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

May 15, 2019

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

Statement of Commissioner Dawn D. Stump on the Certification of ICE Futures U.S., Inc. Submission No. 19-119

May 15, 2019

ICE Futures U.S., Inc. (“IFUS”) seeks to implement new Passive Order Protection (“POP”) Functionality in its Gold Daily and Silver Daily futures markets.[1]  It has submitted the POP Functionality, or “speed bump,” to the Commission pursuant to the self-certification provisions of Sections 5c(c)(1)-(3) of the Commodity Exchange Act (“CEA”)[2] and Commission Regulation 40.6.[3] 

I strongly support the Commission’s self-certification process.  Pursuant to that process, an exchange – as a self-regulatory organization responsible for the operation of its own markets – can implement a new or amended rule (which includes, among other things, trading protocols and terms and conditions[4]) on a prompt basis (generally 10 business days or, in some cases, an additional 90 days) if:  1) the exchange provides the Commission with a written certification that the change “complies with” the CEA and Commission regulations; and 2) the Commission does not object “on the grounds that it is inconsistent with” the CEA or Commission regulations.    

This is the first time that a futures exchange has self-certified speed bump functionality.  Commenters, including IFUS, have presented competing predictions of the anticipated effects of implementing this functionality.  Yet, no reliable data or empirical analysis actually exists.  I am unable to conclude within the bounds of the self-certification standard prescribed by the CEA that, notwithstanding IFUS’ certification of compliance, this speed bump for the IFUS Gold Daily and Silver Daily futures markets is inconsistent with the CEA or the Commission’s regulations.

That determination, however, must always be based on the specific facts and circumstances of a given market (e.g., the product, number of participants, and market depth or liquidity), and the particular attributes of the proposed speed bump (e.g., three milliseconds in this case).  IFUS, in the first instance, is responsible for determining that its trading functionality for a particular market complies with the CEA and the Commission’s regulations.  It is my expectation that if IFUS seeks to implement a speed bump in any other market, and/or on any other terms, it will self-certify that determination to the Commission pursuant to the self-certification process.[5]    

Statement of Commissioner Brian D. Quintenz on the Certification of ICE Futures U.S., Inc. Submission No. 19-119

May 15, 2019

“The year was 2081, and everybody was finally equal. They weren’t only equal before God and the law.  They were equal every which way. Nobody was smarter than anybody else. Nobody was better looking than anybody else.  Nobody was stronger or quicker than anybody else. All the equality was due to the 211^th, 212^th, and 213^th Amendments to the Constitution, and to the unceasing vigilance of agents of the United States Handicapper General.”

-Introduction to Harrison Bergeron, by Kurt Vonnegut, Jr.

The story of Harrison Bergeron is one of downward equality.  It is a story of penalizing advantages in order to equalize at the lowest level.  The strong slung multiple hundred pound sacks around their shoulders.  The beautiful wore hideous masks to disguise their features.  The smart had government-issued earpieces which delivered endless, piercing noises to scramble their thoughts.

The results were predictable.  Artistic performances became debacles.  Newscasts became unintelligible.  Family discussions became fishbowl dialogues. What was not described in the story was the state of the country’s economy or its markets.  One could only imagine.

The Commodity Futures Trading Commission (CFTC) is now confronted with a small, but precedent-setting exchange rule-filing that seeks to “equalize downward.”  Its potential ramifications on the perpetual forces of efficient market evolution are profound.

The Commodity Exchange Act (CEA) lists 23 “Core Principles” that Designated Contract Markets (DCMs, or exchanges) must follow. Each exchange, in adopting things like rules governing trading or the listing of new contracts, must certify that those rules meet all of the CEA’s core principles.  The CFTC, as a principles-based regulator, has given exchanges wide latitude in interpreting those core principles.  This process has worked well and for the benefit of markets – the potential political considerations of regulators are diminished and the exchanges are empowered to more freely and quickly respond to a dynamic marketplace.

However, there are, and need to be, limits to core principle interpretation.

A recent self-certified filing by an exchange seeks to implement a “speed bump” in its markets, but only for certain types of orders.[1]  The speed bump would halt an incoming order that would otherwise match with a resting order, thereby giving the resting order a small time window to be adjusted and avoid execution.  The speed bump’s effect would be to preclude a firm with faster networks from using its speed advantage to trade on market information by matching with resting orders.

The goal of financial markets is not to protect or shelter the less informed. Rather, the market incentivizes being informed and executing on that knowledge.  In other words, market efficiencies are earned - they are created through research, investment, and intellectual property.

Risk (and reward) move at the speed of information.  Those that invent, and invest in, faster information transmission technologies to capitalize on market dislocations reap the profits of their advantage.  That process enhances market efficiency – market prices more immediately reflect value-changing events, the advantaging inventions usually become more widespread after the robust early adoption by the sector where the rewards are the greatest, the gains available to further enhancing efficiency remain, and new rounds of innovation are undertaken.  The virtuous cycle of profit motivation, innovation, reward, and enhanced market efficiency have created the most liquid, technologically advanced, accessible, and instantaneously responsive markets in the world.

Profiting from innovations in the speed of information transmission has long been a driving force behind the communications revolution and market efficiency evolution.  In 1790, upon learning of Congress’ potential passage of Alexander Hamilton’s proposal in which the federal government would purchase the Revolutionary War debts issued by the states and the Continental Congress, traders chartered the fastest ships they could find to sail to ports and buy up the cheap debt before news of the law reached those cities.[2]  In the early 1800’s, carrier pigeons were employed to bring news from European ships docking in Nova Scotia back to Boston – stage coaches were then sent to New York to transmit that tradable intelligence.[3]  In the 1830s, William C. Bridges tried to cut out the pigeon, ship, horse, and stagecoach news transmission network all together.[4]  Instead, he operated a private signal network between New York and Philadelphia which consisted of a series of boards on poles mounted on hills which could be seen by telescope from each successive pole station.[5]  Bridges’ system transmitted stock market news between those cities within 10-30 minutes, cutting the normal two-day stagecoach news cycle by 99%.[6]

Yet, Bridges’ system was made obsolete a few years later by the telegraph, whose first customers were, unsurprisingly, stock brokers.[7]  Ultimately, the investments which Western Union made in expanding its telegraph network across the United States were funded through the profits from the financial community’s early adoption of its technology.[8]  In 1887, Western Union’s president claimed that 87% of its revenue came from stock and commodity traders.[9]

Imagine the lack of innovation of, and investment in, information transmission and distribution if the stock markets (with the backing of the government) imposed a two-day trading “speed bump” in the 1830s so that Bridges’ lucrative visual signal system was rendered ineffective.  How much of an incentive would have been removed from spurring the telegraph’s invention and adoption?  How long would it have delayed a country-wide communications network which was funded through profits from the trading community’s expenditures on that new technology?

Further, and more appropriate to this specific rule filing, had a two-day trading delay been implemented, what type of after-the-fact data analysis could have ever proved its negative impact on technological advancement?  I remain concerned that, even with the agency’s good intentions of a future data-driven analysis of this or additional speed bumps, the most important verdict for which we must answer – the potential negative impact or outright preclusion of technological advancement and corresponding market efficiency evolution – could never be conclusively stated. No amount or kind of data can ever prove a negative.

I have registered my objection to this self-certification with the Secretariat.  I also call on the Commission to develop and put forward regulations around Core Principle 9, which states, “[t]he board of trade shall provide a competitive, open, and efficient market and mechanism for executing transactions that protects the price discovery process of trading in the centralized market of the board of trade,”[10]  such that market efficiency concerns around speed bumps, asymmetric or two-sided, can be more clearly articulated.

The evolution of market efficiency elevates the status quo. It “equalizes up.” Shame on us if we advantage the opposite.

Remarks of CFTC Director of Division of Swap Dealer & Intermediary Oversight Matthew Kulkin at New York City Bar Association

May 14, 2019

Good evening.  Thank you to Gary Kalbaugh and the Futures and Derivatives Regulation Committee for having me tonight.

These views are my own and do not represent the views of the Commodity Futures Trading Commission (“CFTC” or “Commission”), our Chairman, any of the Commissioners, or staff.

About the Division of Swap Dealer & Intermediary Oversight

The Division of Swap Dealer & Intermediary Oversight (“DSIO” or “Division”) is one of three policymaking divisions supporting the Commission.  We have about 75 lawyers, examiners, accountants, economists, and risk analysts working in Chicago, Kansas City, New York, and Washington, D.C.

DSIO has primary oversight responsibility over derivatives market intermediaries, including commodity pool operators (“CPOs”), commodity trading advisors (“CTAs”), futures commission merchants (“FCMs”), introducing brokers (“IBs”), major swap participants (“MSPs”), retail foreign exchange dealers (“RFEDs”), swap dealers (“SDs”) (collectively, “Registrants”), and the associated persons of the foregoing, as well as designated self-regulatory organizations (“SROs”).

As part of its oversight, the Division develops and monitors compliance with regulations addressing registration, business conduct standards, capital adequacy, and margin requirements for SDs and MSPs.  The Division also oversees the registration and compliance of the other intermediaries I just listed and futures industry SROs, including U.S. derivatives exchanges and the National Futures Association (“NFA”).

