Remarks of Commissioner Brian D Quintenz at SIFMA 2018 Operations Conference & Exhibition

Cutting the Grass, Adding Integrity, and Promoting Growth

May 8, 2018

Good morning and thank you for that very kind introduction.  I’m delighted to be here with you today.  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 Commission.

As a child, I would often do chores to earn money.  In particular, I would frequently mow the front and back lawns of our house.  There were some tricky parts – a small, uneven hill posed challenges to straight lines, and lots of curved flower bed borders made wheel placement critical – but I did what I thought was a pretty good and meticulous job.  That was an important learning experience for me to appreciate the value of money, the effort required to purchase the things that I wanted, and learning how to spend those dollars wisely.  I imagine that many of you had similar experiences.  And, as much as we all wish otherwise, the importance of saving, managing, and budgeting money grows with our age and responsibilities.

Currently, our nation is facing what some might call a debt crisis.  Regardless of what you call it, the fact is that our federal debt exceeds $21 trillion.  Annual federal budgets with $500 billion deficits have become the rule, rather than the exception.  Congress has the enormous task every year of setting the federal government’s $4 trillion budget, and a priority of the current Congress and administration is to balance the budget, rather than burden American citizens with additional debt.  I support efforts to reign in our burgeoning national debt, especially when it seems likely that interest rates will continue to rise.  As George Washington wisely stated, “We must consult our means, rather than our wishes.”

Therefore, I do not take lightly the topic of my speech today, which advocates for enhanced funding for the Commodity Futures Trading Commission (CFTC).  As some of you may know, the agency’s budget for 2018 was recently cut by $1 million.  I understand that we do not live in a world of infinite resources.  Quite the opposite – resources are scarce.  Congress must wisely allocate funding among many competing, worthy programs.  Today, I hope to make the case for why, under Chairman Christopher Giancarlo’s leadership, the CFTC deserves additional funds.

A common perception of regulation is that it acts as a drag on private enterprise, imposing costs and distorting the market.  I would never argue with the notion that regulation can be costly – I have actually tried numerous times in prior speeches to point out cases in the agency’s prior rulemakings where those costs are needlessly large – but I would also point out that good regulation doesn’t have to be costly.  Thoughtful, appropriately calibrated regulation should, even accounting for the costs imposed on the private sector, ultimately enhance our financial markets, promote economic growth, and benefit the public.  Regulation should not be, and does not have to be, a tax on the economy.  Instead, smart regulation should target demonstrable problems and asymmetries in our markets, which, once addressed, increase the integrity of the marketplace, helping to attract capital and liquidity and driving economic growth.  This is the kind of smart regulation that I believe the CFTC is committed to providing under Chairman Giancarlo’s leadership and it is one of the reasons why I believe providing the agency with additional resources is worth the cost.

I also hope my remarks demonstrate how the CFTC of today and Chairman Giancarlo’s vision for the future stand in stark contrast to the actions of recent CFTC Chairmen.  I believe that the CFTC’s grim budget situation today is largely attributable to the irresponsible stewardship of the prior administration.  Under the leadership of Chairman Gary Gensler and Chairman Timothy Massad, years of unrealistic budget requests, fiscal mismanagement, and political gamesmanship with Capitol Hill damaged the agency’s reputation and credibility with appropriators who, when now forced to pick and choose between competing priorities, remember those past affronts like yesterday.  

The Beginning

When I was earning money mowing my parents’ lawn, imagine what they would think, or how they might change our deal, if, for instance, I left large, unmowed strips of grass or carelessly ran over my mom’s flower beds and pulverized her petunias.  Ultimately, I’m willing to bet, my parents would not have paid me until I had shown them that I had done a good job and was up to the task.  Unfortunately, such has been the case with the CFTC’s budget requests, spending decisions, and fiscal management over the past eight years.

The CFTC’s irresponsible fiscal practices began under Chairman Gensler.  A prominent example of agency waste during his tenure which I would like to highlight for you today involves his negotiation of the CFTC’s lease for its D.C. headquarters – what we will call the D.C. Lease.  The saga of the D.C. Lease begins in 2009, when former Chairman Gensler began planning for large increases in CFTC budget and staffing in anticipation of financial reform legislation that he believed would greatly augment the responsibilities of the agency.[1]  In fact, it was August 2009, almost a full year before the Dodd-Frank Act was signed into law, when Chairman Gensler renegotiated and extended the D.C. Lease, ultimately leading to the CFTC’s occupancy of practically the entire office building.[2]

In early 2010, and still in advance of receiving any new oversight authorities, Chairman Gensler requested that Congress increase the CFTC’s budget from $168 million to $261 million for FY 2011, a 55% increase from the prior year’s appropriation.[3]   The Commission sought this significant bump in funding to increase its staff from 580 to 864 employees.[4]  Ultimately, Congress only appropriated $202 million to the agency.  Instead of 284 additional employees, only 61 new individuals were hired.[5]  Regardless of its relatively small increase in staffing, the Commission exercised a clause in the D.C. Lease to expand its D.C. office space by 67%, incurring approximately $3 million more in annual rental costs.[6]

The Commission repeated this questionable approach the following year.  For FY 2012, Chairman Gensler requested $308 million, a 53% increase over the $202 million the agency had just received, and proposed to expand to 983 employees.[7]  However, Congress kept the agency essentially flat funded, appropriating only $205 million.  And yet, under Chairman Gensler’s direction, the Commission further expanded its D.C. office space, adding approximately 18,000 square feet, and costing the agency an additional $3.3 million more in annual rental costs.[8]

The lease amendments were irresponsible in other respects as well – namely, they were negotiated without the assistance and expertise of the General Services Administration (GSA).  As a result, the renegotiated D.C. Lease contained many terms that were inappropriate for a government agency.[9]  For example, the D.C. Lease contains several open-ended clauses that subject the agency to uncontrolled liabilities.  These clauses were the subject of a Government Accountability Office (GAO) inquiry and caused the agency to violate the Antideficiency Act.[10]  In addition, the D.C. Lease is a so-called “pass-through lease,” in which the tenant, rather than the landlord, is required to pay property taxes on the property in addition to rent.[11]  These terms were highly unusual for a federal agency.  In FY 2017 alone, this clause in the D.C. Lease has cost taxpayers nearly $1 million.

In the course of reviewing the space utilization of the D.C. office, the agency’s Inspector General estimated that the CFTC will spend approximately $36.4 to $48.3 million on empty office space by the time the D.C. Lease ends in 2025.[12]  Moreover, the Inspector General’s Report advised the Commission that “there is a problem with obligating the expenditure of millions in taxpayer dollars on empty office space based on anticipated rather than actual staffing levels, particularly when the gap between anticipated and actual funding is that large.  It wastes taxpayer money.”[13]  It is simply astounding – astounding – that the Inspector General would need to inform a federal agency of such basic practices.

Of course, these abuses eventually came to light, causing Congress to question the agency’s fiscal responsibility and annual requests for increased funding.[14]  Under Chairman Gensler’s leadership, the perception of inflated CFTC budget requests that were out of line with actual agency needs began to develop.[15]

Unnecessary Furloughs in 2013

This perception was reinforced in 2013, when the agency unnecessarily furloughed its workers in an act of political gamesmanship with Capitol Hill.  On October 24, 2013, in the middle of an omnibus spending bill debate on Capitol Hill, Chairman Gensler announced that the agency would need to furlough workers for up to 14 days.[16]  That very same day, Congressman Aderholt, the Chairman of the Appropriations Subcommittee responsible for funding the CFTC, issued a statement making clear that the CFTC had explicit legal authority to spend amounts necessary to avoid furloughs.[17]  In his press release, Chairman Aderholt made clear that he strongly disapproved of Chairman Gensler’s furlough threat, stating that “budgetary games where public servants are used as political pawns [are] not admirable.”[18]

Yet Chairman Gensler, fully aware that the agency had other measures at its disposal to avoid a furlough, nonetheless proceeded to furlough the agency’s workers for two days.  I would like to think that the importance of the CFTC’s mission to the markets, and the morale and wellbeing of its employees, would trump political ploys designed to coerce additional funding from Congress.  Sadly, under prior CFTC leadership, that was not always the case.  To complete the analogy from earlier, if Chairman Gensler had mowed my parents’ lawn, my mom’s flowers would have been toast. 

Union Negotiations

Unfortunately, this pattern of political gamesmanship with Congressional appropriators continued under Chairman Timothy Massad, albeit to a lesser degree.  Shortly after Chairman Gensler’s leadership of the Commission, CFTC employees in all offices, for the first time in the agency’s history, joined a national federal employee labor union.[19]  During his tenure as Chairman, Mr. Massad engaged in extensive negotiations with the labor union regarding compensation and benefits.  In the fall of 2016, those negotiations stalled, with both sides feeling they were unable to make further concessions.  The case was set to be decided in January 2017 by an impasse panel – which is essentially a neutral third party mediator.

The decision of the impasse panel would be final and binding on the agency.  Therefore, Chairman Massad directed agency staff to brief appropriators on Capitol Hill about the possible outcomes.  However, the briefing highlighted the worst case scenarios in the event the impasse panel agreed with all of the union’s demands and warned appropriators that significant staff reductions and furloughs might be necessary if the Commission was not provided additional funds.

