Washington, D.C. — The Commodity Futures Trading Commission’s Market Participants Division and Division of Market Oversight (Divisions) today are jointly issuing this statement to advise market participants and swap execution facilities (SEFs) of the importance of ensuring a smooth and timely transition away from LIBOR.

Sound functioning systemically important benchmarks are vital to derivatives markets that the CFTC oversees. As the timelines for the end of all LIBOR panels are now clear, the Divisions’ staff believe that continued reliance on LIBOR benchmarks poses risks to the stability and integrity of these markets and consumer protection. Market participants and SEFs themselves may also face financial, conduct, litigation, operational, and reputational risks associated with inadequate preparation.

Therefore, the cessation of and transition away from LIBOR remains one of the Divisions’ significant regulatory priorities. This transition will require market participants to take steps to stop issuance of new derivatives linked to LIBOR and to transition away from LIBOR in legacy contracts. For this purpose, the use of LIBOR rates in new contracts should, with very limited exceptions,[1] be ceased as soon as practicable and no later than December 31, 2021[2] to avoid these risks. Further, market participants should accelerate their conversion of legacy LIBOR contracts and SEFs should continue to focus on efforts to build liquidity in alternative reference rates in their markets.  The Divisions expect that these entities have been and will continue to keep their clients, participants, and stakeholders informed of developments in this area.

The Financial Stability Board published a set of documents that outlines recommendations further supporting stakeholders transitioning away from LIBOR, and the Federal Housing Finance Agency issued a letter on alternative reference rate selection risk management. The Divisions believe that prudent risk management should consider, among other things, the robustness of the reference rate being used in place of LIBOR.

Further, the CFTC’s Market Risk Advisory Committee (MRAC) yesterday unanimously adopted its recommendation that the Commission adopt SOFR First as a best practice. [See CFTC Press Release No. 8409-21] SOFR First represents a prioritization of trading in the Secured Overnight Financing Rate (SOFR) rather than USD LIBOR for particular market segments and products, and is designed to help market participants decrease reliance on USD LIBOR.  The first three phases of SOFR First only apply to the interdealer market and the fourth, and final, phase applies more broadly. The first phase applies only to linear swaps and is recommended for July 26, 2021, with the additional phases applicable to other products expected to occur later this year.[3]  MRAC’s SOFR First is neither Commission nor Division action and should be viewed as a best practice. However, the Divisions strongly encourage market participants and SEFs to consider following SOFR First. Market participants and SEFs should also monitor the transition away from other IBOR rates relevant to their businesses.

This statement represents the views of the Divisions listed above and does not necessarily represent the views of the Commission or those of any other Division or office of the Commission. The staff statements herein have no legal force or effect; they do not alter or amend applicable law, and they do not create any enforceable rights or new or additional obligations for any person.

[1] For example, for the purposes of transactions that reduce or hedge LIBOR exposure on contracts entered into before January 1, 2022.

[2] See similar statement of the Board of Governors of the Federal Reserve System (Reserve Board), the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation (November 2020), the Reserve Board’s related examination guidance (March 2021), and IOSCO’s statement (June 2021).

[3] Interdealer LIBOR screens will no longer be available starting on October 22, 2021.

As derivatives market participants transition from using the London Interbank Offered Rate (LIBOR) to using other benchmarks, namely the Secured Overnight Financing Rate (SOFR), I am pleased that Commodity Futures Trading Commission (CFTC) Acting Chairman Behnam today noted the important work we will soon undertake to ensure that existing clearing mandates for interest rate swaps can transition to preserve their effectiveness.  Mandatory clearing is an important element of the post-financial crisis reforms that I wholeheartedly support.  And as the use of LIBOR ceases, all of the CFTC’s clearing mandates for interest rate swaps need to be revisited.

But continuing to mandate clearing of any specific product, while at the same time disallowing access to a robustly regulated, non-U.S. clearinghouse providing the type of liquidity U.S. clients seek to most effectively comply with the mandate to clear that product, is a critical issue that can no longer go unaddressed.  The need to update our clearing mandates presents an opportunity to reconsider the restrictions the CFTC has imposed that prevent U.S. clients from accessing central counterparties (CCPs) around the world.  Simply put, U.S. market participants cannot fulfill the clearing obligations we demand if they cannot access clearing infrastructure around the world.  In my opinion, clearing mandates and clearing access are undeniably linked.

In response to the financial crisis, the G-20 in 2009 took great care to recognize that derivatives markets are global and that international coordination and regulatory deference would be essential to effectively strengthen them.[1]  It is, therefore, not surprising that many of our clearing mandates have an international currency element.

Because the CFTC implemented our clearing mandates and requisite clearing infrastructure updates ahead of other jurisdictions, at that time we could not recognize other regulatory structures as comparable to our own.  But this should always have been recognized as a temporary state.  As other jurisdictions adopted their own measures to achieve the common goals agreed to by the G-20, the CFTC should have long ago revisited its policies to allow U.S. persons to access clearing services at non-U.S. CCPs that are subject to a comparable regulatory structure to our own, without requiring them to register and be directly overseen by the CFTC.

The need to reconstitute existing clearing mandates presents us with another opportunity to get clearing access right.  Only then can we as regulators fairly demand compliance with the clearing obligations in interest rate swaps tied to various global currencies.

Good morning and welcome to the CFTC’s Market Risk Advisory Committee (MRAC or Committee) summer meeting.  I want to thank Commissioners Quintenz, Stump, and Berkovitz for joining today’s meeting.  I also want to thank and acknowledge the MRAC members and the subcommittee chairs who will present reports today.

I would like to extend my gratitude to MRAC Chair Nadia Zakir for her leadership and to Alicia Lewis, the Committee’s Designated Federal Officer, for her commitment to making the MRAC and its subcommittees a success.  I would also like to thank all the CFTC staff behind the scenes who make these virtual meetings possible.

I would like to extend a warm welcome to our new members: Andrew Danzig, Vice President, Federal Reserve Bank of New York; Amy Hong, Head of Market Structure & Strategic Partnerships in the Global Markets Division, Goldman Sachs; David Horner, Chief Risk Officer, LCH Limited, and Elisabeth Kirby, Head of Market Structure, Tradeweb.

I would like to say farewell to our departing MRAC members: Dennis McLaughlin, Sujatha Srinivasan, Marcus Stanley, Janine Tramontana, Scott Zucker, and CCP Risk and Governance Subcommittee member, Bill Thum.  On behalf of the MRAC, I thank you for your time and dedicated service and wish you luck as you take on new and engaging issues and challenges.

And finally, I would like to acknowledge that since our last MRAC meeting, the Market Structure and Climate—Related Market Risk Subcommittees concluded, having delivered their final recommendations.  Thank you to all the Subcommittee members, and special thanks to their chairs, MRAC members Lisa Shemie and Stephen Berger who led the Market Structure Subcommittee, and Bob Litterman, a market risk expert and climate policy pioneer who led the Climate Subcommittee.