In many ways, although perhaps not easily visible to market participants, DSIO staffers are the “front line” CFTC employees working to protect customer funds, identify and mitigate systemic risk, and promote market integrity.

Last year, at my direction, DSIO staff – from all of our offices and across disciplines – adopted a Division mission statement:

DSIO’s mission is to protect derivatives market users and their funds by ensuring the financial integrity, fitness, and fair business conduct of derivatives market intermediaries.

DSIO achieves its mission by:

• examining intermediaries and designated self-regulatory organizations;
• maintaining appropriate standards for registration of intermediaries;
• providing expertise to the Commission in its promulgation of rules; and
• issuing concise and timely interpretations and guidance for intermediaries.

Principles for DSIO Rulemakings

Chairman J. Christopher Giancarlo has long spoken about his principles for financial regulation.[1]  In 2014, then-Commissioner Giancarlo laid out six principles that he would follow during his time on the Commission.  More recently, in 2017, then-Acting Chairman Giancarlo announced Project KISS, an “agency-wide review of CFTC rules, regulations, and practices to make them simpler, less burdensome, and less costly.”[2]  DSIO staffers, and market participants, have responded positively to the Project KISS initiative, and we’ve started to see the fruits of this labor, with much more work to be done.

Tonight, I will speak about how our Division approaches financial regulation, and more specifically, how DSIO staff approaches the task of developing new proposed rules or proposed amendments to existing rules.  I’ll address two of our principal guiding factors – regulatory compliance costs and impact to market quality.  And although my remarks will largely focus on DSIO’s work, these observations could easily apply to the work by colleagues in the Division of Clearing and Risk and the Division of Market Oversight.

Balance Policy Interests with the Regulatory Costs and Burdens Imposed

Of the two factors I’ve mentioned, you are probably most familiar with the Commission’s work to consider and balance the compliance costs and regulatory burdens with its underlying policy interests.  DSIO staff has undertaken a comprehensive review of our rules and related guidance.  Similarly, we’ve received a number of suggestions from market participants on ways to improve our regulatory framework and practices.

DSIO has been very busy on this front.  Project KISS has been incorporated into much of our work over the last two years.

• Streamlined Chief Compliance Officer Duties and Annual Reports: In August 2018, the Commission adopted amendments to rule 3.3 related to the duties of chief compliance officers of SDs, MSPs, and FCMs.[3]  These amendments clarified and modified certain requirements for preparing, certifying, and furnishing to the Commission an annual report containing an assessment of the registrant’s compliance activities.  The amendments provide greater clarity regarding the CCO’s reporting line and the CCO’s duties with respect to administering policies and procedures specific to the registrant’s business.  Several of the modifications and clarifications contained in the amendments further harmonize associated CFTC and US Securities and Exchange Commission regulations.
• Reduced Regulatory Burdens Associated with Swap Dealer Segregation Notices: In March 2019, the Commission adopted a final rule modifying a swap dealer’s notice requirement obligations related to the right to elect segregation.[4]
• Provided Relief for Designated Self-Regulatory Organizations: In March 2019, the Commission adopted an amendment to rule 1.52, revising certain minimum standards that a designated SRO must maintain in its financial surveillance program over FCMs.[5]
• Proposal to Codify Certain Commodity Pool Operator and Commodity Trading Advisor Staff Letters: In October 2018, the Commission proposed a series of amendments related to CPOs and CTAs.[6]  This proposed rule, in part, would provide regulatory certainty to market participants by including relief set out in various staff no-action letters directly in the Commission’s regulations.  The proposed changes would also help advance the CFTC’s ongoing effort to harmonize rules with the SEC regulations.  DSIO staff is hard at work incorporating the feedback received into final recommendations for the Commission.

There is much more work to be done.  This includes, as discussed by Mike Gill, the Chairman’s Chief of Staff, at the National Press Club in February 2018,[7] simplifying risk management rules for FCMs and SDs, by providing a more effective programmatic risk management system, and modifying quarterly risk reporting obligations.  We continue to review certain parts of the swap dealer business conduct standards regime, as well as ways to make our CPO/CTA regulation better reflect our statutory objectives.  With all of this work, we prioritize coordination and collaboration with our peers at the SEC to harmonize our requirements for dual Registrants.

We are constantly evaluating how staff can provide a better “customer experience” for our Registrants.  As part of our internal Project KISS assessment, we realized we can do a better job making Division information easily accessible by Registrants and market participants.  In the last few months, DSIO has launched a new website[8] that serves as a resource for the public containing our mission statement, senior staffs’ contact information, as well as links to recent Commission rulemakings, staff letters, NFA resources, and other valuable materials.  DSIO has also worked with our colleagues to improve the CFTC’s staff letter website,[9] making it easier for market participants to search for and locate relevant staff letters.

DSIO will continue to focus on and implement these good government modifications that simplify obligations and reduce unnecessary burdens.  These changes are important and further the Chairman’s goals of a more flexible and durable market framework, all of which leads to more efficient markets and greater economic growth.

Regulations Should Improve Market Conditions and Foster More Liquid Markets

In developing policy recommendations, DSIO spends considerable time evaluating the costs and benefits to market participants, as well as the impact such recommendations may have on market quality.  This evaluation should be continuous.  DSIO expects our Registrants to regularly review and revise their policies and procedures – not just to ensure they demonstrate compliance with our rules – but also to accurately reflect their business.  Firms’ methods constantly evolve to better align with emerging technologies and industry best practices.  In other words, they improve and adapt.

We should do the same.  If our rules have unintended negative consequences, we should address them.  If our rules are unduly impeding innovation and competition, we should reconsider their application.  We, too, should improve and adapt to the constant evolution of our markets.

We should focus our efforts on providing a more supportive framework for deep and liquid markets.  We should make every effort to remove barriers for new entrants and to reduce obstacles for those seeking to access our markets.  We should review parts of our regulatory regime that were written a generation ago and intended for a different market structure, just as we should review those written in response to a crisis to assess their efficacy and determine areas ripe for improvement.

To that end, in addition to the Project KISS initiatives I previously mentioned, the Division has worked, and will continue to work, to directly improve market quality by eliminating unnecessary barriers and removing ancillary regulations that prevent entities from entering the derivatives market. Specifically, over the last two years, DSIO has undertaken a number of initiatives that have had a direct impact on market quality.

Some of these efforts include:

• Removing Barriers for Banks Entering into Customer Swaps in Connection with Loans:  In April 2019, the Commission adopted an exception to the swap dealer registration regime to encourage more insured depository institutions (“IDIs”) to participate in the swap market, increasing the availability of loan-related swaps and helping end-user customers hedge loan-related exposure.[10]  This rule will also allow certain banks to engage in an ancillary amount of dealing without significant hurdles to market entry.
• Relieving Prime Brokers from Certain Swap Dealer Business Conduct Standards:  In March 2019, the Division issued a no-action letter that allows prime brokers to act as a source of liquidity in swaps, particularly FX swaps, without the burden of certain pre-trade disclosure obligations that are difficult to provide in the context of a PB transaction.[11]  Division staff believes this relief will attract more PBs to provide bids and offers in swaps markets, including those trades executed on swap execution facilities.
• Providing Regulatory Certainty in the Face of a No-Deal Brexit:  Over the past few months, DSIO has taken steps to mitigate potential market disruption in the case of a no-deal Brexit.  These measures have included the issuance of staff no-action letters[12] and a Commission interim final rule related to the application of the CFTC’s margin rules.[13]

DSIO is actively considering additional possible recommendations on other similar initiatives that could improve market quality:

• Floor Trader Exclusion for Swap Dealing:  As the Chairman has noted,[14] DSIO continues to review the application of the floor trader exclusion from the swap dealer definition.  DSIO continues to consider how to provide clarifications that assist registered floor traders to provide swaps liquidity.
• Permitted Investments for FCMs.  Similar to the recent Commission order granting an exemption for derivatives clearing organizations’ investment of customer funds in certain euro-denominated sovereign debt,[15]  DSIO staff is considering recommendations for the Commission to grant a similar exemption for FCMs.  DSIO staff is assessing several types of investments and beginning to analyze the appropriateness of sophisticated market participants being able to make commercial decisions with the need for highly liquid, stable investments.
• Phase Five Margin Implementation.  DSIO staff continues to work on Phase Five uncleared margin implementation for September 2020.  The Division is considering various measures related to the large number of firms that may be impacted, evaluating potential relief, and working with global regulators through the Basel Committee on Banking Supervision and the International Organization of Securities Commissions to avoid any potential market disruption.

Conclusion

I began my remarks this evening by sharing DSIO’s mission statement.  Our Division mission very clearly includes supporting the Commission’s stated mission to “foster open, transparent, competitive, and financially sound markets.”  By appropriately addressing regulatory burdens facing Registrants and thoughtfully considering how our rules impact market quality, I believe our work can indeed foster more open and competitive markets.

My challenge to you, the members of the NYC Bar Association, is to identify regulatory barriers that are unnecessarily inhibiting market growth.  As legal counsel, you are uniquely qualified to recognize these provisions, assess whether they may be exceeding the statutory intent and the Commission’s mission, and develop creative solutions.