Ultimately, the impasse panel’s decision allowed the CFTC to continue operations without the need to furlough, although other cuts were necessary.  In the aftermath of the decision, some lawmakers felt the agency had, in keeping with the agency’s reputation of engaging in political stunts, deliberately presented them with doomsday scenarios in an effort to persuade them to provide additional funding.[20]  Under Chairman Massad’s leadership, this failure to present a balanced view further eroded Capitol Hill’s trust in our agency.

As a result of two prior leaderships at the CFTC, it has become difficult for appropriators, and the public, to take our agency’s word at face value when recent history shows a pattern of mismanaging existing resources, crying wolf, and warning of catastrophic outcomes that are almost always avoidable.

A New Kind of Leadership

Luckily, the CFTC is now under new leadership.  I believe that Chairman Giancarlo has demonstrated his vision for, and commitment to, providing superior, thoughtful regulatory oversight of the derivatives markets.  I wholeheartedly associate myself with that vision and that commitment.  Unlike past administrations, which may have approached market regulation through a politically-focused lens, the present administration has pursued regulation that is carefully calibrated to address demonstrable issues and problems, all with an eye to enhancing the resiliency, competitiveness, and vibrancy of the derivatives markets.

I strongly believe that this fresh approach has notably carried over to the agency’s finances.  As one of his first acts as Chairman, Chairman Giancarlo initiated a wholesale review of the CFTC’s budget.  Instead of formulaically determining the agency’s budget request by taking last year’s number and automatically grossing up by a certain percentage, the Chairman engaged in a rigorous analysis of each of the agency’s functions and expenditures.  Chairman Giancarlo built the 2018 budget from the ground up based upon the real needs of the Commission that are essential to fulfilling is core missions.

During the course of that review, the Chairman identified ways that the agency could be more efficient, and he is implementing the changes necessary to realize those efficiencies.  Departments are being reorganized and streamlined to increase productivity and provide long-term cost savings.  The Chairman also negotiated with the Commission’s Kansas City landlord to return an entire floor of vacant space back to the landlord.  This will result in significant savings over the remaining life of the Kansas City lease.  Going forward, he is also firmly committed to working with GSA in connection with all of the CFTC’s regional office leases when the current leases expire.

But the Chairman’s vision for the agency as one which adds to market integrity and promotes economic growth, as opposed to simply taxing growth, will also require some degree of investment. Chairman Giancarlo has identified three areas where a modest increase in the agency’s budget could achieve that result. It starts with cultivating an economic and econometric focus at the agency.  An increase in funding for the Office of Chief Economist would promote the agency’s use of sophisticated econometric and quantitative analyses necessary to model risk, conduct stress tests, and assess the impact of regulations.  For example, in order to effectively monitor the derivatives markets, new forms of economic analysis that convert notional amounts into measures of actual risk are essential.  Simply put, we need more quants and fewer lawyers.  Chairman Giancarlo and I are committed to providing the forward-looking leadership on this topic that the world expects from the premiere derivatives regulator.

Second, market integrity around counterparty risk has increased significantly with the clearing of standardized swaps.  An add-on result has been the “super-sizing” of derivative clearinghouses, which heightens the importance of robust examinations and stress-testing procedures.  A few additional staffers will help ensure that each clearinghouse is regularly examined for liquidity, risk management, and cybersecurity, so that in a market stress event, clearinghouse resiliency does not become a source of panic.

And finally, the transformational challenges associated with fintech advancements and oversight of the burgeoning cryptocurrency markets require a forward-looking regulator with in-house fintech expertise and an ability to proactively engage with innovators. A small funding increase would build on the Chairman’s highly impactful LabCFTC initiative.

After conducting this thorough, reasoned assessment, the Chairman determined that the CFTC would require $281.5 million to achieve his regulatory vision – one that can contribute to, not weigh down, economic growth.  This amount, while an increase of 13% from the prior year’s funding, is still a significantly smaller percentage increase than the prior administration’s budget requests.

Unfortunately, additional resources were not provided to the agency for 2018 – in fact, the agency’s budget for this year was reduced by $1 million.  This marks the fourth consecutive year of essentially flat funding for the agency.[21]  While flat funding can sometimes sound like the status quo, I’d like to provide a quick perspective on how flat funding doesn’t mean flat resources.  In FY 2016, under a $250 million appropriation, the agency employed 715 Full Time Equivalent (FTE) employees.  However, because of built-in cost increases in our salary packages and in our poorly negotiated leases, if we do not receive additional funding by the end of 2018, the agency will need to make adjustments in anticipation of only being able to support 636 FTE employees – an FTE number which is only about 30 more than the agency had in 2010 prior to the implementation of Dodd-Frank.

For now, the CFTC is making the best use of the resources it has been given.  We are already working to prudently manage our resources and cut costs wherever possible.  However, without sounding alarmist, I do want to express my genuine concern that the recent budget cuts hinder the CFTC’s ability to meet its core missions.  Staff’s ability to conduct regular risk, compliance, and cybersecurity examinations will be curtailed; enforcement efforts to police fraud and manipulation – particularly in the cryptocurrency spot markets – will be strained.  I have no doubt that the CFTC’s dedicated staff will do everything in their power to overcome these challenges.  But we can only expect them to do so much with the resources they have been given.

In the past, the CFTC has been accused of playing politics and engaging in political games with respect to budget requests.  I would like to state this clearly – those times are over.  This is a new administration, a new Chairman, and a new vision.  I am hopeful that next year’s appropriation will reflect that reality, and the agency will be provided with the resources it needs to provide superior oversight of our markets that can add to economic growth and enhance market integrity.

We should measure the success of the CFTC by whether the U.S. derivatives markets attract the world’s capital – meaning the world recognizes them to be not only the most durable and the most vibrant, but also the most stable and the best regulated.[22]  That is a high standard to which we should hold this agency – but anything less would be settling for a crookedly mowed lawn.

Remarks of Chairman J. Christopher Giancarlo at the Association of German Banks, Berlin, Germany

May 7, 2018

Thank you, Andreas Krautscheid for that kind introduction.  I also wish to thank the Bankenverband for hosting this event.  Good afternoon.  Thank you all for coming.

It is good to be in Berlin.

My last name is Italian.  However, my mother’s maiden name is German: Schwarz.  My great-great grandfather, Josef Alfons Schwarz, taught pharmacology at Humboldt University here in Berlin over a hundred and twenty-five years ago.

Introduction

Just as it was then, today Berlin is a dynamic, energetic, influential and vibrant city at the heart of Europe.  It is a powerful center of culture, finance, trade and commerce.

As members of this Association, many of you are directly responsible for Berlin’s rebirth through strong and resilient and responsible banking practices.  German banking has helped the world overcome the turbulence of 2008 and recover from the Great Recession.  You are essential to Germany’s global economic leadership.  And, I know you want future stability, order and opportunity.

Two weeks ago, there was much talk about Germany in America.  The German flag was flying in Washington, which hosted Chancellor Angela Merkel and other German officials.  In the financial press there were articles about trade, banking, cybersecurity and bi-lateral cooperation.  Chancellor Merkel’s visit was an opportunity to review our relationship and discuss issues that need to be addressed.  It is a time for, what one commentator called, a “sifting of ideas” to use our strong ties to concentrate on core principles and resolve differences.

I have come to Berlin in that same spirit of respect, reciprocity and partnership.  I want to discuss some crucial issues for both of our countries.  I invite your thoughts and response.

Cross Border Regulatory Cooperation

As the regulator for U.S. derivatives markets, the world’s largest, I am very aware that the rules and regulations adopted in the United States impact firms around the world, including financial institutions here in Germany.  Therefore, it is important that you know that I am committed to cross border regulatory harmonization.

The Duff and Phelps 2018 Global Regulatory Outlook Survey found, among the financial executives surveyed, 19 percent of executives called greater harmonization among regulations the “single most important factor in maintaining an effective regulatory system.”  Fortunately, 52 percent believe regulators are improving their ability to collaborate with peer across borders.  Almost one-third said the effort has led to greater harmonization and consistency in global regulations.

Cross-border harmonization entails creative approaches and flexibilities that honor differing legal regimes while permitting and enhancing market collaboration across borders and ensuring our markets remain strong and resilient.  I am committed to outcomes-based deference decisions that acknowledge that different regulators can get to the same result in different ways.  Different regulators use different legal frameworks and different legal tools, and we need to respect such differences when they achieve similar regulatory outcomes.

We need greater harmonization.  We also need to be consistent, reasonable, and cost-efficient.  I have expressed concern over the current European Union (EU) legislative proposal for a new framework for the regulation and supervision of central clearing counterparties (CCPs).  I have the highest respect for Germany’s BaFin and other European authorities.  My concern lies with parts of the EU proposal that would subject U.S. CCPs to overlapping EU regulation and supervision without due deference to CFTC regulation and supervision – due deference that was already agreed to between the EU and the United States in the 2016 common approach for transatlantic CCPs.  We spent three years working on that agreement and remain committed to it.  We do not want to renegotiate it.

As Bundesbank Board member Andreas Dombret and others have said, there is no need to alter this already robust arrangement concerning U.S. CCPs.  We have been supervising them for decades.  The CFTC’s requirements for CCPs, like the EU’s, are based on agreed upon international principles.  Additional regulation is unnecessary and adds to confusion and cost.  The arrangement is working now.  I hope this issue does not divide the United States and Europe.  Regulatory and supervisory deference is the path upon which the United States and Europe should journey together.