Our last meeting found us almost one year into the COVID-19 pandemic with an ambitious agenda where we heard from all four of the MRAC subcommittees and held our first panel focused on diversity, equity, and inclusion in the derivatives industry and related markets.[1]  The vibrant discussions and overwhelming participation exemplified the MRAC as a forum for developing ideas, provoking change, and ensuring that consensus is reached through open and transparent debate.  Having seen the momentum generated by the Climate Report[2] in our industry and beyond, and the ongoing debates regarding swap dealer regulation and the Made Available—to—Trade or “MAT” process, there is no doubt that our efforts lead to success.  We have changed the landscape, and more importantly, started dialogues to explore and identify solutions.  As I pledged to continue supporting MRAC and subcommittee momentum in addressing the issues of the day and those to come in 2021, I highlighted the larger role of financial market regulators in ensuring transparency and equity, as well as providing firm and decisive leadership during times of market transition.

Today’s agenda will hone in on transition and building consensus.  First, we will hear from Tom Wipf and the Subcommittee on Interest Rate Benchmark Reform (Benchmark Subcommittee), and the full MRAC will vote on whether to adopt the Subcommittee’s SOFR First Recommendation.

On June 8th, the Commission announced that the Benchmark Subcommittee voted to recommend the SOFR First [Transition] Initiative (the Initiative) as a best practice aimed at prioritizing interdealer trading in SOFR over LIBOR for consideration by the MRAC.[3]  That same day, I delivered remarks at the SOFR Symposium sponsored by the Alternative Reference Rates Committee (ARRC) and the New York Fed.[4]  I spoke at length about the history of LIBOR, its regression on several fronts, and the general observation that, as a market regulator, it would be indefensible to stand by and allow market participants to mechanically continue down LIBOR’s road to obsolescence when a sustainable path is clearly in sight.

The Initiative represents a prioritization of interdealer trading in SOFR over LIBOR.  Specifically, as part of the Initiative, the Benchmark Subcommittee recommends that interdealer brokers change U.S. Dollar (USD) linear swap trading conventions to SOFR on July 26, 2021.  After July 26, 2021, the interdealer market should replace trading of LIBOR linear swaps with trading of SOFR linear swaps.  LIBOR would be expected to be accessible as a basis to SOFR after this date.  However, screens for LIBOR linear swaps should remain visible for informational purposes only after this date.  In other words, the recommendation is that dealer to dealer trading in LIBOR linear swaps should cease at the end of July. All trading, outrights and basis swaps, would be around SOFR.  After October 22, 2021, the recommendation is that screens operated by platforms specializing in inter-dealer trading for LIBOR linear swaps should be turned off altogether.

Later that week, I shared a shortened version of those remarks at the Open Session of the Meeting of the Financial Stability Oversight Council, during which I took the opportunity to highlight the significant ongoing and collaborative work of the Benchmark Subcommittee and the ARRC and the milestones they had reached alongside one another.[5]

Shortly thereafter on June 24th, the Benchmark Subcommittee voted to broaden the SOFR First Initiative to cover additional products including cross currency swaps, non-linear derivatives and exchange-traded derivatives.

The SOFR First Initiative is designed to help market participants decrease reliance on USD LIBOR in light of the FSB and IOSCO statements on LIBOR transition,[6]  which are supportive of interagency guidance from U.S. banking regulators that banks cease entering new contracts that reference USD LIBOR post December 31, 2021.[7]

Since the early June announcement, the Commission has received feedback regarding how the SOFR First Initiative implicates the mandatory clearing requirements and related MAT determinations for SOFR swaps under the Commodity Exchange Act and Commission regulations.  In anticipation of the end of LIBOR and its replacement with SOFR, my plan is to have staff present the Commission with a rule proposal addressing mandatory clearing of SOFR swaps, with the expectation of finalization in 2022.

Relatedly, and in the interim of a Commission rulemaking on mandatory clearing, for purposes of the Commission rule prohibiting post-trade name give up (PTNGU) on swap execution facilities (SEFs), which is now applicable to swaps that are mandatorily cleared or intended to be cleared,[8] Commission staff expects that SEF’s will treat SOFR swaps as intended to be cleared or as mandatorily cleared swaps for purposes of Commission Rule 37.9(d).[9] 

In short, it may be simplest to think of LIBOR and SOFR swaps as identical with regard to their treatment under the post-trade name give up rule.

Second, the CCP Risk and Governance Subcommittee will present its reports on (1) Capital and Skin—in—the—Game and (2) Stress Testing and Liquidity for acceptance by the full MRAC.  The reports provide a glimpse into the areas of discussion that took place throughout the last 1 ½ years, and given the considerable diversity of views represented by the MRAC, I recognize that there is still much left to be done.  I am committed to continuing an open and fulsome dialogue on these issues.  Along those lines, I wish to thank Alicia Crighton and Lee Betsill, the CCP Risk and Governance Subcommittee Co-Chairs and workstream heads for their leadership, and the Subcommittee for its steadfast commitment to completing the task before them.

As our time is short this morning, I will wrap it up quickly so we can hear from my fellow Commissioners and move forward with our agenda.  Again, I wish to thank everyone participating in the MRAC today, and out there watching for the comments, collaboration, coordination, and communication that help ensure that our Advisory Committees keep us moving in the right direction.  Thank you.

This past fall, I made a speech in Dubai to highlight what I believe will be a fundamental challenge for financial regulators in the coming years: how do regulators apply or modernize regulatory frameworks in the face of emerging technologies, especially where the functions performed by registered market intermediaries and exchanges may be increasingly performed by computer code or protocols.

My speech was designed to ask questions, offer preliminary thoughts, and start a larger conversation about these complex policy issues.  Regulators and innovators will have to grapple with these challenges together.  I very much appreciate Coin Center’s thoughtful analysis of my supportive approach to innovation generally, as well as my speech specifically, and I am grateful for the opportunity to build upon that conversation here.

At the outset, I would like to say that the views I express on this topic are my own and do not represent the views of the Commodity Futures Trading Commission (CFTC), where I am fortunate enough to serve as a Commissioner.  The CFTC is responsible for regulating the derivatives markets in the United States, including derivatives on commodity crypto-assets.