I look forward to working with all of you.

Keynote Address of Commissioner Dan M. Berkovitz at Energy Risk 2019, Houston, Texas

Improving Energy Derivatives Markets for a Changing Energy Industry

May 14, 2019

Good morning and thank you for the warm welcome.  I would like to thank Ruta Gnedeviciute and Energy Risk for inviting me to speak today.

Before I begin, I am obligated to remind you that the views I express today are my own and do not represent the views of the Commission, its staff, or any of my fellow Commissioners.

I’m very pleased to be here at Energy Risk in my capacity as a CFTC Commissioner.  I first attended this conference in May 2008, when I was working on energy issues as a staffer in the United States Senate.  We have seen some remarkable changes in the energy sector since then.  Today I will talk about how our derivatives markets have responded to these changes.  I’ll also talk about the improvements that we have made in the regulation of our financial and commodity derivative markets.  These developments in our physical and financial markets demonstrate that a vibrant energy sector and strong market regulation go hand-in-hand to benefit American businesses and consumers.  However, our work is not done.  I will also outline for you the policies I believe the Commission should adopt to increase competition in, and access to, the energy derivative markets.

The importance of the energy markets was drilled into me nearly twenty years ago in the Senate, when I was investigating spikes in the price of gasoline in the Midwest.  I was questioning an oil company executive about the effect of mergers amongst the oil majors, and increasing vertical integration in the industry.  Exasperated, the executive said to me, “Your focus on antitrust is all wrong.  The majors can’t control the prices any more.  Those days are long gone.  Energy is now a commodity.  If you want to understand energy prices, you need to understand the energy markets.”  He then said, “Go study the energy markets.  There will be plenty to keep you busy.”

How right he was.  After leaving the Hill several years—and several energy market investigations—later, I became General Counsel of the CFTC, and in August 2018, returned as a Commissioner.  I’ve had the privilege of a front-row seat to observe many of the changes I’ll be talking about today.

A New Age in Energy Supply and Technology

A lot has changed since Energy Risk in 2008.  Back then, crude oil prices had climbed over $130 a barrel, and peak at $147 per barrel about a month later.  Wall Street analysts were predicting they would soon reach $200 per barrel.  Natural gas prices were also volatile and high.  Natural gas spot prices averaged $8.86 per million Btus that same year, and topped out over $13 per million Btu in June.[1]  During the first decade of this century, the energy derivative markets were largely unregulated and scandal-plagued—recall Enron, the Western Power Crisis, and the Amaranth hedge fund.  At that conference, we debated whether the oil price spike was due to a speculative bubble or was a harbinger of “peak oil.”

The financial crisis of 2008 was brewing that spring as well.  The mortgage and housing markets were in turmoil and the collapse of Lehman Brothers—which ignited the financial crisis —was just a few months away.

We have come a long way in the past decade.   Our domestic energy industry has been transformed and we have created a new framework for the regulation of our financial markets.

From traditional fossil fuels to clean, renewable technologies that can help us reduce our carbon footprint, we have witnessed a revolution in our ability to produce affordable energy.  Technological innovations such as horizontal drilling and hydraulic fracturing have enabled the United States to increase its oil production from less than 6 million barrels per day in 2009 to nearly 12 million barrels per day by January 2019.[2]  Shale oil production now accounts for over 60% of total U.S. production,[3] and the U.S. is now the world’s leading oil producer.[4] 

These new technologies have also led the U.S. to become the world’s largest producer of natural gas.[5]  Since 2008, natural gas production has increased by nearly 60%.[6]  Costs to liquefy and regasify liquefied natural gas (“LNG”), as well as to store and ship LNG, are declining.[7]  In 2017, U.S. LNG exports quadrupled,[8] making it a net natural gas exporter for the first time in almost 60 years.[9]  Developments in all segments of the LNG value chain have made LNG more economic and will only further propel demand.    

We have also seen tremendous growth in renewable energy sources.  The generation of energy from solar, wind, and geothermal resources has doubled in the last ten years,[10] while costs have fallen to more competitive levels.  For example, U.S. wind costs have fallen by more than 50% and solar costs by 70%, drawing prices closer to that of traditional fossil fuels.[11]  In the aggregate, renewables account for around a quarter of global electricity generation.[12]  Last month, for the first time, renewables generated more electricity in the United States than coal-fired power plants.[13]

These developments are good news for American consumers and businesses.  They are a testament to the ingenuity and determination of companies like yours that make up our country’s energy industry.  And they demonstrate the potential fruits of a market-based, competitive economy that is founded on property rights and the rule of law.

No industry is more familiar than the energy industry, however, with the boom-and-bust cycles inherent in commodity markets and the need to find ways to manage the price risks posed by changing conditions of supply and demand in these markets.  Derivative instruments such as futures, swaps, and options enable firms to manage these price risks.

It is the responsibility of the market regulators like the CFTC to ensure that the markets for these products are fair, transparent, and competitive, and free from fraud and manipulation.  And the CFTC must be vigilant to ensure that its regulations keep pace with the changes in the underlying markets.

Derivative Markets’ Response to Physical Changes in the Energy Industry

I am the proud sponsor of the CFTC’s Energy and Environmental Markets Advisory Committee (“EEMAC”).  The objective of this Committee is to “advise the Commission on important new developments in energy and environmental derivatives markets that may raise new regulatory issues, and the appropriate regulatory response to ensure market integrity and competition, and protect consumers.”[14]  The Advisory Committee members include a diverse group of commercial end-users, swap dealers, consumers, public interest groups, and the exchanges.  At the EEMAC meeting last month, we heard presentations on how the developments in the physical energy markets are generating an appetite for new risk management tools, and derivatives exchanges are creating new products to satisfy that demand.

For example, due to developments in shale oil production, the Permian Basin in the Southwest region now produces more crude oil than any other region in the country and that trend is projected to continue.[15]  With new pipelines opening up from West Texas to the Gulf Coast and the growth in U.S. crude oil exports, producers are increasingly delivering to export facilities on the coast.  The resulting need to hedge the price of crude on the U.S. Gulf Coast has led ICE and CME to introduce futures contracts for delivery of West Texas Intermediate (“WTI”) crude oil in Houston.[16]

Commercial end users seeking to reduce their environmental footprint also have access to a growing suite of products.  Futures exchanges are offering a growing suite of carbon allowance, renewable energy, and low sulfur gasoil contracts.[17]

In addition, as the U.S. exports a higher volume of crude oil to the rest of the world, the use of WTI futures has increased globally.  Today, 15% of the trading volume in CME’s energy products is executed during non-U.S. hours, compared with just 6% five years ago.[18]  Similarly, as U.S. gulf coast LNG reaches more destinations abroad, Henry Hub is increasingly seen as a global benchmark for natural gas.  And there are now at least six derivative contracts for LNG.  The most established is ICE’s Japan-Korea Marker (“JKM”),[19] which saw more than 17,000 contracts traded in December 2018—a ten-fold increase from the year before.[20]

We also see a shift in how market participants are using derivatives contracts to hedge risk.  The CFTC’s Market Intelligence Branch recently published a report on the impact of U.S. shale oil production on NYMEX WTI futures.[21]  This report noted that over the past ten years, the trading volume and open interest in NYMEX WTI futures contracts has doubled.[22]  However, despite this sharp increase in open interest, we see that it is concentrated over the first two to three years of the futures curve.[23]  Open interest in futures contracts for delivery five or more years into the future has markedly declined.[24]  The report concludes that the shortened production horizon for shale oil has reduced commercial end users’ need for longer dated contracts.[25]  This trend also indicates that there is less speculative interest in the back end of the futures curve, most likely due to abundant oil supply.[26]

The Role of Regulation in the Derivatives Markets

Over the past decade, the regulatory system for our financial and commodity markets has also undergone a remarkable transformation.  Following the collapse of global financial markets in September 2009, the G20 convened in Pittsburgh to establish the principles that the nations of the world would follow to safeguard the global financial system.  The core objectives established by the G20 leaders included raising bank capital standards, increasing central clearing and exchange trading for standardized derivatives, and fostering fair and transparent competition in our financial markets.[27]  Concurrently, the G20 leaders pledged to promote global energy security, the development of clean, sustainable energy supplies, and improved regulatory oversight of the energy markets.[28] 

In 2010, Congress passed the Dodd-Frank Act.[29]  This legislation created a new framework to regulate swaps, which had previously been unregulated.  Congress directed the CFTC to write rules to decrease risk and increase transparency in the swaps market, including the registration of and business conduct standards for the large swap dealers, mandating that certain standardized swaps be cleared and traded on regulated facilities, and requiring that all swaps be reported to a swap data repository.   In addition to broadening its jurisdiction to include swaps, Congress also gave the Commission new tools to prosecute fraud and manipulation.

