Statement of Commissioner Rostin Behnam on Proposed Amendments to the Commission’s Regulations Relating to Certain Swap Data Repository and Swap Data Reporting Requirements

April 25, 2019

I respectfully concur with the Commodity Futures Trading Commission’s (the “Commission” or “CFTC”) approval of its proposed rule regarding amendments to the Commission’s Regulations Relating to Certain Swap Data Repository and Swap Data Reporting Requirements (the “Proposal”).  In 2011, the Commission adopted part 49 of the Commission’s Regulations[1] to implement the requirements of section 21 of the Commodity Exchange Act (the “Act” or “CEA”).[2]  Section 21 describes the registration regime for and operation of swap data repositories (“SDRs”) by setting out applicable registration rules, data standards, duties, core principles, and requirements regarding confidentiality and chief compliance officers as envisioned by Congress in the Dodd-Frank Act to implement the key trade reporting provisions laid out at the 2009 G20 Pittsburgh Summit.[3]  Similarly, part 49 builds out a regulatory framework aimed at ensuring the legal and operational stability and soundness of SDRs in support of post-trade transparency in the swaps market.  The Proposal aims to improve upon the quality, accuracy, and completeness of swap data reported to the Commission via SDRs and generally follows a plan laid out in the Commission’s 2017 Roadmap to Achieve High Quality Swap Data.[4]  This Proposal purports to be the first step in following that Roadmap.  While true, I prefer to view this as a part of the Commission’s ongoing duties to regularly review its Regulations to increase efficiencies and avoid unintended consequences, and to be certain that our SDR rules further the goals of increasing transparency and identifying risk.

As I have stated several times during my tenure as a Commissioner, as we engage in strategic regulatory decisions, our policy goals from 2010 remain unchanged.  As we endeavor to provide surgical flexibility and a more principles-based approach, I will continue to oppose any roll backs of Dodd-Frank initiatives.[5]  While I do not believe that today’s Proposal would be considered a rollback per se, I would like to call attention to a section of the Proposal where we deviate from the language of section 21 regarding the role of the chief compliance officer (“CCO”) at an SDR. 

Section 21(e)(2)(C) affirmatively requires an SDR’s CCO, in consultation with the board of directors or similar body, to “resolve any conflicts of interest that may arise.”  The Commission’s current part 49 rules mirror the language of the CEA exactly.  Regulation 49.22(d)(2) affirmatively requires an SDR’s CCO to “resolve any conflicts of interest that may arise,” using precisely the same language as the Act. 

However, today’s Proposal would amend 49.22(d)(2) in a way that deviates from the plain language of the statute.  While the statute requires that CCOs actually resolve any conflicts of interest, today’s Proposal would simply require a CCO to take “reasonable steps” to resolve any conflict of interest.  In addition, the Proposal would only apply to “material” conflicts of interest.  Neither this new reasonableness standard nor this new materiality standard appear in the language of the statute.  My concern is that adding these new standards may deviate from Congressional intent.  This potentially dilutes the CCO’s obligation to address conflicts of interest, but perhaps more importantly, it dilutes the CCO’s ability to do so.  Under the language of the Act and the current Regulation, a CCO can point to their statutory obligation in working to resolve conflicts of interest.  Imposing a new reasonableness standard may have the real world impact of making it more difficult for a CCO to actually resolve conflicts of interest. 

I note that the same statutory language appears elsewhere in the Act regarding CCO resolution of conflicts of interest at other types of Commission registrants, and the Commission has issued a final rule implementing the same new reasonableness and materiality standards regarding CCOs of futures commission merchants, swap dealers and major swap participants.[6]  The Commission also has recently proposed adding these new standards for CCOs of swap execution facilities.[7]  However, in contrast, this week the Commission is issuing amendments to the Part 39 regulations for Derivatives Clearing Organizations (“DCO”) (the “Part 39 Proposal”).  Current regulation 39.10(c)(2)(ii) requires a DCO’s CCO to resolve conflicts of interest.  Regulation 39.10(c)(2)(ii) exactly follows the language of Section 5b(i)(2)(C).  While the Part 39 Proposal makes amendments to 39.10, the Commission does not alter the CCO’s current duty to resolve conflicts of interest.  In other words, for DCOs the Commission is choosing to maintain the statutory language.  I believe that this may be the more appropriate approach for CCOs generally. 

The Commission has, of late, begun a practice of re-interpreting statutory provisions with a somewhat flippant regard for their underlying purpose and rationales in order to lessen the burdens that are rarely substantiated by anything more than a call for change.  While it is not out of the ordinary for an independent agency to reexamine whether its regulatory approach remains fit for purpose, I believe that we should be mindful that our role is not to bend too easily to unsupported claims of burden or complexity.  This is particularly true when the re-interpretation seems to be at odds with the express language of the statute itself.  I look forward to reading the comments on this CCO issue.  I am particularly interested to learn whether various stakeholders believe that the statute itself is diluted by the addition of the reasonableness and materiality standards to CCO obligations in this and other rulemakings. 

Statement of Commissioner Dan M. Berkovitz on Proposed Amendments to Part 39:  Derivatives Clearing Organization General Provisions and Core Principles

April 29, 2019

Introduction

I support issuing for public comment the notice of proposed rulemaking (“NPRM”) to amend certain provisions of Part 39 of the Commission’s regulations governing derivatives clearing organizations (“DCOs”).  Part 39 generally covers registration and regulation of DCOs that centrally clear futures, options, and swaps regulated by the Commission.

