize that the blunt nature of these bright line distinctions makes it easier to regulate, I worry that it may not be workable in practice.  I support putting these proposals out for public comment in hopes that those who participate in these markets and who are expected to apply the new swap clearing mandates will be able to lend their voices to the discussion.  However, I anticipate that the elements left unaddressed in these proposals, which are detailed in the requests for comments, may require a re-proposal at some future date.  Nonetheless, if that is to occur we will be well served to have that discussion with the benefit of public comments.

Registration with Alternative Compliance for Non-U.S. DCOs

This proposal is designed to more clearly spell out how we would provide regulatory oversight for those clearinghouses that do not pose substantial risk to the U.S. financial system and that may obtain Alternative Compliance by demonstrating fulfillment of statutorily-established core principles.

Unfortunately, the proposal fails to address, and in my opinion may even worsen, a challenge of great concern to this Commission – the increased strain on our registered FCMs.  Under the Alternative Compliance proposal, any non-U.S. DCO seeking to apply the regime would be required to do so ONLY through clearing members that are FCMs, and may not do so through an affiliate of the FCM in the home country that is already acting as a clearing member of the DCO.  This is the status quo, and frankly it often makes very little economic sense for both the FCM and its affiliate to be capitalizing a clearinghouse simultaneously.  Consideration should be given to the efficiency of utilizing an affiliated entity, which would allow this to be a business decision between FCMs and their customers, rather than a regulatory impediment to sustaining FCMs that play a critical role in cleared derivatives markets.

It is costly for an FCM to join any clearinghouse and may be especially uneconomic if the FCM only has a few customers who wish to access a particular non-U.S. DCO.  It may make more sense to structure the arrangement with the assistance of a non-U.S. affiliate, already actively participating as a member of the DCO.  To do otherwise limits U.S. customer choice and access to clearing of the product in a foreign jurisdiction, which seems at odds with the reform agenda of encouraging clearing – mandated or not.

To be clear, two affiliated entities may each be subjected to risk mutualization obligations at the same CCP, and unfortunately, this proposal does not discuss how we might address this duplicative burden.  Rather, we are requesting comment in the separate Exempt DCO proposal about how this problem might be addressed through an affiliate guarantee arrangement such that an FCM could potentially participate as a “special” member whose obligations to the DCO could be guaranteed by its non-FCM affiliate acting as a “traditional” member of the DCO.  I hope commenters will consider and discuss this concept in the context of the proposed Alternative Compliance regime where it is more applicable to CFTC-registered FCMs at non-U.S., CFTC-registered DCOs.  I hope that commenters will also provide other potential solutions to help alleviate undue burdens on FCMs and their customers in the context of the Alternative Compliance proposal.

As a Commission, I believe we are all concerned about the consolidation these clearing service providers are already experiencing and the constraint on the availability of clearing services for market participants.  I hope we will be able to avoid policies that unnecessarily challenge the economics of, or otherwise impede, operating as an FCM.  Otherwise, we might find that our mandate to increase swaps clearing is futile: Simply put, the clearinghouses don’t work without clearing members and so we must seek to preserve both.

Exemption from DCO Registration

The CFTC implemented the clearing elements of the G-20 principles before other regulatory jurisdictions, and in that context determined that any non-U.S. CCP wishing to clear swap products for U.S. customers must become a fully registered DCO.  Today, we can re-assess based on fellow international regulatory authorities having now implemented their own comparable reforms, thus aligning many of our regulatory principles, just as the G-20 envisioned.  Notably, in authorizing the CFTC to implement these G-20 principles, Congress recognized that consistency, not duplication, is the goal and therefore provided authority in the Dodd-Frank Act to exempt, conditionally or unconditionally, a non-U.S. CCP from registration as a DCO if the CFTC determines that the entity is subject to comparable, comprehensive supervision and regulation by its home country authorities.  Certainly, individual CCPs around the world should be able to seek registration with the CFTC to clear swaps for U.S. customers if they determine that is appropriate based on their individual commercial interests and the demands of their clearing members and end users; but, it is time to revisit the policy rationale of compelled DCO registration for comparably and comprehensively regulated non-U.S. CCPs.

Under this proposal, non-U.S. CCPs that do not pose substantial risk to the U.S. financial system will have another option for offering swap clearing services to U.S. customers in that they may request an exemption from registration, as provided by the Dodd-Frank Act.  I appreciate that this may raise concerns by some, and I welcome public input on how best to address any such concerns.  However, I would be remiss if I failed to point out that the G-20 leaders recognized in 2009 that we should not ignore the global nature of derivatives markets, a fact even more relevant today as U.S. persons increasingly need access to clearinghouses around the world.  Contributing to this increased demand is the fact that during the past decade international regulatory bodies, including the CFTC and pursuant to the G-20 principles, have expanded the obligations for market participants to utilize clearing.  It is not fair that we mandate and encourage the adoption of derivatives clearing and then limit access to, or severely hamper efficient operation of, such clearing services.