As a result of this new framework and the CFTC’s implementing regulations, our financial markets are safer and more resilient than they were in 2008.  The mandates for swap dealer registration and swap clearing, trading, and reporting have been applied to large segments of the swaps market.  Today, 105 swap dealers and 23 swap execution facilities are now registered with the Commission.[30]  Almost 89% of interest rate swaps and 96% of broad index credit default swaps are cleared through a central clearinghouse.[31]  Nearly 98% of all swap transactions involve at least one registered swap dealer.[32]

Derivative markets do not always evolve naturally within a given industry.  Compared to the agricultural commodity markets, which date back to the time of the Civil War, our energy commodity markets are of recent vintage.  But this is not because the oil industry had less need to hedge its risks.  Rather it was the belief of John D. Rockefeller and his firm, Standard Oil, at the dawn of the age of oil, that commodity exchanges were a source of price volatility.

It did not take long after “Colonel” Drake drilled the first oil well in 1859, and the oil rush was on in Pennsylvania, for oil markets to develop.  At first, producers and buyers met regularly at specific locations to transact, and these gathering places soon evolved into exchanges.  The Titusville Oil Exchange opened in Pennsylvania 1871, and the National Petroleum Exchange in New York was founded in 1882.  Both exchanges offered oil spot and futures contracts.^[33]  Like markets today, the exchanges thrived when prices were volatile. 

Yet the nascent exchanges developed some very powerful enemies.  Rockefeller and the oil producers believed that speculators who were short selling futures contracts were causing volatility and depressing the price of oil.  So Standard Oil and other members of the Producers’ Protective Association stopped buying or selling on the exchanges, choking off their liquidity.[34]  By the beginning of the twentieth century, the oil exchanges had collapsed.

As one contemporary described it, “the regulation of prices by the Standard has eliminated the speculation in certificates entirely.”[35]  For Rockefeller, it was not free markets, but rather firms acting together to avoid “ruinous competition” and prevent uncontrolled speculation, that stabilized prices and brought benefits to the consumer.  Futures markets for crude oil and refined products would not reappear for nearly a hundred years.

But Rockefeller’s view—that combination and control is preferable to competition and open markets—has been rejected in this country.  In 1890, in response to the prevalence of trusts in oil and other major industries, Congress passed the Sherman Antitrust Act, which prohibited contracts and combinations in restraint of trade.^[36]  Soon after, President Theodore Roosevelt successfully brought suit under the Sherman Act to break up the Standard Oil Trust.  In a later antitrust case, the Supreme Court explained the rationale for the Act’s protection of competition:

[The Sherman Antitrust Act] rests on the premise that the unrestrained interaction of competitive forces will yield the best allocation of our economic resources, the lowest prices, the highest quality and the greatest material progress, while at the same time providing an environment conductive to the preservation of our democratic political and social institutions.  .  .  .  [T]he policy unequivocally laid down by the Act is competition.”[37]

It turned out that Rockefeller also was wrong about the value of the exchanges.  Suffocating the exchanges did not eliminate price volatility.  Boom and bust would continue to plague the oil industry throughout its existence.  But oil firms needed a way to manage this volatility.  Although it would take another 70 years before oil futures exchanges re-emerged, once trading began it did not take long for industry participants to see the utility of these risk-management tools and embrace these markets.        

Improving Competition in Financial and Energy Markets

Today, we recognize the value of competition and free markets.  Among the fundamental purposes of the Commodity Exchange Act, as well as the Dodd-Frank Act, is to foster robust and fair competition in the commodity and financial markets.  Although the Dodd-Frank Act has increased competition in certain markets, there are fewer competitors in several major derivative markets.  Fewer competitors leads to increasing concentration and less dispersion of risk throughout the system.  It also means fewer choices for commercial end users.  We must change this.

De Minimis Swap Dealing

Since joining the Commission, I have focused on promoting competition in our markets.

Last fall, the Commission unanimously voted to permanently set the swap dealer registration threshold at $8 billion.  Our data indicated that setting the threshold at a lower level of $3 billion—as contemplated in the original rule—would not materially increase the amount of swap activity covered by dealer regulation, but would result in fewer entities providing dealing services in amounts below $8 billion.[38]  Many of the smaller entities providing swap dealer services told us that they might stop dealing in swaps if they needed to register as dealers because their limited amount of dealing would not justify the cost of registration.[39]  That would likely leave many end users looking to hedge their risks with very few, if any, dealers to provide competitive pricing.  In other words, there would be less competition for swap dealing services for smaller end users.  I therefore voted to support keeping the swap dealer registration threshold at $8 billion.

Swap Trading Facilities

Last November, the Commission issued a proposal that would overhaul our regulations for swap execution facilities, or “SEFs” (“SEF Proposal”).^[40]  I voted against the SEF Proposal.^[41]

In my view, the proposed changes conflict with the principles of free and open competition that are embodied in the Commodity Exchange Act and the Dodd-Frank Act.  Among other defects, the SEF Proposal would eviscerate the requirement in the Dodd-Frank Act that SEFs establish rules that “provide market participants with impartial access to the market.”[42]  Authorizing discrimination based on the type of entity accessing a SEF will permit the largest bank dealers to trade exclusively with each other.  By denying other firms access to the lower prices in the interdealer market, bank dealers can prevent other traders from competing for customers.  This is inconsistent with one of the central purposes of the Commodity Exchange Act, which is to “promote . . . fair competition among boards of trade, other markets and market participants.”^[43]  Permitting dealers to control the swaps marketplace will mean less favorable prices for commercial end users and other non-bank market participants.

The levels of dealer concentration in the swaps market are already very high.  The largest five dealing institutions are party to about 70% of all reported swap transactions and 80% of the notional amount traded.[44]  Our futures commission merchant data shows that five bank-owned futures commission merchants provide clearing for about 80% of cleared swaps.[45]  The SEF Proposal would lead to even higher levels of concentration, which would reduce competition and increase systemic risk.

I have urged the Commission to consider several other regulatory measures to foster competition and reduce concentration in swaps trading.  These measures include amending the floor trader provision in the swap dealer definition to permit proprietary traders who only trade swaps, and do not have customer relationships with counterparties, to register as floor traders rather than as swap dealers.

I also propose abolishing the practice of name give-up for standardized, cleared swaps.  Requiring non-dealers to disclose their identities— when this is not necessary to manage credit risk—has discouraged non-dealers from participating in exchange-style markets that currently serve only dealers.  Name give-up has contributed to the fragmentation of the swaps market into separate dealer-to-dealer and dealer-to-customer markets, to the detriment of end-users and overall market efficiency.

Finally, I believe the Commission should work with market participants and facilities to enable average pricing for swaps, which would encourage more participation by buy-side asset managers on SEFs.

The bottom line is that we need more diversity of participants in our swaps markets.  Commercial end users and other market participants should not have to go to Wall Street for their swaps services and should be able to access the most competitive prices.  Fixing floor trader registration, abolishing name give-up, and enabling average pricing are not new proposals, but they have languished for years. It is time for the Commission to act.

Clearing and Trading

At the EEMAC meeting last month, we also heard market participants talk about how the current and proposed capital requirements imposed on banks by the prudential regulators are affecting the ability of energy merchants, producers, and consumers to obtain clearing services and cost-effective swaps to hedge or mitigate their exposures.

Bank capital requirements are critical for financial stability and they reduce systemic risk.  But financial market regulation fosters other goals that also mitigate systemic risk, such as increasing the clearing of standardized derivatives and promoting competition in the derivative markets.  Regulators must ensure that their rules work together to support all of these goals.

Since the passage of Dodd-Frank, the CFTC and the prudential regulators have made great progress in consulting and coordinating with each other on financial regulatory issues.  We should continue to work together to ensure that we have strong capital requirements that do not discourage the provision of clearing and other vital risk-management services to end users.

Position Limits

Finally, turning to upcoming Commission rulemakings, our Chairman has indicated that he would like us to consider a position limits proposal by the end of the second quarter.   I look forward to addressing this important issue.

Although we do not yet have a proposal in front of us, I can tell you that I strongly support meaningful position limits to prevent excessive speculation in commodity markets.  The CFTC has a long history with speculative positions limits and the benefits of these limits are well-established.  Speculative position limits can help prevent corners, squeezes, and other forms of price manipulation.[46]

The Hunt brothers’ attempts to corner the silver market, the Ferruzzi squeeze of the soybean market, and the Amaranth hedge fund’s excessively large positions in the natural gas futures and swaps markets are clear examples of why position limits are needed to prevent price distortions that can result from excessive speculation.[47]  These price distortions ultimately harm the end-users and consumers of these vital commodities.

I am equally committed to crafting bona fide hedge exemptions that reflect the characteristics of the energy commodity markets.  The bona fide hedge exemptions in the current rules were based on the agricultural commodity markets.  We have received many comments on the prior proposals that the hedge exemptions in the new rules need to more effectively address how energy contracts are delivered, settled, and used to manage risk.  As the next position limits proposal moves forward, I will consider these comments and work to ensure that hedge exemptions are appropriately tailored to the characteristics of the energy markets.  I look forward to further comments you may have to help us craft effective hedge exemptions.

Conclusion

When I was here eleven years ago, I heard pessimism about the availability and cost of our energy resources, and cynicism about the fairness of our energy markets.  Today, we are optimistic about our future energy supplies.  And through new laws and regulations, we have bolstered the integrity of our energy markets.  Both the private and public sectors have come together to solve problems that once were considered intractable and debilitating.  Our progress should give us reason for confidence and optimism about the future of our energy industry and our markets.  I look forward to attending this conference in the year 2030 to marvel over the incredible things we will accomplish together over the next eleven years to further strengthen our energy industry and its markets.