A Pro-Innovation Posture

The CFTC has developed a robust, pro-innovation, do-no-harm posture that engages with innovators to understand how evolving technologies fit within our current regulatory structure.  In instances where an innovation may achieve the desired outcome of a regulation, but not fit within the letter of the rule, the CFTC is open to considering whether rule revisions or regulatory relief may be appropriate.  Through engagement with innovators, entrepreneurs and disruptors, the CFTC can best determine whether exemptions from the immediate application and full weight of regulatory responsibilities would better allow, or at least not preclude, a limited demonstration of an innovation’s potential.  I strongly believe that the government should not create existential regulatory economies of scale or costs of regulatory compliance so large as to insulate existing market participants.  Rather, we should promote free and full competition from new entrants that maximizes the marketplace’s efficient allocation of capital.  Therefore, I am supportive of the CFTC’s willingness to simplify, and in many cases rationalize, its rules, or provide limited exemptions from them, to promote or at least not inhibit the innovation potential of a truly competitive market.

The Promise of Smart Contract Protocols and Disintermediated Markets

The CFTC has a responsibility to ensure that broad-based activity which falls within the definitions and requirements of its existing rules is approached consistently, regardless of the underlying technology, form, platform, or code.  Given that mandate, it is important to consider how, or if, our existing supervisory framework is implicated by certain innovations, including the blockchain, related smart contracts, and trading software more generally.

But first, some background into smart contracts and their tremendous potential.  Certain blockchain networks, like Ethereum, allow smart contracts to be integrated into the chain.  A smart contract is a computer code containing all terms of the contract and is self-enforcing—meaning the software can execute the terms of the contract without additional input from the parties[1].  Once the smart contract is formed on the blockchain network, it operates without further intervention.  Some software developers have written code that allows users to create various types of smart contracts that can then be deployed on the blockchain.  Once users download these applications, they can find others using that same protocol willing to transact.

Smart contracts are easily customizable and can be used in a wide variety of exciting applications or to disrupt currently inefficient processes.  For example, smart contracts can be used to facilitate the sharing economy by enabling users to rent houses, cars, and other property.  They can be used to streamline business operations by, for example, tracking product movement along the supply chain.  They can also be used to streamline certain corporate actions, for example, by automating the payment of dividends to shareholders.  Many of the potential applications of smart contracts do not fall within the CFTC’s jurisdiction and have the potential to create substantial efficiencies and savings for businesses and users.

However, certain smart contacts more closely resemble traditional financial products or services within the CFTC’s jurisdiction, and it is upon this narrower ambit of activity that I would like to focus.  One area I would like to explore today is how the CFTC can ensure it is holding the appropriate parties responsible for software code or computer programs used to violate CFTC regulations—for example, trading programs designed and executed to manipulate the price of a particular futures contract.  In all cases, the CFTC should work to ensure its regulations are applied fairly to similar activity across existing and new marketplaces while working to establish clear lines of accountability that do not depress innovation.

Smart Contracts and Software Programs Facilitating Unlawful Activity

Advancements in technology, from trading software to information dissemination to market connectivity, have revolutionized the electronic trading environment on registered exchanges, and promise to continue to do so.  Similarly, there is a broad spectrum of activity by developers, programmers, miners, and users on the blockchain that are revolutionizing efficiencies and markets.  In both the existing markets and the newer blockchain ecosystem, some of these technological innovations, protocols, or computer code may be used to facilitate unlawful activity, leaving regulators with the duty to hold the appropriate people accountable for that unlawful conduct.  While much of the assignment of liability depends on the facts and circumstances, I would like to further explain some of my own thoughts.

Looking at the spectrum of activity, on one side there is the publication of code alone.  Absent proof that developers intended that the code facilitate conduct that is illegal, the CFTC should not bring a case against them.  On the opposite side of the spectrum, there are instances where developers knowingly design code that can be used for unlawful purposes, and intend that the code be used for such purposes.  For example, take the case of a software developer who, at a broker’s request, personally develops custom trading software that the developer knows can be used to “front run” or “trade ahead” of the broker’s clients, and intends for the code to be used by the broker for that purpose. In that situation, the CFTC could pursue a case against the developer under an aiding and abetting theory.

I expect most activity will likely fall somewhere in the middle of the spectrum.  Focusing the conversation on this gray area will yield the greatest benefit for both innovators and regulators.

The key determination in every matter concerns the developers’ intent.  Questions that should be considered include whether the developers: 1) made modifications to the code that enhanced the unlawful activity; 2) promoted the unlawful activity through a website or marketing materials; or 3) had a financial stake in the unlawful activity.  Another factor to consider is whether the code is narrowly designed to enable an unlawful purpose rather than broadly designed for legal activities.  The more a code is narrowly tailored to achieve a particular end, the more it appears as if it was intentionally designed to achieve that end.  Take for example, a computer code that is specifically programmed only to trade heavily on one side of the market during a future’s contract settlement period to purposefully distort the final settlement price either higher or lower, otherwise known as “banging the close.”  If developers were aware that traders would use the program in this manner, the developers’ conduct begins to look a lot like classic aiding and abetting.

Let me be clear. I do not view any of these factors as being independent, dispositive tests for liability.  Nor do I view the list above to be exhaustive. But, when taken as a whole, these factors will help provide regulators with insight into an individual’s responsibility for a software code’s unlawful use.  I am hopeful that this more holistic and detailed explanation of potential liability eases the minds of the vast majority of developers designing code for broad purposes intended to be put to legal uses.

Conclusion

Due to the nascency of this space, more work remains to be done to establish regulatory clarity.  To-date, the agency and I have benefited immensely from the current engagement with market participants and innovators, from LabCFTC’s numerous interactions with the technologists and disruptors to the CFTC’s Technology Advisory Committee (which I am proud to sponsor) and its public meetings where novel issues involving blockchain and distributed tokenization are presented for debate.[2]  We also have a number of tools available—no-action relief, exemptions, and ultimately, rule amendments—that can be used to give embryonic innovations a chance to flourish while the agency modifies an existing, or builds a new, regulatory framework. But I also expect, like many areas at the confluence of technological advancements and complex policy issues, legal standards and norms in this space will be developed incrementally based upon a facts and circumstances analysis that evolves with the innovation and disruption.

In Dubai, I expressed my strong interest in hearing feedback from innovators, technologists, disruptors, and others within the blockchain community.  I reiterate that interest today and look forward to being part of that ongoing conversation, while always remaining open to learning and hearing other points of view.  My hope is that, through good faith engagement, both regulators and innovators can educate one another, with the end result being a regulatory regime that supports innovation, protects customers, and promotes the integrity of our financial system.

Remarks as Prepared for Delivery at the ISDA Derivatives Trading Forum

Overview

The Greek philosopher Heraclitus is credited with the oft-cited saying that change is the only constant in life.[1]  This idea seems particularly pertinent to our financial markets—which probably explains why I have been asked to speak today about how regulators adapt to changing market structure.  Before I begin, though, please allow me to remind you that the views I express today in these remarks are my own and do not represent the views of the Commodity Futures Trading Commission (CFTC or Commission) or my fellow Commissioners.

