Remarks of Commissioner Brian D. Quintenz at the 14th Annual China International Derivatives Forum (CIDF)

November 30, 2018
[Delivered in Shenzhen, China December 1, 2018]

Introduction

Thank you for that very warm welcome.  It is a great honor to join you today at the 14^th Annual China International Derivatives Forum (CIDF) in Shenzhen.  I would like to thank Chairman Wang of the China Futures Association for inviting me and am grateful for the very productive dialogue with the China Securities Regulatory Commission Vice Chairman Fang Xinghai.  Before I begin, let me quickly say that the views contained in this speech are my own and do not represent the views of the Commodity Futures Trading Commission (Commission or CFTC).

I’d like to start today by telling a story about an important event in U.S. history.  It doesn’t have anything to do with the financial markets.  Yet, I believe it holds valuable lessons from which we can all learn about the conditions under which successful markets thrive.

December 2018 represents an anniversary of one of the United States’ great accomplishments.  This month marks the 50^th anniversary of NASA’s Apollo 8 space mission, the first manned space craft to leave low Earth orbit, reach and orbit the Moon, and return safely to Earth.  Yet, its accomplishments were not what NASA originally intended, and its success was far from certain.

Apollo 8 was one of many distinct, sequenced missions which were designed to gradually test capabilities, processes and systems that would build up to landing a man safely on the moon and returning him home.  The mission’s original purpose within the planned sequence was only to orbit the Earth to test the Lunar module.  However, upon learning that the Soviet Union was on the cusp of sending a mission to orbit the moon, on August 19, 1968 – just four months before the launch date – NASA changed Apollo 8’s mission to instead target that same objective.

In the intervening four months, NASA scientists worked tirelessly to solve intractable problems that had stymied past lunar missions.  At the same time, NASA employees’ progress was subject to intense scrutiny.  The loss of three astronauts in the tragic Apollo 1 fire in January 1967 was fresh in America’s psyche.  In the aftermath, Congress and the public demanded NASA take all necessary precautions to ensure this tragedy was never repeated.  As a result, NASA engineers were held to an incredibly high level of accountability, all while ferociously competing to make the advancements and improvements needed to transform Apollo 8 into a lunar mission.

Their efforts prevailed.  On December 21, 1968, Apollo 8 launched from Cape Canaveral, Florida, with three American astronauts onboard, and three days later, on Christmas Eve, the crew celebrated the first manned mission to orbit our celestial partner.[1]  During this groundbreaking mission, the Apollo 8 crew captured an iconic photograph, known today as Earthrise, which showed, in color, for the first time, the Earth emerging from behind the lunar horizon.  In reflecting upon the mission and that famous image, astronaut Bill Anders remarked that, despite all the crew’s training and preparation for exploring the moon, the crew ultimately ended up discovering Earth.[2]

Some of you may be asking yourself what the story of Apollo 8 has to do with global financial markets.  I think this story holds an important lesson for all of us.  I believe the combination of stringent competition paired with incredible accountability forced NASA to rise to new levels of excellence.  Failure would result in a loss of agency reputation, superpower inferiority, or worse, a loss of life.  Corners could not be cut.  Every solution had to be precise, reliable, and elegant – but all of it had to be done under extreme time pressure.  Had that mixture of competition and accountability not been present, the result could have certainly been different.

The strongest financial markets are shaped by the same pressures.  People and businesses from across the world strenuously compete based on the merits of their products and services.  At the same time, strong markets are defined by accountability and fairness.  Poor performance is publically known.  Failed firms attach to their operators’ reputations.  And bad actors who commit fraud or impugn market integrity are prosecuted, and the law is applied transparently and without favor.

This combination, of fierce competition, stringent accountability, and legal certainty attracts investors, businesses, and capital.  I believe this has the been the experience of the American financial markets, including our futures markets, which I would humbly say, remain among the most dynamic and liquid, but yet still fastest growing, markets in the world.

Of course, while I believe the free market model results in the optimal outcome for societies, I recognize the wide range of views held on this topic, which has been fiercely debated over recent years, decades, and even centuries.  There is an ever-present tension between open, transparent markets and the natural self-interest of any nation to ensure the prosperity of its economy and people and to control downside risk.

Today I would like to discuss three primary things:  first, the important role derivatives play in supporting economic growth; second, why I believe the open access, principles-based regulatory model of the U.S. derivatives markets has been so successful; and third, the concrete steps taken here in China to achieve similar outcomes. 

Derivatives Markets Support Economic Growth

Since the 2008 financial crisis, derivatives have been portrayed by some as inherently “risky.”  I take issue with this label.  All economic and investment endeavors have risk.  Yet, the derivatives markets actually present the powerful tools to manage and efficiently transfer risk to those market participants who are most efficient at bearing it.

At the macro level, derivatives boost economic growth and employment.  For example, between 2003 and 2012, one study estimates that the use of derivatives boosted employment and expanded economic activity in the U.S. by 1.1 percent, or $149.5 billion.[3]  But the use of derivatives also has implications at the micro level by providing individuals and families with stability; consumers do not have to worry about wild price swings in everyday household goods when they go to the store.  Derivatives are vital to the health and growth of a country’s real economy in any number of ways, but two in particular stand out.

First, derivatives permit banks to extend more credit to the private sector, which spurs economic growth and investment in the real economy.  Derivatives bolster credit extension because they allow banks to protect themselves from their own market risks, thereby strengthening the bank’s own financial position and enabling greater lending to non-financial firms.  From 2003 to 2012, this same study found that banks’ increased extension of credit due to their derivatives hedging increased U.S. quarterly real GDP by about $2.7 billion each quarter.[4]

The second main driver of economic growth from derivatives use is allowing companies to smooth out cost structures, thereby promoting predicable cash flows that better allow for investments in growth.  The same study I just mentioned also found that commercial firms’ use of derivatives from 2003-2012 increased U.S. quarterly real GDP by about $1 billion by improving their ability to undertake capital investments.[5]  Non-financial firms that use derivatives have also been found to enjoy a lower cost of capital and increased expected cash flows, all factors that increase the firm’s value and spur expansion.[6]  In other words, derivatives enable businesses to focus on and expand their core activities, because they can hedge more peripheral risks.  It should be no surprise that a 2009 survey found that 92% of the world’s 500 largest companies managed their price risk using derivatives.[7]

Derivatives also help nations manage their own credit risks.  One recent study found that the availability of credit default swaps (CDS) trading on any nation’s sovereign bonds actually lowered those countries’ cost of debt.[8]  In fact, the borrowers who experienced the biggest cost reductions were those with the highest default risk.[9]

On the whole, I believe that derivatives hold great social and economic value for society.  A diverse, liquid and predictably regulated derivatives marketplace best allows that activity to occur.

The U.S. futures market has a number of attributes which I believe help it thrive.