Utility of Global Swaps Markets

Let me now turn to the swaps market.  As you know, swaps and other derivatives help stabilize the cost of living for our citizens.  They serve the needs of society to help moderate price, supply and other commercial risks to free up capital for economic growth, job creation and prosperity.  They allow the risks of variable production costs, such as the price of raw materials, energy, foreign currency, and interest rates, to be transferred from those who cannot afford them to those who can.  While often derided in the tabloid press as “risky,” derivatives – when used properly – are tools for efficient risk transfer and mitigation.  More than 90 percent of Fortune 500 companies use derivatives to manage commercial or market risk in their worldwide business operations.

And yet, global derivatives markets have not always performed as well as they should.

Global Reform Initiative

Ten years have passed since the start of the 2008 financial crisis.  In September 2008, Lehman Brothers filed for Chapter 11 bankruptcy protection.  Its failure was a consequence of the bursting of a double bubble of housing prices and consumer credit, as lenders became concerned about a fall in property values and repayment of mortgages.  An extraordinary “run-on-the-bank” ensued with rapidly falling asset values preventing U.S. and foreign lenders from meeting their cash obligations.  This marked the beginning of a financial crisis that was devastating for far too many businesses and families.

Over-the-counter (OTC) derivatives contributed to the financial crisis through American International Group’s (AIG) writing of credit default swaps (CDS) protection on mortgage products – a substantial part of AIG’s failure – and through synthetic mortgage collateralized debt obligations (CDOs), which had made their way onto bank balance sheets.  Perhaps most important, however, was the lack of reliable information about OTC derivatives positions contributing to the “fog of war.”  Very simply, government authorities did not have the data to accurately assess the implication of the failures of Bear Stearns, Lehman Brothers and AIG on derivatives counterparties throughout the financial system.

It became clear that financial market regulatory reform was needed.

At the 2009 Pittsburgh G-20 Summit, global leaders agreed to work together to support economic recovery through a “Framework for Strong, Sustainable and Balanced Growth.”  They pledged to work together to “implement global standards” in financial markets, while rejecting “protectionism.”

The G-20 leaders agreed upon several fundamental principles to reform OTC derivatives markets, namely: regulation of swaps trading and execution, reporting of swaps transactions, increased central counterparty clearing of swaps transactions, and swap dealer capital requirements.

The United States moved first, with Congress enacting many of the Pittsburgh reforms into law under Dodd-Frank in 2010.  Among U.S. regulators, the Commodity Futures Trading Commission (CFTC) was given responsibility given to regulate most swaps under Title VII of Dodd-Frank.  It has been the most active, implementing most of the swaps reforms by 2014.  In Europe, swaps market reform was first implemented in the form of EMIR in 2012, to be followed by MIFID II, much of which first came on line at the start of 2018.

We now have more than four years of U.S. experience with the current CFTC regulatory framework for swaps, and have learned from its varied strengths and shortcomings.  Four years provides a significant sample size to evaluate the effects of these reforms and their implementation.  Based on a careful analysis of that data and experience, we are in position to address flaws, recalibrate imprecision and optimize measures in the CFTC’s initial implementation of swaps market reform.

In many ways, regulatory frameworks are like software applications.  Their value can be enhanced by addressing flaws, improving security, meeting additional requirements, becoming easier to use, more efficient, accommodating newer technology, and expanding the user base.  The goal is to preserve the value of the core regulatory framework over time.

Like software users, market participants will always look to participate in well-designed, regulatory frameworks.  I do not subscribe to the “race to the bottom” thesis of comparative regulation.  It is based on a naïve understanding of trade and commerce.  Frankly, it is insulting to the responsible businessmen and women who build and operate our modern economy.  Trading counterparties seek neither the least nor the most regulated marketplaces, but marketplaces that have the right balance of sensible, objective and well-maintained regulation – in other words: good software.

And just as with software, the details of regulatory frameworks matter.  There inevitably will be flaws and bugs in the first release of major software.  It has to be improved and maintained.  Reasonable adjustments and fixes can make dramatic improvements in the effectiveness of regulations.

I believe that market regulators have a duty to apply broad policy prescriptions in ways that enhance markets and their underlying vibrancy, diversity and resiliency.  That duty also includes the responsibility to continuously review past policy applications to confirm they remain optimized for the purposes intended.  It further includes anticipating changing market dynamics and the impact of technological innovation.

White Paper: “Regulatory Reform 2.0.”

Two weeks ago I released a White Paper on swaps reform called “Regulatory Reform 2.0.”  The White Paper was co-authored with Bruce Tuckman, the CFTC’s Chief Economist.  This White Paper analyzes the range of academic research, market activity and regulatory experience with the CFTC’s current implementation of swaps reform.  It explores and considers a range of improvements to the current reform implementation that is pro-reform, aligned to legislative intent and better balances systemic risk mitigation with healthy swaps market activity in support of broad-based economic growth.

The White Paper assesses the CFTC’s implementation of Dodd-Frank swaps reforms in the areas of central counterparty clearing, trade reporting, trade execution, swap dealer capital and the end user exception.  It looks both at areas of success and recognized shortcomings.  In numerous areas, it makes considered recommendations for improvement.  Let me summarize it for you.

Swaps Central Counterparties

Swaps clearing was probably the most far-reaching and consequential of the G-20 swaps reforms.  The Bank for International Settlements (BIS) estimated that minimum global clearing rates at the time of the financial crisis was about 40% for interest rate swaps and 8% for credit default swaps.  By 2017, about 85% of new interest rate swaps and credit default swaps were being cleared.  The default risk of swaps counterparties that was once spread across Wall Street is now pooled and managed within regulated CCPs.

Unquestionably, the CFTC’s swaps clearing mandate was highly successful.  Its success, however, has significantly increased the volume of swap transactions cleared through CCPs and has led to a number of considerations for further deliberation.

The first consideration is to ensure that CCPs are safe and sound under extreme but plausible conditions.  Each CCP runs a perfectly “matched book,” meaning that they take zero market risk.  They do face the risk, however, that clearing members default at the same time they lose value in their cleared positions.  Against this risk, CCPs operate under CFTC supervision to carefully scrutinize member creditworthiness, collect calibrated resources against potential losses, and undergo rigorous regulatory examinations.

There is room for further analysis, however, along several dimensions: ensuring the liquidity of funded resources, understanding correlated defaults and network effects, and properly accounting for liquidation costs (particularly for new products).

The second consideration is with respect to recovery plans, which describe how a CCP, in extreme adverse scenarios, would comprehensively allocate losses, restore its matched book and replenish its financial resources.  A great deal of progress has been made here as well, but some issues remain: the transparency and predictability of recovery plans and the role of unfunded resources, namely, assessments.

Third, there are considerations related to resolution by government authorities, in the event that recovery plans prove inadequate.  This would be a very extreme scenario, in which the financial system would almost certainly have greater and more pressing problems than derivatives clearing, but prudence dictates that such plans be ready and as transparent as possible.

Swaps Reporting Rules

I turn to the trade reporting mandate.  A critical fact of the 2008 financial crisis was the inability of regulators to assess and quantify the counterparty credit risk of large banks and swap dealers.  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.  The regulatory failure to complete it is certainly the most disappointing.

Despite the hard work and effort that has gone into establishing swap data repositories (SDRs) and supplying them with swaps data, a decade after the financial crisis, SDRs still cannot provide regulators with a complete and accurate picture of counterparty credit risk in global swaps markets.

In part, the problem has been faulty implementation by regulators, including the CFTC.  The CFTC’s initial approach to swaps reporting provided insufficient technological detail and specification.  Instead, it relied on industry participants to utilize standardized nomenclature and data protocols, assuming the existence of a similar degree of standardization of swaps market data that exists in futures markets.  Since then, substantial progress has been made here and abroad by both regulators and market participants in standardizing data nomenclature, reporting elements and reporting protocols.

The CFTC is committed to success in the global reform efforts towards swaps data reporting. That means devoting high-level resources and effective project management to complete the process of data standardization and cross-border harmonization.  It also means extensive dialogue and coordination with industry participants and overseas regulatory counterparts.

Swaps Execution Rules

Let me now address the trade execution mandate:  Congress enacted the G-20 swaps execution reforms in the Dodd-Frank Act by requiring that swaps transactions be traded on regulated platforms called swap execution facilities (SEFs) and executed by “any means of interstate commerce.”  There is no requirement in U.S. law for electronic execution. Unfortunately, in its first draft, the CFTC incorrectly implemented some of this reform.  It grafted into its SEF rules a number of market practices from highly liquid futures markets that are antithetical to episodically liquid swaps trading.  The CFTC limited methods of swaps execution in a misinformed attempt to re-engineer the market structure of swaps execution.

To use software terminology, these features are a significant design flaw.  They have led to harmful market fragmentation, a systemic risk.  Instead of establishing the SEF regulatory construct to be salutary to liquidity formation, CFTC rules turned SEFs into environments that are unconducive to it.  One effect has been to shift swaps price discovery and liquidity formation away from SEFs to platforms that are not subject to conduct and compliance requirements appropriate for swaps products.

