Introduction
Good morning and thank you to ISDA for bringing back this event in-person, and to Scott O’Malia for the warm introduction. It’s a pleasure to join you here today in Madrid. This is my second post-pandemic international trip in two weeks, having traveled to the UK to participate alongside many of you during City Week in London.
We have emerged from the quarantine culture of tightly scheduled virtual assemblies where agenda items dominated discussions, as online forums don’t allow for in person human connections. Participating in these marathon meetings invigorates creativity and strengthens the bonds of trust necessary to ensure our engagement leads to tangible results. There is little doubt in my mind that these face-to-face opportunities to congregate and integrate sustain the collective problem solving that yields the greatest rewards.
Today, a confluence of unique externalities of a global health pandemic and subsequent monetary and fiscal policy shifts, geopolitical unrest and uncertainty, and technological innovation and disruption are whipsawing the derivatives and underlying commodity markets and impacting customers, consumers, and the larger economy in countless ways.
Our goal is to be resilient and responsive. And, we can best do that by re-committing to transparency in our standards and processes, establishing rules and best practices reinforced by clear and firm expectations of compliance, and prioritizing participation to ensure that change happens thoughtfully. As our present and future challenges require us to assess risks borne from newer and more novel sources, our ability to adapt swiftly from theory to practice will be tested over and over again. Our challenge will be doing so in a manner that minimizes market disruption, maximizes the risk-mitigating opportunities within our interconnected markets, and ensures a level of fairness that cannot be undermined by regulatory arbitrage.
As reflected in the AGM Agenda, we agree that in 2022, we have some remaining business with regard to LIBOR and margin for non-cleared derivatives, some innovative opportunities with regard to regulatory reporting, and new frontiers in climate finance, decentralized finance (DeFi) and digital assets. Before we move into the conversation portion, I would like to provide an update on the CFTC’s current agenda regarding these topics.
LIBOR
I’d like to begin with LIBOR. As a regulator, working through LIBOR reform these past several years and reaching the end-game with our peers has been one of the most rewarding exercises. As I remarked at ISDA’s 34th AGM in Hong Kong, despite our differences, financial regulators sharing common foundations and driving principles took collective action to resolve a flawed system embedded in the global financial system—and we did so with tenacity.[1] There is value in the collective because we can assist one another in working through the “what ifs” and friction points to accomplish something that benefits the many.
Across the globe, various jurisdictions agreed that success hinged on progress: we needed to build a new model for risk-free rates that would make LIBOR obsolete. We are now past the much-anticipated December 31, 2021 end-date for a majority of the non-USD LIBOR settings, as well as 1-week and 2-month USD LIBOR.[2] New alternative rates with liquid markets for swaps and futures are building around them and are gaining momentum. Our preferred rate in the U.S. is the Secured Overnight Financing Rate or SOFR, which is a fully transactions-based rate with the widest coverage of any U.S. Treasury repurchase rate available.[3]
In the U.S., collaboration among the Alternative Reference Rates Committee, the New York Fed, and the CFTC’s Market Risk Advisory Committee’s Interest Rate Benchmark Reform Subcommittee led to the July 2021 announcement of the SOFR First initiative as a recommended market best practice for moving interdealer trading conventions from LIBOR to SOFR.[4]
The Alternative Reference Rates Committee progress report highlighted the transition’s positive momentum, particularly in the interest rate swap and futures markets.[5] According to the report, building on the SOFR First initiatives, volume and liquidity in SOFR swaps sharply increased by 600 percent from March 2021, through the report’s publication.[6] In the OTC derivatives markets, since the first stage of SOFR First, which prioritized trading of swap products in the interdealer market linked to SOFR beginning July 26, 2021, the share of SOFR in interdealer swaps trading had increased to 80-100 percent.
Earlier this week, the CFTC unanimously voted to approve a notice of proposed rulemaking seeking to modify the Commission’s interest rate swap clearing requirement to remove certain clearing requirements tied to LIBOR and other interbank offered rates, and replace them with similar clearing requirements for swaps referencing overnight, nearly risk-free reference rates.[7] The proposed amendments update the swaps required to be submitted for clearing to a derivatives clearing organization (DCO) or an exempt DCO under part 50 of the CFTC’s regulations and update the table of compliance dates for the CFTC’s swap clearing requirement to reflect the new set of swaps required to be cleared. We will be working to finalize the proposed rule this summer.
More recently, CME announced its SOFR First for Options initiative aimed at further incentivizing SOFR options trading.[8] Set to begin this summer, support for the transition of exchange-traded options to SOFR is another important milestone and step forward in the shift away from U.S. dollar LIBOR. Increasing SOFR options trading will further develop overall SOFR derivatives liquidity and bolster the transition effort as we focus our collective efforts on the remaining months of U.S. LIBOR through June 30, 2023.