Regulation of U.S. Futures Markets

In my opinion, there are three characteristics of the U.S. futures markets that have significantly contributed to their resiliency, vitality, and efficiency:  participant diversity, customer protection, and the promotion of market integrity through principles-based regulations.

Participant Diversity.  The U.S. futures markets are used by market participants around the world to hedge their risks.  This policy of open participation has increased liquidity, particularly in times of stress, which allows companies to engage with the market even during periods of intense volatility.  It also means that the pool of participants is quite diverse; a variety of commercial hedgers – with different exposures, timelines, and specifications – along with a variety of speculators – with different strategies, information flows, and analytical judgements – from across the globe can trade the contracts listed on our exchanges and, through their various perspectives and market interactions, create a robust price discovery mechanism.

Diversity within large liquidity pools gives the pool strength, similar to diversity within environmental ecosystems.  As ecosystems become fragmented or increasingly uniform, their ability to adapt to adverse conditions is impaired, which increases their vulnerability to new predators or disease.[10]  The same is true for financial markets.  The strongest, most resilient markets are integrated and diverse.  These markets are best able to withstand market shocks and economic downturns.  I believe that is one of the reasons why the U.S. futures markets performed so well during the financial crisis.[11]

Customer Protection.  Secondly, the legal regime underlying the U.S. futures markets provides strong customer protections.  Both the CFTC and the exchanges themselves police the markets for fraud, abuse, and manipulation.[12]  In addition to these basic market protections, one of the bedrock principles of CFTC futures regulation is the protection of customer funds.  Futures brokers, known as futures commission merchants (FCMs) in the U.S., must always hold customer funds segregated from their own assets.[13]  FCMs are prohibited from using customer funds for their own benefit or for the benefit of another futures customer.[14]  CFTC regulations also provide market participants with certainty about how their funds will be treated in the event of a default by another FCM customer or the FCM itself.  The legal certainty of customer funds’ treatment in bankruptcy promotes the confidence in, and therefore the use of, the U.S. futures markets.

Market Integrity and Principles-Based Regulation.  In addition to ensuring the markets remain free from fraud and market manipulation, one of the CFTC’s core responsibilities is to promote futures markets that reflect supply and demand fundamentals.[15]  While volatility can present challenges for regulators, including potentially intense political pressure to intervene in markets, I believe the choice between controlling volatility and promoting market integrity is zero sum.  The more a regulator chooses to limit participation, speculation, or two-sided price action in an effort to control the market’s movements, the less that regulator allows the market to find a clearing price.

The CFTC is not immune to such conversations.  The establishment of the agency’s precursor, called the Commodity Exchange Commission, in the 1930s was in response to price volatility and the suspicion that speculative activity was its contributing cause.[16]  Even today, there are still debates between different political philosophies on the need to limit speculative activity to protect markets as opposed to the, in my mind, better view that speculative activity provides counterparties and liquidity for natural hedgers and that only a narrow set of this speculative activity may raise concerns of manipulation.[17]

In my mind, the CFTC has seen its greatest success when it maintains its long-standing principles-based approach to regulation, as opposed to a rules-based or prescriptive regulatory approach that is seen in some other jurisdictions.  A principles-based approach has a number of advantages over a prescriptive approach:  it not only allows each market participant to develop internal rules appropriate to its unique business model or marketplace, but principles-based regulation also allows market participants to be individually responsive to market dynamics.  Lastly, enforcing principles as opposed to prescriptive rules encourages the regulator to have a cooperative and informed relationship with its registrants.  We may take the view that a market participant is failing to meet certain regulatory principles, but in order to make such a determination, we must have a detailed understanding of their business and marketplace.

As China continues to develop its regulatory concepts, I would strongly encourage such an approach to futures market regulation.

Growth of China’s Futures Markets

Speaking of China, the U.S. is certainly not the only country with growing, vibrant futures markets.  Almost 30 years ago, futures trading began in the Zhengzhou, Henan Province on the China Zhengzhou Grain Wholesale Market.  Since then, the Chinese futures markets have experienced incredible growth.  In 2017, China’s four futures exchanges – the Dalian Commodity Exchange, the Shanghai Futures Exchange, the Zhengzhou Commodity Exchange and the China Financial Futures Exchange – all ranked among the top derivative exchanges in the world by trade volume.[18]  In 2017, China’s three domestic physical commodities exchanges accounted for over 90% of the volumes traded in the Asia-Pacific region.[19]  Many of the world’s most heavily traded energy, metals, and agricultural futures and options contracts are found on these three exchanges.[20]

The rapid growth of China’s futures markets has been essential to its broader economic growth.  As the largest consumer of raw commodities in the world, and one of the largest manufacturers, it is imperative that domestic Chinese businesses are able to easily and effectively hedge their commodity price risk.[21]  To that end, I think that China’s recent steps to internationalize its futures markets will further spur their growth and give local businesses a larger, more diverse liquidity pool to manage risk.

In the past, due to numerous restrictions, it has generally been very difficult for foreign entities to access China’s domestic financial markets.  But more recently, we have seen incremental steps taken to encourage the liberalization of China’s financial markets.  For example, this past March, the Shanghai International Energy Exchange launched a yuan-denominated crude oil futures contract open to non-Chinese market participants to trade directly for the first time.[22]  In another first, this past August, the China Securities Regulatory Commission authorized foreign companies to hold majority ownership of domestic futures and securities firms, with a commitment to abolish the foreign ownership cap altogether after three years.[23]

I applaud these market reforms.  I believe that greater, more diverse participation in China’s domestic futures markets from both domestic and overseas participants will increase liquidity, reduce volatility, and make it easier for local Chinese businesses to hedge their risks and invest in growth.

Conclusion

Since the iconic photo of Earth rising behind the Moon was first taken, space exploration has marched on.  We now have the first photo of Earth from Mars (2003), the first photo of a planet beyond our solar system (2004), and, most recently, the first photo of an exploding supernova (2018).  During that time, remarkable advances have also been made in technology, medicine, the arts, and our financial markets.

The mission of Apollo 8 was 50 years ago, but the competitive and accountable environment which produced such incredible results are ever present in our global financial markets.  As China’s domestic futures markets continue to grow, I welcome the opportunity for greater participation by outside investors, including American firms, and hope to engage with you on a regulatory approach that provides the greatest price transparency and participant diversity.

CFTC Chairman Giancarlo Statement on the Decision in CFTC v. Wilson et al.

December 3, 2018

Washington, DC – Commodity Futures Trading Commission (CFTC) Chairman J. Christopher Giancarlo issued the following statement regarding the December 3, 2018 decision in CFTC v. Wilson et al., which followed a bench trial that concluded on December 7, 2016.

“We acknowledge the Court’s long-awaited decision in this case, which involves the CFTC’s pre-Dodd Frank legal authority,” said Giancarlo. “We are reviewing the decision and will analyze it carefully in considering next steps.  We will continue to vigorously enforce the Commission’s anti-manipulation provisions and to prosecute cases through trial where necessary.”         