Swap Dealer Capital

The White Paper next addresses swaps dealer capital requirements.  While the debate has not been conclusively settled, the emerging consensus seems to have endorsed the principle of risk-based capital requirements.  However, because regulators have not allowed regulator-approved internal models in all cases, many parts of the current regime are biased against swaps.

The particular problems of standardized, regulatory capital models arise from inappropriately relying on swap notional amount to measure risk, from not sufficiently recognizing offsetting swap positions between pairs of counterparties, and from not sufficiently acknowledging the risk-mitigation of posted margin.  These appear to be unintended consequences of swaps market reform, and should be corrected.

One approach to correcting the problem is to continue to refine, and by necessity complicate, the standardized models imposed on market participants.  A better approach may be to ascertain how regulators might rely more heavily, but confidently, on the internal risk models used by banks and their swap dealer affiliates.

End User Exception

Finally, the White Paper covers end users of swaps.  The Dodd-Frank Act required various market participants to clear standardized swaps and required swap dealers to collect margin on uncleared swaps.  The benefits of these requirements, with respect to reducing systemic risk, were judged to be worth the concomitant costs.

At the same time, Dodd-Frank exempted commercial end users from these requirements through a legislative arrangement known as the “end user exception.” These market participants are not sources of systemic risk and would find the requirements particularly costly.

The fate of many financial end users, by contrast, was not as definitive, particularly with respect to uncleared margin requirements.  Smaller financial end users should be exempt from clearing and margin requirements through a material swaps exposure threshold, for the same reasons that commercial end users are exempt.  Larger financial end users, on the other hand, that can very well be sources of systemic risk, should remain subject to the clearing and uncleared margin requirements.

Uncleared margin rules can and should achieve their objectives without being as prescriptive as currently constructed.  A less prescriptive approach would both encourage sound and innovative risk management and be less likely to encourage model herding, itself a source of systemic risk.

Conclusion

The essential role of global derivatives markets are to help mitigate price, supply and other commercial risks – shifting risk to those who can best bear it from those who cannot.  Thus, well-functioning global derivatives markets free up capital for business lending and investment necessary for economic growth.  Flourishing derivatives markets underpin global economic health.  We must foster safe, sound and vibrant global markets for investment and risk management to stimulate greater job creation and broad-based prosperity both in America and in Europe.

Market regulators have a duty to apply the policy prescriptions of their legislatures in ways that enhance markets and their underlying vibrancy, diversity and resiliency.  That duty also includes the responsibility to review past policy applications continuously to confirm they remain optimized for the purposes intended.  It further includes anticipating changing market dynamics and the impact of technological innovation.

My White Paper analyzes and considers the CFTC’s particular implementation of swaps reform from a perspective that is strongly aligned with the G20 reforms.  It seeks to better balance market durability and systemic risk mitigation with healthy trading liquidity necessary for broad-based economic growth and revival.  Its purpose is to establish a vision for a continuous process of improvement to swaps market reform.

To ensure the global success of these reforms, we will rely on pragmatic cross-border principles of deference, comity and cooperation to guide CFTC rulemaking and staff actions.  These principles will address market fragmentation, contraction of liquidity, market disruption and dislocation in the global derivatives markets.

We must not be afraid to make appropriate adjustments.  With better calibration, we can make these markets more vibrant, successful and accessible while reducing systemic risk.  Safe and robust swaps markets must underpin economic growth and prosperity, which of course, enhance the human condition.

I will finish my formal remarks by turning to the well-known remarks by President John Kennedy here in Berlin, fifty-five years ago next month.  He spoke of the importance of Berlin in the “advance of freedom everywhere.”  He asked us to lift our eyes to the “hopes of tomorrow.”  He said that if we wanted to see a future of prosperity, democracy and freedom, “Let them come to Berlin.”

And, President Kennedy said something else.  He said any free person, wherever he may be, is an honorary citizen of Berlin.

If so, then as a free man, I take pride in that honorary citizenship, that linkage across the years and history and geography, this association, this solidarity, this timeless hard-won force of freedom.

Thank you.

Keynote of Commissioner Rostin Behnam at the FIA 40th Annual Law & Compliance Division Conference on the Regulation of Futures, Derivatives and OTC Products, Washington, DC

Our Charming Ways

May 3, 2018

Introduction

Good morning.  It’s great to be with you today.  Before I begin, I want to extend my thanks to Walt Lukken and the entire FIA team for inviting me to share my thoughts.  Also, let me say that the views I express are my own and do not represent the views of the Commission.  As many of you know I worked on Capitol Hill between 2011 and 2017.  As far as I can remember, FIA usually held its annual Law & Compliance (L&C) meeting in Baltimore.  Despite the relatively short distance between Washington, D.C. and Baltimore, I sadly never attended the conference.  My job rarely afforded an opportunity to stray far from the congressional campus — even for a few hours, particularly when the Senate was in session.

Now a CFTC Commissioner, and more importantly, a proud, and relatively new resident of Baltimore, having left the District with my wife and newborn in November, 2016, Law & Compliance has conveniently settled, I think, in D.C.; and Walt— also conveniently — offered me the 8:15 a.m. speaking slot.  I could not have planned my L&C debut any worse.

Honestly, though, I love early mornings, and I am thrilled to be here to share my thoughts on policy and current events at the CFTC.  But, not before I make a pitch for Charm City.  Baltimore is a scrappy city, and has for over 100 years been one of our nation’s great hubs for the financial services industry, and would welcome Law and Compliance back with open arms.

The FIA L&C conference has a strong reputation as the premier legal conference for the derivatives industry.  While it may not offer the sweet salty air of Boca, the views of Dana Point, or the historic charm of the Brewery on Chiswell Street, every year since 1978, regardless of its location, L&C has served as a hive of activity for legal and compliance professionals to share, learn, and explore the legal and regulatory issues of the day.

This year marks L&C’s 40^th anniversary, having grown from a gathering of few dozen in the early years to nearly 900 attendees annually.  As I learned from the FIA website, in the beginning, industry professionals were “grappling with a new regulator, a new regulatory environment and understanding how newly adopted and proposed regulations would affect commodities futures contracts.”[1]  In many respects, the same could be said for where we are today.  We just need to use that trick where we add “and swaps” to the end clause of the statement.  If only regulatory reform were that simple.  Joking aside, while the CFTC isn’t a new regulator per se, it is a new regulator for many (new) industry practitioners and participants, and it is becoming a relevant regulator in some newer, emerging areas.  And, as I will touch upon in a little bit, we are eight years into implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act,[2] and we are still evaluating and refining the “new” regulatory environment.  I also suppose “grappling” still fairly describes where we are, at least with respect to some of the more challenging issues of our time.

Chairman Giancarlo graciously swore me in as a Commissioner nearly eight months ago to the day.  Pretty remarkable to think it has already been eight months.  If these first eight months are an indication of how quickly my term will come and go, then I’ve got to keep moving if we are going to meet the Chairman’s agenda.  I might need to learn to love my mornings even earlier.

As I thought about my remarks, and reflected on the first eight months of my time at the CFTC, a few events came to mind: (i) my maiden speech at Georgetown University; (ii) the listing of bitcoin futures and the increasingly rapid proliferation of financial technology; (iii) participating in the FIA/SIFMA AMG Annual Asset Management Derivatives Forum; (iv) convening the Market Risk Advisory Committee (MRAC); and (v) the first Project KISS and Reg Reform 2.0 initiatives.  As I continue to refine my approach as a Commissioner and formulate strategies in support of goals and priorities, these first events will serve as both developmental milestones and guideposts for tackling our agenda in the months and years to come.  The derivatives industry is vast and diverse, and yet through its ecosystem of industry groups, trade associations, self-regulatory organizations (SROs), and the National Futures Association (NFA), it provides meaningful collaboration, education, and feedback as we continually grow and re-evaluate efforts towards ensuring the safety and integrity of our markets, customer protections, and the professionalism of our market participants.

It’s this last point that segues into my actual remarks.  To be blunt, there is a lot going on right now.  It’s important that we continue to collaborate, focus on transparency, and act responsibly.   The Commission and industry must move in tandem as we move forward on the ambitious timetable before us.  While I am optimistic and supportive of our leadership, I will continue to insist that we listen to our constituents and the broader markets and general public in determining how best to serve our purpose and achieve our mission.  We cannot eschew and ignore process and progress in a rush to indulge in initiatives that respond to the rhetoric of the moment.  Doing so could undermine sound policy, create greater uncertainty and impracticability regarding our rules, and leave us vulnerable to creating regulation by enforcement.

Last month, during my “Washington Outlook” at FIA Boca, I made clear that we are all in this together.[3]  We’ve been waiting for deliverables in terms of Project KISS, Reg Reform 2.0, and CFTC and SEC harmonization, and anticipating resolution of unfinished business in terms of the de Minimis exception, position limits, capital, and Regulation Automated Trading (Reg AT).  Since that time, we’ve received the Chairman’s white paper on “Swaps Regulation Version 2.0,” which purports to set the agenda for Reg Reform 2.0.[4]  While I appreciate the Chairman’s transparency in setting forth his vision and, in his words, starting a dialogue, I can’t help but note that there is already a process for dialogue with market participants regarding potential rule changes – the notice and comment process for proposed rules under the Administrative Procedure Act.  Adding another white paper just pushes back the timeline for getting to actual deliverables.  It adds another step to the process.  It also takes a lot of staff time when budgets are tight.