The NPRM includes a number of beneficial provisions.  I commend the staff of the Division of Clearing and Risk for this important effort to clarify and clean up some issues in the rules and staff guidance that have accumulated since Part 39 was substantively amended in 2011 and 2013.  The NPRM also proposes several changes to the regulations that merit scrutiny as outlined below.  I particularly look forward to comments on those provisions to help guide the Commission’s deliberations on the proposed amendments.

Background

Central clearing of futures positions has been a fundamental risk mitigation measure for derivatives market participants in the United States for well over a hundred years.  In more recent times, as futures and swap trading has grown dramatically,[1] central clearing of derivatives including swaps has become a critical element in risk management of the financial system as a whole.  In response to the 2008 financial crisis, world leaders at the G20 summit in Pittsburgh established central clearing for derivatives as a core objective in mitigating systemic risk.[2]  DCOs are a critical component of the clearing infrastructure, and effective clearinghouse registration and regulation is key to facilitating efficient, sound derivatives markets and preventing another financial crisis.

As described in the NPRM, the Commission adopted regulations in 2011 and 2013 to further implement DCO core principles and Title VIII of the Dodd-Frank Act.  Based on experience in implementing these regulations and subsequent developments, including the establishment of international principles for clearing, the CFTC staff has provided guidance on the new regulations.  It is now appropriate for the Commission to address this experience and these developments through amendments to our regulations. 

Codification and Clarification

The NPRM includes numerous amendments that clarify, further define, or provide more explicit direction to market participants.  Governance requirements are more fully developed and applied across all DCOs.  The NPRM adds new regulations 39.24, 39.25, and 39.26 that establish governance requirements for DCOs to better ensure that DCOs are well managed.[3]  These amendments provide greater certainty and uniform rules, and are important not only for fairness and consistency, but to improve risk management across the clearing space.  The changes may help guard against risks from governance failures. 

While the new governance regulations are beneficial, many of the provisions set out only general principles and do not provide specific guidance or prescriptive standards.  I look forward to public comment on whether more explicit guidance or requirements would be appropriate for any specific provisions.  In particular, I look forward to comments on whether members should play a larger role in governance.

Under the NPRM, regulation 39.16 would be amended to improve requirements around member default management.[4]  The recent member default at NASDAQ Clearing reinforces the importance of default management mechanisms and information sharing when a default occurs.[5]  The amendments explicitly require DCOs to have a default committee that must include clearing members.  In addition, the amendments would require a DCO to include members in tests of the default management plan.  I look forward to comments on how and when DCO members should be included in default management.

In addition to the above, the NPRM would provide a number of more discrete improvements, such as an explicit requirement for initial margin to cover concentration risk; a requirement for DCO personnel to certify certain reports; and several new reporting requirements around settlement bank arrangements, depositories, and liquidity funding arrangements.  Clarifying these types of issues will help maintain consistent, objective, and transparent oversight of registered DCOs.

Issues Warranting Further Comment and Consideration

The NPRM includes several proposed amendments that, while beneficial in some respects, may also present additional issues for the Commission to consider in developing the final rule.  Comments in these areas would be particularly helpful to inform the Commission in its deliberations.

Changes to regulation 39.13(g)(8) regarding calculation of initial margin and in particular, excess margin, attempt to incorporate in the regulation, and to clarify, staff guidance.[6]  Getting initial margin calculations right is critical to providing sufficient resources to cover variation margin shortfalls that may occur when resolving a member’s default.  The proposed standard for margin to be “commensurate with the risk presented by each customer account,” as a principle, seems appropriate.  However, little guidance is provided on how that principle should be applied or the appropriate parameters for consideration.  Given the importance of initial margin calculations, I look forward to comments on whether the Commission should provide a more detailed standard in the regulation or further guidance on the calculation.

New regulation 39.13(i) provides explicit procedures and requirements for filing DCO rules to implement a cross-margining program with other clearing organizations.[7]  From a general policy perspective, establishing explicit procedures in regulation for evaluating such arrangements would facilitate consistent, objective reviews by the Commission. 

However, multi-entity cross-margining – which could cross borders and involve multiple regulatory regimes of different regulators – creates additional layers of legal, operational, and financial risk that may be difficult to evaluate.  The members of the DCO could be affected in ways not previously contemplated and that may be more obscure to the members and difficult for them to assess.  The information that the DCO would be required to provide to the Commission under the NPRM is fashioned from less complex portfolio margining evaluation requirements and is general in nature.  Will a bankruptcy involving a member of one of the clearing organizations, the DCO, or the other clearing organization affect the other entity and its members in ways that are not anticipated?  Are there margin model risks, such as greater concentration risk across both entities, that are not properly accounted for in the proposed regulations?  Do members of the DCO have other concerns and do they have appropriate mechanisms to voice those concerns through the DCO rules, governance structures, and/or CFTC review procedures?  I look forward to reviewing the comments on these and other issues regarding the proposed multi-entity cross margining regulations.

