Opening Statement of CFTC Commissioner Dan M. Berkovitz before the Commission Meeting

March 25, 2019

 

Good morning Mr. Chairman and my fellow Commissioners.

 

I’d like to begin by thanking Commission staff.  The CFTC has been particularly busy lately on issues of global importance.  Your hard work and dedication to our mission allows us, despite our size, to be one of the world’s preeminent financial regulatory agencies.  In particular, I appreciate your work on the issues we’ll be discussing today, your consideration and incorporation of many of my office’s comments, and the time you’ve spent with my staff in preparation for this meeting. 

 

When the Chairman announced this meeting just over a week ago, we had seven items on the agenda.  Fortunately, we were able to approve five of these items ahead of today’s meeting, including amendments to Commission Regulation 1.52, concerning requirements for self-regulatory organizations; Regulation 23.700, concerning requirements for segregated margin for swaps; margin comparability determinations for Australia and Japan; and updates to memorandums of understanding with the U.K’s Financial Conduct Authority in preparation for Brexit.  So I’m pleased to report that we won’t be keeping you here all day!  I thank the Chairman and my fellow Commissioners and their staffs for their work towards our unanimous approval of these matters.  

 

In addition, in the past couple of weeks, the Commission has also exempted certain derivatives trading venues in Singapore from registration as swap execution facilities because they met our comparability standards; has been taking steps with the European Commission to ensure the continuity of derivatives trading and clearing after the U.K.’s withdrawal from the EU; and today, will be voting to maintain the “legacy” status of certain uncleared swaps if those swaps need to be legally transferred due to a no-deal Brexit. 

 

These recent actions show that the CFTC’s cross-border regulatory approach that has now been in place for nearly six years, and implemented by several successive Commissions, provides an appropriately flexible framework for addressing the varied cross border issues that the Commission faces in international derivatives markets, while simultaneously minimizing the financial risks that could come back to the U.S. 

 

Finally, the other issue being voted on today is an amendment to the de minimis exception to the swap dealer definition, which excludes from counting toward the de minimis threshold certain swaps entered into by insured depository institutions, or “IDIs.”  I will now say briefly that I plan to vote against this amendment, for both substantive and procedural reasons.  In my view, this amendment drives a truck through the de minimis exception to the swap dealer registration rule by permitting an unlimited quantity of swap dealing by an IDI in connection with loans, and any expansion of the IDI exclusion can be adopted only through joint rulemaking with the SEC.  I will address these concerns in greater detail when we consider that rule for a vote.

Statement of CFTC Commissioner Rostin Behnam on the Final Rule amending the De Minimis Exception to the Swap Dealer Definition—Swaps Entered into by Insured Depository Institutions in Connection with Loans before the Public Meeting

March 25, 2019

 

Thank you Mr. Chairman.  I would like to start by thanking all of the Commission staff who worked to make today’s meeting possible – both those who will be presenting at the table today and those who provided the knowledge and analysis supporting their statements.  I will keep this statement brief as I have submitted a statement for publication with the final rule.

 

Albert Einstein said that, “A clever person solves a problem.  A wise person avoids it.”

 

Today, the Commission is voting to finalize a rule that purports to resolve longstanding concerns with the IDI loan-related swap exclusion referred to in today’s final rule as the “IDI Swap Dealing Exclusion.”  The IDI Swap Dealing Exclusion codifies part of the statutory swap dealer definition in section 1a(49)(A) of the Commodity Exchange Act that was jointly adopted with the Securities and Exchange Commission as paragraph (5) to the regulatory swap dealer definition.  This is not to be confused with the IDI De Minimis Provision being finalized today, which establishes an alternative to the exclusion, absent SEC coordination, that in purpose and effect, revises the scope of activity that constitutes swap dealing. 

 

There is no doubt that the Commission was clever in choosing how to address longstanding concerns that the IDI Swap Dealing Exclusion is unnecessarily restrictive, lacks clarity, and limits the ability of IDIs to serve their loan customers through the unilateral exercise of its authority with respect to the de minimis exception.  However, there is also little doubt in my mind that being clever does not make one correct, and I will not be voting in favor of the IDI De Minimis Provision.  The uncertainties embodied in the IDI De Minimis Provision deprive IDIs and their customers the legal certainty and clarity intended by Congress and may result in increased risk for market participants and perhaps contribute to systemic risk.  The Commission would have been wise to avoid creating this rambling IDI exemption that will now sit awkwardly beside the IDI Swap Dealing Exclusion in the Commission regulations.  These regulations are a marker of our inability to engage and collaborate with our fellow regulators towards a more practical and legally sound solution.  As an independent agency, the Commission should use its expertise to act within its authority; and not abuse ill-defined powers to create loopholes.  Our agencies are better than that.  And more importantly, our stakeholders deserve it. 

 

There has been a concerted effort these last few weeks to window dress.  However, any suggestion that this relief is surgically targeted to “small and midsize banks” and their end-user customers is unfounded.  The IDI De Minimis Provision refrains from imposing any limitations on size or structure of eligible IDIs or their customers.  Nor does it cap or require affirmative verification of the aggregate gross notional amount of swaps entered into by an IDI for which it will rely on the IDI De Minimis Provision.  I do not mean to suggest at all that size should be deterministic of whether an IDI should be able to avail itself of relief related to swap activities in connection with loan origination.  Indeed, Congress did not set such limitations on the exclusionary language in CEA section 1a(49)(a).  However, taken in the context of the unrestricted nature of the rule before the Commission today, as it relates to the relationship between swaps activity and loan origination and absence of any caps, I am extremely concerned about the potential systemic risk implication to our financial markets.

 

Small, midsize, and large IDIs should not be considered swap dealers or required to register as swap dealers with regard to swap activities related to loan origination with customers because Congress has determined that such activities—subject to the joint interpretation of the CFTC and SEC—are not swap dealing activities warranting oversight by the Commissions; not because such activities are swap dealing activities which the Commission unilaterally has determined to overlook.  I believe that IDIs deserve the fullest application of the exclusion provided by Congress in section 1a(49)(A) of the Commodity Exchange Act.  An exemption or exception leaves IDIs within the crosshairs of future Commission action should political headwinds or shifting policy dispose it to again alter the rules or its interpretation of the Act.  I stand by my now several prior statements and continue to believe that the Commission should have worked with the SEC to jointly amend the IDI Swap Dealing Exclusion to more accurately address swap activities inherent to credit risk management encompassed by loan origination in the commercial lending space. 

Statement of Chairman J. Christopher Giancarlo on the Final Rule Regarding De Minimis Exception to the Swap Dealer Definition – Swaps Entered into by Insured Depository Institutions (IDI) in Connection with Loans to Customers

March 25, 2019

The Commission will today consider the final rule for the de minimis exception for swaps entered into by Insured Depository Institutions (“IDIs”) in connection with loans to customers.  Today’s action builds upon the strong public support the CFTC has received for providing a narrowly-tailored exception that promotes the use of loan-related swaps in a commercially practicable and cost-effective manner.

This final rule will increase efficiencies and reduce the burdens for banks, particularly small and regional banks, to enter into swaps with their end-user loan customers without the added burden of unnecessary regulation and associated compliance costs.

But this proposal is far more important than that.  This proposal will allow small and medium size commercial borrowers – manufacturers, home builders, agricultural cooperatives, community hospitals and small municipalities - to conduct prudent risk management that is difficult for them under the current rule.

I recently telephoned senior executives of several regional banks to hear about their commercial lending and swaps hedging practices.

One executive serving clients in the Mid Atlantic explained that his firm was the only bank service provider to most of his small and medium sized business clients.  If his regional bank could not offer these smaller businesses a fixed interest rate swap to hedge their floating rate loan borrowing, then these borrowers had no means to hedge their exposure to rising interest rates on their loans.

Another executive with a South Eastern bank explained that regulatory limitations on his bank’s ability to offer swap hedging facilities to commercial borrowers meant that they remained exposed to rising interest rates, putting them at risk of having to curtail operations or lay off workers if rates rose.  In effect, the current situation is pushing risk down into the real economy, rather than mitigating it as derivatives market reforms were intended.

Another executive with a Midwestern bank said that greater regulatory flexibility would allow his bank to be there for its clients not only in good times, but also in times of greater volatility.  It would allow his bank to provide properly hedged lending to support good jobs, healthy communities and safe retirements in towns throughout the Midwest.

I specifically asked these executives if they would engage in more swaps dealing to compete with Wall Street.  Each of them said that they had no intention whatsoever to engage in that type of swaps dealing or speculate in swaps markets. They said that their prudential bank regulator would not allow them to do so.   They made clear that their intention was to enable business borrowers to use swaps to mitigate the risk of floating rate commercial loans invested in their local communities. I was impressed with their commitment to serving the risk management needs of their regional clients.