Statement of CFTC Chairman J. Christopher Giancarlo on the Proposal to Amend Annual Privacy Notice Requirements to Implement the FAST Act

November 30, 2018

This proposal will revise Commission regulation 160.5’s privacy notice requirements to implement the Fixing America’s Surface Transportation (FAST) Act’s December 2015 statutory amendment to the Gramm-Leach-Bliley Act (GLBA).  In proposing to implement what is now almost a three-year-old statutory requirement, this proposal is a good demonstration of this Commission’s commitment to supporting good governance.

Remarks of CFTC Commissioner Brian D. Quintenz at FIA Asia 2018 

November 29, 2018

[Delivered in Singapore November 28, 2018]

 

Introduction

 

Thank you for that very kind welcome.  Before I begin, let me quickly say that the views contained in this speech are my own and do not represent the views of the Commodity Futures Trading Commission (Commission or CFTC).

 

Let me just say a word about how impressed I am with our host jurisdiction.  Singapore is a global hub for finance, trade, technology, and culture.  Home to 5.6 million residents, this diverse city-state has achieved an unparalleled degree of economic prosperity.  In 2018, the per-person income in Singapore was 321% of the global average.[1]  And yet, Singapore’s extraordinary economic growth and high standards of living were not always a fait accompli.  In 1970, the per-person income was 54% of the global average.  The dynamic success of the Singaporean economy may have something to do with the consistency of its commitment to economic freedoms over that period of time.

 

In 1970, Singapore had the third freest economy in the world; in 2018, Singapore’s economy is ranked as the second freest.  This ranking is based on many factors, including a nation’s protection of private property, judicial effectiveness, government integrity, and the degree of freedom present with respect to labor, investment, and trade.[2]  In fact, over the past 50 years, Singapore has consistently ranked highly across all of those metrics.  I do not believe it is a coincidence that during that time frame, the Singaporean economy has also thrived.  Nor do I think it is a coincidence that the world’s major financial centers – New York, London, Hong Kong – are also located in nations ranked highly for their economic freedoms.[3]

 

Growth and prosperity are cultivated in free markets, where participants from around the globe can compete on a level playing field based on the merits of their own products and services.  Yet, it is important to remember that a “free market” is not synonymous with an unregulated one.  Quite the contrary; businesses and innovators are attracted to nations with a strong commitment to the rule of law, the protection of private property, and low tolerance for corruption and fraud.  

The world’s most prosperous markets are frequently located in countries with their own unique legal framework and local market customs, but each is committed to protecting economic freedoms and encouraging growth.  

 

These markets, also not coincidentally, tend to be the global hubs for a large degree of the world’s derivatives activity.  It is a priority for the CFTC, the agency responsible for overseeing the derivatives markets in the United States, to work with other regulators to enhance the health and resiliency of the global derivatives market, and ensure that economic activity and risk management can occur across jurisdictions, without concerns of market fragmentation caused by regulatory overreach.

 

A New Philosophical Approach

 

A little over two months ago, Chairman Giancarlo visited Singapore to present his vision for the cross-border regulation of the global swaps market; a vision committed to reversing the agency’s prior, overly expansive extraterritorial approach that has, at times, caused market fragmentation and subjected market participants to duplicative, overlapping, costly, and operationally complex regulation.  Subsequent to his visit, the Chairman published a White Paper with specific recommendations to improve the CFTC’s current cross-border approach.[4]

 

Today, I want to build upon the Chairman’s message by expressing my strong support for revisiting and updating the CFTC’s cross-border framework to better reflect the current realities of the derivatives markets.  

 

But first, let me take a moment and align myself fully with the form and manner by which the Chairman launched his views.  Recently, a counterpart of mine visited Asia and took issue with the release of the White Paper, calling it an arrow apart from its bundle, suggesting that since it was released as a solo effort, not as a proposed rule, and without his input, it was weak.

 

I disagree.  Regulatory white papers can play very productive roles in policy formation and international cooperation through their philosophical, non-legal, and pro-dialogue format that helps signal direction and build consensus.  It is my belief that a majority of the Commissioners at the CFTC will indeed find a consensus on restructuring the agency’s cross border approach in the coming months.

 

When the CFTC first adopted its cross-border guidance in 2013, it had raced ahead of other G-20 nations in the implementation of post-crisis swaps reforms.  Perhaps it is not surprising then that the guiding principle of the 2013 guidance seemed to be the belief that almost every swap a U.S. person enters into, regardless of location or counterparty, should be subject to, and presumably protected by, CFTC regulation.   

 

Five years later, the world looks very different, and not only because a different philosophical mindset is now installed across U.S. financial regulatory bodies.  Today, the world’s largest swap markets have made substantial progress toward implementing the G-20 commitments, including trade reporting, clearing, margin for uncleared swaps, and heightened capital requirements for uncleared derivatives.  In light of this significant progress, the 2013 guidance, a legally tenuous construct to begin with, is now unequivocally outdated.  We must acknowledge and embrace the comparable regulation present in other jurisdictions and other regulators’ greater supervisory interests in regulating the swaps activities within their own local markets. 

 

Chairman Giancarlo’s White Paper identifies a number of foundational principles upon which the CFTC’s regulation of cross-border swaps activity should be built.  Perhaps the most important of these principles, and the prism through which all extraterritorial reach by the CFTC must be viewed, is the statutory directive from Congress that the agency may only regulate those activities outside the United States that “have a direct and significant connection with activities in, or effect on commerce of, the United States.”[5]  If it was not apparent in 2013, it should be apparent now, not necessarily every swap that involves a U.S. person or U.S. personnel has a “direct and significant” connection with U.S. commerce that should trigger the application of CFTC rules.  

 

Building upon this principle, the White Paper rightfully distinguishes between swaps reforms intended to address the systemic risk reforms at the heart of Dodd-Frank, such as margin and clearing, and those reforms designed to address market trading practices, such as methods of trade execution.  Generally, reforms targeting systemic risk and its transmission across jurisdictions are intended to address activities that may have a “direct and significant” effect on the U.S. economy and therefore may be more likely to warrant the application of CFTC regulations.  On the other hand, reforms pertaining to market structure or trading platform practices have a more attenuated connection with systemic risk mitigation.  Countries may choose to enact market structure reforms that reflect the characteristics of their local markets and which, while different from the CFTC’s approach, may nonetheless achieve the goals of the G-20 reforms. 