Finally, the NPRM would establish regulation 40.5 as the mechanism for Commission review of certain DCO rule sets including: (1) a request to transfer a DCO’s open interest – in many cases its entire open interest, (2) cross-margining programs among different clearing organizations – including across borders and for entities subject to different regulators, and (3) commingling of futures, options, and swaps positions in a section 4d(a) futures account.  These rule reviews could involve consideration of novel issues, customer protections, and other factors.  Accordingly, I have some concern that regulation 40.5 may not provide sufficiently robust review procedures or the Commission with adequate authority to require a DCO to mitigate risks arising from the proposed actions.

Section 40.5 was intended to address voluntary submission of DCO rule changes pursuant to section 5c(c) of the Commodity Exchange Act.  While the process for submission and Commission review is more detailed under regulation 40.5 than under regulation 40.6, regulation 40.5 provides for automatic approval after 45 days if that period is not extended by the Commission and a narrow standard of review; namely, the Commission shall approve a DCO rule under review unless it “is inconsistent with the [Commodity Exchange] Act or Commission’s regulations.”  However, the DCO activities to which this review procedure would be applied under the NPRM are significant actions that likely will raise customer protection concerns, entail a sophisticated risk management analysis, and call for a more nuanced review and response than can be accomplished under the blunt “inconsistent with the CEA” standard that governs the Commission under regulation 40.5.  

Accordingly, I encourage comments on whether regulation 40.5 is the appropriate mechanism to review these proposed DCO actions or whether a more balanced procedure should be employed that would provide the Commission more flexibility to ensure the proposed actions adequately address issues involving customer protection, potential risks to FCMs, and market integrity.

Conclusion

In conclusion, I commend the staff of the Division of Clearing and Risk for their efforts in preparing the NPRM to codify practices that are currently addressed through staff guidance and to conform our regulations to developments that have occurred since the regulations were issued.  The NPRM will help clarify and provide explicit rules for clearing organizations that provide a vital service to derivatives markets.  Finally, I look forward to the public comments on the NPRM, particularly on the proposed amendments discussed above.

Statement of Commissioner Dan M. Berkovitz on Proposed Amendments to the Commission’s Regulations Relating to Certain Swap Data Repository and Data Reporting Requirements

April 25, 2019

I am pleased to support the Commission’s notice of proposed rulemaking (“NPRM”) to amend its rules for swap data repositories (“SDRs”) and data reporting requirements.[1]  The proposed amendments reflect the Commission’s commitment to accurate, detailed, and timely swaps data for regulators, market participants, and the public through enhanced data verification and error correction procedures, among other amendments.  They are an important step in achieving the Dodd-Frank Act’s mandate of swap data reporting as an integral part of OTC derivatives reform and financial market stability.[2]

The Dodd-Frank Act codified important new swap data reporting obligations,[3] and established SDRs as the vehicles for reporting and retaining swaps data.[4]  It recognized the role of regulatory reporting and real-time public reporting in enhancing transparency and reducing systemic risk in the U.S. financial system.  Consistent with these foundational principles, the Commission has focused on swap data reporting since the very inception of its Dodd-Frank efforts.  In 2011, it began finalizing a series of coordinated reporting rules that provide for both regulatory and real-time public reporting of swap transaction and pricing data (Parts 45 and 43);[5] establish SDRs to receive data and make it available to regulators and the public (Part 49);[6] and define certain swap dealer and major swap participant reporting obligations (Part 23).[7]

The Commission’s regulations leverage real-time public reporting to help increase transparency, fairness, and efficiency in swaps markets,[8] while regulatory reporting assists the Commission and other financial regulators in market oversight and systemic risk mitigation.[9]  In this regard, SDRs provide a more consolidated view[10] of market participants’ exposures across their swaps portfolios, and can help to identify concentrations and other potential risks that are dispersed across individual portfolios, trading platforms, and clearinghouses.  Accurate, complete, and timely information is therefore vital to any successful swaps data reporting regime.  These objectives were central to post-crisis reform efforts, and they must remain the primary considerations as the Commission moves to enhance its reporting rules.

It is important to note that the existing reporting rules have already achieved important successes.  Currently, three provisionally registered SDRs[11] facilitate regulatory reporting and real-time public reporting, and CFTC staff estimates that SDRs processed approximately 13 million unique swaps in 2018.  SDRs provide online systems where any member of the public can track transaction-by-transaction information as swaps are executed and publicly reported.  SDRs have also designed portals and other resources to provide CFTC staff with more complete regulatory access. 

While building on this solid foundation, the NPRM and the proposed amendments acknowledge areas where the Commission’s existing swap data reporting rules are not working as effectively as they might.  Registered swap dealers began reporting swap data on December 31, 2012, and the proposed amendments are therefore based on over six years of Commission experience with SDRs and swap data reporting.  In this regard, the NPRM addresses several areas that the Commission identified for improvement in its 2017 Roadmap.  For example, the NPRM addresses swap data verification and the prompt correction of errors or omissions in previously reported data.  It proposes to clarify and strengthen the obligations of SDRs and reporting counterparties by requiring SDRs to provide reporting counterparties with regular reports on open swaps to “verify the accuracy and completeness of swap data reported to SDRs.”[12]  In turn, reporting counterparties must respond affirmatively by indicating that the records in the reports they receive are accurate, or otherwise correcting any errors or omissions.[13]  Reporting counterparties must respond within timeframes specified in the NPRM, and they must do so pursuant to standards established by SDRs.

The NPRM also proposes that SDRs provide open swap reports to the Commission.  SDRs must provide such reports pursuant to timing, method, frequency, content, and other instructions that the Commission may issue.[14]  While working with SDRs, open swaps reports will help the Commission to perform its regulatory functions more effectively and efficiently through reports that SDRs standardize in content, format, calculation methods, and other variables.