The preamble to the rule directs the CFTC Office of Chief Economist to conduct a study after three years of implementation.  This study will examine future trading data to see how the market operates under the rule.   It will assist a future Commission in considering whether there is a need for limitations on swap activity, and if so, at what levels.   This study is the result of a discussion with a fellow Commissioner who suggested adding limits to the notional size of swaps entered into in connection with the principal balance of related loans.   The final rule before us does not set such limits, but does not preclude the Commission from doing so in the future if considered appropriate based upon the study.   I believe imposing such limits at this time would be inappropriate without data on which to base such limits and supportive public comments.   As I have said many times before, I believe that CFTC policy is best when it is driven by data and not assumptions.

I take seriously, however, the concern about potential misuse of this provision in ways that are not intended.  The preamble makes it clear that the Commission expects that the swaps entered into by IDIs are in connection with and related to the originating loan.   For instance, a swap with a borrower entering into it for speculative or investment purposes not related to the loan would not be excepted by the IDI from the de minimis calculation.   And IDIs, as depository institutions, remain subject to prudential supervision for all of their activities, including swaps dealing.   Finally, this rule does not remove the core Dodd-Frank Act swaps requirements of clearing, post-trade reporting, and mandatory trade execution, which I fully support.

Again, I am pleased to see this rule finalized.  I do not intend to put before the Commission any other de minimis exception during my remaining time at the CFTC.   Nevertheless, staff continues to study possible alternative metrics for the calculation of the swap dealer de minimis threshold, including possible risk-based approaches.   I expect that the results of their work will be reviewed by the Commission under the next Chairman and considered for further action.

In conclusion, today’s proposed rulemaking is about much more than legal technicalities, joint rule making or even relief for regional American banks – as important as those things are. Today’s rule is about prudent risk management by America’s small business borrowers and job creators.  It is about investment in local communities in the real economy.   It is about increasing prosperity and employing our fellow Americans.   Frankly, things just don’t get more important than that.

Joint Concurring Statement of Commissioners Dan M. Berkovitz and Rostin Behnam

Order of Exemption of Certain Approved Exchanges and Recognised Market Operators Authorized within Singapore from the Swap Execution Facility Registration Requirements

March 13, 2019

 

The derivatives markets are global.  Many markets and products trade 24/7 with the opening and closing of markets following the sun.  The trading day begins in Europe, then moves to the U.S., and as our markets close, traders in Asia take over.  Banks, traders, and market operators domiciled in the U.S. are major participants and competitors in all of these markets.  It is important that we as regulators be vigilant in our efforts to avoid allowing risk to develop in other markets around the globe that could be brought back to the U.S., but in so doing we also should avoid unnecessarily impeding proper market activity.  This consideration favors a mutual recognition of markets with other countries where appropriate, effective regulation and oversight exist.

 

Under the Commodity Exchange Act (“CEA”), in order to exempt a swap execution facility (“SEF”) from registration, the Commission must determine that the facility is “subject to comparable, comprehensive supervision and regulation on a consolidated basis” by the facility’s home regulator.[1]  This determination should not only be based on the home country’s written laws and regulations, but also give due consideration to that country’s system of regulation including its approach to supervision, guidance, and enforcement.

 

When assessing whether to exempt a facility subject to the laws of a foreign jurisdiction, the Commission also should be mindful of the principle of comity: the reciprocal recognition of the legislative, executive, and judicial acts of another jurisdiction.[2]   Nonetheless, this Commission has a legal responsibility to ensure that U.S. persons trading on an exempt SEF in a foreign jurisdiction are afforded protections that are comparable to those provided under U.S. law, and that U.S. markets are protected as well.

 

Concurrence

 

We are concurring in today’s determination because the combination of Singapore’s stated goals in its laws for regulation of the listed Approved Exchanges (“AEs”) and Recognized Market Operators (“RMOs”), together with the Monetary Authority of Singapore’s (“MAS”) monographs, guidance, and overall system of supervision and regulation, can attain an outcome that is as comparable and comprehensive on a consolidated basis as our laws and regulations for SEFs.  In reaching this conclusion, we relied heavily on the analysis and communications with MAS conducted by the excellent staff of the CFTC, which included an extensive comparative analysis of Singapore’s regulatory system.

 

MAS’s legal framework for regulating AEs and RMOs is different from the CFTC’s regulation of SEFs in a few notable ways.  MAS relies more heavily on guidance, directives, and hands-on oversight by the regulator than our system of regulation.  Singapore’s Securities and Futures Act (“SFA”) and relevant regulations for AEs and RMOs do not have the same specificity that the CEA and our regulations have for SEFs.  For example, Congress established pre-trade price transparency as one of two primary goals for SEF regulation.[3]  To implement this goal, the CFTC adopted regulations requiring that, at a minimum, all SEFs maintain an order book functionality[4] and all transactions required to be traded on SEFs must be traded through an order book or request for quote system offering the quote to at least three parties for a specified period of time.[5]

 

The SFA and related regulations contain a general goal that its markets be “fair, orderly and transparent,” but do not set forth specific requirements for achieving pre-trade price transparency, such as prescribed methods of execution.  However, MAS’s Monograph on the Objectives and Principles of Financial Sector Oversight in Singapore provides that “[p]re-trade information, such as bids and offers, should be made available to enable investors to know whether they can deal and at what prices.”[6]

 

After considering the extensive analysis provided by CFTC staff, which is based in part upon their dialogue with MAS, we conclude that the statutory objectives of fairness and transparency, when considered with the more specific directives and oversight provided by MAS, provide for an outcome that is comparable to our SEF regulations.

 

Ultimately, under the principle of comity we should, where possible, respect the differences in approach that other countries take to implement effective regulation.  We understand that Singapore will take the same approach in recognizing our SEFs.

 

Continued Monitoring

 

Today’s Order states that the Commission may, at its discretion, modify, condition, suspend, terminate, or otherwise restrict the terms of the Order.  As discussed above, MAS relies more heavily on monographs, guidance, and active oversight in the regulation of Singapore’s AE and RMO facilities, as compared to our more specific legislative and regulatory requirements.

 

Accordingly, we are requesting that the CFTC staff continue to monitor whether the implementation of this regulatory regime is in fact comparable in practice.  As a general principle, such monitoring is particularly important when comparability determinations rely on representations, undertakings, or conditions to address what might otherwise be meaningful differences between the CFTC’s regulatory regime for SEFs and that of a foreign regulator.

 

Statement of Chairman J. Christopher Giancarlo on EMIR 2.2

March 13, 2019

Boca Raton, FL – The Chairman of the U.S. Commodity Futures Trading Commission (CFTC), J. Christopher Giancarlo, today issued the following statement on cross-border derivatives regulation on the occasion of a political agreement by EU co-legislators on the EMIR 2.2 legislation.

The CFTC recognizes the significant step that the EU has taken in reaching agreement on the EMIR 2.2 legislation.  It will provide EU authorities with greater ability to monitor and manage the EU’s exposure to systemic risk benefiting all market participants that transact in the EU derivatives markets.

The United States has informed the European Commission and other EU authorities of a range of concerns regarding the implementation of EMIR 2.2 and its potential impact on U.S. CCPs and the broader U.S. financial markets.  We have made clear U.S. expectation that these concerns will be afforded due consideration during the upcoming development of the EMIR 2.2 delegated acts and application of EMIR 2.2. 

While EMIR 2.2 requires a number of implementation steps such that application of EMIR 2.2 to U.S. CCPs will likely not take effect until 2021 or beyond, it is understood that during this time EU authorities, including the European Commission and European Securities and Markets Authority, will work with the CFTC to address U.S. concerns.  It is understood that the starting point for any future recognition assessment of U.S. CCPs will be the EC’s current 2016 equivalence decision and the recognition decisions made as a product of the agreement between the CFTC and EC in 2016.  This understanding is critical to allow for the continued economic growth, vitality and stability of our transatlantic derivatives markets.

For the past eighteen years, the CFTC has regulated CCPs domiciled outside of the U.S. based on the core principle of deference to the oversight of primary regulators. This approach has helped to create durable liquidity pools for effective risk management that supports economic growth both in the U.S. and globally. The approach does not impinge on national laws and practices that are essential to domestic derivatives markets.  Moreover, it provides legal certainty to market participants while preserving the ability of the primary home countries of global CCPs to oversee their markets as they deem necessary and appropriate. 

The CFTC staff’s current review of CFTC cross-border regulations, along the lines set forth in the recent white paper, Cross-Border Swaps Regulation Version 2.0,[1] is based on the premise that, in order to effectively achieve the G20 reforms in a global derivatives market, it is necessary for national regulatory authorities to embrace deference and apply it to those jurisdictions that have comparable regulatory and supervisory regimes.

Joint European Commission and CFTC Statement on EMIR 2.2

March 13, 2019

Vice President of the European Commission (EC) Valdis Dombrovskis and U.S. Commodity Futures Trading Commission (CFTC) Chairman J. Christopher Giancarlo today issued the following statement on cross-border derivatives regulation on the occasion of a political agreement between European Union (EU) co-legislators on the EMIR 2.2 legislation.

The EU and the United States are committed to ensuring the implementation of the G20 reforms are effective to achieve the goals of increased financial stability, resilience and transparency in the global transatlantic OTC derivatives market.