While I am therefore pleased to see this exemption process advancing, I maintain reservations about the lack of optionality for registered FCMs to engage in clearing services for their customers at an Exempt DCO.  Once our agency has determined that an Exempt DCO is subject to regulation that is comprehensive and comparable to our own, then the arrangement by which a U.S. person may access the Exempt DCO should be a business decision between the customer and their preferred clearing member, which may well be an FCM.  I very much want to hear from commenters on how we might accomplish this going forward.  We have extensive history in allowing such arrangements for U.S. futures clients of CFTC-registered FCMs to access non-U.S. DCOs.  I am certain that the public input will assist us in determining how a clearing structure that works for futures customers might sensibly be extended to swaps customers.

I would remind commenters that only sophisticated market participants qualify as eligible contract participants able to enter into swaps (other than on a designated contract market).  We need to assist these qualified U.S. market participants and their clearing members not only by providing access, but by pragmatically preserving their ability to enter into prudent business arrangements that they deem most appropriate for their operations and business needs.  While prohibiting FCM participation on Exempt DCOs, as we are proposing today, is designed for simplicity, the realities of clearing arrangements and the bankruptcy treatment that applies to them are complex.  I fear that ignoring that fact may render the Exempt DCO option with less appeal than I believe it is due and that Congress contemplated.  I am confident that the tremendous institutional knowledge at this agency, coupled with public input, will enable us to design a workable solution, but it may not be the bright line test envisioned by this proposal.

Closing

At the beginning of this year I penned an opinion piece in the Financial Times[3] in which I attempted to appeal to our international regulatory partners to recommit to a coordinated approach, ensuring that our alliance remains strong rather than fractured.  Regulatory conflicts are at odds with our shared mission and do a disservice to global market participants.  I am committed to advancing a coordinated approach, and I believe the proposals we are putting forward today are a first step in that process.  There is, however, more work to be done both in the way of the CFTC extending deference to other jurisdictions and vice versa.  I hope our international regulatory partners will also take the opportunity to reset and recognize that our shared interest of advancing derivatives clearing is best achieved by respecting each jurisdiction’s successful implementation of the principles agreed to ten years ago.  Otherwise, it might unfortunately become challenging to advance the concept of deference under consideration today to the next stage of the process.

Finally, I would like to express my sincere thanks to the staff of the Division of Clearing & Risk and the rest of the team that have worked so hard on the proposals that we are considering today.  The interplay between these proposals has presented particular challenges, and I am most appreciative of staff’s diligence and responsiveness in addressing our comments and questions.

Statement of Commissioner Dan M. Berkovitz Regarding the Proposed Amendments for Customer Margin Rules for Security Futures

July 9, 2019

I support issuing the joint notice of proposed rulemaking (“Proposal”) with the Securities Exchange Commission (“SEC”) (collectively with the CFTC, “Commissions”) to amend the security futures margin requirements.

In 2000, Congress passed the Commodity Futures Modernization Act (“CFMA”) which permitted security futures trading.[1]  The CFMA provides that customer margin requirements for security futures shall be set at levels that: (1) require (a) consistency with the margin requirements for comparable exchange-traded options and (b) margin levels not lower than the lowest level of margin, exclusive of premium, required for any comparable exchange-traded options, (2) preserve the financial integrity of markets trading security futures products, (3) prevent systemic risk, and (4) are and remain consistent with certain margin requirements established by the Federal Reserve Board under its Regulation T.[2]

The Proposal would decrease the required minimum margin from 20 percent to 15 percent of the current market value.  The Proposal reasons that amending the minimum required margin reflects the current stress level percentage of 15 percent set for unhedged exchange-traded options in self-regulated organization risk-based portfolio margining programs.[3]  This action would increase consistency in the markets by bringing the margin requirement for security futures held outside of a securities portfolio margin account into alignment with the margining for security futures under risk-based portfolio margining methodologies.[4]

The 20 percent level was originally set by the Commissions in 2002.  Markets have evolved since that time and it is appropriate to reconsider the margin level in light of the subsequent adoption of the risk-based portfolio margining programs.  In doing so, the Proposal has followed the statutory mandate to set the security futures margin requirement at levels consistent with, and not lower than, levels for similar options.   

In conclusion, I commend the joint work by the Commissions’ respective staffs in preparing the Proposal.  The Proposal represents an opportunity for the Commissions to gain more knowledge about the security futures markets, reevaluate the status quo, and establish a more effective regulatory standard.  I look forward to public comments in response to the Proposal, particularly comments that provide additional data and analysis regarding the appropriateness of the 15 percent level under each of the statutory factors the Commissions must consider.

Statement of Commissioner Brian D. Quintenz Regarding DSIO Staff Report on the Swap Dealer De Minimis Exception

July 8, 2019

In connection with the Commission’s adoption of a permanent $8 billion gross notional de minimis threshold in November 2018, the Chairman directed staff within the Division of Swap Dealer and Intermediary Oversight (DSIO) to continue their analysis of possible alternatives for the de minimis exception, including the impact of removing cleared swaps. The staff report issued today elucidates two fundamental facts about the de minimis exception. First, the report shows that the removal of exchange-traded[1] and cleared swaps from the de minimis calculation would result in no reduction of regulatory coverage. Second, the report highlights once again the glaring deficiencies of using notional value as the registration threshold triggering swap dealer registration.