In addition to these important data-focused amendments, the NPRM also proposes amendments to rules in Part 49 of the Commission’s regulations that govern the internal operations of SDRs, particularly as they pertain to an SDR’s chief compliance officer (“CCO”), conflicts of interest, and annual compliance reports.  I am interested in receiving comments regarding these proposed amendments, including areas where the Commission’s existing CCO-related rules for SDRs are working well and where they could be improved.  In this regard, the Commission should be vigilant that changes to compliance or other requirements made in the name of efficiency do not diminish the self-regulatory foundation of the Commission’s oversight of derivatives markets. 

I thank the staff of the Division of Market Oversight for their dedicated work on both this NPRM and potential future proposals related to swaps data reporting.  I also thank staff for their responsiveness to questions and comments from my office, including their willingness to consider changes that have improved the NPRM before the Commission today.  While swap data reporting is not always the most glamorous area of the Commission’s work, it is vitally important that we get it right.  I look forward to public comments on the NPRM, and to continued efforts by market participants and the Commission to achieve the most effective swap data reporting possible.

Statement of Chairman J. Christopher Giancarlo on Proposed Rule Amendments to The Commission’s Regulations Relating to Certain Swap Data Repository and Data Reporting Requirements

April 25, 2019

A critical component of the 2008 financial crisis was the inability of regulators to assess and quantify the counterparty credit risk of large banks and swaps dealers.  To address this shortcoming, the Dodd-Frank Act gave the CFTC broad responsibility to enhance regulatory transparency and price discovery for market participants through trade reporting to swap data repositories (SDRs).

In 2011 and 2012, the CFTC adopted rules for swap data reporting, recordkeeping and SDRs.  Unfortunately, these initial rules lacked technological detail and specification.  Under my direction in 2017, CFTC staff began the process of assessing the effectiveness of the swap reporting rules in Parts 43, 45, and 49 of the CFTC’s regulations.  The 2017 Roadmap to Achieve High Quality Swaps Data (Roadmap) outlined a series of steps to improve data reporting requirements.  The CFTC received a wide range of feedback on the Roadmap, via written comments and discussions with SDRs and market participants.

I am pleased to see the first part of the Roadmap, the proposed changes to Part 49, issued today.  These proposed changes update the requirements for SDRs and swap counterparties to verify the accuracy and completeness of swap data reported to SDRs.  Completion of these and the other changes proposed by the Roadmap will result in more complete, more accurate, and higher-quality data available to the CFTC and to the public; streamline data reporting; and help the CFTC perform its regulatory responsibilities.  The time has come to revisit this important post-crisis reform and ensure the CFTC is fulfilling its commitments.

Opening Statement of Commissioner Brian D. Quintenz before the CFTC Energy and Environmental Markets Advisory Committee

"Gold Plating to Nowhere"

April 17, 2019

Thank you Commissioner Berkovitz for convening today’s meeting of the Energy and Environmental Markets Advisory Committee (EEMAC).  I am delighted to join you and my fellow Commissioners for the Committee’s first meeting in over three years and its inaugural meeting since it was reconstituted last year.  Before we begin, I would like to welcome the Committee’s new members and thank them for so generously giving us their time and expertise.

This Committee plays an invaluable role in advising the Commission about areas essential to our core mission, including ensuring that producers, merchants, and users of energy and environmental products are able to reliably access the derivatives markets to manage and hedge their commercial risks.  There is a packed agenda before us today and I look forward to hearing all three panels’ discussion of the developments and challenges associated with physical commodity derivatives trading.

I am looking forward to hearing from the CFTC’s own Chris Goodenow of DMO’s Market Intelligence Branch to discuss two very impressive research reports regarding liquefied natural gas (LNG) developments and the impact of U.S. tight oil on NYMEX WTI futures.  Over the past ten years, the United States has gone from being a net importer to a net exporter of LNG.  Natural gas production has increased dramatically, accompanied by a similar growth in financial trading.  I do not believe this transformative growth in domestic natural gas production could have occurred without the robust derivatives markets we have in the United States, which enable exploration and production companies to effectively manage their commercial risks.  Both these reports demonstrate how liquid futures markets with prices reflective of market fundamentals, including supply and demand forces, support real economic growth.  They also reflect CFTC staff’s ongoing commitment to better understand the relationship between futures markets and the underlying cash markets.

Today’s final panel will focus on an issue critical to well-functioning derivatives markets:  the availability of clearing services for commercial end-user clients.  As I have noted previously, I have serious concerns that the current implementation of the supplementary leverage ratio (SLR) is limiting clients’ access to clearing and further encouraging FCM consolidation. 

Most recently, the Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation proposed a new approach for calculating the exposure amount of derivatives contracts under the agencies’ regulatory capital rule.[1]  The Proposal would move away from the current exposure methodology (CEM), replacing it with the standardized approach for counterparty credit risk (SA-CCR) methodology for purposes of calculating risk-weighted assets under the capital rule.  The Proposal also incorporates a modified version of SA-CCR into a firm’s SLR calculation.  The implementation of SA-CCR for both risk-weighted assets and SLR calculations will have a profound impact on the derivatives markets, particularly with respect to commercial end-users. 