I know that the natural information asymmetries are at work and that you are all working to solidify what the path forward for the balance of 2018 may look like for you and those you represent.  I am here today to let you know that I continue to believe we must focus on reform and be wary of huge and potentially premature policy shifts; strive for accountability, and continue to have productive dialogs aimed at ensuring that the Commission serves its purpose and remains true to its mission.  With that in mind, I will use the remainder of my remarks to elaborate using my milestone markers.

The Maiden Speech

Admittedly, I tend to share my views directly with market participants, end-users, and the public instead of making prepared public remarks.  However, I realize that in terms of broader messaging, I may need to provide a little more background.

I gave my first public remarks at Georgetown University in November, 2017.[5]  Briefly, I observed that the CFTC is at an inflection point.  I suggested that the CFTC, having largely completed its rulemaking requirements under Title VII of the Dodd-Frank Act, is settling in to its new post-crisis role as a world class regulator of futures, options, and swaps (see how I did that there?).  The CFTC — despite rhetoric of regulatory rollbacks here in D.C. and economic tailwinds — should primarily focus its limited resources on moving forward and not backward.  Of course, I recognize that detours are necessary to address emerging issues and advancements in our markets.

I also stated that the inflection point must include careful reflection on what has been done since 2010.  Any outcome should be a careful, limited fine-tuning and adjustment to reforms that have resulted in unintended consequences or do not further congressional intent or the CFTC’s core mission.  I’ll augment those sentiments today by adding that, as we engage in these exercises, we must be mindful that our rules and policies interconnect in various places, and that each adjustment must be accompanied by sound analysis to ensure that we don’t create misalignments and new uncertainty.  I’ll also add that we must also consider the rules of our fellow domestic regulators, the Securities and Exchange Commission (SEC) and the prudential regulators, and our foreign counterparts.  Our newest registrants operate across jurisdictional lines and we ought not to assume that our rules should trump all others, or that their purposes cannot be met absent the strictest interpretation of compliance.  In adjusting our rules, we should leverage existing regulatory structures and identify synergies that support our goals and meet the highest standards of global regulatory cross-border harmonization.

Fintech

The last quarter of 2017 gave many of us a hard and fast introduction to Bitcoin and its underlying technology.  Although I had a base understanding of the technology and its potential uses, the rapid rise in crypto-asset prices, and the introduction of Bitcoin futures on two CFTC registered designated contract markets forced a much deeper understanding.  There were many lessons from those weeks and months leading up to the launch of the contracts in December, 2017, and then after when I convened a meeting of the Market Risk Advisory Committee to discuss the self-certification process and crypto-assets in January.  But, one of the most important lessons is that policymakers, including myself, need to prioritize the discussions and policy roadmap for the oversight and regulation of fintech.

The experience of overseeing the introduction of the first Bitcoin futures contracts epitomized how regulators and policymakers can end up on the tail of technological advancement, scurrying to keep pace with swift innovations that capture market efficiencies, open the markets to new products and participants, and often reward those willing to take risk.  We’ve been assured by the G20 that financial stability is not yet implicated by the transformative technology underlying crypto-assets, and that any urgency to create new laws and regulations must be tempered by our lack of a full understanding of the promise and perils of this fintech phenomenon.[6]  However, to make sure we firmly catch the tail, I’ve proposed that the U.S., through the multi-member Financial Stability Oversight Council (FSOC), lead the collaborative, interdisciplinary effort to identify and craft an appropriate path forward for ensuring that legal issues resulting from these technologies are identifiable and solvable before they cross the horizon.[7]

In 2010, the Dodd-Frank Act created the FSOC as a tool for identifying risks and responding to emerging threats to financial stability.[8]  Accountable to Congress and the American public, the FSOC, Chaired by the Treasury Secretary, includes in its membership representatives from each of the federal financial regulators.  FSOC must play a more direct, inclusive role in the broader fintech economy to effectively capture its breadth and global market impact.  Critically, discussions must move beyond the role of crypto-assets as currency; fintech presents advancement in financial commerce, including payment systems, distributed ledger, artificial intelligence, and identity verification.

Given its mandate, the FSOC has authority to (i) convene all key U.S. financial regulators; (ii) establish a mutually agreed lexicon for discussing crypto-assets and related fintech; (iii) convene public hearings; and (iv) propose policy direction and guide jurisdictional responsibility based on input from regulators, stakeholders, academics, and the public.

The interests of regulators, the markets, and market participants should be aligned when it comes to building legal certainty.  Anything less than decisive action by policymakers in the short term will leave us all scratching heads, pointing fingers, and asking who, what, when, and how.  The task certainly will not be easy, but complacency by policymakers could lead to industry-led policies and practices that ultimately provide short-term solutions of limited application without including impacted stakeholders and appropriate consumer protections.

Those who support the creation of an industry-led self-regulatory organization in the crypto-asset markets clearly recognize the need to fill the regulatory vacuum, but their motives may be too focused on supporting industry growth without being stifled by the perceived bureaucratic stall that regulation may bring.  Nevertheless, their movement towards development of industry standards signals support of the concept of regulation.  Industry buy-in will be critical in achieving the engagement with policymakers needed to ensure that any recommendations and decisions reflect an understanding of fintech and address the concerns and needs of all stakeholders.

FIA/SIFMA AMG Forum

I took a breather from fintech and headed across the country to meet with--well, actually, first with members of the Federal Reserve Bank of San Francisco and several crypto-asset and fintech pioneers.  But then, I continued down the coast to participate in the annual FIA/SIFMA Asset Management Derivatives Forum in Dana Point, California.  Besides the obvious pleasant memories of spending a few days near the ocean, I am continually heartened by the feedback I received from my prepared remarks at the conference.[9]  In part, I spoke about my position on the CFTC and the SEC efforts to harmonize rules.  Given the large number of dually registered market participants and overlapping policy, there is a real opportunity for the CFTC and SEC to harmonize redundant rules and leave both market participants and regulators in a stronger position. 

My message to market participants was clear: let’s work together, have an honest conversation, and seek solutions that focus on an inclusive regulatory landscape.  This ambitious strategy can be achieved by recognizing statutory limitations and congressional intent; leveraging expertise at each of the respective agencies; and maximizing collaboration between the two agencies to ensure each are contributing without duplication.

I believe the audience appreciated my message, and I am hopeful that with continued dialogue, results will be delivered.  I’d like to continue to be a part of the conversation and believe a bipartisan solution will not only provide a more thoughtful outcome, but also an outcome that will stand the test of time.

I mentioned this particular speech because I do believe harmonization and exhaustive collaboration is critical among regulators.  I believe it is one of our most important responsibilities.  But, I also mention this speech as a proxy for my thinking on all policy issues.  Dialogue, honesty, and transparency are key elements to any relationship, including the relationship between a regulator and its regulated market participants.

Whatever your issue, my door is open.  Whatever your concern, my door is open.  Whatever your question, my door is open.  Let’s tackle problems together, and find solutions.  I am not suggesting this is easy.  And we will probably not agree on many things, but moving forward doesn’t necessarily mean getting everything you want in short order.  Small steps count as progress towards future solutions.

Market Risk Advisory Committee

As I mentioned earlier, as sponsor of the Market Risk Advisory Committee, I convened the Committee in January to provide a public forum for an open dialogue regarding the CFTC’s regulatory self-certification process for new products, specifically those in the crypto-asset space.  Looking forward, I am in the process of renewing the MRAC’s charter, and reconstituting its membership.  I hope to convene the Committee twice more before the year ends.  The MRAC refresh will mean new membership and new issues.  Based on much feedback, the MRAC will focus on current issues involving benchmark risk (specifically the Libor transition), clearinghouse risk, operational risk and third-party service providers, and financial technology risk that can have an impact on the financial stability of our markets.

I want the MRAC to be a forum for robust dialogue of wide ranging issues, including those that may not be easy to discuss.  My philosophy is based in well-grounded relationships and transparent conversation.  I believe keeping these two principles in mind provide the best chance to identify problems and provide solutions.

Project Kiss & Reg Reform 2.0

Shortly after his appointment as Acting Chairman, Chairman Giancarlo announced Project KISS, or “Keep It Simple, Stupid.”[10]  Market participants and even a few law makers have broadly supported its underlying goals of reducing regulatory burdens by making our existing regulations and practices simpler, less burdensome, and less costly.  More recently, the Chairman co-authored and released Reg Reform 2.0, a white paper outlining a future vision for swaps markets.[11]

In principle, I support the Chairman’s efforts to reduce regulatory burdens.  I have said as much since becoming a Commissioner, and even earlier in these remarks.  Reflection and improvement have long been woven into the fabric of the CFTC and its entire staff.  We have wide ranging responsibilities to the general public, customers, market participants, and the Congress.  In my view, always seeking to improve and be better regulators is certainly one of those responsibilities.  The Chairman’s initiatives give new names to processes and goals that have long been part of the Commission’s approach to regulation.

However, as with any government agency, or private sector business for that matter, the CFTC must work within its means.  The CFTC must always remain focused and vigilant to its core mission and responsibilities, and only undertake significant overhauls when resources allow, or under the most necessary circumstance.  The President recently signed an omnibus spending package for the balance of fiscal year 2018.  The funding level appropriated to the CFTC is $249 million; a decrease of one million dollars from federal year 2017’s funding level of $250 million.[12]

Given the President’s request of $281.5 million,[13] the CFTC is in a time of prolonged belt tightening.  We need to utilize the limited resources we have on mission critical issues not major overhauls.  The most important and valuable resource the CFTC has is its dedicated, expert professional staff.