 

To that end, I support the White Paper’s approach toward substituted compliance determinations that differentiates between these two types of reforms, applying a strong comparability standard to the first, while applying a more flexible standard to the latter.  More generally, I support a substituted compliance framework that measures comparability by whether the particular legal regime achieves comparable outcomes, instead of requiring a finding of comparability on a provision-by-provision basis.  Indeed, in 2013, the G-20 recognized the necessity of regulatory deference to other jurisdictions “when it is justified by the quality of their respective regulatory and enforcement regimes, based on similar outcomes.”[6]  I believe a holistic, outcomes-based approach to substituted compliance respects the sovereignty of foreign jurisdictions to implement the G-20 reforms as they see fit for their markets.  In my view, this comprehensive, outcomes-based approach will only increase the efficacy of the G-20 reforms and strengthen the global commitment to a transparent, well-regulated, liquid swaps market. 

 

In light of the significant progress toward implementing the G-20 goals, the White Paper also differentiates between jurisdictions that have largely adopted G-20 reforms comparable to the CFTC regime, so called “comparable jurisdictions,” and other jurisdictions where implementation is incomplete or substantively different, so called, “non-comparable jurisdictions.”  Generally, the White Paper suggests that whenever possible the CFTC should exercise deference with respect to comparable jurisdictions, reserving a more stringent application of CFTC regulations for non-comparable jurisdictions.  I support this differentiation and believe it strikes the appropriate balance between the CFTC’s regulatory mission and showing comity to competent non-U.S. regulators.

 

With these principles in mind, the White Paper proposes refinements to the CFTC’s cross-border approach that would differentiate between systemic risk versus market structure reforms and comparable versus non-comparable jurisdictions.  I want to briefly discuss the White Paper’s proposed approach to the treatment of non-U.S. clearing and trading venues, as well as swap dealer registration and the regulations which follow personnel as opposed to firms.

 

Registration of Non-U.S. Central Counterparties (CCPs)

 

In the area of CCP oversight, the CFTC has applied a policy of deference to non-U.S. CCPs providing access to U.S. persons.  For example, with respect to swaps clearing activities, the CFTC has exempted four non-U.S. swaps CCPs from registering as a designated clearing organization (DCO), because they are located in jurisdictions with “comparable, comprehensive supervision and regulation.”[7] These exemptions permit non-U.S. CCPs to clear proprietary swaps positions for U.S. clearing members and their affiliates, but do not allow customer clearing – meaning, U.S. customers cannot clear through these non-U.S. CCPs. 

 

The White Paper recommends expanding the use of this exemptive authority for non-U.S. CCPs that do not pose substantial risk to the U.S. financial system.[8]  Specifically, where a foreign jurisdiction has implemented comparable CCP regulation, in addition to proprietary clearing by U.S. clearing members, exempt CCPs would be permitted to provide swaps clearing services to U.S. customers through non-U.S. clearing members, without triggering DCO or FCM registration. In that situation, local bankruptcy laws would apply to the funds of the U.S. customers who wished to participate in the foreign market.  This approach mirrors the CFTC’s historical cross-border approach for futures clearing and I support exploring its potential application to the swaps markets as well.  Given the professional nature of the swaps market, I believe this approach would appropriately give sophisticated, institutional market participants the commercial choice whether to rely on local, non-U.S. bankruptcy law protections or instead choose to do business with U.S. FCMs subject to U.S. bankruptcy law protections. 

 

I agree with the White Paper’s view that CCPs posing a substantial risk to the U.S. financial system should continue to be registered with the CFTC.  But I also support the White Paper’s position that although these non-U.S. CCPs would be CFTC registrants, the home country regulator should still have supervisory primacy, with the CFTC primarily focused on U.S. clearing activity.[9]  In addition, determining what constitutes a “substantial risk” to the U.S. financial system, I believe, should focus on the CCP’s U.S.-facing swaps clearing activity.  While there are many metrics by which to measure a CCP’s significance to the U.S. markets, I think one particularly meaningful factor may be the amount of swaps initial margin posted by U.S. clearing members to the non-U.S. CCP.  The greater the amount and/or percentage of the non-U.S. CCP’s total swaps initial margin that is posted by U.S. clearing members, the greater the potential exposure the non-U.S. CCP poses to the United States.  I look forward to working with staff to develop a clearer definition of the “substantial risk” standard – one that is appropriately tailored and narrowly focused on those non-U.S. CCPs posing true, substantial risk to the U.S. financial system and not just a generic view towards any entity’s universal size.  

 

Registration of Swap Execution Facilities

 

In addition to expanding the exemptive relief available to non-U.S. CCPs in comparable jurisdictions, the White Paper also seeks to combat market fragmentation through its proposed treatment of non-U.S. swaps trading venues.  I support the White Paper’s general view that swaps trading venues subject to comparable regulation abroad should be exempt from swap execution facility (SEF) registration with the CFTC.  In this regard, the CFTC’s 2017 Order exempting certain trading facilities in the European Union (EU) from SEF registration on the basis of comparable regulation under EU law serves as an excellent model for future Commission action.[10]  The EU reciprocated this finding of comparability, such that U.S. and EU trading participants now have their choice of executing swaps on either EU or U.S. platforms.[11]

 

The White Paper also revisits the SEF registration requirement for non-U.S. swaps trading venues in non-comparable jurisdictions.  Although DMO issued guidance in 2013 providing a range of factors that may trigger SEF registration for platforms outside the U.S., non-U.S. platforms remain concerned that a single U.S. person executing a swap could trigger registration.[12]  In my view, requiring SEF registration due to the participation of a few U.S. persons is not appropriate.  In that scenario, I do not believe the requisite “direct and significant” effect on U.S. commerce is present such that the CFTC should extend its oversight and devote its resources to the regulation of the foreign platform.  This is why I support the approach suggested in the White Paper that U.S. persons should be allowed to access non-U.S. platforms in non-comparable jurisdictions without triggering SEF registration subject to a materiality threshold.  In determining this materiality threshold, I think it would be appropriate to look at a number of factors, including the percentage of the venue’s trading volume executed by U.S. persons, as well as whether the venue directly solicits U.S. participation.  

 

Swap Dealer Registration

 

Another significant issue addressed by the White Paper is the identification of which swaps a non-U.S. person must count toward its de minimis threshold for purposes of determining whether it may need to register as a swap dealer. 

 

With respect to comparable jurisdictions, the White Paper recommends that non-U.S. persons, including foreign consolidated subsidiaries (FCS) whose ultimate parent is a U.S. person, only count their swap dealing activity with U.S. persons and guaranteed entities, with certain exceptions.[13]  This approach contrasts with a 2016 cross-border proposal that was never finalized by the Commission.  The 2016 proposal would have treated FCS like U.S. persons and required them to include both their U.S.- and non-U.S.-facing swap dealing activity in their de minimis count – in effect, requiring these entities to include dealing activity occurring entirely outside the United States between two non-U.S. persons in their calculation.  The 2016 proposal found that this non-U.S. activity had a “direct and significant” effect on the U.S. financial system because the swap activity of the FCS created a direct risk to the U.S. parent due to the consolidated financial reporting required by U.S. GAAP.[14]

 

I think the more limited approach recommended in the White Paper is appropriate for two reasons.  From a pragmatic perspective, the White Paper recognizes that comparable jurisdictions have the primary supervisory interest in regulating the swap activity occurring within their home countries by their own domestic entities.  If the CFTC attempts to reach this activity, those jurisdictions may similarly attempt to regulate subsidiaries located within the U.S., thereby subjecting those U.S. firms to overlapping, duplicative, and costly regulation.  In my view, the optimal solution is for the CFTC and comparable jurisdictions to recognize and defer to one another’s regulatory authority over swaps activity that does not directly involve our respective domestic firms.  Second, I think the White Paper’s approach is consistent with the CFTC’s Congressional mandate, which does not charge the agency with the regulation of firms on a consolidated-basis, but instead contemplates the regulation of firms on an entity-by-entity basis.  