Remarks of CFTC Chairman J. Christopher Giancarlo at the Futures Industry Association Law & Compliance Division Conference

“The Tao of Derivatives Clearing: Clearinghouse Resiliency, Recovery and Resolution”

May 10, 2019

 

“It produces them and makes no claim to the possession of them; it carries them through their processes and does not vaunt its ability in doing so; it brings them to maturity and exercises no control over them – this is called its mysterious operation.”

 

Tao Te Ching, 51.

 

INTRODUCTION

 

Good morning.  Thank you for your kind welcome.  It is great to be at FIA’s annual gathering of leading legal and compliance professionals overseeing U.S. and international derivatives markets.

 

This will not be my final speech to FIA – that will be next month in London – but it is likely to be one of my last. I expect to pass the Chairman’s baton sometime in early summer.

 

Nevertheless, at least one portion of this speech will sound the same as many other speeches I have given over the past five years.  That is, I will champion the economic and social utility of derivatives.

 

DERIVATIVES AND RISK MITIGATION

 

Two days ago, I testified at the Senate Appropriations Subcommittee on Financial Services and General Government beside Securities and Exchange Commission (SEC) Chairman, Jay Clayton.  I explained that when people think of the SEC, they think of American markets for capital formation and investment transfer.  Markets where investors with capital find innovators with ideas and products that produce prosperity and create jobs.

 

When people think of the CFTC, they think of futures, options and swaps markets, known as derivatives.  I explained that these are markets - not for capital formation - but for risk mitigation across a wide-range of business risks, including those related to capital formation.  They enable the transfer of risk of variable and sometimes sudden moves in prices, such as in commodities, energy, foreign currency, securities markets and interest rates from those who cannot bear the risk to those that can.  Derivatives markets serve the social good of moderating price, supply and other commercial risks, freeing up capital for job creation and economic growth.  In short, derivatives underpin the working of the American economy.

 

But risk transfer is just that: risk transfer.  It achieves risk efficiency in the financial system, but not risk elimination.  In fact, as a general proposition economic risk cannot be eliminated but can be mitigated through a range of effective risk management practices.[1]

 

One of the primary methods of risk mitigation in derivatives markets is central counterparty (CCP) clearing.   CCP clearing does not extinguish all risk, but it does provide a range of effective risk mitigation functions including professional management, position netting, mutualization and collateralization.  In developed economies, these CCP functions are provided by private sector businesses, known as clearinghouses, which are substantially regulated and supervised by agencies like ours, the CFTC.

 

DERIVATIVES CLEARING: Past and Present

 

The origin of U.S. derivatives clearinghouses go back over a century, providing CCP clearing services to exchange-traded futures and options.  Clearing of some over-the-counter swaps, particularly interest rate swaps (IRS), was available before the 2008 financial crisis,[2] but really took off after implementation of the G-20 efforts to reform the global derivatives markets, including under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).  

 

The CFTC estimates that, in 2007, about 15% of the global outstanding notional amount of interest rate swaps (IRS) was cleared.  By 2018, that percentage had risen to about 60% globally and 80% for U.S.-reporting entities.  As a percentage of notional transaction volume the current percentage is approximately 85% for IRS and 80% for index credit default swaps (CDS).

 

Unquestionably, the swaps clearing mandate has been highly successful.  The result is that a few large swaps clearinghouses have seen dramatic increases in the transactional volume and the amount of cleared positions and the respective value of related margin.  This success has heighted awareness of the integral function of these clearinghouses in the financial system.  It has raised the possibility of clearinghouse failures being transmitted to the global economy and whether regulators and regulatory frameworks are up to the task of supervising them.

 

If you were to read some press reports, you would think that regulators are unaware of, and unprepared for, these challenges.  A recent New York Times article cites “experts” asserting that “regulation has not kept pace” with the growth and importance of derivatives clearing in the wake of the financial crisis, that authorities stake so much trust in CCPs that they have “stepped into the unknown,” and that, prior to last fall’s Nasdaq Clearing default in Sweden, they did not realize that CCPs could suffer losses that challenge or exceed their prefunded default resources, and they had never confronted the question of “What if a CCP blows up?”[3]  

 

Similarly, the Systemic Risk Council, an independent group of former government officials, lawyers and financial professionals, asserts that regulators commonly believe that a CCP’s own recovery plans can substitute for resolution action by authorities, and that there are no high-level principles that guide authorities’ approaches to resolution.[4] 

 

None of this is true.

 

The CFTC has been a global leader in clearinghouse supervision for decades before the 2008 financial crisis and since.  Our regulatory framework requires that CCPs use multiple layers of protection to support their resiliency.  It ensures that no member default, however large, involving any number of members, will place the CCP in a position where it cannot meet its obligations. 

 

In 2016, my former colleague and predecessor, Chairman Tim Massad, confirmed the comprehensive work of the CFTC in derivatives clearinghouse supervision and our cooperation in critical international efforts at standard setting.[5]

 

Today, I want to review the design of CCP clearing and the standards that apply, both internationally and under the CEA and CFTC regulations.  I will tell you about the determination and effectiveness of the CFTC’s regulatory supervision of US clearinghouses and how we are advancing the swaps clearing mandate of the G-20 and Dodd-Frank Act.  I will show you how, under my leadership, the CFTC is: recommitted to critical Dodd-Frank swaps market mandates, including Title II’s Orderly Liquidation Authority, working more effectively with fellow U.S. and overseas clearinghouse supervisors, resolution authorities and standard setting bodies, and enhancing CCP oversight with greater quantitative analytical capabilities appropriate for a 21^st Century regulator.

 

Chairman Massad also noted that there are three “Rs” to CCP regulation and oversight: Resiliency, Recovery and Resolution.[6]  Those elements remain at the center of the CFTC’s work. 

 

Clearinghouse Resiliency

 

Let start with the first “R” of resiliency. The CFTC’s regulatory framework provides multiple and overlapping layers of support for CCP resiliency, including clearing member qualification,[7] member-posted collateral, daily settlement, default management planning, and mutualized default resources.  They are designed to mitigate the risk to the CCP, and to support the CCP’s ability to meet its obligations even where some of these layers of support fail.

 

For example, with respect to member qualification, CFTC-regulated clearinghouses, which we call derivatives clearing organizations, or DCOs for short, are required to have risk-based admission criteria and continuing participation requirements for their clearing members, as well as risk limits for each clearing member and rules to require clearing members to have their own risk management policies and procedures.[8]

 

Every member is required to post collateral, the amount of which is reviewed and adjusted (as necessary) every business day, and DCOs are required to use margin models that call for collateral that is commensurate with the risks of each product and portfolio, and are reviewed and back-tested on a regular basis.[9]  Moreover, by collecting losses and paying gains at least once each day (i.e., variation margin), DCOs mitigate their counterparty credit exposure.

 

For the rare occasions when a member does default, DCOs are required to have well-designed default rules and procedures and default management plans, and to test those plans at least annually. 

 

Finally, each DCO is required to maintain pre-funded default resources, most of which are mutualized, to cover the one – or, in the case of the most systemically important DCOs, two – largest exposures in excess of margin in extreme but plausible market conditions, calculated based on stress testing, subject to stringent standards for the DCO’s design, conduct, analysis and review of those stress tests.[10]

 

These standards are informed by, and are consistent with, the relevant international standards, the Principles for Financial Market Infrastructures (“PFMI”), which were developed by what is now the Committee on Payments and Market Infrastructures and International Organization of Securities Commissions (CPMI-IOSCO).  CFTC plays a leading role in CPMI-IOSCO’s work on standards for CCPs, including by co-chairing CPMI-IOSCO’s Policy Standing Group.

 

Clearinghouse Supervision

 

The CFTC approaches its supervision of clearinghouse resiliency from two different perspectives: qualitative examinations and quantitative risk surveillance.

 

I.     Examination Function

 

The clearinghouse examination program is conducted by the CFTC’s Division of Clearing and Risk (DCR) under the experienced leadership of Deputy Director Julie Mohr.  The goal of her examination program is to identify weaknesses in CFTC-regulated DCOs before those weaknesses result in enterprise or systemic risk.  It looks for areas of non-compliance with CEA core principles and CFTC regulations that are critical to a safe and efficient clearing process.  It also prescribes remediation actions to correct any weaknesses that may be identified.

 

DCR prioritizes its examination resources to meet statutory requirements.  Systemically important DCOs (known as SIDCOs)[11] are formally examined annually using a risk assessment process to establish examination priorities. CFTC staff also has supervisory meetings with the management of SIDCOs six times a year to discuss material changes in business, such as key operational systems or collateral on deposit.  DCOs that are not SIDCOs but elect to opt-in to the SIDCO regulatory requirements (“Subpart C DCOs”) are examined at least every three years.  All other DCOs are examined based upon individual risk assessment.  The risk assessment considers the varying impact of all 17 core principles[12] on a DCO’s safety and resilience through such matters as potential compromised systems, loss of data and inability to clear contracts or manage risk. 