With respect to the first point, the report measures the estimated “regulatory coverage” of the market – that is, the percentage of the market subject to swap dealer regulation – under various “exclusion scenarios.”[2] Under the existing $8 billion de minimis threshold, staff estimates that 99.95% of the baseline $221 trillion swaps market is subject to swap dealer regulation.[3] The report shows that when exchange-traded and cleared swaps are excluded from the de minimis analysis, that percentage remains unchanged – 99.95% of the market continues to be covered by swap dealer regulation.[4] The regulatory coverage of the market remains the same because, although exchange-traded and cleared swaps represent a significant amount of activity, applying the $8 billion de minimis threshold to uncleared activity captures the same universe of swap dealers.

The report clearly demonstrates that exchange-traded and cleared swaps can be removed from an entity’s swap dealer analysis without sacrificing the regulatory protections that are at the core of the Commission’s swap dealer regime. The Commission has already opened up the door to excluding this type of activity from the de minimis calculation through its recent floor trader no-action letter, which allows proprietary trading firms to exclude exchange-traded and cleared swaps from their de minimis calculations if they register as floor traders and comply with minimal swap dealer regulatory requirements.[5] The Commission should revise its regulations to make this policy applicable to all market participants, not just a select few.

With respect to the second point, the staff report clearly demonstrates that notional value is a poor measure of activity in the swaps market. This is evidenced by the comparison of the impact that removing exchange-traded and cleared swaps has on notional coverage, relative to the impact that removing those swaps has on transaction and counterparty coverages.[6] If exchange-traded and cleared swaps are excluded, notional coverage decreases from $221trillion to $127.8 trillion (57.80% of the baseline market).[7] However, when you apply the same exclusions to transaction coverage, the number of covered transactions only declines from 3.8 million to 3.22 million (84.70% of the baseline market).[8] Similarly, when excluding exchange-traded and cleared swaps, counterparty coverage only decreases from 30,879 to 30,631 (88.09% of the baseline market).[9]

The impact of these exclusions on notional coverage is dramatically more severe than on transaction and counterparty coverages. The disparate impact demonstrates that notional value is a poor measure of a firm’s activity in the market and that relying solely on notional amounts as the basis for triggering swap dealer registration may result in instances of “false positives,” whereby firms with a relatively small footprint in the marketplace are nonetheless required to register. In my view, the Commission should move away from using notional value in its registration thresholds and move toward adopting metrics more representative of an entity’s actual size and risk in the market.

Today’s report is a step in the right direction. I would like to thank DSIO staff for their commitment to providing the Commission with the information and analysis it needs to make data-driven policy decisions. I believe DSIO’s staff report will help further inform and guide the Commission’s consideration of the de minimis exception.                      

Statement of Commissioner Dan M. Berkovitz in Support of the Staff No Action Letter Regarding Floor Traders

June 27, 2019

I support today’s issuance by the Division of Swap Dealer and Intermediary Oversight of the letter entitled “No-Action Relief for Certain Conditions of the Floor Trader Provision.”  Since my first public statement as a CFTC Commissioner in November 2018, I have urged us to fix the floor trader provision in the swap dealer definition so that it can serve its intended purpose.[1]

Swap trading is highly concentrated.  The five largest swap dealing banking institutions were party to 70% of all swaps and 80% of the total notional amount traded.[2]  Expanding and diversifying the sources of liquidity should improve price discovery and the safety and resiliency of the swap markets.

Many proprietary traders have indicated that they would like to act as market makers for swaps on electronic swap execution facilities (“SEFs”) or designated contract markets (“DCMs”).[3]  These traders generally do not directly solicit customers in the manner of traditional swap dealers.  To facilitate this type of market making on SEFs and DCMs, the Commission included a floor trader registration provision in the swap dealer registration rule as an alternative to full swap dealer registration.[4]  I believe the floor trader registration category is appropriate for proprietary traders who provide liquidity on electronic trading platforms, but in so doing, do not act as traditional dealers by soliciting customers or negotiating swap terms other than price or quantity.

The current floor trader rule has not worked as intended.  Potential sources of liquidity have not entered into these markets due to concerns about the potential breadth of the restrictions in the current provision.  Addressing the issues with the existing rule will diversify the available sources of liquidity beyond the few large bank dealers that dominate swap trading today.

In the long run, a rulemaking to amend the swap dealer definition is the best way to fix the issues with the current rule.  Chairman Giancarlo has agreed to direct the CFTC staff to draft a proposed amendment to the floor trader provision that is consistent with the scope of today’s no action relief.  However, rule amendments take time, so in the interim, I support the issuance of this no action letter.

Notably, today’s no action relief is limited to cleared swap activities conducted on a SEF or DCM.  Other off-facility or uncleared swaps that meet the definition of dealing swaps will still count towards the swap dealing registration threshold for these traders.

I thank the staff of the Division of Swap Dealer and Intermediary Oversight for their excellent work and collaboration with my office on this matter.