 

With respect to swap dealing activity in non-comparable jurisdictions, the White Paper proposes some possible approaches and solicits feedback.  For example, it suggests that FCS that are part of bank holding companies (BHC-FCS) should only be required to include their dealing activity with U.S. persons in their de minimis count.[15]  I think this outcome may be appropriate, given that these BHCs are already subject to consolidated supervision and regulation by U.S. prudential regulators.[16]

 

For non-bank, financial FCS operating in non-comparable jurisdictions, the CFTC could take into consideration whether the firm has been designated as “systemically significant” by the Financial Stability Oversight Council.  If the non-bank FCS is part of a financial conglomerate that has been designated as systemically significant to the U.S. financial system, its swaps activities, due to their nature and scale, are more likely to have a “direct and significant” effect on U.S. commerce such that CFTC oversight is warranted.  In those circumstances, it may be appropriate to require the FCS to include its swap activities with both U.S. and non-U.S. persons in its de minimis count. 

 

The discussion of the proper treatment of FCS in the White Paper has begun a larger conversation and I look forward to working with staff and market participants to calibrate the swap dealer registration requirement appropriately. 

 

Arrange, Negotiate and Execute (ANE)

 

The White Paper also raises questions regarding how the CFTC defines its jurisdiction, specifically, whether its regulation of some cross-border activities should be based upon the status of one or both of the counterparties as U.S. persons, or whether it should take a territorial view of transactions for the application of some regulations.

 

The suggestion of a territorial approach to regulation has always prompted robust debate, most notably with respect to the treatment of swaps between a CFTC-registered, non-U.S. swap dealer and a non-U.S. person, when the non-U.S. dealer regularly uses personnel located in the United States to “arrange, negotiate, or execute” the trade – so called “ANE Transactions.”

 

ANE Transactions were not directly addressed in the Commission’s 2013 guidance, but a staff advisory issued that year suggested that non-U.S. swap dealers must comply with certain transaction-level requirements, like clearing, margin, or trade reporting, with respect to ANE transactions.[17]  The publication of the staff advisory created uncertainty over when the involvement of U.S. personnel might trigger the full panoply of CFTC swap regulations.[18]  Within 12 days of the advisory’s publication, CFTC staff issued a no-action letter relieving non-U.S. SDs from complying with certain transaction-level requirements for their ANE transactions.[19]   

 

The White Paper revisits the ANE issue, suggesting that swaps trading in the U.S. should be subject to U.S. swaps trading rules, regardless of whether the counterparties are U.S. persons.[20]   To the extent transaction-level requirements attach to the trade, the White Paper contemplates that out of deference to comparable jurisdictions, the CFTC might make substituted compliance available.[21]  The White Paper also requests feedback on this concept, recognizing that there are a variety of fact patterns implicated by ANE transactions, and desiring to avoid the fragmentation of the U.S. swap market.[22]

 

It is a credible proposition to state that the involvement of U.S. personnel in a trade should implicate some U.S.-based regulations.  The challenge is how to define that involvement and how broadly it should implicate our rules.  Thus, the concept of an ANE standard raises three questions in my mind. 

 

Definitionally, what types of activities should be captured by an “arrange, negotiate, or execute” standard? 

 

Then, based upon this definition, how can the CFTC develop a standard that is administrable by non-U.S. firms? 

 

Finally, assuming some level of U.S. personnel involvement should trigger CFTC regulations, which regulations should apply?  The answer to this last question is particularly important because a single trade could become subject to two sets of conflicting regulatory requirements.  Therefore, the CFTC should weigh carefully if its supervisory interest in a trade outweighs that of a non-U.S. regulator(s) who directly oversees the counterparties. 

 

With respect to the first question, I believe the ANE standard should focus on client-facing, sales and trading activity, as opposed to incidental activity, by U.S. personnel.  For example, if a trader in London communicates with a colleague in New York about market color or the logistics of a potential trade with, for instance, a Brazilian counterparty, I do not believe that should implicate the ANE standard.  In that example, U.S. personnel have not directly communicated with a counterparty and I do not believe it is appropriate to capture internal advice or communication as ANE activity. 

 

Another potential fact pattern is the involvement of U.S. personnel to facilitate trading outside the business hours of non-U.S. jurisdictions.  In this situation, the use of U.S. personnel seems to be incidental, because the trade is initiated between non-U.S. counterparties, but due to convenience and differences in active trading hours across markets, the involvement of U.S. personnel may be required.    

 

On the other side of the spectrum, one could imagine two non-U.S. firms with offices in New York whose respective traders initiate, negotiate, and execute all terms of a trade.  In that instance, U.S. personnel are the primary catalysts of the trade.  The involvement of U.S. personnel in the trade is not incidental, it is absolutely necessary to the trade’s execution.

 

Clearly, there is a broad spectrum of activity that may or may not implicate an ANE construct.  The question then becomes, can the CFTC distill this activity into a clear, administrable standard?  Non-U.S. swap dealers must be able to operationalize the standard in an efficient manner.  Requiring a facts and circumstances analysis every time U.S. personnel could potentially be involved in a trade is not feasible for real-time trading.  I believe that, if it were to be adopted, any ANE standard must provide market participants with clarity about what regulations will apply to a swap transaction from its inception – changing the regulatory treatment of a transaction midway through its negotiation creates operational complexity and legal uncertainty. 

 

One possible way to create this clarity is to avoid the application of the ANE standard on a trade-by-trade basis and instead try to establish general rules based on specific counterparty relationships.  For example, perhaps a non-U.S. counterparty that has its primary trading relationship with a trader of a non-U.S. swap dealer in London should be viewed differently than a non-U.S. counterparty that has a primary trading relationship with personnel in the U.S. branch of that same swap dealer. 

 

Finally, to what rule set should an ANE standard apply?