Today’s agreement in the EU regarding new legislation to enhance the supervision of CCPs, with a view to safeguarding the financial stability of the EU and its Member States is part of the EU’s re-assessment of the effectiveness of its implementation of the G20 reforms.  The legislation is in response to the need to monitor changes in the concentration of risk in these infrastructures as well as the departure of the United Kingdom from the EU.  As required by the legislation, the EC will shortly adopt a number of delegated acts to define the scope and content of certain provisions, drawing on public consultations and relevant assessments.  Before their adoption, these delegated acts will, under the EU’s Better Regulation principles, be subject to a public consultation by the EC to which all stakeholders will be invited to respond, including the CFTC.  The CFTC has indicated it will participate in the consultation process.  The EC will take due consideration of all stakeholder comments received, including any comments submitted by the CFTC, before adopting its legal acts to respond to any legitimate concerns raised by firms and regulators from within the EU and its major derivatives clearing stakeholders in Third Countries.  Once these acts are all in force, the European Securities and Markets Authority (ESMA) will apply these new acts.

We expect the implementation of EMIR 2.2 and the CFTC’s ongoing review of both its swaps regulatory framework and its cross-border approach will result in more deference between the CFTC and the EU supervisors than is currently the case.

Remarks of Chairman J. Christopher Giancarlo at 44th Annual International Futures Industry Conference

“Improving the Past, Tackling the Present, and Advancing to a Digital Market Future”

March 13, 2019

INTRODUCTION

Thank you, Walt.  Good morning everyone.

It is an honor to speak to you in what is almost certainly my last appearance here as CFTC Chairman.

In the next hour, Heath Tarbert, the President’s nominee to succeed me, will testify in Washington before the Senate Agriculture Committee.  I am sure he will do exceptionally well.  I expect his confirmation and arrival at the Commission sometime this summer.  I know Heath Tarbert and I know he will make a superb CFTC Chairman.

In fact, it was exactly five years ago this month that I first testified before the Ag Committee concerning my nomination to serve on the Commission.

I knew that, if I was confirmed, my tenure would be transitional.  It would bridge the last years of the Obama Administration and the beginning years of the next Administration.  I was determined to serve only one five year term.  What I could not know was who would be the next President and what that would mean for me.

I found out what it meant two years ago here in Boca.  On the Tuesday evening of the Conference, President Trump announced his intention to nominate me as CFTC Chairman.  The next morning, I stood at this same podium and set out my agenda, an agenda I called a “New Direction Forward.”

Knowing that my time as Chairman would be short, I wanted to be bold in action.  I pledged that the agency would work to enhance American markets to revive stagnant economic growth.  We would make sure our derivatives markets performed their essential role moderating price, supply and other commercial risks – shifting risk to those who can best bear it from those who cannot.  Thus, they free up capital for business lending and investment that are necessary for economic growth, job creation and prosperity.

I said that our markets should be neither the least nor the most prescriptively regulated – but the BEST regulated – balancing market oversight, health and vitality.  Thus, our approach to regulation should never be based on a crude measure of the quantity of regulation, but the quality of regulation and oversight.

To do that, we would follow a three-part agenda: completing unfinished business of the past, improving current operations, and preparing for the future, what I call becoming a 21^st Century digital regulator.

Let me now review our work on this agenda, starting with the past.

IMPROVING PAST WORK

I have long been a public supporter of the G-20 swaps market reforms adopted by the U.S. Congress in Title VII of the Dodd-Frank Act.  Yet, I have been critical of some of the regulatory implementation.

Dealer Capital

On the subject of dealer capital, I have consistently raised the concern of whether the amount of capital that bank regulators have caused financial institutions to take out of trading markets is at all calibrated to the amount of capital needed to be kept in global markets to support their overall health and durability.

In fact, the issue of the adverse impact of new bank capital requirements, particularly the supplementary leverage ratio (“SLR”) has been a bipartisan concern of the CFTC.  Chairman Tim Massad, Commissioner Sharon Bowen, and I were quite aligned on the issue.  Unfortunately, we were unable to influence prior leadership at the FDIC and the Fed.  New leadership at both agencies has a better understanding of the importance of derivatives markets to economic growth and employment.

In April of last year, I co-authored a White Paper[1] that addressed elements of emerging frameworks for bank capital requirements, including the SLR, which are biased against derivatives.  It called for recalibrating bank capital requirements to better balance systemic risk concerns with healthy economic growth.

Recently, Commissioners Brian Quintenz, Russ Behnam, Dan Berkovitz, and I submitted a comment on the notice of proposed rulemaking issued by the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation to implement a new approach for calculating the exposure amount of derivatives contracts under the agencies’ regulatory capital rules.[2]  We explained that the proposed method of computing a bank’s supplemental leverage ratio would not adequately give credit to the risk-reducing impact of a clearing firm receiving and holding a client’s initial margin against a client’s derivatives position.  This proposed amended method – termed “SA-CCR” – would continue to disincentivize clearing members from providing clearing services, and thereby limit access to clearing in contravention of G-20 mandates and Dodd-Frank.

My CFTC colleagues and I are hopeful that the three agencies will soon take appropriate action to address these concerns.

SEF Rules

The CFTC’s implementation of its swaps trading rules has long been a concern of mine.  I believe the current framework is inconsistent with the Dodd-Frank Act by being too prescriptive, too burdensome and too modeled on futures markets.  The framework is also highly subjective and overly reliant on a series of no-action letters, staff interpretations and temporary regulatory forbearance that may change at any time.

That is why, last November, the Commission issued a proposed rule on Amendments to Regulations on Swap Execution Facilities and the Trade Execution Requirement and a Request for Comment regarding the Practice of “Post-Trade Name Give-Up.”[3]

I believe there are two crucial reasons to improve the SEF rules: risk and opportunity.  The impermanence of the current SEF rule framework poses risk for market participants.  Staff in this, or a future administration less sympathetic to free markets, may well change or withdraw the numerous interpretations, guidance and compliance expectations that underpin the current framework.

Moreover, the current restrictions on methods of execution may turn out to be, by themselves, a source of trading risk during a liquidity crisis – when swaps counterparties need to be found through less prescriptive and more flexible means of execution.

On the other hand, improving the SEF rules presents opportunity – opportunity for service innovation by existing and new market entrants that has waned under the current framework.  It is the opportunity to boldly create a regulatory framework that actually fosters innovation, entrepreneurship, competition and increased market vibrancy rather than stifle it.

Improving the SEF rules also increases the chance that the SEC will draw on the new framework in whole or in part for their security-based SEF regime.  It would create a common U.S. regulatory approach for all swaps products, reducing operational and compliance costs and risks.

Perhaps, most importantly, improving the CFTC’s SEF rules to make them more compatible with the inherent trading dynamics and episodic liquidity of swaps trading will enhance markets as mechanisms for price discovery and risk mitigation.  We should be unafraid to build a better and more durable regulatory framework for swaps execution that will support vibrant markets and broad-based prosperity for a generation or more.  We should do so now, while there is open-mindedness at the Commission for improvement.

Swap Data Harmonization

Swaps data harmonization is one of the last unfinished elements of the G-20 swaps reforms to be completed.  Of all the swaps reforms to emerge from the financial crisis, visibility into counterparty credit risk of major financial institutions was perhaps the most pressing.  It is quite disappointing that regulators are still working to complete this task.

Ideally, the harmonization of many dozens of swaps data standards would be done by experienced swaps regulators who understand how these swaps data standards are best arranged and formulated for active use and analysis.  Swaps market regulators like the CFTC are the ones who have the legal authority and, thus, accountability to put these data standards in place and make them work.

Unfortunately, the global system for the governance of identifiers is being steered by a bureaucracy of agencies lacking necessary “skin in the game” attained from overseeing market participants required to report trades to data repositories.  They seek to control how these identifiers are implemented around the world, yet they do not have the authority to mandate their use.  Their interests are not focused on meeting the G-20 swaps reform objective.

The CFTC and other swaps regulators worldwide that oversee vital and active markets with legal authority to require the use of these identifiers must be the key voices on implementation and governance decisions for derivatives reporting rules and swaps data standards.  It is only logical.  It is a failure of international governance that the CFTC, the SEC, and our relevant counterparts in Europe and Asia are not fully managing this effort.

As a strong supporter of the G-20 reforms who does not suffer futility well, I am losing patience with the current process.  If changes are not forthcoming in the governance of the implementation of these data standards, I am prepared to have the CFTC work with its key international counterparts and pursue a separate and more effective course to finally complete this long-overdue swaps reform.

ADDRESSING THE PRESENT

Project KISS

Turning to the present, two years ago, I announced to you the launch of Project KISS.  It stands for “Keep It Simple Stupid.”  It is an agency-wide review of CFTC rules, regulations and practices to make them simpler, less burdensome and less costly.  It has resulted in a range of rule and process improvements that are reducing regulatory costs and burdens.  Many KISS initiatives were recommended by market participants, but many were also initiated by our own agency staff that saw ways to reduce undue obligations on registrants and market participants.  There are still more Project KISS initiatives in the pipeline.