With respect to the SLR calculation, the Proposal continues to require a clearing member FCM to include in its leverage calculation the full exposure resulting from its guarantee of a client’s trade, without reducing this exposure by the amount of segregated margin posted by the client, and then counts this margin as a source of leverage against which additional capital should be held.  This thinking ignores the fact that segregated margin will always be used to absorb client losses before the central counterparty looks to the clearing member to absorb any residual losses.

Moreover, the clearing member cannot use the margin to leverage itself under any circumstance.[2]  As a result, segregated margin is not just risk-free.  It is actually more than risk-free—it is always risk-reducing. This policy is like requiring a bank to hold capital against both a mortgage loan and the house. If the goal of the leverage ratio is to calculate the clearing member’s most accurate amount of leverage, then it should never count segregated client margin.

I joined a comment letter along with some of my fellow Commissioners highlighting our significant concerns that unless the treatment of client margin changes, clearing member firms will continue to limit the provision of clearing services to clients.  In a recent study, 72% of client clearing service providers stated that the current leverage ratio disincentivizes providing client clearing services.[3]  Moreover, 70% of clients who were able to maintain their clearing services agreements stated restrictions had been placed on their cleared derivatives activity.[4]  Including an initial margin offset in a firm’s SLR calculation would have a meaningful impact on a firm’s ability to continue to offer client clearing services.  One comment letter to the Proposal estimated that including an offset for initial margin would decrease banking organizations’ client clearing exposures by 37%.[5] 

Let me say that I appreciate the fact that a question was included in the release about this topic, which I believe shows the Prudential Regulators’ willingness to listen to fellow regulators, market participants, and data analysis. Unfortunately, this question only represents one small step forward for process, whereas, in other areas, the Proposal contains giant leaps backward for policy.

With respect to calculating counterparty credit risk and risk-weighted assets for commodity derivatives, the Proposal would potentially increase transaction costs and diminish market liquidity for commercial end-users.  This potential outcome arises in part because the Proposal takes the Basel Committee's already arbitrary and inflated supervisory factors for the various commodity asset classes and “gold plates” them, proposing the highest supervisory factor across all energy commodities.  The Basel Committee did at least distinguish between electricity and oil/gas commodities, assigning the latter a much lower supervisory factor compared to the 40% charge for electricity contracts.  While I have significant concerns with the quality of the data analysis, or perhaps total lack thereof, which led to this arbitrary Basel Committee decision as it is, I am shocked that, with just as little explanation, the Proposal uniformly applies electricity’s grossly inflated supervisory factor of 40% to the entire energy hedging set.  The result is an enormously punitive treatment of oil and gas derivatives transactions that, according to some commenters, would increase a bank’s exposure calculations under SA-CCR with an end-user counterparty by up to 460%.[6] Increased exposure calculations will result in higher capital charges to the bank, which, in turn, the bank will likely pass along to the end-user in the form of higher transaction pricing. 

Gold plating a bad idea does not magically transform it into a good idea. By way of analogy, if you build a ship out of gold, it looks great in dry dock.  But when you put that ship in the water, it becomes the world’s most expensive scuba diving attraction. 

I believe the Proposal should revisit the supervisory factors for all types of commodities to ensure they are appropriately calibrated to the actual risks of the underlying commodity and the maturity of the derivatives contract.

Similarly, in order to ensure that end-users’ exposures to bank counterparties are not over-inflated, I hope the Prudential Regulators consider recognition of non-cash collateral arrangements under SA-CCR, like asset liens.  Alternative collateral arrangements are frequently used in derivatives transactions with end-users and are effective means of reducing the bank’s exposure.  The recognition of these risk-reducing arrangements would increase the risk-sensitivity of SA-CCR and reduce the possible increased transaction costs passed on to commercial end-users by bank counterparties. 

I look forward to hearing from the panelists today about how the Proposal could impact their ability to effectively hedge the risks of their core businesses, either through reduced access to clearing, higher transaction costs, or a diminished willingness of bank counterparties to engage in uncleared swap transactions. 

[1]   Standardized Approach for Calculating the Exposure Amount of Derivative Contracts, 83 Fed. Reg. 64,660 (proposed Dec. 17, 2018) (hereinafter, the “Proposal”), available at https://www.federalregister.gov/documents /2018/12/17/2018-24924/ standardized-approach-for-calculating-the-exposure-amount-of-derivative-contracts.
[2]   17 C.F.R. §§ 1.20-1.30 (futures); 17 C.F.R. §§ 22.2-22.7 (cleared swaps).  These rules require FCMs to separately account for, and segregate as belonging to the client, all money, securities, and property received from a client as margin. The FCM cannot re-hypothecate the margin to leverage the bank and must maintain the collateral in cash or certain other very low risk, highly liquid assets, such as U.S. government and municipal securities “with the objectives of preserving principal and maintaining liquidity.” 17 C.F.R. §1.25.
[3]   Incentives to Centrally Clear Over-the-Counter Derivatives:  A Post-Implementation Evaluation of the G20 Financial Regulatory Reforms, Basel Committee on Banking Supervision, the Committee on Payments and Market Infrastructures, the Financial Stability Board and the International Organization of Securities Commissions 24 (August 7, 2018), http://www.fsb.org/wp-content/uploads/P070818.pdf. 
[4]   Id.
[5]  Joint Comment Letter from International Swaps and Derivatives Association, Inc. (“ISDA”), the Securities Industry and Financial Markets Association (“SIFMA”), the American Bankers Association (“ABA”), the Bank Policy Institute (“BPI”), and the Futures Industry Association (“FIA”) at 12 (March 18, 2019), https://www.isda.org/2019/03/18/industry-response-to-standardized-approach-for-counterparty-credit-risk-sa-ccr.
[6]  Comment Letter from Coalition for Derivatives End-Users at 5 (March 18, 2019).