Put quite bluntly, regulators struggle with adaptation.  It is a not a new struggle, nor is the stress it imposes necessarily negative.  Rather, it is the natural challenge of our job to ensure that regulations are keeping pace in such a way to enable the benefits of innovation and increased efficiency for the marketplace.  When I am contemplating the sometimes-difficult question of applying our legacy regulatory structure to modern applications, I often remind myself that many before me have struggled with the same questions, and had to get out of their comfort zone in order to permit previously unheard-of market advancements to develop into essential elements of the modern market structure.  Our challenges of today are unique, but not unprecedented.

So, let’s take a brief walk down memory lane and remember some of the developments and events that have for years required regulators to think outside the box.  I am going to focus on the Year 1999, at which point I was only a few years into my career, and I had become interested in the commodity markets and the work of a small U.S. agency overseeing the futures markets.  I quickly discovered that my college textbooks about futures trading were completely outdated.

The textbooks could not possibly keep pace, but the agency knew it had to.  So, in 1999, the CFTC established the Technology Advisory Committee (TAC), and at its first meeting, the agenda included a discussion of how to oversee electronic order routing and execution systems.[2]  The regulators of the time were struggling with how to apply their regulatory oversight as market structure transformed from trading pits to electrification.  Today, we cannot fathom a derivatives market without electronic routing and execution, but in 1999 this evidently perplexed regulators.  So, too, will be the case 20 years from now when the history books judge our contributions to the next generation of markets.

Re-Visiting Existing Rules:  Swaps Market Evolution

Experience has taught us that regulators must respond to change rather than try to avoid its inevitability.  In 1999, there was need for legal certainty as to the regulation of over-the-counter (OTC) swaps.  The result was that Congress—with bipartisan support—enacted the Commodity Futures Modernization Act (CFMA),[3] which explicitly instructed the CFTC not to regulate OTC swaps because, at the time, many such products were considered bespoke and lacking the standardized elements befitting a market infrastructure like that supporting the futures markets.

But over a few short years, the OTC market saw tremendous growth, the introduction of more standardized products, and the development of a web of interconnected counterparties to OTC transactions.  It was logical that the evolution of this market would eventually require a more common set of execution, clearing, and reporting obligations.  Unfortunately, the impetus for this mandate was the financial crisis.

In 2008, I had a front-row seat to the calamity of the crisis.  I was a Congressional staffer and distinctly recall thinking how quickly things had changed:  In less than a decade, this market had transformed to a point that the law was outdated.  As you know, Title VII of Dodd-Frank[4] was the response.  This history provides a lesson as to why the law should constantly be re-visited.

Another decade has passed since then, and I am proud to have the opportunity to serve at the agency responsible for implementing many of the Dodd-Frank reforms.  Experience tells me that we cannot simply idle the regulations of the past decade or they, too, will soon be outdated and unfit for their intended function.  Thus, one way in which regulators should adapt to changing market structure is to be vigilant about regularly reviewing and refining their rule sets—keeping what works and updating or revising as needed in light of the then-current market environment.[5]  I am pleased that several of the rulemakings that we adopted last year with respect to the CFTC’s Dodd-Frank rules—in areas ranging from reporting to swap execution facilities to cross-border issues—did exactly that.

A Changing Global Environment:  Further Implementation of Dodd-Frank Swap Reforms

That being said, the CFTC still has work to do to adapt its Dodd-Frank swap reforms to perform in the global environment envisioned by the G-20 when the Pittsburgh agreements were established.  Three areas stand out in particular:  1) access to clearing; 2) swap dealer capital requirements; and 3) data refinement.

1.  Clearing Access:  First, to fulfill our obligation to make the Dodd-Frank regulatory structure workable, we must continually renew our commitment to clearing access.  While increasing central clearing globally is a critical tenet of the post-crisis reforms, we must acknowledge the vital precursor to achieving this goal—our obligation to help market participants access the clearing infrastructure.  Market participants cannot fulfill the clearing obligations we demand if they cannot access central counterparties (CCPs) around the world.  Regulators must focus on enabling access by allowing CCPs across the globe to compete, while minimizing location-based limitations.  To do otherwise leaves our work as regulators unfinished.

I often acknowledge that the CFTC implemented the OTC clearing mandate and requisite infrastructure updates ahead of other jurisdictions.  As a result, we could not, at that time, recognize other regulatory regimes as comparable to our own.  But adaptation requires us to note the progress that has been made in other countries since then.  The CFTC should have long ago re-visited its policies to allow U.S. persons to access clearing services at non-U.S. CCPs that are subject to a regulatory structure comparable to our own, without requiring those CCPs to register with the CFTC.  After all, we have applied such a structure to listed futures for over 30 years.

2.  Swap Dealer Capital Requirements:  Second, when we finalized the CFTC’s swap dealer capital rules last summer,[6] I emphasized the importance of considering substituted compliance determinations well in advance of the October 2021 compliance date.[7]  I am pleased that since then, staff of our Market Participants Division has been working with swap dealers, trade associations, and our regulatory counterparts in other countries to assess the comparability of capital adequacy and financial reporting requirements in other jurisdictions.

3.  Data Refinement:  Third, the response to the financial crisis created an entirely new type of infrastructure provider:  the swap data repository.  This entity provides the type of information that market participants, regulators, and legislators sought in the heat of the crisis in 2008, but that no one could then provide.  To accurately compile global swaps data and realize the full potential of the data repositories, the CFTC and our international counterparts must coordinate our data fields and our expectations of market participants, and trust each other in doing so.  To that end, in the years since creating these new data repositories, the CFTC and regulators globally have spent significant time and energy working to re-think, update, and better coordinate their swap data reporting rules.[8]  I hope that this will enable the CFTC to assess the comparability of the reporting requirements in other jurisdictions in the near term.

Responding to Changing Interests of Market Participants:  New Products

While market structure is constantly adapting, so are the products the structure supports.  Some of you may recall that back in 1999, the hot new product that everybody was talking about was security futures.  Congress was poised to remove the existing prohibition on the product in the CFMA, and explosive trading in the product was expected.  That did not happen (unfortunately, in my view)—for reasons that must be left for another day and another speech.  But more recently, we at the CFTC have spent much time learning of many new product types that could not even have been imagined at the turn of the century.

For example, there is obviously increasing interest in listing and clearing derivatives on cryptocurrencies such as bitcoin and ether.  In addition, we also are seeing exchanges that plan to list so-called “event contracts” for hedging risks from the anticipated outcome of future events.  We also are having many conversations about new risks to the financial system posed by climate-related events and policies.  