For cleared swaps, LCH recently published a consultation on its proposal to convert outstanding cleared swaps contracts that reference the remaining USD LIBOR settings.[9] LCH proposes splitting the conversion into two tranches of products—to be converted over two separate weekends in April and May 2023—in order to reduce the scale of a single conversion event, allow certain product types to be given greater attention, and manage potential contingencies.[10]
Initial Margin
As with LIBOR, we are reaching the final phase in executing the initial margin (IM) requirements for uncleared swaps. The September 2022 implementation date, “Phase Six” is just under four months away. Compared to earlier phases, Phase Six will capture a greater range of firms with notional amounts between $8 and $50 billion, capturing more than 775 counterparties and 5,400 relationships.[11] At this time, more firms will come in scope for margin requirements than in all prior phases combined.
The collaborative efforts of ISDA, other trade associations, and the Working Group on Margin Requirements (WGMR) Monitoring Group, with input from the CFTC’s Global Markets Advisory Committee, resulted in a different roadmap than the five-phase approach first laid out in 2013. Recognizing the importance of aligning the CFTC’s rule with international standards, addressing transition risks, and accommodating the immediate impact of the pandemic, we split the original Phase Five by creating an additional Phase Six and extending the compliance phase-in schedule from 2020 to 2022.[12] Additionally, CFTC staff issued an advisory in 2019, clarifying that the Commission’s uncleared swap margin rules do not require documentation governing the posting, collection, and custody of initial margin until the initial margin threshold amount exceeds $50 million.[13]
Towards the end of 2020, I expressed my expectation that covered entities would work diligently in the time they have been given to come into compliance, reminding of our collective goals of continuity, resiliency, and normalcy. I was also firm and will continue to be so as we approach September, 2022. The Commission will continue to foster open engagement and address appropriate concerns—a hallmark of our agency—but we will ensure timely compliance with our core reforms. This is especially true at times of market volatility and stress.[14]
Preparation for compliance with the regulatory initial margin requirements is complex and resource intensive, involving the bilateral negotiation of new documentation, the establishment of custodial accounts, and operational preparations for the exchange of initial margin and collateral management. ISDA has diligently worked with the industry to assist and support firms with preparation and compliance ahead of the fast approaching deadline. While CFTC staff remains vigilant and engaged with affected participants, no further relief is being contemplated and the expectation will be compliance.
Data Reporting
Bringing implementation of initial margin requirements to its final phase required analytical expertise in evaluating and validating the need for the sixth phase of compliance and for the two-year extension. Building off this experience, our Division of Data is transforming the agency’s analytics toolkit to leverage the cloud architecture with advancements in AI, machine learning, and data analytics. At the core of these efforts is the need for accurate, efficient, and consistent data reporting.
Since the G20 sought to have OTC derivatives reported to trade repositories, which was enshrined in laws around the world, the CFTC has taken a lead role in the international harmonization working groups to standardize data at a global level to bring transparency and mitigate systemic risk. If the CFTC receives data in an automated and standardized way, it can be integrated with our existing analytics. This ensures that subject matter experts spend less time cleaning data and more time developing insights in support of surveillance, enforcement, and monitoring programs aimed at ensuring our markets maintain the highest level of integrity and transparency.
Think of it this way: data without standardization is like a jar filled with muddy water–we can filter it so the rocks and sand are separated and the water is clear. But we know there are other particles in the water, and this requires additional filtering in order to drink that water. Standardized reporting improves data quality, so we can have better oversight of the markets that we regulate.
Clear water is what you get when you have consistent data definitions and formats. Clear water is what you get when you have machine-readable code that cleans the mud out. And the benefits of machine-readable code and consistent data definitions means the water is safe to drink.
To make sure we have clear water when standardized reporting is not available, the CFTC is building an AI toolkit. Natural Language Processing will allow us to convert regulatory reports that come in different formats into structured data that we can look at over time. And we will continue to fine tune our rulemakings to specify the reporting standards so that we are not sifting through mud in the first place. Machine learning will allow us to perform pattern recognition, as it has already for our spoofing dashboard, for other types of market manipulation in support of our enforcement efforts. These will all be built on our cloud repositories of data so we can expand or contract based on need, allowing us to more efficiently allocate funding and other resources.
Climate
Turning to our efforts to highlight the risks and opportunities related to climate change, I am sure you noticed that in March 2021, I announced the creation of the CFTC’s multi-divisional Climate Risk Unit (CRU) to better understand the role of derivatives to price and mitigate climate-related risk. This unit also works to support the orderly transition to a low-carbon economy through market-based initiatives and product innovation.[15] As climate change is a collective action problem, I believe a joint effort between the CFTC and market participants can foster product innovation in the commodity and derivatives markets to tackle the climate crisis.[16]
Within the environmental markets, voluntary carbon markets represent an area of considerable growth as companies, organizations, and individuals increasingly purchase carbon offsets to mitigate their greenhouse gas emissions as they seek to support their “net-zero” and “carbon-neutral” objectives. Despite the momentum, the majority of carbon offsets trade bilaterally in the OTC markets. As the Commission works to foster transparent, fair, and liquid markets, I have tasked the CRU to engage with market participants in the voluntary carbon markets to better understand the potential role of the official sector in these markets, particularly as we see the emergence of CFTC regulated derivatives referencing cash offset markets.