I am concerned that as our jurisdiction has significantly grown since 2010, and markets have become more complex and global, we will struggle to be the vigilant cop on the beat we need to be, leaving our nation’s critically important derivatives market and the general public increasingly vulnerable to systemic (and other) risk, and susceptible to fraud and manipulation.  If staff is directed to focus on reworking the broader framework for the swaps market in lieu of fine-tuning and building on the progress we’ve made since 2008, we risk creating greater uncertainty and impracticability at increased costs to market participants.

The core reforms are solid, the principles are sound, and markets are functioning well.  As Federal Reserve Board Governor Lael Brainard recently suggested, we cannot afford to begin reassessments before we’ve had the opportunity to evaluate the efficacy of those we’ve already put in place. [14]

All this said, I want to emphasize and level set a few things: (i) I want to thank all CFTC staff for their dedication, and commitment to the agency; (ii) I have long supported and will continue to support additional funding for the CFTC; and (iii) I am fully supportive of getting better, and being a better regulator.  Let’s focus on the needs of the day: operational risk, fraud and manipulation; developments in financial technology to name a few.  Project KISS and presumably Reg Reform 2.0 have set the bar high.  Let’s focus on what’s absolutely necessary, and maximize staff resources in a manner that best serves market participants.

The National Futures Association

Before I wrap things up, I’d like to acknowledge my deepest appreciation for the NFA, our designated registered futures association and the industrywide, self-regulatory organization for the U.S. derivatives industry.  I’d also like to mention two important and timely initiatives aimed at improving our understanding of and ability to oversee participation in the virtual currency markets and further protecting customers and market integrity by raising the standards of professionalism in the swaps market.

First, NFA staff is focused on understanding and obtaining information about their members’ activities in underlying/spot virtual currencies and virtual currency derivatives in order to ensure appropriate regulatory oversight of this area.  Since December 2017, NFA has required futures commission merchants (FCMs), commodity pool operators (CPOs), commodity trading advisors (CTAs) and introducing brokers (IBs) to report information relating to their virtual currency activities.[15]^, [16]  The NFA recently informed me that the number of Members trading these products remains relatively flat and modest.  As of March 27th, three FCMs for which NFA is the DSRO, 63 IBs, 35 CPOs and 16 CTAs have reported that their business activities currently involve virtual currency derivatives.

NFA staff is working on a proposed Interpretive Notice designed to enhance disclosure requirements for Members that trade underlying/spot virtual currencies and virtual currency derivatives.  The proposed Notice would provide guidance on customer disclosures regarding the risks of trading virtual currency products that should be included in promotional materials, disclosure documents and other offering materials.  NFA's Executive Committee recently approved the Notice and it will be submitted to NFA’s Board later this month.  NFA continues to work with its advisory committees and CFTC staff to finalize and refine the disclosures before submission to the CFTC for final approval.

Second, the NFA is in the initial stages of developing an online learning program with an embedded test for swaps professionals.  In his 2015 White Paper, Chairman Giancarlo cited the need to raise the standards of professionalism in the swaps market by establishing requirements for product and market knowledge, professionalism and ethical behavior for swaps market personnel.[17]  NFA's Registration Rules require that associated persons (APs) engaged in futures and forex activities must take and pass proficiency examinations that test both their market knowledge and their knowledge of regulatory requirements.  However, currently, there are no analogous requirements applicable to swaps related activity.  I support a swaps proficiency requirements program and, along with DSIO staff, have agreed to NFA’s proposed approach to develop an examination as part of an internet-based learning program for all APs engaging in swaps activities.[18]

NFA is in the initial stages of developing swaps proficiency requirements, and is forming a special advisory committee composed of industry experts from NFA Member firms and other entities that would be impacted by these requirements.  NFA will continue to work with the Commission and the industry throughout this process.

Conclusion

The CFTC is a unique regulatory agency.  The subject matter is puzzling to most outsiders.  The agency’s history is rich, dating back over a century to American agriculture.  The agency is also relatively small by D.C. standards; but, I think this and its other unique attributes make it rather charming and one of the best in town.  The CFTC has gone through many dramatic changes in the past decade.  Tectonic shifts, one might say.  By in large, the changes have been successful, and the market has responded positively, adjusting to the new regime and adapting to the new rules of the road.

As we move forward, let’s reflect on the past, address the unintended consequences, properly calibrate the numbers, and focus on our day-to- day responsibilities of protecting customers, preserving market integrity, and keeping markets safe.  As we move forward into new areas, innovating and evolving with our markets does not mean we must cast aside our charming ways.  Like Baltimore, part of that charm is an understated scrappiness.  We are a resourceful agency that dreams big.  We have tremendous responsibilities, and sometimes must reserve those big dreams for another day.  But, I am confident that as we continue to grapple with the issues of today—and those on the horizon, we will continue to do so responsibly and with the support and buy-in of our industry.

Remarks of Commissioner Brian D. Quintenz at FIA’s 40th Annual Law and Compliance Conference

May 2, 2018

Good afternoon and thank you for that very kind introduction.  I’m delighted to be here with you today at FIA’s 40th Annual Law and Compliance Conference.  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 Commission.

I’d like to take you back to last summer and my first day on the job as a CFTC Commissioner.  It happens that the day came with a surprise.  That morning, in a weekly senior staff briefing, Chairman Giancarlo announced it was a special day – not because of me at all, but rather because it was the day of the annual CFTC versus SEC softball game.  I enthusiastically agreed to participate.

So, after work, I ventured down to the Ellipse and joined Chairman Giancarlo, Chairman Clayton, and our respective staffs. And, just for the record, I’d like everyone to know that I hit a double – please ignore whatever you may have heard about any associated fielding error.

In reflecting on that experience, I remember thinking that while our staffs were competing on the field, there was great comradery off of it. And that makes sense – because when it comes to protecting our financial markets and making them the best regulated in the world, we are all really on the same team.

The CFTC’s mission is to foster open, transparent, competitive, and financially-sound derivatives markets that can be used for price discovery and managing risks.[1]  The SEC’s mission is to protect investors, maintain fair, orderly, and efficient securities markets, and facilitate capital formation.[2]  And yet, despite their different missions and their regulation of distinct markets that serve fundamentally different purposes, the SEC and CFTC undoubtedly have common regulatory interests:  promoting market integrity, preventing fraud and manipulation, and fostering market innovation and fair competition.  In fact, in many instances the SEC’s and CFTC’s oversight is interconnected, as is the case for security futures products, swap dealers and security-based swap dealers, swap and security-based swap execution facilities (SEFs), and investment managers and commodity pool operators (CPOs).  Indeed, in the case of many Dodd-Frank Act reforms, Congress explicitly required both agencies to “consult and coordinate to the extent possible … for the purposes of assuring regulatory consistency and comparability.”[3] 

Given the agencies’ shared regulatory objectives, I want to discuss an effort that is underway at both the SEC and CFTC to coordinate and harmonize regulatory oversight, as well as the ways in which I hope that cooperation can be strengthened in the future.  In particular, I want to focus today on harmonizing requirements for dual registrants, our coordination of enforcement actions, and ongoing efforts to update the Memorandum of Understanding (MOU) between our agencies.

Dual Registrants

The CFTC and SEC have a long history of overseeing dual registrants:  a financial institution registers with both the CFTC, as a futures commission merchant (FCM), and with the SEC, as a broker-dealer, in order to facilitate customers’ derivatives and securities transactions; an investment firm registers with both the CFTC, as a commodity trading advisor (CTA) and CPO, and with the SEC, as an investment adviser, in order to operate investment vehicles that invest in securities and assume derivatives positions.  Under the Dodd-Frank Act, firms must register with the CFTC, as a swap dealer, and with the SEC, as a security-based swap dealer, if they engage in dealing activity in swaps and security-based swaps.

I believe a sensible regulatory framework for these dual registrants is one in which similarly-situated market participants are treated identically, if not similarly, under our agencies’ respective regulations.  Harmonization of regulatory requirements benefits the registrants themselves, our financial markets, and the American public.  Registrants benefit because they are subject to consistent regulatory requirements. This consistency facilitates compliance by reducing registrants’ costs and eliminating unnecessary confusion about each agency’s respective requirements.  Markets benefit because needlessly conflicting requirements stifle innovation and competition, and can create harmful regulatory arbitrage.  The American public benefits because firms’ reduced compliance and operational costs will ultimately lead to lower costs to investors and companies using the derivatives markets to transfer risk. 

The more transparent and efficient the rules of our markets are, the more they facilitate broad-based economic growth and capital formation.  Quite simply, differences should only exist between the two agencies to the extent they reflect a concrete and irreconcilable difference between the securities and derivatives markets.  Otherwise, I believe the regulatory requirements for dual registrants should be either identical or substitutable.  Identical – meaning that even minor details of the regulatory regimes should be the same – is a high standard to meet.  A substitutability concept may allow for the rules of one agency to satisfy the rules of another – much like the process of deference the CFTC uses in international comparability determinations. 