 

The CFTC’s SIDCO examination program is conducted in coordination with the Board of Governors of the Federal Reserve System (Federal Reserve) pursuant to authority under Title VIII of Dodd-Frank.  Upon becoming Chairman, I committed the CFTC to a cooperative relationship with the Fed on SIDCO examinations.  Today, with the firm support of Federal Reserve Governor Lael Brainard, our two organizations work in close collaboration on SIDCO examination scope, priorities, methodology and conclusions. 

 

Many CFTC-registered DCOs are also registered, authorized or otherwise recognized to operate in overseas jurisdictions.  The CFTC works cooperatively with overseas market regulators to conduct a supervisory program that efficiently and effectively identifies areas of risk.  The CFTC has had a highly successful working relationship of almost two decades with UK regulators responsible for CCPs, most recently the Bank of England.  Staff from DCR and the Bank of England consult regularly on clearinghouse supervision, and regulatory and policy, matters.

 

Examinations are just one method of oversight.  DCOs are required to file many different types of information throughout the year, including quarterly financial resource reports and annual certified financial statements.  DCR staff analyzes these filings to determine compliance with requirements such as financial resources and liquidity facility arrangements.  DCOs are also required to report a range of matters, including hardware or software malfunctions and cyber-security events that may materially impact clearing as well as many operational developments.  These filings and regular dialogue allow agency staff to have a current in-depth understanding of the risk profile of regulated clearinghouses.

 

II.     Risk Surveillance Function

 

As I said, the CFTC’s clearinghouse examination program is designed to produce a qualitative understanding of our DCO registrants and any deficiencies in resilience.  We couple that with a comprehensive clearinghouse risk surveillance program that provides a quantitative risk analysis of our clearing eco-system.  

 

The CFTC’s clearinghouse risk surveillance program is led by former CFTC Chief Economist Sayee Srinivasan.  The program has three core functions:

 

1. Margin model oversight
2. Daily risk surveillance
3. Supervisory stress tests

 

A.       Margin model oversight

 

Margin models are the first line of defense of derivatives clearing.  This idea is based on the simple premise that if a customer cannot afford initial margin, the customer cannot trade.  

 

The CFTC prescribes rules for DCO margin models and monitors their performance.  The CFTC’s margin model team works closely with DCOs to ensure that models are being implemented adequately to capture the different risk factors of particular products.  The goal of the team is to be able to regularly review every margin model.  Recently, the team conducted a study of the manner in which CCPs’ margin models are capturing the risks from concentrated positions. 

 

DCO margin models continue to grow in complexity and sophistication.  The CFTC is determined to expand its quantitative model analysis capabilities to keep pace.

 

B.       Daily risk surveillance

 

One of the CFTC’s most effective tools is its daily risk surveillance program, a data-driven, real-time risk management function.  The program brings together market intelligence, agility, data savvy and analytics to analyze risk during the trading day.

 

In conducting this work, the CFTC has been endowed with a unique – and uniquely useful – set of regulatory data, namely, large trader reports for both futures and swaps positions.  This information enables risk surveillance staff to understand and analyze cleared positions at the clearing member and beneficial owner levels, including across CCPs.

 

Using a myriad set of dynamic dashboards, daily position reports and payment records, the risk surveillance team actively monitors the performance of CCPs, clearing members and their clients.  The team views risk exposures from cleared derivatives, including futures, options and swaps, and ties them to clearinghouse margins and financial resources of the clearing members.  The team also has the ability to aggregate a firm’s risk exposures across different clearinghouses, trading venues and clearing members.

 

In addition, the team has developed the capability for daily stress tests.  Using a range of tools, they stress test positions at an account level on an intra-day basis.  So if there is a sharp intra-day move in prices, one that could potentially require a large variation margin payment to be collected, staff will be on the phone with the relevant DCO and clearing member or futures commission merchant, to ensure that they are able to fulfill their payment obligations.

 

CFTC staff is adept at using an array of data streams to gain visibility into market conditions and counterparty exposures.  While the development of swap data repositories and uniform product and transaction identifiers remains to be perfected through the concerted efforts of the CFTC, fellow regulators and international bodies, the CFTC is not hindered from monitoring swaps trading activities of non-U.S. operations of U.S.-based entities.

 

In fact, the CFTC receives and analyzes an enormous amount of cleared swaps data as a result of the large increase in swaps clearing in the CFTC-regulated clearinghouses.  This allows the agency to monitor the vast amount of derivatives across the major product types held by large U.S. bank holding companies (BHCs) in the UK, where most BHCs have subsidiaries.  Relevant UK authorities, with whom the CFTC works closely, receive detailed data on the remainder of these derivatives.  This effective transparency into the derivatives exposure of overseas subsidiaries of U.S. banks is in stark contrast to the situation prior to the 2008 financial crisis.​

 

C.       Supervisory stress tests

 

Just over a week ago, the CFTC released its annual supervisory stress test.[13]  This is the CFTC’s third major testing of overall clearinghouse systemic resiliency to major financial shocks.[14]  The exercises are meant to probe for vulnerabilities across the derivatives clearing eco-system, not just at one DCO.[15]  This latest study examined DCOs operated by CME Group and LCH Group.

 

The results of the recent study indicate that the two clearinghouses are adequately provisioned to be able to absorb defaults from some extraordinary stressful market moves.  Previously, their resources were measured using a standard of extreme but plausible market moves. The latest study utilized extreme and highly implausible scenarios in order to measure the size of shocks necessary to exhaust their pre-funded resources.  The results showed that it would take intra-day market moves bigger than those of the 2008 financial crisis to have any meaningful impact on the pre-funded resources of the two clearinghouses.  This study also stress tested the liquidation risk component of the two DCOs’ margin models for IRS, and found them to be robust in hundreds of different scenarios.  The CFTC’s supervisory stress tests conducted to date provide comfort that the large, systemically important CCPs have robust risk management systems to absorb shocks from extreme market moves.

 

Historically, CFTC supervisory stress tests have examined futures and options separately from swaps, and even within the different types of swaps, IRS risks as distinct from CDS. Yet, all trading markets are tightly inter-connected – a bank could do a crude oil commodity swap with an airline and turn around and hedge the risk from the swap in the futures markets.  It is reasonable to assume that if a large firm were to default, it would be defaulting across all of these different markets.  That is why the CFTC risk surveillance team is preparing to aggregate programmatically risk exposures across these different markets, and conduct routine stress tests by shocking different markets and assessing potential impact on larger risk exposures.

 

We believe the combination of the examinations, the activities performed during the continuous monitoring program, analysis performed by the risk surveillance program, and discussions with our fellow regulators around of the globe allow the CFTC to have a strong supervisory program and one in which all DCOs are being monitored for compliance.

 

Default by Nasdaq Clearing (Sweden):  Before I turn to clearinghouse recovery and resolution, I want to briefly address the default at Nasdaq Clearing in Sweden, which was the subject of the recent New York Times article I referenced earlier.  The journalists never reached out to the CFTC to discuss the matter.  Perhaps they knew that the CFTC does not regulate Nasdaq Clearing.  Had they contacted us, however, we would have directed them to our risk surveillance program, which surprisingly did not feature in their article.  Moreover, we would have pointed out the unlikelihood today of a SIDCO admitting an individual as a clearing member. Had they asked me, I would have expressed confidence that the CFTC’s risk surveillance program would have questioned the trading activity and margin model adequacy of what was clearly a dominant position by an individual market participant in an asset class with thin trading liquidity.  I would have explained that the CFTC’s regular reviews of DCOs’ margin models, concentration charges and default management plans surely would have identified the potential for the default described in the article.

 

Clearinghouse Recovery and Resolution

 

Let’s now turn to the second and third “Rs” - recovery and resolution.

 

Our exam function and the risk surveillance function are designed to ensure that CCPs are resilient. But what if a CCP faces a default that goes beyond “extreme but plausible”?  This takes us into the realm of Recovery.

 

Both the PFMI and CFTC regulations require SIDCOs and Subpart C DCOs to maintain recovery plans that identify scenarios that may potentially prevent the DCO from being able to meet its obligations and provide its critical services as a going concern, and to assess the effectiveness of a full range of options for recovery or orderly wind-down.[16]  Critically, they are also required to “adopt explicit rules and procedures that address fully any loss arising from any individual or combined default relating to clearing members’ obligations ….”[17]  I repeat.  Any loss.  These explicit rules and procedures are important parts of the “clear plan to cope with a meltdown.”

 

As suggested in the CPMI-IOSCO guidance on Recovery Plans, DCOs use a variety of recovery tools to address the possibility that default losses will exceed pre-funded resources.  These include limited assessment powers that can expand the financial resources available, as well as tools such as gains-based haircutting and partial tear-up of contracts (for cases where auctions cannot successfully liquidate positions).  The implementation of these tools enables a pre-determined plan and procedure to enable a DCO to survive ANY loss, no matter how large.  CFTC staff are also working both internally and in coordination with regulatory partners, both domestic and international, to enhance their understanding of potential impacts of the use of these tools.

 

While our SIDCOs and Subpart C DCOs can address fully any uncovered credit loss, what happens if the events that lead to such a loss fatally undermine member or market confidence in the DCO, and thus members are, for example, unwilling to replenish mutualized resources?  This leads us to the final R – Resolution, known in the United States as “Orderly Liquidation Authority.”