Opening Statement of Chairman J. Christopher Giancarlo before the Energy and Environmental Markets Advisory Committee

April 17, 2019
 

A warm welcome to all of the EEMAC members, presenters and participants, both here and on the telephone.  It is good to have you all with us.

As a former Chair of EEMAC, I am particularly pleased to see the important work of this committee continuing under the very capable hands of Commissioner Berkovitz.

In my brief remarks today, I want to focus on two issues.

Supplementary Leverage Ratio

The first is the Supplementary Leverage Ratio (“SLR”). 

The SLR is a global capital requirement for banks.  It is size-based rather than risk-based and is designed to restrain bank balance sheet activity (namely lending).  It requires large U.S. banks to set aside roughly five percent of assets for loss absorption.  This is intended to supplement risk-based capital requirements like the Common Equity Tier 1 Ratio.  Banks that hold clearing customer client margin in the form of cash through their affiliate futures commission merchant (“FCM”) clearing services must also set aside the requisite five percent SLR

Unfortunately, the SLR is being applied to an entirely different activity – swaps clearing – that is itself intended to steer risk away from bank balance sheets.  Applying the SLR to clearing customer margin reflects a flawed understanding of central counterparty (“CCP”) clearing.

The current implementation of the SLR is biased against derivatives.  It does not take into account the fact that outstanding derivative contracts in a portfolio can offset each other and thus reduce the potential risk exposure.  It incorrectly treats the notional size of a derivative contract as representative of the total potential risk of that contract.  It ignores the exposure-reducing effect of margin for clearing firms. 

This Commission fully supports U.S. and global swaps reform efforts to move customer margin off the balance sheets of bank FCMs and into CCPs. Yet applying a capital charge against that customer margin works against the swaps clearing mandate by treating FCMs as having retained balance sheet exposure.

This Commission has consistently advocated for adjustments to the SLR in its current form.  Back in 2016, Chairman Massad, Commissioner Sharon Bowen and I called for reworking the SLR formulation to reduce its disincentives to the use of derivatives and central clearing. 

I am pleased that the Commission continues to speak in a bipartisan voice regarding the SLR. 

Importance of Energy Derivatives

The second issue I want to touch on has to do with the importance of derivatives for the energy markets. 

Last year I had the good fortune to visit West Texas.  For those of you who do not know, West Texas is the epicenter of a stunning accomplishment of American exceptionalism – the shale revolution.  This is one of the greatest economic success stories the world has ever seen.  Because of it, the United States has become one of the world’s largest energy producers.[1]  This has changed, not just the structure of global energy markets, but global geo-politics as well. 

As I explained in my remarks in West Texas, our newfound energy independence is the result of a unique combination of factors, especially American entrepreneurship and free enterprise.[2]  One key factor was the role that financial hedges and commodity derivatives played in enabling the industry and its financial backers to withstand the cartel squeeze by Russia and the Organization of the Petroleum Exporting Countries (“OPEC”). 

Without the ability to efficiently hedge depressed energy prices and variable costs of production, America’s shale producers may well have succumbed to OPEC’s concerted efforts and failed to secure our country’s growing energy independence.  Instead, American shale producers not only survived, but became more efficient, more productive, and more innovative than their overseas competitors.  They are a shining example of the ability of American free market capitalism to benefit future generations of Americans. 

I look forward to your discussion of the topics on the agenda today, particularly the availability of clearing and other services in the energy derivatives markets.  As we confront the challenges ahead, we will look to the thoughtful discussions of advisory committees like yours.

And, again, thank you Commissioner Berkovitz for organizing this meeting.

[1] See Osamu Tsukimori, U.S. to Overtake Russia as Top Oil Producer by 2019 at latest: IEA, Reuters, Feb. 26, 2018, available at: https://www.reuters.com/article/us-energy-iea/u-s-to-overtake-russia-as-worlds-biggest-oil-producer-by-2019-latest-iea-idUSKCN1GB0C6.

[2] Remarks of CFTC Chairman J. Christopher Giancarlo at the West Texas Legislative Summit, Angelo State University, San Angelo, Texas (Aug. 2, 2018), available at: https://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo51.

Opening Statement of Commissioner Dan M. Berkovitz before the Energy and Environmental Markets Advisory Committee

April 17, 2019

Good morning, and welcome to the Energy and Environmental Markets Advisory Committee (EEMAC or Committee).  I am pleased to be joining you here today in my first meeting as the EEMAC Sponsor.  Prior to first joining the CFTC, I spent a number of years working on energy issues on Capitol Hill, so I have an affinity for the subjects within this Committee’s purview.

The CFTC established this Committee in 2008, a time of turmoil in our energy and financial markets, and Congress codified it in the Dodd-Frank Act two years later.[1]  Congress said the EEMAC should “serve as a vehicle for discussion and communication on matters of concern to exchanges, firms, end users, and regulators” regarding the energy and environmental markets and their regulation by the CFTC.[2]

The wealth of expertise and broad diversity of perspectives that the Members and Associate Members bring to this Committee will help inform and enable the Commission to fulfill its mission to foster open, transparent, competitive, and financially sound energy markets.