While any harmonization progress is good, I would also hope that we avoid outcomes which are “almost completely harmonized.”  To me, that is code language for “still different.”  Indeed, if identical or substitutable rules are not achieved, we must remember that even small, seemingly superficial differences between regulations can impose outsized costs on registrants and the marketplace.

We need to harmonize conflicting or overlapping regulatory requirements for swap dealers and security-based swap dealers.  For example, with respect to business conduct standards, the SEC’s and CFTC’s regulations impose similar, but slightly different, disclosure requirements on dealers.[4]  In addition, the business conduct regimes impose different onuses on church plans to identify if they want to be treated as a “special entity.”  Under the CFTC regime, church plans are excluded from the definition of “special entity,” unless they affirmatively choose to opt-in; under the SEC regime, church plans are automatically included in the “special entity” definition, unless they affirmatively choose to opt-out.[5]  These differences may seem superficial, but they impose real world headaches and documentation nightmares as dealers struggle to ensure they have the correct representations recorded for the same counterparties to comply with both agencies’ regulations.  Moreover, in the case of church plans under the CFTC regime, it is my understanding that a grand total of zero plans have elected special entity status – zip, zilch, nada, bubkis – perhaps a telling market signal to a public policy prescription.

Thus far I have focused my remarks on tweaks and minor adjustments to our rule sets that would promote an identical approach, allowing both agencies to accomplish their shared goals in the same manner.  However, thinking more broadly, I think there are certain areas of overlapping jurisdiction where deference to the other agency, rather than harmonization, could be a good solution.  For example, in the CPO space, I think it is worth revisiting the Commission’s 2012 decision to eliminate the exclusion of investment managers of registered investment companies (RICs) from the definition of CPO.[6]  Currently, these CPOs are subject to two distinct, but overlapping, regulatory regimes – including similar but divergent recordkeeping and reporting requirements.  More efficient, effective oversight over these investment vehicles is possible.  For example, perhaps sole registration with the SEC is appropriate in instances where the focus of the investment vehicle’s business is primarily securities rather than derivatives, but derivatives activity can be disclosed and shared with the CFTC and NFA.

Other areas where deference may be appropriate include SEFs and swap data repositories (SDRs).  The Dodd-Frank Act set forth requirements for both SEFs and security-based SEFs and for both SDRs and security-based SDRs.  Likely, the same company will list, or collect information for, both swaps and security-based swaps.  Therefore, it would make sense for a firm to follow one set of rules, instead of two, for trading and reporting swaps and security-based swaps.  Similarly, a single rule set for SEFs, and a single rule set for SDRs, would advance the CFTC’s and SEC’s policy objectives efficiently and simply. 

Whether it is small tweaks to rule sets, or larger endeavors, we have heard from many market participants through the Project KISS initiative about areas where greater SEC-CFTC coordination or deference could be beneficial.  Additional thoughts and ideas are always welcome.

Having had numerous conversations with CFTC staff, the staff at the SEC, and my counterpart in this harmonization effort, SEC Commissioner Hester Pierce, to create a short list of low hanging fruit with which we can develop some momentum, I am very optimistic that all of us have the right perspective and correct motivations to make this joint review by the agencies a highly productive process.  Our registrants, Congress, and taxpayers expect government agencies to communicate and coordinate, and I am very hopeful we will eliminate the burdens and complexities of complying with both regulatory regimes. 

Given that almost eight years has passed since Dodd-Frank required the SEC and CFTC to “consult and coordinate … for purposes of assuring regulatory consistency,” I am pleased that both agencies are finally undertaking a cooperative review of Title VII regulations.[7]  

Enforcement Coordination

Of course, coordination extends beyond the rule writing process.  The CFTC Division of Enforcement greatly values cooperation with federal and state criminal and civil enforcement authorities.  The Commission and the SEC have a long history of robust and effective cooperative enforcement.  Coordination of investigative and prosecutorial actions sends consistent messages to the marketplace and promotes efficient use of the Commission’s resources.

In particular, in the cryptocurrency space, the CFTC has formed an internal cryptocurrency enforcement task force to develop the necessary expertise to prosecute fraud in this evolving asset class.  The task force shares information and works cooperatively with counterparts at the SEC with similar virtual currency expertise.  Both agencies’ Divisions of Enforcement have demonstrated their commitment to work closely to prosecute fraud and ensure that differences in product nomenclature do not enable bad actors to slip through jurisdictional cracks.[8]  Over the past several months, the CFTC has worked closely with the SEC in bringing civil enforcement actions against fraud, market manipulation and disruptive trading involving virtual currency.[9]  Finally, with respect to jurisdictional considerations, the CFTC has been, and continues to be, in close communication with the SEC. 

SEC MOU

To further this commitment to regulatory coordination between the agencies, the CFTC and the SEC are working to update the existing MOU to improve the sharing of information.  The current MOU was entered into a decade ago, prior to the enactment of Dodd-Frank.[10]  Since that time, a number of new products and regulations have been developed or adopted that are outside the scope of the MOU.  An updated agreement will facilitate information sharing between the agencies related to swaps and security-based swaps data, dual registrants, financial technology (fintech) developments, and market events.  Updating the MOU is an important reaffirmation of our agencies’ mutual commitment to regulatory coordination and market innovation.

Audit Trail Harmonization

Harmonization and coordination efforts are not only necessary between the SEC and CFTC.  As Project KISS has shown, there are a number of CFTC regulations that can benefit from harmonization and simplification.  One such area is audit trail requirements.  Audit trail requirements are designed to provide the Commission with the information necessary to reconstruct how a transaction was executed after-the-fact.  These records are critical to the Commission’s ability to conduct surveillance inquiries and investigations in order to protect customers and ensure market integrity.[11]  However, the Commission’s current audit trail requirements are redundant, placing similar recordkeeping obligations on FCMs, exchange members, designated contract markets, and SEFs.[12]  The overlapping requirements impose significant costs on market participant and exchanges, which must each store and maintain massive amounts of duplicative transactional data.  In my view, the rules could be updated to reduce redundant recordkeeping requirements and better reflect the modern reality of real-time, electronic trading systems, all while ensuring the Commission receives the data it needs to fulfill its mission. 

More generally, exploring how Commission regulations can be updated to reflect the challenges of big data, such as audit trail requirements, is one area where the Technology Advisory Committee (TAC) may also be able to provide input.  At the Committee’s last meeting, the TAC recommended that the Commission create four subcommittees to provide actionable advice regarding cryptocurrencies, distributed ledger technologies, cybersecurity, and the modern trading environment.  Since that time, the TAC’s Designated Federal Officer, Dan Gorfine, has been working to establish these subcommittees and I look forward to their first meetings.

Conclusion

We are now well into spring and softball season is about to start.  The annual CFTC versus SEC softball game is coming up and I am looking forward to some friendly competition.  This time when I play, I expect to recognize some familiar faces.  I know that both of our agencies are committed to coordinating and harmonizing regulatory requirements for the benefit of our registrants and our markets.

Remarks of Commissioner Brian D. Quintenz before the Eurofi High Level Seminar 2018

April 26, 2018

Introduction

Good morning.  This is the first Eurofi Seminar that I have had the privilege to attend and I am delighted to be able to participate in this remarkable conference.  Before I begin, let me quickly say that the views I express are my own and do not represent the views of the Commission.

In addition to being my first Eurofi conference, this is also my first trip to Sofia.  I have been struck by the city’s beauty and its embodiment of living history.  Sofia has been inhabited for over 8,500 years, but perhaps its closest modern day precursor was the Thracian settlement Serdica built by the Roman Emperor Trajan in the second century BC.  Reminders of antiquity are scattered amongst modernity in this bustling city.  Indeed, I have only to look out the window of my hotel to see St. George's Church – built in the 4^th century AD – safely ensconced in the courtyard. I discovered that the very parking lot of my hotel was once rumored to sit on top of Constantine the Great’s palace.[1]  However, recent excavations of St. Nedeylya square unearthed not a palace, but the ruins of an enormous building containing various artefacts, including a ceramic vessel containing 3,000 silver Roman coins inside, with the owner’s name, Selvius Calistus, scratched on the outside.[2]

Sofia is a city where the ancient past and present converge. In many ways, we are living through that same convergence now with respect to technology and innovation. Once novel inventions – like the home phone, film cameras, VHS tapes – have become obsolete.  And yet, the underlying functions and needs they addressed remain with us, persisting into the future to be solved by new, once unthinkable, but quickly taken for granted, innovations. Although our world would certainly be unrecognizable to Selvius Calistus if he were here with us – we do know there would be some shared understanding – the need for money as a medium of exchange, the desire for shared society and recreation.  The question emerges, how do we harness creativity and technological innovation so that they work to better meet the needs and desires of all of us today, so that they have a lasting positive impact in our daily lives, on our cultures, and, in light of the focus of this conference, on our financial markets.

Supporting Responsible Financial Innovation

In the midst of the technological renaissance we are living through, what then is the proper role of the regulator?  I believe it starts with leadership, clarity, cooperation, and open-mindedness.  I think it is incumbent upon regulators to create a workable and appropriate regulatory framework that facilitates market-enhancing innovation.  This means adopting regulation that is fair, technology-neutral, and does not stifle positive innovations.  It means actively engaging with the financial technology (fintech) community and other regulators to provide the regulatory certainty necessary to support innovation that promotes competition, vibrancy, and growth in our financial markets.  It also means developing thoughtful, balanced regulation that allows nascent markets to develop while also protecting investors and preserving market integrity.