Market Intelligence

Market Intelligence Branch.  Here at Boca, I also announced that the CFTC would strengthen its ability to understand the current evolution of markets.  In 2017, we set up the Market Intelligence Branch (MIB) as part of the CFTC’s Division of Market Oversight.  The work of the new branch is important.  It is to understand, analyze and communicate current and emerging derivatives market dynamics, developments and trends – such as the impact of new technologies and trading methodologies.  The purpose of MIB is to increase the Commission’s knowledge of evolving market structures and practices in order to inform sound policymaking.

MIB has been a resounding success.  It provides Commissioners and senior staff with daily summaries of market news a weekly report of key market developments.  It also briefs other U.S. financial regulators, including the SEC, the Federal Reserve and the Treasury.  In these briefings MIB covers the full range of derivatives markets from financials and precious metals to energy, currencies and agricultural commodities.  In addition, MIB and other CFTC staff regularly present analyses of emerging trends, such as impacts of high frequency trading or block trade sizes in specific markets.[4]

Chief Market Intelligence Officer.  Another step was the creation and appointment of a Chief Market Intelligence Officer (CMIO).  Last month, we announced Mel Gunewardena as CMIO and Deputy Director of MIB.  Mel’s deep experience in domestic and international financial markets, especially in over-the-counter derivatives, will be a superb addition and help the CFTC keep pace with rapidly markets evolution.

The Chief Market Intelligence Officer is also tasked with helping the public understand risk transfer markets and why they are so important to prosperity.  Too many people, including investors, do not know what the CFTC does or why it does it – both from a marketplace and regulatory perspective.  That is why we will continue our popular podcast series, #CFTC-Talks, that now has been downloaded over 75,000 times.

Chief Economist.  Another element of market intelligence is building a 1^st rate Office of the Chief Economist headed by a world-recognized economist, Bruce Tuckman, whom I recruited a year and a half ago.  Since Dr. Tuckman’s arrival, the office has harnessed regulatory data to contribute meaningfully to policy deliberations and has continued to produce cutting-edge research so that we can better understand the roles of derivatives markets and their participants in our financial system.  The office’s quantification of risk transfer through OTC derivatives markets using Entity-Netted Notionals or “ENNs” is being recognized as seminal work that adds much needed clarity and perspective to global swaps markets.

Agricultural Commodity Futures

The agency has also refocused its attention on agricultural commodity futures, its traditional foundation.  During almost five years on the Commission, I have travelled the country and visited agriculture producers in over two dozen states from Montana, Texas, Arkansas, Louisiana and Iowa to Minnesota, Missouri, New York, Georgia, Mississippi and Oklahoma.  I have walked in wheat fields and harvested soybeans, tramped through rice farms and beneath pecan groves, milked dairy cows and toured feedlots, visited grain elevators and viewed cotton gins.  I have also met with our energy producers, going 900 feet underground in a Kentucky coal mine and 90 feet in the air on a North Dakota oil rig.  Throughout, I have been moved by the diverse beauty of this country. I have come to love its hard-working families producing food and energy from this abundant land.  These visits have been a great privilege for me.

Last year in Kansas, we held the CFTC’s first ever annual agricultural futures conference along with Kansas State University.[5]  Panelists discussed current macro-economic trends and issues affecting our markets, like market speculation, high frequency trading, trade data transparency, novel hedging practices and market manipulation.  Participants looked at problems in convergence between cash and futures prices and volatile storage rates and heard about advances in distributed ledger technology, algorithmic trading and other emerging digital technologies, as well as current regulatory activities in protecting participants from manipulation, fraud and other unlawful activities.

Our common purpose was to hear from end users who use our markets to hedge risk and consider and address issues of emerging market structure and trading practices.  We will hold our second Ag futures conference on April 11-12, 2019.[6]  The program is excellent.  I hope to see many of you there.

Enforcement

Focusing on the present includes due attention to the agency’s enforcement program.  Two years ago, I issued a warning to those who may seek to cheat or manipulate our markets that they would face aggressive and assertive enforcement action by the CFTC.  I pledged there would be no pause, let up or reduction in our enforcement of the law and punishment of wrongdoing.

And that was true.  During my watch, the CFTC has been resolute in holding market participants to the highest standards of behavior.  In fact, by any measure, enforcement has been among the most vigorous in the history of the CFTC, including more enforcement actions, more penalties, more large-scale matters, more accountability, more partnering with criminal law enforcement and more whistleblower awards than in prior years.[7]  By almost any measure, we are enforcing the law with gusto and determination.

Yet, our strong fist of enforcement is wrapped in a velvet glove, a glove of cooperation and of transparency.  Our cooperation and self-reporting program is meant to encourage a “culture of compliance” by reducing penalties for companies and individuals who identify the misconduct and tell us about it.[8]  This program is modeled on those of other national law enforcement agencies.  We also strive to be transparent in our work, including publishing the Enforcement Division’s first Annual Report.[9]  It also includes, again for the first time, announcing the priorities of our various examination branches.[10]

Before I entered government service, I spent a decade and a half working on Wall Street.  My commitment to transparent examination practices and robust regulatory enforcement derives from that experience.  I have enormous respect for all of you – the good men and women of America’s financial service industry who conduct themselves each and every day with integrity and honesty.  You are the ones who are betrayed by the very few who engage in wrongful behavior.

It is the duty of government generally and the particular mission of the CFTC to fairly enforce market regulation and prosecute bad actors.  We fulfill that mission so that America’s financial markets are places for good people to fulfill their dreams, grow the economy and increase prosperity.

Run a Tight Ship

Two years ago, I pledged that I would run a tight ship at the CFTC.  As a former business executive, I wanted to bring best operational practices from the private sector to the CFTC.  I felt that such practices would best reward the trust placed in the agency by our Congressional overseers and U.S. taxpayers, who are our ultimate shareholders.

I am pleased to report that we have made progress.  Staff morale is good.  Our volunteer pay and benefits review team has made some thoughtful recommendations.  We have a great cadre of new division directors, smart deputies and engaged staff with renewed focus on the operation of our markets.

We are working well with our labor union ending an adversarial posture before a Federal impasse panel upon my arrival.  We have just received our first clean audit opinion in almost two decades, something of which I am most proud.  And, importantly, the CFTC has just received its first funding increase in half-a-dozen years solely on the merits of our budget request.

With the funding increase, we can at last turn to many important needs of the agency, including some longer-range goals that have had too little attention.  One is to leverage diversity to help us do a better job as a regulator working across a diverse global economy.  I know this is an important theme of this year’s FIA Conference.  We have implemented targeted outreach to minority institutions such as Historically Black Colleges and Universities in order to identify potential student candidates for our internship program.  We have also partnered with Gallaudet University, a federally chartered school for the deaf and hard of hearing, for future internship opportunities for students.

I am pleased to announce that, thanks to our increased funding, the CFTC will be able to offer a paid internship program this summer, which will ensure a diversity of participants and not just those who have the wherewithal to support themselves financially for the term.

Okay, now let me turn to overseas matters.

Effective International Engagement

Bridge Over Brexit.  Two weeks ago, the CFTC along with the Bank of England and the Financial Conduct Authority (FCA), with support from Her Majesty’s Treasury, issued a joint statement providing assurances to market participants on the continuity of derivatives trading and clearing activities between the UK and U.S. regardless of the outcome of the UK’s withdrawal from the EU.

Together, the four authorities are taking measures to avoid regulatory uncertainty about the continuation of derivatives market activity between the UK and U.S.  These measures should give confidence to market participants about their ability to trade and manage risk across the Atlantic.  It is a great credit to the decades-long cooperation between the CFTC and the Bank of England, FCA, and HM Treasury, that we are able to work together to take these steps.

It is critical that the CFTC continue to work positively with its overseas regulatory counterparts, not just in the UK, but in all financial centers.  That is why the afternoon after the CFTC-UK announcement, I traveled to Brussels to meet with European Commission Vice President Valdis Dombrovskis and Director-General Olivier Guersent to discuss how to broaden cooperation between the CFTC and the EC.  And this is also why I asked the Monetary Authority of Singapore to join me here in Boca Raton today to announce the latest example of close cooperation between the CFTC and Singapore.  I hope you will join us at 11:00 am today for this important announcement.

EMIR 2.2.  As you know, the EU is in the process of reaching a political agreement on new amendments to the European Market Infrastructure Regulation (EMIR 2.2) pertaining to the regulation and supervision of central counterparties (CCPs).  Agreement on the EMIR 2.2 legislation would begin a multi-year process in the EU to issue the delegated acts to implement the legislation and ultimately decide on the application of the EMIR 2.2 to individual CCPs.

I have made it clear to our counterparts in Brussels the range of U.S. concerns regarding the implementation of EMIR 2.2 and its potential impact on U.S. CCPs and the broader U.S. financial markets.  These concerns include the application of EU law to U.S. domestic clearing activity conducted by U.S. market participants, the scope of systemic risk subject to proposed Tier II supervision, the lack of regulatory distinction between futures and swaps, and other issues of concern.  We expect that these concerns will be afforded due consideration during the implementation of EMIR 2.2.  We also expect that the starting point for discussion of any application of EMIR 2.2 to U.S. CCPs will be the agreement reached between the CFTC and EC in 2016 on CCPs and the recognition decisions that came out of that agreement.