 

I.     Orderly Liquidation Authority

 

The New York Times asserts, “In the United States, it is unclear which regulator would deal with a failure.” 

 

Far from unclear, Title II of the Dodd-Frank Act manifestly gives the Federal Deposit Insurance Corporation (FDIC) “Orderly Liquidation Authority” for a failed SIDCO.[18]  Furthermore, the U.S. Treasury Department October 2017 Report[19] confirms without qualification that the FDIC would be in charge of the failure resolution of financial market infrastructure, such as a systemically important clearinghouse. 

 

Under my Chairmanship, the CFTC has recognized and endorsed the FDIC’s Orderly Liquidation Authority under Title II of Dodd-Frank.  CFTC staff has worked diligently with counterparts at the FDIC to better the FDIC’s understanding of how derivatives clearing works, including default management and recovery and extreme tail scenarios.  The work has included development of resolution scenarios tailored to the unique clearinghouse business model.  Because of this work, the CFTC and FDIC today have in place protocols to respond to the highly unlikely event of a failure of a systemically important clearinghouse.

 

 In addition, I have personally led regular multilateral discussions between CFTC staff and colleagues from the FDIC, the Bank of England, the Federal Reserve and the SEC examining hypothetical failure and recovery and resolution of systemically important clearinghouses.  This work started with discussions of approaches to common problems and comparing legal frameworks for clearinghouse resolution in the U.S. and the UK.  Staff analyzed respective rulebooks and diverse approaches for resolving CCPs.  Later, we considered hypothetical default and non-default loss scenarios and resolution strategies to address them, as well as continuity of access to clearinghouses for major global banks in resolution.[20]

 

II.     International Standards for Clearinghouse Recovery and Resolution

 

Of course, the CFTC has also participated actively in international standard-setting work on CCP resolution at the Financial Stability Board (“FSB”).  The CFTC has also co-led, along with the FDIC, crisis management groups (“CMGs”) for CME and ICE Clear Credit, to aid in coordination with authorities in other jurisdictions that consider these CCPs systemically important.  This work – domestic, bilateral and international – is a prime example of how regulators cooperate to address significant issues.

 

Yet, work on clearinghouse recovery and resolution has not been confined to direct action by the CFTC and fellow regulators.  The CFTC also actively participates in, and in some cases co-leads, the important work of international standard setting and systemic risk authorities concerning derivatives clearing.  That work includes the FSB promulgation of the FMI annex to the Key Attributes (“FMI Resolution Annex”) in October 2014,[21] and Guidance on CCP Resolution and Resolution Planning (“CCP Resolution Guidance”) in July 2017.[22]  Similarly, CPMI-IOSCO published guidance on CCP Recovery in 2014,[23] and updated that guidance in 2017.[24]

 

Systemic Risk Council Letter:  The SRC’s statement that the FSB’s recent work on CCP resolution is “as welcome as it is overdue” is as catchy as it is ill-informed.  It disregards the significant work that has been accomplished over the past five years.  The SRC Letter demands what is already extant and available – a “set of high-level principles that will guide [FSB’s] approach to CCP resolution.”  

 

In fact, such principles are thoroughly set forth in the FSB and CPMI-IOSCO documents discussed above. They call for, and the recovery plans and rules of CFTC-supervised SIDCOs establish, recovery arrangements that allocate, fully and comprehensively, any uncovered credit loss.  Moreover, such recovery plans are both enforceable and transparent, at least for CFTC-regulated SIDCOs, leaving members’ exposure to loss measurable, manageable and controllable.  Tools discussed in the CPMI-IOSCO PFMI recovery guidance – including gains-based haircutting, in conjunction with partial tear-up – are readily available to accomplish those standards. 

 

Yet, it is inarguably true that recovery plans and rules, while necessary, are not sufficient.  The SRC Letter appears to knock down a straw man when it refers to a “belief, not uncommonly held among regulators, that a CCP’s own recovery plans can substitute for resolution.”  Neither I, nor CFTC staff, believe any such thing, nor do the other regulators, both U.S. and international, with whom I discuss CCP resolution regularly. 

 

Rather, as noted above, we work to ensure that the CCPs that we regulate have thorough, viable and well-developed recovery plans and rules to avoid the necessity for resolution, and to serve as the foundation for resolution planning.[25]  It is because of the extraordinary systemic importance of the CCPs that we regulate, in particular our SIDCOs, that CFTC staff have been working so keenly and continuously with their colleagues at the FDIC, the Federal Reserve, the SEC and the Bank of England on further developing our own regulatory readiness and strategies to oversee the implementation of clearinghouse recovery and resolution.

 

The SRC claims that the recovery tools discussed in the CPMI-IOSCO guidance will themselves cause systemic risk.  Yet, the SRC does not explain how that would be so.  It also does not explain how self-liquidation – the only recovery approach among many that the SRC suggests members might take – would cause a systemic crisis.  What about other recovery tools?  Nor does the SRC grapple with the systemic implications of incentives that would be created if losses in resolution – and rights in the CCP – are allocated differently than in recovery.

 

Instead, the SRC calls for the FSB to overreach its authority with an extraordinary set of measures requiring CCPs to: (1) issue, during business as usual, debt that they do not need, and (2) participate in a mutualized international CCP-default fund invested in the Bank for International Settlements.  These are unprecedented and unexplored arrangements that would likely engender unintended consequences.

 

DERIVATIVES CLEARING: The Way Forward

 

Turning back to the CFTC’s swaps clearing regulatory and supervisory framework, we undoubtedly have a strong foundation, but we cannot, are not, and will not rest on our laurels. 

 

Let me give you a flavor of some of the things we aspire to do in the coming months and years:

 

We want to continue to enhance our qualitative DCO examination capabilities while keenly expanding our quantitative analysis competence and proficiency.  We want not only to assess the resiliency of clearinghouses, but the entire client clearing industry, including clearing members and futures commission merchants (“FCMs”).  I have tasked the risk surveillance team with leveraging the rich data available to us to develop analytical capabilities for more sophisticated monitoring of the cleared derivatives ecosystem.  For example, we want to be able to quantify the potential impact of the withdrawal of a large FCM from the client clearing business.  We want to be able to assess the risk of large client bringing down an FCM.  We want to measure the true impact on client clearing caused by inaptly calibrated capital rules and “gold-plated” leverage ratios.

 

We also want to expand the scope of our risk analysis to cover both cleared and uncleared swaps. Regulated firms do not look at cleared risks as distinct and separate from uncleared risks.  Neither should regulators.  Risk exposures should be managed in a holistic manner.  In the coming months, we expect to be able to issue a proposal to amend Part 45 of our rules to enable collection of risk measures for swaps, especially uncleared swaps.

 

We want to map the inter-connectedness of regulated derivatives markets to the broader financial system and study risk transmission throughout.  Undoubtedly, the CFTC’s regulatory authority is limited to a portion of the global derivatives markets (a materially large portion).  So while some of our efforts will be centered on the data directly reported to us, we will be looking to collaborate with other relevant authorities, including our partners across Washington at the SEC, to routinely assess vulnerabilities in the global financial system.  Nevertheless, we want to use our unique data sets and our growing quantitative analysis capability and draw upon the emerging field of network science to explore and diagnose systemic fragilities and mitigate critical vulnerabilities and escalating risk patterns. 

 

CONCLUSION

 

Unquestionably, the G-20 swaps clearing mandate has been highly successful.  The result is that a few large swaps clearinghouses have seen dramatic increases in the volume of cleared transactions and the value of posted margin.  The success has heighted awareness of the integral function of these clearinghouses in the financial system and the possibility of clearinghouse failures being transmitted to the global economy.  It raises the legitimate question of whether market regulators can stay abreast of rapid growth and pace of change.

 

This regulatory challenge is compounded by the fundamental data and technological transformation of modern financial and derivatives markets.  The amount of market data continues to grow exponentially and become infinitely more granular, quantitative data analysis increasingly drives commercial trade execution and strategy, and limited agency funding requires increasing operational efficiency.

 

The world’s preeminent derivatives markets need the world’s most advanced technological competency and risk analysis capability.  I believe that the CFTC and, indeed, all market regulators here and abroad, must boldly transform themselves into quant-driven agencies conducting risk surveillance and analysis using broad data collection, automated data analysis and state-of-the-art artificial intelligence. 

 

I have previously said that the CFTC must become a highly effective, 21^st Century regulator. Under my watch, the CFTC has recommitted itself to the Dodd-Frank swaps clearing mandate and Orderly Liquidation Authority; has worked more effectively and cooperatively with fellow U.S. and overseas clearinghouse supervisors, resolution authorities and standard setting bodies; and has enhanced its CCP oversight with greater qualitative understanding and quantitative analytical capabilities appropriate for a 21^st Century regulator.

 

The CFTC aspires to nothing less than to match its effective market intelligence and risk surveillance with unparalleled quantitative data analytical capability.  We intend to continue to be thought leaders on evolving issues in derivatives markets and their role in global systemic risk mitigation.  The CFTC is ready to lead the world in quantitative risk analysis and drivatives market regulation:  QuantReg.