I would be remiss if I didn’t mention interest in the broader application of “ESG”[9] generally, and the CFTC’s role.  Difficult questions exist in how to value a company’s ESG standing – opinions vary widely, and reliable data is often hard to come by.  This is a dilemma facing every investor as well as those who harbor the related risks.  But the CFTC should remain focused on our job – regulating any derivatives markets that develop in response to demand for ESG investing, which will logically create new risks which then leads to interest in derivatives products.  Indeed, some may be unaware that the CFTC already regulates approximately 150 climate-related derivatives products developed in response to vulnerabilities faced by various end-users.

It is not particularly remarkable to consider that as risks evolve, derivatives products will develop in response—this is a common progression.  Whether the risks result from government mandates or consumer demand (though in my personal view, the latter is preferred), there will be interest in using derivatives to manage those risks.  And it is the role of the CFTC to preserve the function of new risk-mitigating derivatives products that develop in response to that interest—just as we do for derivatives products in more traditional asset classes today.

Fostering Innovation:  Digital Assets, FinTech and DeFi

Regulators have many jobs:  In addition to re-visiting our rules and embracing the utility of new products, we must commit to fostering innovation for future development.  A recent popular song my kids often play contains the lyrics “I just wanna go back, back to 1999,”[10] which recalls and longs for simpler times.  Yes, certainly my job would be easier if the markets we regulate weren’t constantly changing, but in reality, I didn’t sign onto an easy job and would not want to revert to 1999.  Much innovation has improved our markets since then, and with market structure changes came the need for new regulatory considerations.

In the Commodity Exchange Act (CEA), Congress recognized that innovation is the lifeblood of the derivatives industry, and that it is innovation that has spurred the tremendous growth of the U.S. derivatives markets.  The CEA explicitly states that one of its purposes is to “promote responsible innovation” among markets and market participants,[11] and it provides the CFTC with the necessary flexibility to do so through a principles-based approach to derivatives regulation.  It is not an accident that the CFTC is structured to be nimble in order to enable innovation.  Rather, that was an intentional decision by Congress, and one that I am proud to promote.

This is what truly sets the CFTC apart:  Welcoming innovation in derivatives markets is at the heart of what we do, through a long history of principles-based regulation.  Adapting to market evolution through principles rather than prescription both: 1) allows the CFTC to oversee growth and change, while not having to constantly re-write regulations in response to every market development; and 2) allows market participants to innovate and compete globally, while still complying with legal requirements.

A principles-based approach avoids one-size-fits-all regulation, and leaves the CFTC well-positioned to adapt to the innovations inevitably coming to derivatives markets due to developments in digital assets, financial technology (FinTech), and decentralized finance (DeFi).  Sure, a prescriptive approach makes regulating easier, but stagnant and inflexible rules may very well render us unable to respond to the constant market progression underway, thereby jeopardizing our mission.  In short:  Regulation by principles limits the risk of stifling innovation, and allows for the ongoing renaissance we expect from our derivatives markets.

Customer Education:  A Shared Responsibility

Of course, with technology comes an increased need for education regarding the derivatives markets.  I know this sounds rudimentary to those of us operating in this space every day, but the evidence of misconception and misunderstanding is widespread.  We need look no further than recent trading activity and market volatility triggered by posts on online message boards and social media platforms.  Sadly, the authors and readers of this misinformation jeopardize the utility of these markets to the detriment of others.

There is a real need—and an opportunity—to step up and educate the public about our markets.  I am pleased that the CFTC recently initiated a new advisory encouraging the public to research and understand the futures markets, physical markets, and securities markets before trading based on information on social media.[12]  The CFTC also has issued several advisories that provide warnings and examples of the latest scams.[13]

This customer education imperative is no small task because the range of those interested in derivatives products is vastly expanded from just a few years ago.  For example, it is evident that retail interest in the derivatives markets has increased significantly.  Back in 1999, such retail interest was not really “a thing.”  But the number of smaller, non-institutional participants in certain derivatives markets has increased significantly in recent years.  In addition, at the CFTC, the markets we regulate are being impacted by retail interest in certain exchange-traded funds.

Evidence of the changing landscape of market participants is all around us.  First, we have seen increasing listings by CFTC-registered exchanges of “micro” and “micro e-mini” futures and options contracts that allow participants to gain exposure to the futures markets at much lower cost and capital requirements compared to standard futures contracts.  Separately, last year, the CFTC granted designations to four new futures exchanges whose business models focus on retail traders.  Some do not yet have contracts listed for trading, but one that does has seen modest—but steady—participation.

If increased retail participation in the derivatives markets is a trend that is here to stay, we must constantly evaluate what adaptations are needed to account for the expanding variety of participants trading in our markets.  And that will require a commitment to education. 

That commitment must not be the CFTC’s alone.  Education is a shared responsibility between the Commission as regulator and you, the industry and infrastructure providers.  I am hopeful that we all will step up our educational efforts and undertake new initiatives to help assure that retail traders are properly informed about how the derivatives markets operate and are fully aware of the degree of risk that such trading inherently entails.

Handling Curveballs:  Operational Challenges Posed by the Pandemic

Up until this point, I have discussed how regulators must adapt to market-driven changes, but curveballs from circumstantial events also challenge our norms.  Sticking with the theme of 1999, you all likely recall the anticipated trouble known as the “millennium bug” or the “Y2K Problem,” in which there was uncertainty as to the continued operations of our banking sector, transportation infrastructure, and healthcare operations due to a computer coding glitch in which programs only recognized the last two digits of any year, making the Year 2000 indistinguishable from the Year 1900.  Much planning went into avoiding the potential undesirable impacts of the Y2K Problem.

But no such preparations were feasible for the modern-day havoc experienced due to the curveball thrown us by the Covid-19 pandemic and all of its follow-on effects.  As a regulator, there were, of course, many immediate considerations that required the CFTC’s prompt attention.  I commend Commission staff for issuing several temporary, targeted no-action letters[14] to help facilitate orderly trading and liquidity in the U.S. derivatives markets while allowing market participants to implement lifesaving social distancing measures at a time when nearly all workers had to abruptly start working from home.  The issues addressed related to obligations that could not readily be achieved while working at remote locations, such as suitably granular timestamping, recording oral communications, fingerprinting new staff and members, and submitting certain required reports and forms.

As we hopefully (and thankfully) appear to be entering into the recovery, there are long-term considerations as well.  For starters, while market participants found compliance solutions for many of the issues posed by physical separation such that the CFTC’s no-action relief ultimately could be allowed to expire, the prospect of hybrid work models involving greater teleworking into the future means that issues such as cybersecurity will demand heightened attention.

Also, while the clearing system performed as designed and expected during last spring’s volatility surrounding the pandemic, many of the reforms we implemented over the past decade were put through the ultimate stress test.  This was not a theoretical assessment of plausible conditions, but rather a real-time test of how the increased volume of cleared products brought about by the G-20 commitments as well as the changes to the clearing infrastructure fared in real, albeit extreme, conditions.