International Workstreams.  The CFTC continues to lead and advance American interests in international financial regulatory negotiations and meetings.  This was evident two years ago when we led the effort to reach a common approach with our counterparts in Europe and Asia to ease the implementation of variation margin on uncleared swaps between dealers and their buy-side customers.

Today, the CFTC participates in more international work streams than ever in its history.  The CFTC is an active contributor to the International Organization of Securities Commissions (IOSCO), Financial Stability Board, and IOSCO’s joint work with the Committee on Payments and Market Infrastructures and Basel Committee on Banking Supervision.  More importantly, the CFTC chairs or co-chairs international working groups on market fragmentation, efficient resiliency of OTC derivatives reforms, commodity principles, cybersecurity, regulation of financial market infrastructures, international data standards, and implementation monitoring and assessment.  I am proud that CFTC leadership has made it possible to have IOSCO, the FSB and other groups produce international standards, guidance and reports that have substantially advanced the goal of a more resilient global financial system while supporting robust markets.

In all of its international engagements with fellow financial regulators and related regulatory bodies, the CFTC seeks to act in a forthright and candid manner, displaying leadership when appropriate and respect and due consideration at all times.  The CFTC aims to be considered a trusted and worthy counterparty by its overseas regulatory counterparts.

Cross-Border Rule Proposals.  Six months ago, I released a White Paper on cross-border swaps regulation that proposed updating the agency’s current cross-border application of its swaps regime with a rule-based framework based on regulatory deference to third-country regulatory jurisdictions that have adopted the G-20 swaps reforms.  As our regulatory counterparts continue to implement swaps reforms in their markets, it is critical that we make sure our rules do not conflict and fragment the global marketplace.  That is why I believe the CFTC should move to a flexible, outcomes-based approach for cross-border equivalence and substituted compliance and operate on the basis of comity, not uniformity, with overseas regulators.

I also directed CFTC staff to prepare as soon as possible to put through the Administrative Procedure Act process various new cross-border rule proposals.  In a moment, I will discuss next steps in cross-border policy development.

PREPARING FOR THE FUTURE: BECOMING A 21^ST CENTURY REGULATOR

Embracing Fintech: Creating LabCFTC

I have frequently talked about transforming the CFTC into a 21^st Century regulator amidst today’s increasingly digital and algorithmic markets.  I recently identified several factors that are challenging the work of regulators:  the extraordinary pace of exponential technological change, the disintermediation of traditional actors and business models, and the need for technological literacy and big data capability.

I said that the CFTC’s response to rapidly changing markets and technological developments, including blockchain technology and cryptocurrencies, is built upon the following four cornerstones:

• adopting an "exponential growth mindset" that anticipates the rapid pace of technological innovation and the need for appropriate regulatory response;
• becoming a "quantitative regulator" able to conduct independent market data analysis across different data sources, including decentralized blockchains and networks, without being reliant on self-regulatory organizations and market intermediaries;
• embracing "market-based solutions" to determine the value of technological innovations, as we witnessed with the launch of crypto-asset-based futures products; and
• establishing an internal Fintech Stakeholder to address the opportunities and challenges that fintech presents and manage the ever-present tension between innovation and regulation.

For us, that stakeholder is LabCFTC.  It was launched almost two years ago.  In that time, it has had over 250 separate interactions with innovators big and small.  It has offices in New York City.  It conducts “lab hours” in places where innovators work:  from Silicon Valley, California to Silicon Hills, Texas and from the South Bank of London to Singapore Center.  LabCFTC is not a “sandbox.”  It does not try to pick winners from losers.  Nor does it exempt firms from CFTC rules.

Instead, LabCFTC provides us both an internal and external technological focus.  Internally, it means explaining technology innovation to agency staff and other regulators and advocating for technology adoption.  Externally, that means reaching out and learning about technological change and market evolution, while providing a dedicated liaison to innovators.  It has entered into fintech cooperation agreements with regulators in London, Singapore and Australia.  It has published well-regarded technology primers and requests for comments.

I am proud to say that LabCFTC has become a category leader.  Every US federal financial regulator has either created or is creating a program similar to LabCFTC.

WHAT’S AHEAD

Okay.  So here is what is immediately ahead and what I plan to get done before I leave.

There are several Project KISS initiatives that will soon move through the Commission.  There are more in the pipeline that will likely finalize under my successor.

Last November, the Commission ruled that the numeric threshold for swap dealer de minimis would not fall from $8 billion to $3 billion.  The Commission will soon consider permanent relief for certain insured depository institutions from counting certain swaps toward the swap dealer de minimis threshold.

All five Commissioners have committed to Congress to move forward with a final position limits rule.  I believe the final rule must be responsive to the public comments and ensure that regulatory barriers do not stand in the way of long standing hedging practices of American farmers, ranchers, producers and manufacturers, who depend on our markets.  I intend to put forth such a position limits rule proposal before I leave the Commission.

A moment ago, I said that the staff is preparing various new cross-border rule proposals.  For the past eighteen years, the CFTC has regulated CCPs domiciled outside of the U.S. based on the core principle of deference to the oversight of primary regulators.  But I believe we can and should defer more in order to effectively achieve the G-20 reforms in a global derivatives market.  Before I leave, I intend to put before the Commission a rule proposal to address the registration of non-U.S. CCPs clearing swaps for U.S. persons.  Among other things, the proposal will set forth a framework under which non-U.S. CCPs that do not pose a substantial risk to the U.S. financial system would have the option of being registered with the CFTC as a derivatives clearing organization “DCO” under an alternative registration framework.  These alternatively registered DCOs would still be able to offer customer clearing through futures commission merchants (FCMs).  Under this “enhanced deference” approach, the home country regulator would continue to have supervisory primacy, but with the CFTC more narrowly focused, from both a legal and practical perspective, on U.S. customer protection.  For non-U.S. DCOs that do pose a substantial risk to the U.S. financial system, we would continue our current deference-based approach to oversight.

The proposal also will provide non-U.S. CCPs that do not pose a substantial risk, and that are subject to “comparable, comprehensive supervision and regulation” by appropriate government regulators in the CCP’s home jurisdiction, the option to be exempt DCOs.  Unlike the current CFTC approach to exempt DCOs, this option would permit exempt DCOs to offer customer clearing to U.S. eligible contract participants through foreign clearing members that are not registered as FCMs.  This approach is similar to the CFTC’s historical cross-border approach for futures clearing.

I also intend to put forth a rule proposal addressing the registration and regulation of non-U.S. swap dealers and major swap participants.  In particular, the proposal will address the risk that non-U.S. swap dealing activity poses to the United States, but do so in a way that does not apply the swap dealer rules extraterritorially without sufficient consideration of whether the activity truly poses a “direct and significant” risk to the U.S. financial system, as Congress intended.

There are other cross-border proposals in the works that I trust will be taken up under the new Chairman.

Staying the Course

I said at the outset that I would serve out my full term, but no further.  My experience of Washington is that most people that come here stay too long, not too short.  In the next few months, I will return with satisfaction to my home and private life in New Jersey.

Looking to the past, I will be pleased that I have furthered and confirmed much of the Dodd-Frank mandate for swaps.  Where I have identified flaws in implementation, I have proposed comprehensive solutions.  The opportunity is at hand to create better frameworks that are more flexible, more durable and more supportive of deep and liquid markets, in good times and in bad.  I hope you will work with Chairman Tarbert and the Commission to seize the opportunity.

As for the present, I have tried to do what my parents taught me – to leave any place I visit in a better condition than I found it: better run, better funded, more transparent, more accountable and more efficient in its vital mission overseeing American markets.

As for the future, I will be satisfied that I have raised the profile and reputation of the CFTC and set it on a course for the digital Twenty-First Century.  So much is changing, and changing rapidly in our commodity derivatives markets.  As market regulators, we are ready to listen, and we are working to understand.  And, we will be dogged.  The greater the pace of change, the greater must be our capacity to keep pace, understand and harness it.

The CFTC is well along the course of that new direction set two years ago – a course that is sustainable and true.  I am confident that this course will continue under Chairman Tarbert.

Renewed Commitment to Free Markets

I have been coming to FIA Boca for over decade and a half.  Today, I stand before you for the last time as CFTC Chairman.

Before I go, I want to reassert for you an enduring ideal.  That is, the value proposition of free market capitalism.

The proposition is that broad and sustained prosperity generally occurs wherever in the world there are open and competitive markets, free of political interference, combined with free enterprise, personal choice, voluntary exchange and legal protection of person and property.

Under free market capitalism, well-regulated and well-ordered trading activity is considered a forum of human self-expression and economic advancement.  Freedom to act in the marketplace is a part of freedom itself.  Billions of consumers, following their own self-interests and individual needs, make the decisions that direct the future, not have it directed for them.  For an emerging generation fascinated by crowd sourcing, free capital markets are the ultimate in crowd sourced decision making.

Free market capitalism is not a source of misery and oppression; free market capitalism is the antidote.  It is unmatched in alleviating global poverty and unlocking human potential.