I would like to welcome our new Member and Associate Members.  Rob Creamer, who previously was an Associate Member, has joined the Committee as a Member.  Mr. Creamer is President and CEO of Geneva Trading USA, serves on the Board of the Futures Industry Association (FIA), and is Chairman of the FIA Principal Traders Group.

Paul Cicio and Matthew Picardi also have joined the Committee as Associate Members.  Mr. Cicio has been the President of the Industrial Energy Consumers of America since its founding sixteen years ago, and is a member of the Department of Energy’s Electricity Advisory Committee.  Mr. Picardi is the Vice President of Regulatory Affairs for Shell Energy North America, is a member of the Northeast Energy and Commerce Association Board of Directors, and has a leadership role on the Commercial Energy Working Group.

Thanks to each of you, as well as all of our existing Members and Associate Members, for agreeing to serve on the EEMAC and contribute your valuable perspectives.

I would like to thank Dena Wiggins for her continued service to the Committee as our EEMAC Chair.  Ms. Wiggins is the President and CEO of the Natural Gas Supply Association, and has over 25 years of experience representing energy clients in federal regulatory matters.  Ms. Wiggins has been involved in all of the Federal Energy Regulatory Commission’s significant natural gas rulemakings in the past 20 years, including the restructuring of the natural gas industry.  This is her second meeting as EEMAC Chair and we are grateful for her leadership.

I would also like to thank Chairman Giancarlo and Commissioners Quintenz, Behnam, and Stump for participating in today’s meeting.  Chairman Giancarlo was the EEMAC’s previous sponsor, and I am very pleased that he has passed me this baton.

Finally, I would like to thank the Commission staff that made today’s meeting possible, including Abigail Knauff, the EEMAC secretary; Margie Yates and Altonio Downing; Lucy Hynes and Erica Quinlan on my staff; and everyone else that worked so hard behind the scenes to prepare for this meeting.

I’d now like to introduce our panelists and the topics they will be addressing.

Panel 1: Derivatives Markets’ Responses to Physical Markets’ Developments

Our first panel of the day will explore how developments in the physical energy markets, particularly in crude oil and natural gas, may be affecting the derivatives markets related to these products.  We will begin by hearing from Chris Goodenow, who will be discussing two reports issued last year by the CFTC’s Market Intelligence Branch in the Division of Market Oversight.  The first report analyzes the effect of the growth of tight oil—also called shale oil—on the WTI and Brent crude oil futures contracts and makes some interesting findings regarding the levels of open interest in longer-dated contracts.[3]  The second report assesses the recent growth of U.S. liquefied natural gas exports and the potential impacts of this evolution on CFTC-regulated markets.[4]

These reports reflect the important work of the Market Intelligence Branch and other data surveillance efforts at the CFTC.  Objective, fact-based market analyses like those we will be discussing today enable the Commission to more effectively tailor our regulatory approach to the evolving markets.

Also on Panel 1, we will hear from Tyson Slocum, Director of Public Citizen’s Energy Program.  Mr. Slocum will discuss how technological innovation and regulatory changes have led to the United States exporting a historic volume of oil and gas.  He will also share his view on how this growth could impact household consumers.

Panel 2:  Exchange-Traded Energy Derivatives Markets

On the second panel, we will hear from Bryan Durkin of CME, Ben Jackson of ICE, and Demetri Karousos of Nodal Exchange.  These Exchange Members will give us an overview of the state of the energy futures markets, including the globalization of oil and gas trading and a shift toward clean and renewable energy sources.  We will also hear about how the changes in the physical energy markets are generating an appetite for new risk management tools, and the products that the exchanges are creating to satisfy that demand.

Panel 3: Availability of Clearing and Other Services in the Energy Derivatives Markets

On our third and final panel, we will hear from market participants about the availability of clearing and other services in the energy derivatives markets.

Among the core objectives of the Dodd-Frank Act, and the G20 Summit that preceded it, are: (1) strengthening prudential oversight of systemically important financial institutions; (2) increasing central clearing for standardized derivatives; and (3) fostering fair and transparent competition in our financial markets.[5]  Ten years after the financial crisis, our financial system is stronger and safer as a result of the Dodd-Frank Act and the regulations implementing the Act, including those promulgated by this Agency.

The G20 Summit also sought to promote global energy security, the development of clean, sustainable energy supplies, and improved regulatory oversight of the energy markets.  Over the past decade, here in the U.S. we have seen dramatic advances in energy supplies and technologies, particularly with respect to oil, natural gas, and renewable and clean energy sources.  The vitality and growth of our domestic energy industry and the improvements in the regulation of our energy derivative markets over the past decade demonstrate that we can have both strong financial market regulation and a strong energy sector.  In my view, both are essential for a robust energy sector and a resilient market-based economy.

As we continue to implement the Dodd-Frank Act, the regulators should continue to work together to ensure that their respective approaches complement one another and further all of the objectives of the Act.  This afternoon we will hear from market participants regarding how several of the prudential regulations may be affecting clearing and trading in the energy derivative markets.