And just as we expect those whom we regulate to apply the results of their stress tests, the CFTC should consider any necessary adjustments and improvements from the lessons of our own recent Covid-related stress test.  The CFTC’s Global Markets Advisory Committee (GMAC), which I am proud to sponsor, has held two informative meetings during which we discussed the impact of the pandemic on global clearing.  Panelists and members discussed several takeaways and offered suggestions for improvement to the global clearing system.[15]

Finally, the CFTC has a critical role to play in getting the economy back up to full force.  After all, the derivatives products that we regulate are, at their core, risk management tools designed to mitigate uncertainty—and the pandemic has injected a lot of uncertainty into our economy.  In our ongoing efforts to handle the curveball of Covid-19, we need to make sure those who manage teacher retirement plans, college savings, food production, and even toilet paper distribution can continue to effectively access derivatives to manage the risk of that uncertainty.

Just Saying No:  Some Things Must End

Now, I’d like to turn to the importance of focusing on some unfinished business that pre-dates the pandemic.  Those less concerned with Y2K computer glitches celebrated the turn of the century at various New Year events almost all of which featured Prince’s hit song “1999,”[16] or as it is more commonly known by its lyrics, “party like it’s 1999.”  Yet, that song actually was recorded in 1982—and not as a Y2K party song, but rather to foreshadow the end of an era. 

Sometimes regulators are called upon to effectuate change by setting difficult era-ending policies.  While no one is likely to write a hit song about such, still, we must stay the course, through its inevitable ups and downs.  Two current examples of things that must end come to mind:  1) Libor; and 2) uncleared margin implementation delays.

Libor:  First, I am pleased to see some voluntary adoption of, and transition to, alternative reference rates to replace Libor.  This process has made good progress thanks to open dialogue, asking questions, sharing ideas, and a little regulatory nudging.

I have always said that our role at the CFTC is to focus on ensuring that derivatives remain accessible and reliable as hedging instruments, through the maintenance of well-functioning and orderly markets.  The CFTC will continue playing a coordination role with other regulators, as well as participating in public-private partnerships like the Alternative Reference Rate Committee (ARRC).  We will interact continuously with all categories of market participants to discuss the impact on listing, trading, and clearing with new reference rates, as well as educating and informing market participants about the implications of the transition. 

We have walked a fine line of supporting industry discussions around Libor transition, without unnecessarily inserting ourselves as regulator into what is already a complex and challenging undertaking.  I would like to thank Acting Chairman Behnam and the leadership of the CFTC’s Market Risk Advisory Committee (MRAC) for their focus on benchmarks, and specifically the work done by MRAC’s Interest Rate Benchmark Reform subcommittee.

Uncleared Margin Implementation:  Second, since the financial crisis, regulators around the world have worked to implement a common regime for margin requirements on transactions not subject to central clearing.  Those margin rules are being implemented in phases, and have already come into effect for uncleared swaps when the largest and most interconnected financial institutions trade with one another.  However, due to the disruptions caused by the pandemic, global regulators extended the implementation dates for the final phases 5 and 6.  These phases apply to a different universe of market participants consisting of financial end-users such as pension plans, endowments, insurance providers, and mortgage service providers.  The deadlines for phases 5 and 6 are now September 1, 2021, and September 1, 2022, respectively.

Recognizing the unique practical and operational challenges posed by the exchange of margin for the financial end-users coming into scope of the uncleared margin rules in these last two phases, the CFTC’s GMAC last year adopted a number of recommendations to ease the implementation of the margin rules in certain circumstances.[17]  The Commission has adopted a number of these recommendations.[18]  I am hopeful that we can consider additional recommendations from GMAC in our quest to facilitate compliance by the vast array of market participants soon to be subject to these margin obligations.

But those compliance dates for phases 5 and 6 are fast approaching—and no further extensions should be expected.  Accordingly, firms that will become subject to uncleared margin requirements on the phase 5—and even the phase 6—implementation date need to treat compliance with those requirements with a sense of urgency.  Let me be clear:  There will be no reprieve from the current compliance deadlines.

Conclusion

In conclusion, I realize that my point of reference today—the Year 1999—is an arbitrary benchmark, since the roots of the derivatives markets are innovation and change from well before 1999 (even dating back to the 1800s, when grain farmers needed to get grain to processors and processors needed a reliable supply of grain and would arrange for a price in advance, but a lack of delivery or payment often frustrated the process).  And remember:  Financial futures were once considered a novel new derivatives product, too.

So, perhaps I should reach back even further, to the 1977 album “What a long strange trip it’s been.”[19]  As I said at the beginning, the particular changes in the derivatives markets today may be new, but the fact of change in these markets is not.

As we confront today’s changes, the CFTC must build on its successful track record of enabling innovators to think creatively as the story evolves.  In doing so, the themes I have discussed—re-visiting rules, responding to a changing global environment and to changing interests of market participants, fostering innovation, committing to customer education, standing ready to handle curveballs, and saying no when necessary—can guide us in exercising our regulatory authority to fulfill our mission such that the derivatives markets can continue to meet their full potential. 

I wish to thank Secretary Yellen and FSOC members for the opportunity to provide some brief remarks.  I’d also like to thank Vice Chair Quarles for his remarks and for his and the Federal Reserve’s work on the transition away from LIBOR.  Earlier this week, I spoke at length at the SOFR Symposium—sponsored by the Alternative Reference Rates Committee (or ARRC) and the NY FED—about the history of LIBOR, its regression on several fronts, and the general observation that, as a market regulator, it would be indefensible to stand by and allow market participants to mechanically continue down LIBOR’s road to obsolescence when a sustainable path is clearly in sight.[1]

As admonished by my fellow regulators, hope is not a solution, and the days of LIBOR are limited.  I wholeheartedly agree with my colleague’s statement that shepherding the LIBOR transition is a key element of safeguarding the stability of the financial system.

It has been over a decade since the first allegations of benchmark manipulation surfaced, and nine years since the CFTC began levying sanctions for LIBOR-related misconduct, resulting in the collection of more than $3.3 billion.

By the numbers, around the time that Governor Andrew Bailey, then the Chief Executive of the UK Financial Conduct Authority (FCA)—which regulates LIBOR—acknowledged that despite significant improvements to LIBOR, the goal of anchoring LIBOR submissions and rates to the greatest extent possible to actual transactions could not be achieved,[2] the U.S. Federal Reserve estimated that the more than $200 trillion in outstanding volumes of USD LIBOR contracts were benchmarked to a rate generated by $1 billion per day.  For the three-month LIBOR, the standard reference rate in the derivatives markets, was less than US $1 billion of borrowing among the largest banks.  On many days, that number dropped below $100 million.[3]  Last month, Governor Bailey reminded us that this dire situation has not changed in the last four years.[4]

The skewed proportionality that underlies LIBOR continues to raise serious concerns about market integrity, conduct risks, and most importantly within the context of this body—greater financial stability risks.  Regulatory authorities have relied on broad market participation in the global cooperative and consultative efforts—by committees like the ARRC, and have stood by ready to facilitate transition efforts by helping to avoid market dislocations.