Whatever the flaws and mistakes of free markets, they are best addressed through the work of associations like FIA and regulators like the CFTC.  The shortcomings of free markets are not fixed through government run economies.  In fact, whenever capital, goods and services are allocated by government agencies, there are black markets and bread lines. Government controlled markets always turn abundance into scarcity and inequality.

Abandoning free markets devastates economies.  It supplants equality of opportunity with equality of misery.  During the twentieth century, approximately 70 million people perished from famine in countries with centrally planned food-procurement systems.[11]  In our own times, these systems produce starvation and disease right before our eyes.[12]

We must disabuse our children of the notion that there is anything attractive or aspirational about political control of markets and human enterprise.  Everywhere it has been tried, it has been a fraud and a failure.  It crushes human liberty and society.  It steals power from individuals and families and gives it to government and government elites.  It enables abuse by a select few who exercise unbridled power over many.  For young people, controlled economies are dream destroyers.  Youth around the globe are ever in flight away from controlled economies toward free markets.

We must tell our children here at home that the value proposition of free market capitalism.  Their American heritage of life, liberty and the pursuit of happiness are about the freedom of the individual – not just moral or political freedom – but economic freedom as well, freedom to live in a self-directed manner and conduct commerce as one may determine.  Free markets should be the natural choice of today’s youth, who today and always, aspire to bright and self-actualized futures.

Conclusion: A Future of Human Potential

I personally hope that we can renew faith in free markets for ourselves and our children.  We must not be intimidated, but be confident.  In so doing, we best encourage and reward the initiative, productivity, drive and dreams of everyone on this planet . . . not just for the soybean growers I met in White Cloud, Kansas; dairy farmers in Melrose, Minnesota; or cotton producers in Bardwell, Texas; but also for commodity traders in Chicago, swap dealers in New York and London, and pension managers in Tokyo.  We must do so for the sakes of the tomorrow’s citizens here at home and abroad, in developed economies and developing ones, in places like the Congo that lack infrastructure to meet growing needs or like Venezuela that face the consequences of bad economic and political choices.

With the proper balance of sound policy, regulatory oversight, private sector innovation and a little bit of courage, new technologies and global trading methodologies will lead our markets to evolve in responsible ways, and continue to grow the economy and create a future of untethered aspiration, a future where creativity and economic expression is a social good in its own right, a source of human growth and advancement.

Thank you for a privilege to speak to you today.

It has been my honor to serve you, our dynamic markets and the American people.

Remarks of Chairman J. Christopher Giancarlo at the 4th Annual DC Blockchain Summit

“The Digital Trinity: Technology, Markets, and Policy”

March 6, 2019

Introduction

I am delighted to join all of you today.

I am delighted because it is great to be part of this program put on by the Chamber of Digital Commerce, an organization that brings so much intelligence to the public discussion of digital assets and Blockchain technology.  My thanks to Perianne Boring, who is truly one of the foundational figures in this emerging field of innovation.

I am delighted because I am following Craig Phillips, who spearheaded the US Treasury’s seminal report last year on “Nonbank Financials, Fintech and Innovation,[1] that contains so many important recommendations for streamlining and modernizing the regulatory environment to foster innovation.

And, I am delighted to be on the same program as “Crypto Mom,” Hester Peirce, my “crypto spouse”!  With the crazy schedules that Hester and I keep, we are like virtual ships passing in the digital night.  I am sure it is a comfort to all of our “crypto-kids” to see us together at this great event.

As you may know, the potential of the blockchain and its impact on financial markets has been a key focus of ours.  I first addressed it three years ago when I called for a “Do No Harm” Regulatory Approach to Distributed Ledger Technology.[2]  Since then, the CFTC’s Technology Advisory Committee, sponsored by Commissioner Brian Quintenz, established a Subcommittee on Distributed Ledger Technology and Virtual Currencies that we will hear from in a few weeks.  Meanwhile, our own Lab CFTC has produced a “Primer on Smart Contracts”[3] that addresses Blockchain and has received a great response.

I am grateful to organizations like the Digital Chamber that have been engaged with us along the way.  They are a trusted resource, as we see in their thoughtful response to our request for information on crypto markets and mechanics.[4]

Today I look forward to sharing with you my thoughts on technology, regulation, and markets, and the relationship between the three -- the “Digital Trinity,” if you will.

Indeed, what makes this era of financial technology innovation so fascinating is the realization that the development of new technologies and business models is intertwined with the existence of older regulatory frameworks and the development of new policy approaches needed to keep pace.  I suppose this is precisely why we are having this discussion here – in Washington, D.C. – and cross-pollinating our best and brightest from many fields and areas of expertise.

The Blockchain – Taking Stock

In the past few years, I have had numerous opportunities to discuss one prominent application of blockchain technology – cryptocurrencies – especially given the CFTC’s oversight of crypto-related futures and derivatives markets.[5]

Today I want to take stock of the current state of blockchain technology and renew a focus on how it can impact – and improve – our markets.  To begin, I want to take you back for a moment to September 2008.[6]  That was a perilous time in global financial markets. An enormous U.S. housing bubble had burst triggering a cascading global credit crisis. Concern was rife about imminent investment and commercial bank failure.

I was on Wall Street, serving as a senior executive of one of the world’s major trading platforms for credit default swaps (CDS), then the epicenter of systemic risk.  Panic was in the air and tension was on our broking floor trying to maintain orderly markets.  I remember a call from a U.S. bank regulator asking about CDS trading exposure of several major banks, including Lehman Brothers. In fact, trading conditions were deteriorating by the hour.  It was clear that the regulator had little means, short of telephone calls, to read all the danger signals that the CDS markets were broadcasting.

But imagine what a difference it would have made a decade ago on the eve of the financial crisis if regulators had access to the real-time trading ledgers of large Wall Street banks, rather than trying to assemble piecemeal data to recreate complex, individual trading portfolios.

Imagine if, instead of having to call around to brokerage firms like mine searching for market information, prudential regulators had access then to a “golden record” of the real-time ledgers of all regulated trading participants.

And imagine if in 2008 regulators could have viewed a real-time distributed ledger, and, perhaps, been able to utilize modern cognitive computing capabilities to recognize anomalies in market-wide trade activity and diverging counterparty exposures indicating heightened risk of bank failure.  And imagine if, that insight would have shown that the $400 billion notional of outstanding credit default swaps written on Lehman Brothers represented under $8 billion in net market exposure to failure of the firm.[7]

In short, what a difference it would have made a decade ago if Blockchain technology had been the informational foundation of Wall Street’s derivatives exposures.  At a minimum, it would certainly have allowed for far prompter, better-informed, and more calibrated regulatory intervention instead of the disorganized response that unfortunately ensued.

Now, let’s fast forward to today.  Bitcoin has refocused attention on topics of back-office infrastructure, interoperable databases, and shared ledgers – and this is a good thing.  It means that efforts to upgrade data infrastructure with blockchain or DLT-inspired systems is getting the attention required to drive broader adoption.  And these systems could enhance efficiencies and transparency not just in our financial markets, but also across the real-economy.

With respect to financial markets, DLT is likely to have a broad and lasting impact in payments, banking, securities settlement, title recording, cyber security and trade reporting and analysis.[8]

Additionally, as our recent LabCFTC primer on smart contracts makes clear,[9] DLT will likely develop hand-in-hand with smart contracts that can value themselves in real-time, report themselves to data repositories, automatically calculate and perform margin payments and even terminate themselves in the event of counterparty default.[10]

DLT may further enable financial market participants to manage the significant operational, transactional and capital complexities brought about by the many mandates, regulations and capital requirements promulgated by regulators here and abroad in the wake of the financial crisis.[11]  In fact, one study estimates that DLT could eventually allow financial institutions to save as much as $20 billion by 2022 in infrastructure and operational costs each year.[12]  Another study reportedly estimates that blockchain could cut trading settlement costs by a third, or $16 billion a year, and cut capital requirements by $120 billion.[13]  Moving from systems-of-record at the level of a firm to an authoritative system-of-record at the level of a market is an enormous opportunity to improve existing market infrastructure.[14]

Outside of the financial services industry, many use cases for DLT are being posited from international trade to charitable endeavors and social services.  International agricultural commodities merchant, Louis Dreyfus, and a group of financing banks last year completed the first agricultural deal using distributed ledger technology for the sale of 60,000 tons of U.S. soybeans to China.[15]  Other DLT use cases include: legal records management, inventory control and logistics, charitable donation tracking and confirmation, voting security, and human refugee identification and relocation.[16]

Clearly, blockchain development and adoption will not be easy, and challenges remain around scalability, governance, security, and value.  Indeed, as I have observed over the past few years, some advances will seem slow, until they hit a tipping point.

Yet it is undeniable that DLT hold enormous commercial promise.  That is why many of you in the room today are doing your best to advance the technology and drive that broader adoption.  From my perspective, that adoption may provide critical assistance to financial market regulators in meeting their mission to oversee healthy markets and mitigate financial risk.  And, that is just one of the reasons why I am excited about the promise and prospects of Distributed Ledger Technology.