First, we will hear from Mr. Creamer about the impacts that the Supplemental Leverage Ratio (Leverage Ratio) imposed by the prudential regulators may be having on the provision of clearing services for energy derivatives transactions.  The Leverage Ratio requires large banks to meet a fixed, non-risk based capital requirement in addition to risk-based capital requirements.  Intended to guard against the underestimation of risk, the prudential regulators implemented the Leverage Ratio so that banks will be adequately capitalized during times of stress.[6]

Mr. Creamer will tell us today about how the manner in which the Leverage Ratio is currently calculated may be affecting the ability of proprietary trading firms to obtain clearing services and compete in the derivatives markets.

We will also hear from Lopa Parikh of Edison Electric Institute, Vincent Johnson of BP Energy Company, and Bill McCoy of Morgan Stanley.  These panelists will present their views as to the potential impacts of certain proposed requirements for uncleared energy derivatives, including the prudential regulators’ Standardized Approach to Counterparty Credit Risk proposal (“SA‑CCR”), on the ability of end users to obtain hedging services for physical commodities.

Although SA-CCR and the Leverage Ratio are not rules imposed or implemented by the CFTC, it is nevertheless important for the CFTC to understand how the various regulatory frameworks affect the derivatives markets we are tasked with overseeing, and look for opportunities to collaborate with other financial agencies to maximize the overall effectiveness of these regulations.

We look forward to hearing from our Members and Associate Members on these issues.

Opening Statement of CFTC Chairman J. Christopher Giancarlo Before the Global Markets Advisory Committee Meeting

April 15, 2019

Thank you, Commissioner Stump. 

Good morning, everyone. 

A warm welcome to all of the Global Markets Advisory Committee (GMAC) Committee members, presenters and participants, both here and on the telephone. It is good to have you all with us.

Today GMAC will discuss how regulators are fulfilling the 2009 G20 directive regarding the OTC derivatives market. 

It will consider how those reforms are being implemented at the G-20 nation state level in a fashion that is “consistent,” though not identical.

The concern, of course, is whether disparate implementation of the reforms is causing undue fragmentation of what - prior to the reform implementation - were global markets for derivatives trading. 

The concern is that such fragmentation exacerbates the already inherent challenge in swaps trading – adequate liquidity – and increases market fragility as a result. 

Fragmentation leads to smaller, disconnected liquidity pools and less efficient and more volatile pricing. 

Divided markets are more brittle, with shallower liquidity, posing a risk of failure in times of economic stress or crisis. 

Fragmentation increases firms’ operational risks as they structure themselves to avoid the rules of one jurisdiction and be subject to the rules of another while managing multiple liquidity pools in different jurisdictions, through different affiliates. 

As structural complexity increases, operational efficiency is reduced.

The issue is how to conduct reform implementation is ways that are well calibrated to systemic risk mitigation without undue market fragmentation. 

Like all things in market regulation and, in fact, in life, the goal is achieving proper balance.

Fortunately, attention to market fragmentation is taking place at the highest levels of global cooperation. 

Japan has placed it on the current agenda of the G-20 Presidency for discussion at the upcoming June Summit in Osaka. 

The Financial Stability Board has assigned a fragmentation review to a key committee focused through the lens of financial stability.

IOSCO has had a long standing concern about fragmentation of financial markets.  

In 2013, it set up the Cross Border Task Force to examine ways to assist member authorities with the challenges of cross-border regulation to promote sound and effective domestic regulation without unduly constraining cross-border trade, investment, and risk mitigation.

The Task Force’s report was published in 2015 and identified three basic tools used by regulators to regulate cross-border securities market activities:

• national treatment;
• recognition; and
• passporting.

This year IOSCO decided to revisit the work of the Cross-Border Task Force, forming the so-called “Follow-Up Group.”

I am pleased to be the Co-Chair of the Follow-Up Group with my JFSA colleague, Jun Mizaguchi.

The Follow-Up Group has three important tasks:

• Examine instances of market fragmentation in securities and derivatives markets, and the potential reasons why fragmentation developed.
• Take stock of members’ experiences using the cross-border tools identified in the 2015 Report, including lessons learned and areas for improvement, and any policy implications from these experiences; and
• Build a central repository of supervisory Memoranda of Understanding (MOUs), to strengthen collaboration and cooperation between IOSCO regulators, and to increase transparency around supervisory arrangements between jurisdictions.

IOSCO has coordinated with the FSB to ensure our endeavors are not redundant. 

In this regard, IOSCO has provided input to the FSB on fragmentation with respect to the securities and derivatives markets which will be reflected in the FSB’s report.

In the last few months, the Follow-Up Group has surveyed IOSCO members about:

(i) instances and possible regulatory drivers of market fragmentation; and

(ii) use of the cross-border tools identified in the 2015 Report, focusing on deference and recognition decisions.   

It has also consulted with industry and other stakeholders in a workshop organized by the FSB in January 2019 and also organized a separate roundtable this past March at FIA Boca with senior members of the derivatives industry.

The Follow-Up Group is now in the process of writing up its observations and considerations.

That is why today’s meeting could not be more timely.  Concerns addressed at GMAC will help inform my contribution to the IOSCO Committee report.

I look forward to your discussion of how regulators are fulfilling the 2009 G20 directive regarding the OTC derivatives market.  As we confront the challenges ahead, in particular the fragmentation of the global swaps markets, we will look to the thoughtful discussions of advisory committees like yours.

And, again, thank you Commissioner Stump for organizing this meeting.  

Thank you all for attending.