In July of 2018, I convened the Market Risk Advisory Committee, a body within the CFTC that I sponsor to focus on benchmark reform,[5] and soon after, the Commission voted to establish the Interest Rate Benchmark Reform Subcommittee to provide reports and recommendations regarding efforts to transition U.S. dollar derivatives and related contracts to SOFR, the risk-free rate for the U.S. dollar selected by the ARRC, and the impact of such transition on the derivatives markets.[6] 

The Benchmark Subcommittee has focused on collaborating with the ARRC on market development initiatives, with a view to supplement and support those efforts.  The first major effort was around “plain English” disclosures, that market participants can use to inform clients and counterparties with whom they continue to transact derivatives referencing LIBOR and other IBORs about the implications of using such products.[7]

The second significant effort was a tabletop exercise with respect to the SOFR discounting switch by the central counterparties.[8]  The CCP discounting shift in October 2020 marked a fundamentally important event positively correlated with the noticeable uptick in SOFR-based derivatives trading that followed.

The third, announced earlier this week, is the Subcommittee’s recommendation of the SOFR First Transition Initiative as a best practice aimed at prioritizing interdealer trading in SOFR over LIBOR.[9]  This is similar to the SONIA First effort encouraged by the UK’s FCA and Bank of England.

Specifically, as part of the Initiative, the Benchmark Subcommittee recommends that interdealer brokers change USD linear swap trading conventions to SOFR on July 26, 2021.  After July 26, 2021, the interdealer market should replace trading of LIBOR linear swaps with trading of SOFR linear swaps.

While LIBOR would be expected to be accessible as a basis to SOFR after this date, the screens for LIBOR linear swaps would remain visible only for informational purposes until October 22, 2021, when they will go dark.

The Benchmark Subcommittee believes its recommendations are especially prudent given the most recent FSB and IOSCO statements on LIBOR transition (June 2) which are consistent with and supportive of the interagency guidance from U.S. banking regulators that banks cease entering new contracts that reference LIBOR post December 31, 2021.

There is broad consensus among all market participants, and not just the dealer banks, of the urgency to shift away from LIBOR. Even Tuesday’s announcement is timed to ensure that market participants, the trading platforms, other service providers, have sufficient time to prepare for the July 26^th event.

We must move on with a rate that is based on sustained and robust transactions.  Of note, the daily transaction volume underlying SOFR often has exceeded $1 trillion and it has never been less than $700 billion.[10]  It reflects activity undertaken by diverse types of institutions, including asset managers, banks, corporate treasurers, insurance companies, money market funds, pension funds, and others.[11]

To avoid the conduct and stability risks that emerged when LIBOR became disconnected from actual activity, we must rely on a benchmark that is both representative of transactions and proportional to the depth and breadth of products that rely upon it.  SOFR demonstrates that fitness for the derivatives markets.

Thank you again Secretary Yellen for raising this very important financial stability issue within the FSOC, and Vice Chair Quarles for his presentation and efforts.  Complacency is no longer an option and market participants cannot assume that they can ride the LIBOR train until the end of the line.  While we collectively act to ensure a smooth transition to SOFR, we must make clear, as we are today, that the time to make the switch is now.

Thank you all who have joined today’s virtual Agricultural Advisory Committee meeting.  I am very hopeful that 2021 will eventually allow us the opportunity to again meet together in person.  But as the Committee has some pressing business I am pleased that we are taking the opportunity to have these important conversations today from our various remote locations.

I’d like to begin by expressing how honored I am to sponsor the Ag Advisory Committee and how much I appreciate my fellow Commissioners supporting my request to do so.  This Committee was the CFTC’s first advisory committee and has been sponsored by many commissioners who I consider to be friends, worthy of admiration and tremendous respect, so I am today, delighted to be the custodian of this important committee.  Also, as many of you know, my roots are in agriculture and the many challenges and issues facing the sector are near and dear to my heart.

However, my excitement in sponsoring the AAC does not suggest that I’m any less excited about the other advisory committee I sponsor, the Global Markets Advisory Committee, also known as GMAC.  Quite the opposite.  I am very passionate about matters involving our markets globally and I continue to be honored and committed to the work and efforts of the GMAC.

At first glance, it may seem that these two advisory committees are vastly different.  One focused on international financial market structure and operations, and the other on our US-based farm economy and the use of our traditional commodity markets.  However, I see a great deal of synergy between the AAC and GMAC.  And hopefully after our presentations today from Owain Johnson and Fred Seamon from the CME Group and FIA’s Will Acworth, we will all have a better appreciation of that connection as it relates specifically to the global landscape of agricultural commodity markets.  I hope that looking at ag commodity markets with a global perspective will help to inform the work of the Committee in maintaining competitive and efficient agricultural futures markets here in the US.

Likewise, the US agricultural sector supports not only our domestic consumers, but feeds and clothe the entire world and we recently witness challenges to that task during the pandemic.  So today we have another panel to provide a glance into how some of the most heavily impacted agricultural sectors managed the uncertainties and significant supply chain disruptions during the pandemic.  We’ll hear from risk management leaders in dairy, pork and cotton—all industries that contribute heavily to the US farm economy, but with supply chains that have a significant global footprint.  I am very grateful to have Christian Edmiston, Senior Director of Sourcing and Risk Management from Land O’Lakes, David Rossen Global Hedging Manager for Cotton at Louis Dreyfus Company, and Dhamu Thamodaran, former Executive Vice President, Chief Strategy Officer and Chief Commodity Hedging Officer for Smithfield Foods on the panel to share their insight with us today.  I believe this conversation will be the kick off to more discussions on how our commodity futures markets contribute to securing those goods that are so important to consumers today and always, but especially as we recover from the pandemic.

Last, but certainly not least, I am looking forward to hearing the full AAC discuss and consider the final recommendations offered by the Subcommittee to Evaluate Commission Policy with Respect to Implementation of Amendments to Enumerated Agricultural Futures Contracts with Open Interest—much more easily spoken and commonly known as the Ag-OI Subcommittee.  This Subcommittee reflects months of hard work between various stakeholders to come up with a consensus-based approach to managing open interest when making changes to ag commodity contracts.  I sincerely appreciate all of the time and effort members of this subcommittee put into the report.  I know there were members who literally had to pull over their tractors in the field to jump on video conferences to ensure the report came together in a timely fashion.  A special thank you to Professor Joe Janzen from the University of Illinois’ Department of Agricultural and Consumer Economics who served as the chair for this subcommittee.  Professor Janzen was the steady hand and driving force in completing the report and he did this work while being a full-time professor.  I would also note that Joe and his wife became parents again in the middle of this undertaking.  Understanding how crazy life can be with a newborn in the house, I cannot thank Professor Janzen enough for his dedication to this project and the final work product.