Regulatory Response to Exponential Technologies: the CFTC Approach

Let’s shift gears, however, to the broader discussion of regulation in the face of exponential technologies.  A threshold question that frequently arises when we talk about fintech is whether or why is this time different when it comes to innovation as compared to historical periods?  After all, one could fairly argue the ATM in the 1960s was financial technology innovation, as was the establishment of electronic trading venues in the 1980s and 90s.

Based on our observations and work at the CFTC, I would suggest, however, that there a number of characteristics of the current period of innovation, that are – in fact – different and require a new, differentiated regulatory response.[17]  Allow me to discuss each in turn.

The first is that we live in a period of exponential technological change.  That is, the sheer speed of innovation has increased exponentially, both in terms of production of new models and products and their subsequent public adoption.  The former dynamic is driven by increases in the power of computing coupled with decreases in computing costs, and the latter is a function of how the internet and mobile allow for rapid public adoption and scalability.  These dynamics put pressure on regulators to keep pace with rapidly changing markets, especially given the potential for new technologies to impact markets in short order.

The second characteristic is the disintermediation of traditional actors or business models, which can challenge regulators and existing regulatory frameworks.  Consider, for example, how the digitization of everything, including music, travel, trading, and even farming have furthered the decentralization of traditional intermediaries.  Such decentralization of key economic actors is an enormous challenge to most regulatory approaches and frameworks, which tend to focus on key intermediaries through registration of major market participants and designation of self-regulatory organizations comprised of such participants.

Consider cryptocurrencies, for example, which seek to offer alternative means and rails to execute payment transactions, power self-executing software, or drive capital raising activity.  In many instances crypto-related activity may occur outside of traditional intermediaries – indeed frequently by intentional design in order to offer an alternative model – and include new economic actors not covered by existing regulatory frameworks or covering them in an ill-fitted manner.

The third characteristic is that the pace and nature of technology-driven innovation requires heightened technological literacy across leaders in business and government.  How many today truly understand the technologies that power underlying business models?  And from a government perspective, how can regulators be expected to mitigate risks and formulate sound policies that foster market-enhancing innovation without requisite technology literacy?

Given these characteristics, how is a regulator to respond and keep pace with rapidly changing markets?

During my tenure as Chairman of the CFTC we have taken affirmative steps to evolve into a 21^st century regulator and craft a modern regulatory approach.  Our formula for this evolution is really quite simple and is predicated on four key elements:

1. Adopting an Exponential Growth Mindset.
2. Creating an Internal Fintech Stakeholder.
3. Becoming a Quantitative Regulator.
4. Embracing Market-Based Solutions.

Let’s look at these ingredients in more detail:

First, it is critical to adopt an exponential growth mindset, which is predicated on “anticipation” or more colloquially “skating to where the puck is headed.”  Specifically, this means anticipating:  the rapid pace of change, market adoption of innovation, the resulting new demands on regulators, and the need for capability and capacity-building at the regulator.  This mindset must inform and serve as the lens through which we approach our markets.

The second ingredient is really a natural outgrowth of the first: that is, the creation of a permanent stakeholder within regulatory agencies to understand and address the opportunities, challenges, and risks posed by innovation.  Absent this stakeholder there is no other constituent tasked with thinking about the direction of emerging technology, considering the impact on existing rules and regulations, exploring ways to internalize such new technologies, and working to mitigate emerging risks.

The stakeholder should have both an external and internal focus.  Externally, the stakeholder engages with innovators – whether start-ups or existing market participants – and can help save them time and resources by providing feedback on new concepts or identifying regulatory friction.  By serving as a liaison to the innovator, the stakeholder also benefits by gleaning key insights into technological change and market evolution.

Internally, this stakeholder helps to educate and inform the agency and staff on new developments.  It can help manage the tension of innovation against existing regulatory frameworks, advocate and inform internal technology and procurement strategies, and serve as a liaison to other domestic and international regulators, as well as political bodies.

If this stakeholder sounds familiar and like a good idea, I am glad to say that it is the description of our very own LabCFTC.

Launched in 2017, LabCFTC has engaged with more than 250 entities in cities and regions around the world, including NYC, Chicago, Silicon Valley, Austin, Singapore, London, Boston, and Washington, D.C.[18]  LabCFTC has published timely primers on emerging technologies, including virtual currencies and smart contracts, embarked on an innovation competition, informed policy at the Commission, participated in numerous external events, operationalized bilateral fintech cooperation arrangements with international regulators, and served point in engaging with Members of Congress and other domestic regulators.

The work of LabCFTC has highlighted an important issue that U.S. regulators face.  We have certain limitations in the ability to test, demo, and generate proof of concepts around these complex emerging technologies and systems.  Specifically, the CFTC lacks the legal authority to partner and collaborate with outside entities engaging directly with fintech and innovation within a research and testing environment, including when the CFTC receives something of value absent a formal procurement.  The general rule is that without such authority, the CFTC must forego the increasing number of opportunities to engage in research that may benefit the derivatives markets that the agency oversees, as well as the CFTC’s own activities.

The Commission would like the ability to partner, collaborate, or engage in a cooperative agreement regarding emerging financial and compliance technologies with persons or entities; Federal, State, or local agencies or instrumentalities; or foreign governments or international organizations.  Legislation introduced last Congress by Congressman Austin Scott provides such authority.  This important initiative would greatly enhance the Commission’s ability to keep pace with emerging technology, explore its potential, and facilitate its adoption.

We look forward to the next phase of LabCFTC as we look to deploy our increased Agency budget in support of modernization and capacity-building.  And, I am pleased that at this point in time every federal financial regulator in the U.S. either has or is creating an innovation program or office similar to LabCFTC as we all seek to develop a blue print for regulatory modernization.

The third ingredient is for the CFTC to become what I have previously called a “Quantitative Regulator.”[19]  Commercial trade execution and strategy in CFTC regulated markets is increasingly driven by quantitative data analysis of highly granular market data.  We are beginning to chart a parallel course for the CFTC to become a Quantitative Regulator, which means an effective and up-to-date big data organization capable of engaging in robust data collection, automated data analytics, and artificial intelligence deployment.  The transformation I describe here will be necessary to ensure we can glean critical market intelligence, conduct effective trade surveillance and oversight, calibrate policy prescriptions, and capably regulate our markets.

In many respects, this quantitative capability is the necessary antidote to systemic disintermediation.  It makes the regulator competent to conduct independent market data analysis across disparate data sources, less reliant on delegation to SROs and major market intermediaries, and a potential node capable of accessing information found in decentralized economic blockchains and networks.

Embracing Market-Based Solutions

The fourth ingredient to evolving into a 21^st century regulator deserves its own discussion and consideration as it is more of a foundational principle rather than a CFTC activity.  The ingredient is to embrace market-based solutions – a concept that should be assumed and readily accepted but that perhaps today requires some reminders.

Markets are in CFTC regulatory DNA, and are the basis for our regulatory mandate.  In the US, market-based capital and risk transfer have allowed for unparalleled industrial and technological innovation.  Indeed, markets are adept at valuing innovation and managing enterprise risk, can be more nimble than bank finance, and are more comfortable with handling intangible collateral.

Through the interaction of hundreds, if not thousands, of individual economic actors, markets further drive price and value discovery, allow for the efficient allocation of resources, and permit risk transfer that drives stability and certainty in real-world economic activity.  Many of you in the room today understand or are learning these dynamics given the development – albeit at times uneven – of modern crypto markets and their many facets.

While markets are not always perfect, they have proven time and again to be the most effective means humans have to drive economic productivity and prosperity.  For today’s younger generations, you can think of markets as the ultimate in crowd-sourced and decentralized decision making and the natural tool to be developed and deployed by those seeking bright and self-actualized futures. [20]

Indeed, that is the central value proposition of free market capitalism.  The proposition that broad and sustained prosperity generally occurs wherever in the world there are open and competitive markets, free of political interference, combined with free enterprise, personal choice, voluntary exchange and legal protection of person and property.

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

Nevertheless, it is frequently tempting to apply a paternalistic hand on markets in order to steer them in desired directions or eliminate all risk – a truly futile exercise. This temptation is understandable, but must be constrained, as efforts to tip the scale are more likely to drive unintended and undesirable outcomes.

This is not to say that careful oversight, targeted enforcement, and proper guardrails are not appropriate, but our individual concerns or judgments should not override the availability of markets for others to make their own determinations or to pursue their own goals.

We at the CFTC believe in the power of markets to be the best determinate of the value of technology-driven innovation.  To this end, a case study can help illustrate the above concepts.

At the end of 2017 two CFTC exchanges – CME and CBOE – sought to self-certify and list futures products based on the value of Bitcoin.  CFTC regulatory practice is for exchanges to self-certify that new contracts meet CFTC core principles before listing.  This approach has allowed for robust and dynamic risk transfer markets to develop and test new products without a time-consuming application process.  Indeed, over 12,000 new futures products have come to market in the US since 2000, far more than in any other national marketplace.