Today, I am pleased to announce that the CRU will host a Voluntary Carbon Markets Convening on June 2nd at the CFTC’s Washington headquarters.[17] The convening will provide market participants and other stakeholders in the voluntary carbon markets and the U.S. derivatives market a venue to share their perspectives on the challenges and opportunities. As companies increasingly turn to the derivatives markets to manage risk and keep pace with global efforts to decarbonize, I look forward to the CFTC’s facilitating these discussions. Our goal is to foster innovation in crafting solutions to the climate crisis while ensuring integrity and customer protection.
I have also tasked the CRU with a broad review of the CFTC’s regulatory landscape in an effort to identify any impediments to or opportunities for innovation in risk management that will support the orderly transition to a zero-carbon future.
De-Fi and Digital Assets
One of the core requirements of the CFTC is promoting “responsible innovation and fair competition” in the markets we regulate and among the entities and individuals who choose to participate.[18] The Commodity Exchange Act, the CFTC’s governing statute, supports this guiding purpose, providing flexibility under the core principles for businesses and individuals to innovate in new ways while meeting longstanding regulatory goals—but always in measure with preserving the safety, reliability and integrity of our markets. Today, while we see new disruptors such as De-Fi and digital assets, our approach to these new frontiers will be familiar, and we will be guided by our longstanding charge that the American derivatives markets remain the most liquid, most fair, most efficient, safest, and most productive markets in the world.
As I have said many times, the CFTC accomplishes its purpose by identifying, assessing, and evaluating risks, and ensuring that we can establish appropriate tolerances and guardrails within our regulatory space to minimize disruption, maintain a level playing field, and preserve critical market participant protections from fraud, abuse, and misuse of customer assets.
In March, the Division of Clearing and Risk issued for public comment a request for an amended order of registration as a derivatives clearing organization (DCO) by an entity seeking to offer non-intermediated clearing of margined products to retail participants.[19] The request represents an innovative proposal that deserves careful consideration as to whether its operation will meet core principles that prioritize customer protections, market stability, and resiliency, among other important safeguards.
As other registered entities have expressed interest in exploring similar models, and given the potential impact on clearing members and FCMs, who play a critical risk management role and currently hold more than $450 billion in customer funds, it is paramount to be transparent and provide an opportunity to hear from the public. As part of our duties above in preserving the intent, purpose, and spirit of our regulatory regime, we must ensure a level playing field.
Given the potential and yet to be determined risks and novelty of the proposed market structure, it was not only important to put out the request for public comment, but to invite every stakeholder, every market participant, and every member of the public an opportunity to share their views on the larger issue of non-intermediation. Accordingly, on May 25th, the CFTC will host a staff-led roundtable to discuss issues related to non-intermediation more generally in derivatives trading and clearing.[20]
There is a collective interest in creating market efficiencies and these proposed market structures may—or may not—sustain that interest. But it is important that we dig in to the issues, recognize the risks, identify the opportunities, and ensure that as we move towards a decision, we do so deliberately, based on comprehensive consideration of the facts and fundamentals.
As no remarks these days can be complete without at least one reference to crypto, I’ll suggest searching for my recent U.S. Senate testimony from February. Concurrently, I believe that President Biden’s recent Executive Order on Ensuring Responsible Development of Digital Assets[21] represents a significant step towards ensuring greater cooperation and coordination between various cabinet-level agencies, independent market regulators, and prudential regulatory bodies. I have long advocated that a more government-wide approach is needed to effectively capture the breadth and potential market impact of crypto for safe and transparent public consumption.[22]
The Executive Order acknowledges that the growth and widespread adoption of digital assets presents unique issues for all regulators. Against this backdrop, the CFTC has actively used our existing statutory authority to stop and deter fraud and manipulation in these emerging markets. Since 2015, the CFTC has been aggressive in using its limited fraud and manipulation authority in the digital asset space, and will continue its proactive approach in using our existing enforcement authority to its fullest extent in the digital asset commodity space to protect customers and markets from fraud and manipulation. Concurrently, I will continue advocating for and supporting legislative authority for the CFTC to develop a regulatory framework for the cash digital asset commodity market. I look forward to cooperating and coordinating with our fellow agencies as outlined in the Executive Order.
Conclusion
Several years back in October 2018, I joined ISDA at its Annual Japan Conference in Tokyo.[23]
I talked about the collective strength within the CFTC, brought by the expertise and diversity among its five member-commissioners, and the collective strength in the global collaborative efforts among regulators and market participants in addressing the challenges of the day—which included several covered today in their more nascent stages. In considering those issues, I acknowledged that an uncomfortable level of uncertainty cannot deter us from acting. I am pleased that today it seems that recent global events have encouraged our tenacity on both sides of the regulatory divide, and that we continue to embrace opportunities to engage even when we know that our shared interests may not ensure the outcomes we individually strive for. The compromise may ultimately be the solution we collectively need.
Thank you.
[17] See Press Release, CFTC, CFTC Announces Voluntary Carbon Markets Convening (May 11, 2022).