 

One could look to the White Paper’s distinction between risk-based and market structure reforms in determining what regulations should apply to the trade between two non-U.S. persons.  The CFTC should also consider that certain regulatory requirements are closely tied together.  For example, although the trade execution requirement is generally thought of as a market structure reform, in the U.S. it is intertwined with the clearing mandate – a systemic risk reform.  Also, in practice, given the difference in pricing between bilateral and cleared trades, it could be difficult for non-U.S. firms to separate the two requirements.  Therefore, if the CFTC suggests that a broad ANE standard applied on a trade-by-trade basis should trigger our SEF execution requirements, this determination could also implicate the associated systemic risk requirements of our clearing rules. 

 

This may be a less deferential approach than is appropriate.  Given that the risk of these trades in question primarily resides between two non-U.S. persons, perhaps the CFTC has less of a supervisory interest in applying its clearing, trade execution, and uncleared margin requirements to the trade than it does in applying its business conduct standards to the activities of the U.S. employee.  Said differently, it may be better to apply the SEF execution mandate in the same way as other systemic risk rules, rather than to invoke the clearing mandate between two non-U.S. persons due to the the trade-by-trade application of market structure reforms.

 

All of these aspects of the ANE issue – or any jurisdictional definition construct for that matter – should be carefully considered so that we do not inadvertently make it too costly or operationally complex for U.S. personnel to support the activity of a non-U.S. dealer servicing its non-U.S. client.  I encourage market participants to provide thoughtful comments on this issue, taking into account how the regulation of ANE transactions could work under a revised, rationalized cross-border framework. 

 

Conclusion

 

Ten years after the financial crisis, the world’s largest derivatives markets have made substantial progress toward achievement of the G-20 objectives.  In order to appreciate the economic freedoms others have created and maintained, we must recognize and defer to those jurisdictions’ various judgements and approaches.  I am hopeful that the CFTC and other like-minded regulator can work together to fully realize the underlying goal of all of our reform efforts – the creation of a well-regulated, global swap marketplace, known for its regulatory deference and harmonious cooperation.

 

Thank you all very much.  It is an honor to have been with you this morning.

Remarks of Chairman J. Christopher Giancarlo before 2018 Financial Stability Conference, Federal Reserve Bank of Cleveland, Office of Financial Research, Washington, D.C.

November 29, 2018

Good afternoon.

The theme of this year’s conference – financial markets and their implications for financial stability – is a fascinating one.

As a market regulator thinking about financial stability, I am drawn to Andrew Lo’s adaptive markets hypothesis that markets are inherently dynamic, evolving and adapting in fits and starts over time.[1]  They cannot be readily modelled and plotted using concepts from physics.  Rather, they are most aptly viewed as complex biological ecosystems.

If Lo is right (and I believe he is), then market management is less a task of putting in place brilliantly designed market frameworks and stepping back to let them operate, but rather the work of active and continuing market engagement and husbandry, testing market resilience, enhancing vitality and mitigating fragility.  In this view, market reform, in which we all have been mightily engaged these past ten years, is not “one and done” but continuous, agile and iterative.

I would like to highlight two critical efforts that CFTC is engaged in.  First, adjusting swaps market reform to enable greater diversity in regulated trade execution and reducing impediments to swaps clearing, and second, benchmark reform and the transition from LIBOR to alternative risk free rates.

Derivatives Markets Reform

The G-20 reforms from over 10 years ago aimed to strengthen the stability of the global financial system by requiring: (1) banks to hold more capital, (2) central clearing for standardized swaps, (3) exchange of margins for uncleared swaps, (4) public and regulatory reporting of swap transactions, and finally, (5) where appropriate, for trading of swaps on regulated platforms.

Congress was prompt in adopting most of these swaps market reforms in Title VII of the Dodd-Frank Act.  The CFTC was also quick out of the gate to implement all of the major Dodd-Frank rules – a great credit to my predecessor chairmen.  Since then, the Commission remains engaged in multiple efforts to continually assess the impact of these rules on US markets.

Greater Diversity of Trade Execution Methods

I have been a consistent supporter of Title VII of Dodd-Frank and support much of the way the CFTC has implemented the law.  Yet, I have been critical of the CFTC’s implementation of the trading mandate, questioning whether prescriptive CFTC rules on execution methods for swaps trading actually helps improve financial stability or just increases market concentration by platform operators with limited methods of trade execution, threatening the very financial stability we seek to enhance.

When presented with evidence that targeted changes can help improve overall market functioning without impacting the larger financial stability goals, I believe we must remain willing to adjust our rule frameworks.  That is why the Commission voted on a proposal a few weeks ago for changes to our swaps trading rules to encompass a wider scope of trading activity while enabling greater transactional flexibility to encourage increased competition and innovation. We look forward to wide ranging public input and discussion on this proposal.

Removing Impediments to Clearing

We also look outside our turf to other rules, both in the US and internationally, potentially impacting the US derivatives markets.  In particular, there has been bipartisan concern at the Commission about the impact of the bank capital rules on incentives to submit swaps transactions to central counterparty clearing, one of the key G-20 swaps market reforms.

Fortunately, about a year and a half ago, the Financial Stability Board (FSB) decided to sponsor a study on impact of the interaction of capital, clearing, and margin rules on the incentives of firms to centrally clear swaps transactions.

Due to its expertise in derivatives markets and implementation of swaps reform, the CFTC was invited to co-chair the study by the FSB’s Derivative Assessment Team (DAT), despite not being a member of the FSB.  The other co-chair was the Bank of England. This co-captain arrangement ensured that expertise from both banking (so-called macro prudential policy) and markets (micro prudential policy) underlay the study.

The final report was published earlier this month.[2]  I would like to highlight a few key learnings from the process, the analysis and the findings.

First, given the broad scope as well as the complex interaction among the regulatory factors, diverse set of institutions, and the dynamics of the derivatives market structure, the study draws upon a rich data set – a mix of qualitative and quantitative information.

Second, the study follows extensive outreach with active market participants.  It considered extensive empirical analysis using quantitative data sourced from authorities and from surveys of large dealers to examine in detail the specific aspects of the capital rules and highlights inefficiencies in the calibration of these rules.

Third, the study evaluated the data through the lens of the trade-off between financial stability goals and our collective interest in efficient and resilient market functioning.

Specifically, the DAT study found that large banks and large buy-side firms, especially those active in the derivatives markets, are incentivized to clear.  But for different reasons – capital rules for banks, and trading liquidity for the active clients.  As these firms collectively are key transmission mechanisms for financial shocks, the G-20 reforms are helping to mitigate systemic risks from the derivatives markets.

On the other hand, the reforms appear to be having a negative impact on smaller and less active market participants that are nevertheless obligated to centrally clear standardized swaps.  That is because clearing service providers, mostly affiliates of large banks, are dis-incentivized by capital rules from accepting the business of such less active market participants. The report provides some interesting narrative on the various efforts by the clearing members to balance their dual responsibility – helping key corporate clients access the derivatives markets, while earning sufficient revenue to cover costs.