With respect to the bitcoin products, because they were novel and based on a unique crypto-asset, the exchanges did engage in substantial prior discussions with CFTC staff before launch; this allowed for incorporation of risk mitigating elements, including around higher margin requirements and contract sizes.[21]

Some have questioned the decision to allow bitcoin futures to be self-certified by the exchanges.  But in my view risk transfer markets comprised of sophisticated institutional investors were in the best place to make individual determinations regarding the value of Bitcoin and the need to offset price or volatility risk.  And I think a strong case can be made that the results of the past year confirm this view.

Indeed, at the time of the launch of Bitcoin futures many observed a potential bubble in the price of Bitcoin, which had exceed $19,000.  That price was reduced to less than $10,000 within months of the futures product offerings.  Some have speculated that this price decrease reflected a reversion to Bitcoin fundamentals: namely the cost of production.  Economists from the San Francisco Fed noted in a 2018 economic letter[22] that the launch of bitcoin futures products coincided with the subsequent and precipitous drop in the price of bitcoin, perhaps because futures allowed for the first accessible way to speculate against the price of the asset.

Notwithstanding the arguments made for Bitcoin’s price declines, it remains true that markets allow actors to meet and reach price equilibrium on the value of an asset and/or transfer risk.  In the case of Bitcoin, I would posit that the decrease in prices has helped end a speculative bubble and perhaps allow this novel technology and asset class quieter time to continue to develop from a technological and adoption sense.

The key takeaway, however, is that markets work even if in ways we do not expect.  And the expression of a market is a healthier forum for such information discovery than the mere opinion or perspective of a few.

Solving for a Digital Economy

So there you have it -- the CFTC approach to fintech innovation and modern market regulation – the digital trinity, if you will: technology, markets, and policy.  The elements of our formula are adopting an exponential growth mind-set, creating an internal fintech stakeholder, becoming a quantitative regulator, and embracing market-based solutions.

So, what should your approach be as innovators?  My advice to you is this: Keep going!  Solve problems. Innovate boldly, innovate with integrity and innovate intelligently. Get competent advice.  Follow the law.  Keep going.  Do not be afraid.

Recognize that while our regulations were designed for environments that have been transformed, the principles underlying our regulations remain relevant – and remain enforceable. So work with us.  Talk to us.  Interact with LabCFTC and work with our regulatory divisions.

Continue to engage with us at the CFTC on this journey we are all on together.  We hope to learn about your own unique responses to these remarkable challenges.  No doubt, you will find your own special way of keeping pace with a rapidly changing world and ensuring a dynamic and successful future for American markets.

Thank you.

Remarks of CFTC Director of Enforcement James M. McDonald at the American Bar Association’s National Institute on White Collar Crime

March 6, 2019

The mission of the CFTC’s Division of Enforcement is to protect the public and preserve market integrity by detecting, investigating, and prosecuting violations of the Commodity Exchange Act (CEA).  In pursuit of this mission, one of the Division’s priorities has been to continue to enhance coordination with our law enforcement partners.  This priority reflects good, common sense.  We know that twenty-first century bad actors do not conform their misconduct to the technical boundaries of our respective jurisdictions, nor do they pause as their conduct crosses international borders.  So we in the enforcement community must work together to meet the challenges presented by this sort of wrongdoing.  As I get started, please keep in mind that these are my own views and not necessarily those of the Commission or its staff.

At the CFTC, we have seen this collective effort bear fruit.  Last year marked a high point in our parallel enforcement program with the Department of Justice.  The same was true with respect to our parallel actions with the SEC.  And we continue to work in close coordination with our international partners, our regulatory partners, and the States.  All the while, we’ve continued our effort to identify any gaps that we at the CFTC might work to fill, where misconduct might otherwise go undetected.

We’ve done this internationally as well as domestically.  From issues like Brexit to global benchmarks like Libor, we recognize that U.S. derivatives and commodity markets are interconnected with other markets around the world.  We know that the prices in our markets can be driven by prices abroad.  And we know that misconduct outside the United States, if left unchecked, can distort prices and undermine the integrity of our markets here.

Today, I want to talk about one type of misconduct that can undermine our domestic markets:  violations of the CEA carried out through foreign corrupt practices.  Companies and individuals engaging in foreign corrupt practices should recognize that this sort of misconduct might constitute fraud, manipulation, false reporting, or a number of other types of violations under the CEA, and thus be subject to enforcement actions brought by the CFTC.  Bribes might be employed, for example, to secure business in connection with regulated activities like trading, advising, or dealing in swaps or derivatives.  Corrupt practices might be used to manipulate benchmarks that serve as the basis for related derivatives contracts.  Prices that are the product of corruption might be falsely reported to benchmarks.  Or corrupt practices in any number of forms might alter the prices in commodity markets that drive U.S. derivatives prices.  We currently have open investigations involving similar conduct.  But regardless of the specific factual scenario, we are committed at the CFTC to enforcing the CEA provisions that encompass foreign corrupt practices.

We recognize, of course, that such misconduct might also violate the Foreign Corrupt Practices Act, and thus might be subject to prosecution under that statute by our partners at DOJ or the SEC.  So as we at the CFTC work to police our markets for this type of misconduct, we’ll work closely with our enforcement partners to ensure that any investigations are properly coordinated and are appropriately aimed at identifying and eliminating any gaps in our investigative and regulatory frameworks.  In fact it was just this sort of coordination that led to our involvement in this space:  it began through conversations with our enforcement partners about factual scenarios known to them, to which we at the CFTC might be able to add our expertise about how those facts would affect American derivatives markets.

In moving forward with this program, we will not pile onto other existing investigations.  When we investigate in parallel with other enforcement authorities, we will work closely with them to avoid duplicative investigative steps.  To the extent the CFTC brings an action that includes a monetary penalty, we will ensure that our penalty appropriately accounts for any imposed by any other enforcement body.  And when the CFTC imposes disgorgement or restitution, we will give dollar-for-dollar credit for disgorgement or restitution payments in connection with other related actions.

We know that combatting corrupt practices that impact financial markets has increasingly become a team effort.  We at the CFTC will do our job as part of the team to identify corruption in our markets and hold wrongdoers accountable, working closely and in coordination with our law enforcement partners domestically and abroad.

We plan to pursue this type of misconduct to protect our markets, and to protect honest businesses.  Our registrants and market participants who obey the law and do the right thing should not be placed at a disadvantage simply because their competitors choose to break the rules.  Our markets should reward those who have the best business model, the best ideas, or have created some other lawful business advantage.  Not those who pay off the right people.

That’s why we are committed to providing incentives for companies and individuals to engage in ethical corporate behavior—to develop a true culture of compliance, to do the right thing.  We have taken significant steps toward this goal over the last several years, as we implemented our cooperation and self-reporting policy, which made clear that companies and individuals could receive a reduction in penalty if they fully cooperate with our investigations, timely remediate, and, most importantly, self-report the misconduct before we learn about it.  In certain cases, we explained, this could include a determination that no civil monetary penalty is warranted.

Today, the Division of Enforcement is releasing an Enforcement Advisory on cooperation and self-reporting.  The Advisory makes clear that if a company or individual not registered (or required to be registered) with the CFTC timely self-reports a violation of the CEA involving foreign corrupt practices, fully cooperates, and appropriately remediates, the Division will apply a presumption, absent aggravating circumstances, that it will not recommend a civil monetary penalty.  In contrast to non-registrants, CFTC registrants have existing obligations to disclose to the Commission CEA violations, including those involving foreign corrupt practices; registrants are thus not eligible for the presumptive recommendation of no penalty set out in this Advisory.  Nevertheless, CFTC registrants who self-report, cooperate, and remediate still would be eligible to receive the recommended substantial reduction in penalty generally applicable under the Division’s existing Enforcement Advisories.

In all events, a self-reporting company or individual will be required to pay disgorgement and restitution resulting from the misconduct.  In addition, the Division will seek all available remedies—including, where appropriate, substantial civil monetary penalties—with respect to companies or individuals implicated in the misconduct that did not make the voluntary disclosure.

It also makes sense to note here that, as always, our Whistleblower Office remains open and ready for business.  The Commission issued a record number of whistleblower awards last year, with record payments to whistleblowers.  And our Whistleblower Program applies to CEA violations involving foreign corrupt practices, just as it does in other areas.  Any tips, complaints, or reports can be sent directly to the CFTC’s Whistleblower Office at www.whistleblower.gov.

We know that wrongdoers will try to evade law enforcement.  But they also need to evade internal controls and compliance programs within their companies.  Companies that are honest, law-abiding, and ethical—and that have meaningful compliance programs and that self-report misconduct when they see it—can significantly deter wrongdoing.  We of course recognize that the single greatest deterrent to misconduct comes from vigorous enforcement.  That’s what you’ve consistently seen from us and can continue to expect.  But we also want to be mindful of the other meaningful deterrents—like corporate internal controls and compliance programs.  And we want to marshal all of these resources to achieve optimal deterrence in our markets.  That’s what the updated cooperation and self-reporting advisory released today is intended to do.  If we achieve this goal, we’ll have taken significant steps toward ensuring that the American markets remain the most open, transparent, competitive, and financially sound in the world.

Thank you.