In order to further these objectives, the CFTC is engaging with industry to learn more about fintech, through the LabCFTC initiative and the Technology Advisory Committee (TAC).  Chairman Giancarlo and the agency launched LabCFTC in the spring of 2017.  Through early engagement during the development process, LabCFTC hopes to offer clarity and guidance about the CFTC’s regulatory framework.  Since its launch less than a year ago, LabCFTC has met with over 150 market participants.

LabCFTC also assists staff in identifying where potential changes to the existing regulatory framework may be beneficial.  For example, if an innovation achieves the desired outcome of a regulation, but does not fit within the letter of the rule, LabCFTC advises on whether regulatory relief should be provided or if it may be appropriate to consider rule revisions.  LabCFTC’s knowledge and expertise also promote technology-neutral regulations—ones which mandate a particular result but not the means by which the result is achieved.

LabCFTC also coordinates with other U.S. and international regulatory authorities.  Through formal and informal relationships, LabCFTC seeks to collaborate with, and learn from, the experience of fellow regulators to develop best practices and recognize emerging trends.  Most recently, the CFTC entered into an arrangement to collaborate on financial innovation with the United Kingdom’s Financial Conduct Authority (FCA).  LabCFTC and Project Innovate, the FCA’s fintech initiative, will share information regarding market trends and developments, as well as insights derived from innovation competitions, sandboxes, or other similar endeavors.

In addition to LabCFTC, the agency also has five advisory committees which solicit the input of outside experts on different topics to advise on developments, risks, and regulatory issues.  I have the privilege of sponsoring the TAC, which explores the potential application of new technologies to the derivatives markets.  For example, at our inaugural meeting this past February, the TAC discussed several areas where rapid technological innovation was creating both challenges and opportunities in our markets, including blockchain and distributed ledger technology, cryptocurrencies, machine learning and artificial intelligence, automated trading technologies, and cybersecurity best practices.  Over the course of the next year, the TAC will explore each of these issues in greater detail, with the ultimate goal of providing the CFTC with actionable, practicable advice.

Cryptocurrencies

One area of technological innovation that has captured the world’s attention is the cryptocurrency space.  Since Satoshi Nakamoto first published his groundbreaking paper on a cryptocurrency called Bitcoin almost a decade ago, we have witnessed the proliferation of many new cryptocurrency concepts and tokenized products.[3]

In fact, I believe it is important to separate the idea of cryptocurrencies, whose main purpose is only to serve as a medium of exchange or a store of value, from the proliferation of “tokens” generally.  As I postulated two days ago at the City Week conference in London, I see three main motivations for the broader tokenization revolution. One motivation for a company or entity to tokenize a product is purely as a marketing ploy – to take advantage of the popular and speculative mania surrounding all things “token.”  However, just because a product is tokenized does not change its underlying qualities.  For example, if Disney World were to tokenize the admissions to its theme parks, those tokens would still be tickets. Tokenizing the tickets does not make them currencies and it does not make them securities. It makes them tickets.  Similarly, tokenizing a security does not change the fact that it is a security.

A second motivation to create a token is to enable and realize the efficiency of the blockchain construct in assigning and tracking ownership. This is having, and will continue to have, an impact on title transfer and settlement processes.  Think of this as the back office tokenization revolution.

Lastly, a third motivation is to utilize the transferability of tokens to create a secondary market for any and all non-tangible things – the eBay of Intangibles so to speak – for rights, services, permissions, etc., that the seller allows to be transferred between parties.  Empowering a secondary market’s price discovery and valuation functions for products that were previously untransferable – such as extra storage space on a home computer – is a fascinating development.

Certainly, not all tokens are cryptocurrencies – in fact, very few are.  And even those best representing a currency-focused concept have yet to truly attain that functionality.  Yet it would be a mistake, in my view, to dismiss those products because of that fact.  Sure, some of these cryptocurrencies have not yet, and may never, achieve the acceptance and stability of a true reserve currency, like the dollar or the euro.  But, there may also be instances where an established cryptocurrency’s volatility and transferability could compare favorably against a sovereign currency.

In fact, it is quite possible, that just as the cryptocurrency trading market evolved from the bottom-up, starting at the retail level and slowly reaching the institutional level, so may the global driver of cryptocurrency acceptance come not from places like Washington, London, Frankfurt, or Tokyo, but rather through a bottom-up process as well.  That may ultimately prove wrong, but it is worth pondering.

Indeed, the intense, ongoing debate about cryptocurrency’s intrinsic value has caused regulators around the globe to grapple with how best to respond.  Some nations have banned cryptocurrency mining and trading.[4]  Others permit cryptocurrency trading, but restrict anonymous trading or require spot platforms to register with regulators.[5]  Many others are vigilantly monitoring developments to determine if additional regulatory oversight is necessary and, if so, what form it should take.[6]  Most recently the G20 called for the Financial Stability Board, in consultation with other standard-setting bodies, including the Committee on Payments and Market Infrastructure (CPMI) and International Organization of Securities Commissions (IOSCO), to report in July 2018 on their work to develop global standards for what they label as crypto-assets.[7]

Given that there are many participants on those boards and groups who are here today, I would like to take a few minutes now to discuss the regulatory framework for cryptocurrencies in the United States as it stands today.

Regulatory Framework in the United States

At the outset, I would note that the regulatory landscape for cryptocurrencies, including so-called tokens, within the United States is an evolving one.  Regulators in the United States, including the CFTC, are monitoring cryptocurrencies and working collaboratively to develop effective regulatory approaches for this new asset class.  The Treasury Department has established a crypto-asset working group which includes the CFTC, Securities and Exchange Commission, and banking regulators.  Ongoing communication among regulators is critical because oversight jurisdiction over cryptocurrencies is shared across multiple agencies in the United States.

For example, state regulators and the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) regulate cryptocurrency platforms as money service businesses, thereby subjecting those “exchanges” to anti-money laundering and know-your-customer requirements.^[8]  The Internal Revenue Service views cryptocurrencies as property and subjects sales to capital gains tax without a de minimis threshold.[9]

The CFTC and SEC also have jurisdiction over cryptocurrencies depending on their status as a commodity or as a security.  From our own perspective, the CFTC has both oversight and enforcement authority over derivatives on commodity cryptocurrencies, but only enforcement authority over the spot transactions of commodity cryptocurrencies.  This means that the CFTC’s role is broad and far reaching with respect to derivatives trading on cryptocurrencies – such as futures contracts on Bitcoin – including setting requirements for registration of trading platforms or firms, trade execution, orderly trading, data reporting, and recordkeeping.  However, in the spot markets, or the platforms where cryptocurrencies themselves are actually bought and sold, the CFTC has only enforcement authority - the CFTC can only police fraud and manipulation in the actual trading of cryptocurrencies, but has no ability to make platforms register with the Commission or set any customer protection policies.

On the other hand, if the cryptocurrency or digital asset is a security, it must be traded on a platform that is registered with the SEC or is specifically exempt from registration.[10]  In addition, the SEC has stated that many initial coin offerings (ICOs) used to raise capital for business projects may be securities, thereby triggering the fully panoply of registration and investment protection requirements under American securities laws.[11]

From my perspective as a CFTC Commissioner, I think the area with the greatest need for enhanced regulatory certainty and oversight is the spot market.  In that regard, the CFTC has undertaken an educational campaign to provide customers with information about cryptocurrencies and to warn about potential fraud in these markets.  The CFTC’s Division of Enforcement has aggressively targeted deception and manipulation to ensure that innocent customers are not exploited by fraudsters.  And with respect to jurisdictional considerations, the CFTC has been, and continues to be, in close communication with the SEC.

In light of the patchwork of state and federal regulation that currently exists in the United States, and until such time as Congress might choose to add spot commodity markets to a regulator’s jurisdiction, I have also encouraged cryptocurrency spot platforms to come together and form an SRO-like entity that could develop and enforce customer protection rules to strengthen the integrity of these growing markets. I think an independent, self-regulating body for spot platforms in the United States could significantly contribute to ongoing efforts to rationalize and formalize cryptocurrency regulation.  I am not now suggesting, nor have I ever suggested, that this potential body should be a substitute for federal oversight in this area; rather, I believe this potential organization’s efforts can fill a current void and could eventually complement federal oversight efforts.

I think it is the role of the CFTC, along with other regulators, to support the integrity of these developing markets so that individuals have the information and transparency they need to make informed choices.  Indeed, when Congress amended the CFTC’s governing statute to give exchanges the ability to list new contracts through a self-certification process, as opposed to requesting the CFTC’s approval, I believe Congress did so intentionally to limit the CFTC’s power to make value judgements on new contracts.  I also think that is appropriate – the markets, investors, and consumers need to decide for themselves which new products and innovations are worthwhile and which are not, and what value truly is.

Conclusion

I am optimistic about the future of financial technology and its potential to improve all of our lives.  Gatherings like this help us to build the partnerships and trust, and attain the expertise and wisdom, to recognize and support those innovations that are genuinely innovative, that have the power to enhance our societies.  I look forward to working with all of you to develop thoughtful regulatory frameworks that allow our markets to flourish and our innovators to innovate.  Thank you.