Finally, the report has identified multiple areas for further study and research both by the official sector, as well as by academic experts, like those assembled here today.  I remain a big fan of econometric analysis, and will encourage the Cleveland Fed and the Office of Financial Research to dedicate next year’s conference to show-case research on some of the issues flagged in the DAT report.

The CFTC remains committed to working with the US banking regulators, the Board of Governors of the Federal Reserve System, the FDIC, and the OCC, the key agencies who hold the pen on capital rules for the US banking system, as well as the Basel Committee and its other members, to educate them about the regulatory framework in place for cleared derivatives.

A key point of elucidation is that US law prohibits banks providing clearing services from leveraging client clearing margin for any purposes other than to cover clients’ derivatives exposures.  This point is not adequately reflected in US banking regulators current formulation of the supplementary leverage ratio that treats such clearing margin as leveragable bank capital.

The DAT study team worked closely with the Basel Committee and other standard setting bodies.  You might be aware that the Basel Committee has also issued a consultation seeking comments of specific proposals to re-calibrate the leverage ratio.[3] The US authorities also have a proposal out for comments on related aspects of the Basel III rules.[4]  I remain optimistic that given the empirical evidence presented by the DAT study, various authorities will consider amendments to their rules to help incentivize central clearing, without having to compromise financial stability goals.

Benchmark Reform

I now turn to the matter of benchmark reform.

I am sure everyone here is familiar with the LIBOR, the short-term unsecured interest rate benchmark.  It used to reflect the rate of interest at which money center banks were willing to lend money to each other.  Following unfortunate incidents of LIBOR rate rigging, for which the CFTC and others brought numerous enforcement actions that led to subsequent benchmark regulation in Europe, the Financial Conduct Authority regulated the ICE Benchmark Administrator.  Changes to the methodology and improved controls at contributor banks have reduced the risk of rate manipulation.

Despite these efforts, markets have moved on.  Money center banks no longer fund their operations through short-term unsecured loans for 1-month, 3-month, 6-month and so on.  Instead, they borrow and lend money overnight on an unsecured basis, enter into overnight secured transactions called repos and borrow money from the capital markets by issuing corporate bonds – 2 year, 5 year tenors.

The fact is that there is no longer a liquid market in unsecured inter-bank term lending underpinning LIBOR.  Based on statistics shared by the Federal Reserve Board, there are less than six to seven transactions per day at market rates to support one-and three-month LIBOR across all the submitting banks.[5]  Longer maturities have fewer than these.  For three-month LIBOR - the standard reference rate in the derivatives markets - on most days, there is less than $ 1 billion of borrowings among the largest banks; on many less days, we see less than $100 million.  For one-month LIBOR, the median daily number of actual borrowing transactions which are observable in the marketplace in Q2 2018 was five.

Yet, while LIBOR is no longer based on a thriving market, there is no question that LIBOR remains of systemic importance to global financial markets.  Based on estimates published by the US Federal Reserve, there are over $200 trillion worth of financial instruments (equivalent to 10 times US GDP) referencing the US$ LIBOR.[6]  While most of this exposure, approximately 95%, is in derivatives (futures and swaps), it also serves as a reference rate for:

• $3.4 trillion in business loans
• $1.8 trillion in floating rate debt
• $1.8 trillion in securitizations, and
• $1.3 trillion in retail mortgages and other consumer and student loans.

LIBOR clearly touches each one of us.  From the terms of the most basic home mortgage, to student loan agreements, auto financing contracts, and credit card purchases, LIBOR is pervasive throughout the consumer economy.  It is similarly extensive in business and trade finance worldwide.

Regulatory Response

So, on one hand LIBOR is widely used across the financial system and, on the other hand, it is built upon a dwindling market: a heavy edifice on a deteriorating foundation, a tower waiting to fall.  The potential for systemic risk posed by this situation is obvious.  A regulatory response is clearly appropriate.

Yet, reforming benchmarks is a complex and delicate process, and cannot be done through heavy handed regulatory rulemaking.  It was recognized early on by my predecessor, CFTC Chairman Tim Massad, and his contemporaries at the FCA and the Fed that reform should be driven primarily by the private sector with active public sector encouragement and coordination.

In July 2013, the FSB established an Official Sector Steering Group (OSSG), which includes senior officials from central banks and regulatory agencies, including the CFTC Chair.[7]  The OSSG serves to focus the FSB’s work on the interest rate benchmarks that are considered to play the most fundamental role in the global financial system.

The FSB published its recommendations in July 2014 and called for the development of alternative interest rate benchmarks.  A determination was made that the banks’ funding behavior has changed fundamentally, and the benchmarks should reflect these changes.

In November 2014, the Alternate Reference Rates Committee, or ARRC,[8] was convened by the Board of Governors of the Federal Reserve System and the Federal Reserve Bank of New York.  The ARRC consists of a group of banks, market participants, industry associations, the CFTC and other US financial regulators.

The ARRC was tasked with two primary goals:

• identify an alternative reference rate to replace LIBOR; and
• develop a market strategy to effect the transition.

After deliberating for over two years, in June 2017, the ARRC selected the Secured Overnight Financing Rate (or SOFR) as the replacement for LIBOR.[9]  SOFR’s publication began in April of this year.

SOFR is calculated by the official sector and is based on actual transactions in the repo markets – interestingly, compared to the less than US$1 billion on a good day transacted in the 3-month LIBOR, the SOFR is according to ARRC based on daily repo volumes of over US$700 billion.

Trading in SOFR futures began in the United States in May and the initial trading volumes and liquidity are quite promising.  Daily trading volumes for this relatively brand new contract are bigger than the 3-month LIBOR transactions.[10]  Firms have started transacting cleared swaps referencing SOFR.

LIBOR’S Days Numbered

The days are numbered for LIBOR.  Undoubtedly, there have been huge improvements in the governance process to produce the LIBOR for which the benchmark administrator and the contributing banks deserve much credit.  Yet, governance improvements cannot offset the fact that banks have left the marketplace for 3-month unsecured loans.  Today, it is only the regulatory authority of the FCA that causes major banks to continue making submissions from which LIBOR is calculated.  And that also will not last.  Earlier this year, FCA Chief Executive Andrew Bailey[11] said that come 2021, the FCA will no longer be willing to exercise this authority to compel LIBOR submissions.

At some point thereafter, as a critical mass of panel banks quit, the FCA may have to make a determination that the LIBOR is no longer a representative benchmark.  If the FCA makes such a determination, supervised firms such as banks, corporates, exchanges, and CCPs operating under UK or EU jurisdiction may no longer be allowed under EU regulation to reference LIBOR for any new derivatives or securities.

Legacy trades can continue to reference LIBOR – what is already being called “Zombie LIBOR” – but imagine the havoc that will be caused in the marketplace if exchanges de-list their contracts, if CCPs cannot accept new swaps for clearing – the whole ecosystem developed to support efficient risk-transfer in our global markets will be in dis-array.  Hence, it is critical that legacy positions too move from LIBOR.