 

I look forward to hearing from all of you – leaders in law, our markets and in technology – as we move forward with our transformation.  It’s an exciting world we live in; one filled with new ideas, innovations and opportunities.  And we at the CFTC look forward to confidently and proactively stepping into the future.

 

Thank you.

 

^[1] Aggregate or systematic risks in an economy cannot be eliminated; they can only be allocated across counterparties through markets for various financial instruments, e.g., stocks, futures, derivatives, etc. See William F. Sharpe, “Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk,” The Journal of Finance 19(3), pp. 425-442 (“[T]here will be a consistent relationship between their [i.e., individual securities’] expected returns and what might best be called systematic risk…”).  In other words, systemic “risk management,” includes both deciding how much systematic risk to bear and evaluating the opportunities and costs of eliminating individual risks.  See also Frank Knight, Risk, Uncertainty, and Profit (1921), available at: https://fraser.stlouisfed.org/files/docs/publications/books/risk/riskuncertaintyprofit.pdf.)

^[2] In 2005, I was involved in an independent effort to develop central clearing for credit default swaps that ultimately contributed to the development of ICE Clear Credit, a leading clearer of credit derivative products. See, e.g., GFI Group Inc., GFI Group Inc. and ICAP plc To Acquire Ownership Stakes In The Clearing Corporation, PRNewswire, Dec. 21, 2006, available at: http://www.prnewswire.com/news-releases/gfi-group-inc-and-icap-plc-to-acquire-ownership-stakes-in-the-clearing-corporation-57223742.html.  See also Testimony Before the H. Committee on Financial Services on Implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act, 112th Cong. 8 (2011) (statement of J. Christopher Giancarlo).

^[3] Jack Ewing and Milan Schreuer, “How a Lone Financial Trader Shook the World’s Financial System,” New York Times, May 3, 2019 (“NYT Article”), available at: https://www.nytimes.com/2019/05/03/business/central-counterparties-financial-meltdown.html.

^[4] Systemic Risk Council Letter, dated March 18, 2019 (“SRC Letter”), responding to FSB Discussion Paper: “Financial resources to support CCP resolution and the treatment of CCP equity in resolution”, 15 November 2018 on the resolution of distressed central counterparty clearing houses (CCPs), at:  https://4atmuz3ab8k0glu2m35oem99-wpengine.netdna-ssl.com/wp-content/uploads/2019/03/CCP_Resolution_-_SRC_-_March18__2019.pdf.

^[5] Statement of Chairman Timothy Massad on Release of Reports on CCP Resilience, Recovery and Resolution, August 16, 2016, available at: https://www.cftc.gov/PressRoom/SpeechesTestimony/massadstatement081616.

^[6] Id.

^[7] It is highly unlikely that a SIDCO today would admit an individual as a clearing member.

^[8] Reg. §§39.12(a), 39.13(h)(1) and (5).

^[9] Reg. §39.13(g).  Back-testing is an ex-post comparison of observed outcomes with expected outcomes derived from the use of margin models.

^[10] CCPs employ stress testing as a key component of prudent risk management practices.  In addition to sizing pre-funded default resources, the core functions of this tool are liquidity resource sizing and identification of material impacts of “tail” events on clearing member and customer exposures.

^[11] Title VIII of the Dodd-Frank Act permits the U.S. Financial Stability Oversight Council (“FSOC”) to designate certain firms, including a derivatives clearinghouse, as a Systemically Important Financial Market Utility (“SIFMU”).  Part 39 of the CFTC’s regulations allow for the designation of SIFMUs as systemically important DCOs (“SIDCOs”).

^[12] See generally CEA Section §5b, 7 USC §7a-1(c)(2).

^[13] CFTC, CCP Supervisory Stress Tests: Reverse Stress Test and Liquidation Stress Test (2018), available at: https://www.cftc.gov/system/files?file=2019/05/02/cftcstresstest042019.pdf.

^[14] CFTC, Supervisory Stress Test of Clearinghouses (2016), available at: https://www.cftc.gov/sites/default/files/idc/groups/public/@newsroom/documents/file/cftcstresstest111516.pdf; and CFTC, Evaluation of Clearinghouse Liquidity (2017), available at:  https://www.cftc.gov/sites/default/files/idc/groups/public/@newsroom/documents/file/dcr_ecl1017.pdf.

^[15] The DCOs are primarily responsible under CFTC rules for stress testing their own organizations, subject to CFTC oversight.

^[16] Reg. §39.39.

^[17] Reg. §39.35(a) (emphasis supplied).

^[18] This is confirmed by the statute’s reference to “covered financial company” (i.e., an entity subject to resolution under Title II) that is a commodity broker having “member property.”  Only registered DCOs can have “member property” in this context. See Dodd-Frank §210(m)(1)(B).

^[19] U.S. Treasury, A Financial System That Creates Economic Opportunities - Capital Markets, October 2017, at: https://www.treasury.gov/press-center/press-releases/Documents/A-Financial-System-Capital-Markets-FINAL-FINAL.pdf

^[20] I believe the procedural mechanism that the five regulators developed to move the work forward – periodic principal-level meetings, with staff working to advance the principals’ agenda between principal-level meetings – has become a model for work in other areas where the issues presented require effective, productive multilateral work of a small handful of regulators (as opposed to the standard setting done by the established international groups).

^[21] Key attributes for effective resolution regimes, II Annex 1, Part I:  Resolution of Financial Market Infrastructures (FSB 2014), available at:  http://www.fsb.org/wp-content/uploads/r_141015.pdf.

^[22] Guidance on Central Counterparty Resolution and Resolution Planning (FSB 2017), available at: http://www.fsb.org/wp-content/uploads/P050717-1.pdf.

^[23] Recovery of Financial Market Infrastructures (CPMI-IOSCO 2014), available at: https://www.bis.org/cpmi/publ/d121.pdf.

^[24]   Recovery of Financial Market Infrastructures (revised 2017) (CPMI-IOSCO), available at: ttps://www.bis.org/cpmi/publ/d162.pdf.

^[25] See CCP Resolution Guidance ¶7.2 (“Given the close relationship between resolution and recovery, the development of the resolution plan should start with the CCP’s recovery plan.”).

 

 

Remarks of CFTC Director of Enforcement James M. McDonald at the 41st Annual Conference of the Future Industry Association’s Law & Compliance Division Conference

May 8, 2019

Over the last few years, under Chairman Giancarlo’s leadership, the CFTC has implemented a number of measures to make our regulations simpler, more accessible, and more transparent.  These reforms have been policy neutral—not designed to advance one particular viewpoint over another.  Instead, these efforts were rooted in common sense—designed to make us better regulators, which in turn would lead to more efficient markets and greater economic growth.[1]

In this vein, the Division of Enforcement today announces and makes public its Enforcement Manual.  The Enforcement Manual serves as a general reference for Division Staff in the investigation and litigation of potential violations of the Commodity Exchange Act (CEA) and Commission Regulations (Regulations).  It lays out the practices and procedures that guide our work.

The Manual creates no private rights.  And it’s not enforceable in court.  But it is important, we believe, to have clear policies to promote consistency across our Division, which spans multiple offices and teams.  Consistency and transparency as to these procedures should promote fairness, increase predictability, and enhance respect for the rule of law.

The decision to create and publish the Enforcement Manual was rooted in the common sense notion that our policies and procedures should be readily accessible to those affected by them.  We’ve come a long way since the time of the old emperors, who, it is said, posted edicts high on the columns so that they would be harder to see and thus easier to transgress.[2]  We in the United States chose a different course—opting instead to follow the likes of Thomas Paine, who famously wrote that “in America the law is king.”[3]  We pursued that path based in part on a view that the law should be predictable, transparent, and fair.  Of course our Manual is not binding law, and—to say it again—creates no private rights.  Still, we seek to adhere to those same principles in our daily work.  And we publish our Enforcement Manual in that spirit.

The Manual is divided into eleven different sections, each addressing a different subject matter—ranging from how we generate and process leads, to how we investigate and litigate cases, to how we evaluate applicable privileges and issues of confidentiality.  In addition, the Manual discusses the Division’s Wells process, sets forth how we work in parallel with other civil and criminal agencies, lays out the various aspects of the Division’s self-reporting and cooperation program as well as the various tools we can use to recognize cooperation, and provides an overview of the Commission’s Whistleblower program, among other things.

Going forward, we expect this Manual to be a living document.  We in the Division regularly evaluate and refine our thinking about our policies and procedures, and whether revisions or additions are warranted.  I expect, as we develop new policies and procedures, that in most cases we would incorporate them into the Enforcement Manual.

In drafting the Manual, we sought to provide an effective overview of the policies and procedures that guide us in our daily work.  But to distill some of the core components of our program into a single, accessible document required significant critical analysis and judgment. 

We had a team that was up to the task.  This project was led by the Division of Enforcement’s Office of Chief Counsel, and in particular by Gretchen Lowe, the Chief Counsel, as well as William Janulis, Edward Riccobene, and Matthew Rowland.  My compliments and appreciation to Gretchen and her team.

The Enforcement Manual is available on our website, cftc.gov.  I encourage you all to read it.

Thank you.