I am sure there are some who would rather prefer that we regulators compel banks to continue making submissions.  But that would be equivalent to perpetuating a fiction that it is business as usual in the inter-bank term lending markets – that LIBOR is based on hundreds of billions US$ of daily transactions.  Unfortunately, we cannot countenance that fiction and the systemic risk it hazards.

Next Steps

Earlier I mentioned the Alternative Reference Rate Committee that has been tasked with leading and directing the transition away from LIBOR to SOFR.  It is a private sector led effort.  While the CFTC and other US regulators participate as ex-officio members, ARRC’s decisions are made by its private sector members.  For example, the decision to select the SOFR as the new reference rate for US Dollar instruments was voted upon by the members of ARRC and supported by the ARRC’s advisory group of end users.

ARRC is now in its 2.0 phase.  It is busy with the education and implementation of the transition from LIBOR to SOFR.  Its membership has been expanded to a much wider group of market participants.  Multiple working groups have been formed to focus on a slew of issues, not all directly related to the derivatives markets.

Let me list a few key initiatives – all happening even as we speak.

ISDA has just closed on a consultation on new fallback language and triggers for a few foreign currencies: GBP, CHF and JPY.[12]  ISDA will soon be publishing the responses from the first survey,[13] and subsequently be issuing a similar consultation for the US Dollar and for the Euro.

ARRC has formed working groups to examine implications of this transition in other related, but non-derivatives markets – Floating Rate Notes, Business Loans and CLOs, Securitizations, and Mortgages and Consumer Loans.  Like ISDA has done for derivatives contracts, consultations have been released for Floating Rate Notes and Syndicated Business Loans.[14]  We expect the groups working on Securitizations and Bilateral Loans to publish their consultation in coming weeks.

In addition to these market-related groups, there are other working groups under the ARRC – Paced Transition, Market Structures, Term Rate, Regulatory Issues, Accounting and Tax, Legal, Outreach and Communications.  The ARRC has already written to us and other US and global regulators alerting us to a slew of CFTC rules impacting the transition from LIBOR to SOFR.[15]  I am happy to report that our staff has been interacting proactively with this group, looking to support an efficient transition. There is a strong commitment from the global regulatory community to ensure that we remove regulatory hurdles for this transition.

The CFTC’s own Market Risk Advisory Committee (MRAC), under the guidance of Commissioner Rostin Behnam, has begun thoughtful consideration of a range of issues related to the transition from LIBOR to SOFR.  At a recent meeting, MRAC reviewed the progress of benchmark transition and considered the effect of reform on CFTC regulated derivatives contracts.[16]  I am confident that MRAC will help troubleshoot emerging issues and make important contributions to the establishment of SOFR as a sound and reliable underpinning for a broad range of traded derivatives.

Transition Underway

Clearly, there is a lot of work being done.  Yet, some firms are concerned that a necessary condition for transitioning away from the LIBOR is the availability of a forward-looking SOFR-based term rate.  Product development experts know how to do the math to compute a forward-looking term rate implied by SOFR futures and swaps. But, development of such a robust, IOSCO compliant rate[17] will depend on the liquidity in SOFR derivatives markets, both futures and swaps.  If firms do not step up today and transact in SOFR derivatives, development of a robust-term rate will be a challenge.

LCH and CME are both clearing SOFR swaps and doing so quite successfully.  Let me suggest that the next time that market participants call a dealer to price an Interest Rate Swap, they consider doing a SOFR swap and clearing it through one of these CCPs.  Let me also suggest that the next time a bank calls a market participant offering an interesting trading opportunity on a 10-year rate swap where the floating rate is linked to the LIBOR, the market participant should ask the sales trader if he or she really expects LIBOR to be around for 10-years – and while at it, check to see if the bank is a member of ARRC.

And here is another suggestion for corporate treasurers, who may be raising funds by issuing fixed rate bonds and doing a fixed-float swap.  In addition to checking the contractual language on the swap, find out if you really must have the floating rate linked to the LIBOR.  Do the math on the potential impact when, in 2021, the bank wants to convert the reference rate from LIBOR to SOFR.  Maybe ask the bank for a quote for both LIBOR and SOFR swaps?

Conclusion

I began these remarks by referring to Professor Andrew Lo’s adaptive markets hypothesis.  I am also drawn to Nassim Taleb’s bold concept of “antifragility,”[18] the notion that some things actually benefit from shocks; they thrive and grow when exposed to volatility, randomness, disorder, and stress.  Taleb warns that naïve over-intervention in complex systems such as financial markets make them more vulnerable, not less, to cascading runaway chains of reactions and ultimately fragile in the face of outsized crisis events.  He argues that that financial markets that, instead, are allowed to grow organically through trial and error and gain and loss, with careful attention, but also plenty of diversity, redundancy, cyclical stresses and disorders, best resemble biological organisms that adapt and, indeed, thrive, in the face of shock and partial destruction.

Our current approach at the CFTC to market oversight is mindful of this insight.  That is why we continue to focus on refining and increasing the flexibility of the CFTC’s framework for regulated swaps execution and addressing disincentives posed by bank capital rules to central counterparty clearing.  In both cases, our steps are designed not to intervene with ever more complex regulatory structures, but to increase market diversity and reduce the risk of concentration of market services – essential components of healthy market ecosystems.

At the same time, we continue to work with fellow regulators to encourage and coordinate – but not dictate the details of - the enormous project of LIBOR benchmark reform.  The forward course for the US markets is clear – it is away from LIBOR toward SOFR.  The official sector will assist and stay close by the course, helping coordinate and encourage, prod and explain.  Yet, the means of travel is also clear.  It is driven by market participants, with engagement by both the buy-side and the sell-side. Yet, it is ultimately a market derived solution.

Yes, there is a lot yet to be done.  But it is worth the effort.  As a great American once said about traveling to the moon, we go “not because [it] is easy, but because [it is] hard.”  You can say the same about enhancing financial stability.  As stewards of trading markets, our work to make them healthier and more resilient goes on day after trading day, year after year.  If done well, the work never ends.

Thank you.

 

Statement of CFTC Chairman J. Christopher Giancarlo on Amending the Definition of “Eligible Master Netting Agreement” and Related Changes in the CFTC Margin Rule

November 19, 2018

Through the Commission’s Project KISS initiative, the Commission received suggestions to harmonize its uncleared swap margin rule with that of the Prudential Regulators.  In response, this final rule does so and provides market certainty, specifically with respect to amending the CFTC’s definition of “eligible master netting agreement” (EMNA) and amending the CFTC Margin Rule such that any legacy swap will not become subject to the CFTC Margin Rule if it is amended solely to comply with changes adopted by the Prudential Regulators in 2017.  The Commission recognizes that the CFTC Margin Rule does not provide relief for legacy swaps that might need to be amended to meet regulatory changes or requirements, and is committed to considering other meritorious requests for relief.