Given our full and fascinating agenda, I do not want to use up any more of our time today with my introductory remarks, but I do want to offer a special thanks to Summer Mersinger and Christa Lachenmayr for their tremendous efforts in organizing the Committee and Subcommittee, thanks to our speakers and presenters for sharing their valuable time with us, thanks to the subcommittee for their hard work on the report and finally thanks to the entire AAC for welcoming me as your sponsor.  Even though this may be a temporary arrangement, I am thrilled to have the opportunity.

With that, I will turn it over to Summer to facilitate opening remarks from my fellow commissioners.

Good morning, and thank you for the opportunity to address this joint forum of FIA and SIFMA AMG.[1]  Today I will provide an update on several regulatory issues of interest to this group, as well as my views on the role of the CFTC in addressing climate change, and my concerns regarding the rise of decentralized financial markets.

Last year, the CFTC completed the rulemakings mandated by the Dodd-Frank Act.  The CFTC’s Dodd-Frank rulemakings began over a decade ago—as Billy Joel said, “when I wore a younger man’s clothes.”  The completion of these rulemakings reflected the leadership of four CFTC Chairs, ten Commissioners, hundreds of CFTC staff, and thousands of pages of comments from market participants and members of the public.  As a result of these rulemakings and their implementation by the financial industry, our financial system is stronger and more resilient than ever before.  Customers and other market participants are better protected.

As evidence of this strength, the derivative markets generally performed well during the Covid pandemic, enabling firms to hedge their risks and discover prices despite extraordinary stresses to the economy and financial markets.  It was not that long ago that the failure of a single firm, such as Long-Term Capital Management or Lehman Brothers, threatened the entire financial system.  During the pandemic, entire sectors of the economy ground to a halt and volatility rose to historic levels, yet the derivative markets continued to perform largely as designed and without disruption.

We must not become complacent, however.  We cannot rest on our recent accomplishments.  History never repeats itself, and as you all know well and inform your customers, the past is not a guarantee of what may happen in the future.  The CFTC must continue to monitor our markets for emerging risks, and we must continue to aggressively enforce the requirements of the Commodity Exchange Act (CEA) and our regulations.

We also must continue to evaluate the effectiveness of our existing regulations, to ensure they are working as intended and are adequate to address new risks.  The CFTC has made significant investments in systems to receive and analyze industry data, and we should continue to build these capabilities.  We must always draft our regulations, and evaluate their effectiveness, using the best available data.

Within this context, I’d like to turn to several of the specific regulatory issues that FIA and SIFMA AMG have urged the CFTC to address.  These include the thresholds for the real-time reporting of block trades, central counterparty transparency and governance, and the adequacy of current initial margin requirements.

Block trade reporting thresholds.  Last fall, the CFTC issued a final rule to improve the real-time reporting of block trades.[2]  As part of this rulemaking the Commission increased the block size threshold that determines which swaps are subject to the real-time reporting timeframes.  The higher the threshold, the more swaps are subject to these real-time reporting timeframes.  The Commission determined that larger block sizes appropriately balanced the statutory objectives of enhancing price discovery, not disclosing the business transactions and market positions of any person, preserving market liquidity, and providing appropriate time delays for block transactions.

Market participants, including the “buy side,” have expressed concern that the timeframes for reporting the new larger blocks may negatively impact liquidity for some of these swaps and increase costs without commensurate benefits.[3]  As I indicated at the time the Commission approved these new thresholds, I support evaluation and refinement of the block trade reporting rules, as appropriate, based upon market data and analyses.[4]  I invite market participants to provide the Commission with any updated analyses or data regarding the effect of the larger block sizes on market liquidity, so that we may ensure that the block sizes are appropriately calibrated to promote price discovery and do not harm market liquidity.  Compliance with the new rule is not required until May 25, 2022.  We can use this time to consider new information and market data and make any adjustments that may be appropriate.

Central counterparty governance.  The mandatory clearing of standardized derivatives is one of the pillars of the Dodd-Frank reforms.  The Dodd-Frank reforms and other measures adopted by the derivative clearing organizations (DCOs) have strengthened their resilience in the years since the 2008 financial crisis, and the clearing system performed well during the stresses of the past year.  However, the increased reliance on clearing has focused attention on the performance of central counterparties (CCPs) during periods of financial stress.  Clearing members and their customers have urged a number of measures to further improve the governance, transparency, and resilience of CCPs in periods of extreme stress.[5]

In a financial crisis, confidence in the financial system is critical to maintaining the stability of the system.  Market participants must have confidence in the integrity of the CCPs and their governance.  Transparency into the CCP’s rules and processes, particularly in times of stress, is vital to this confidence.  The CFTC should continue to work with clearing members, counterparties, and DCOs to ensure there is an appropriate level of transparency into DCO rules, processes, and procedures; that DCOs have appropriate governance structures to manage these risks; and that there are appropriate procedures for equitably allocating losses during extreme events.

Procyclicality of initial margin requirements.  CCPs generally performed as designed during the extreme market volatility precipitated by the Covid pandemic.  However, FIA and others have expressed concern that the increase in margin requirements at derivative clearinghouses during the initial phase of the pandemic indicated that the current clearinghouse margin models may be overly procyclical by increasing the demands for highly liquid assets in times of financial stress, and that such procyclicality could pose significant systemic risks.[6]  CCPs, on the other hand, have disputed this assertion of procyclicality.[7]

Last week the CFTC staff issued a preliminary report entitled “Interim Staff Report on Cleared Derivatives Markets: March – April 2020.”[8]  The CFTC staff stated that its initial analysis of changes in aggregate initial margin flows did not provide “conclusive evidence that these models and associated practices were excessively procyclical,” but also that it will “continue to study the performance of CCP margin models to address these questions.”[9]

The adequacy of initial margin levels is not an issue for the CFTC alone. The CFTC’s initial margin requirements were developed to be consistent with those of other domestic regulators and international standards.  The CFTC should continue to review the FIA and ISDA analyses in light of its ongoing staff analysis, together with the reviews conducted by other national and international organizations, and analyses conducted by the CCPs and other market participants.  It should engage with stakeholders and consult with other regulators to determine whether regulatory action is appropriate to address procyclicality concerns.

I would now like to address several emerging challenges facing the CFTC and indeed, the entire global financial system.

Climate Change

The dangers to our financial markets from climate change are clear and present.  Last fall, the Climate Subcommittee (Subcommittee) of the CFTC’s Market Risk Advisory Committee (MRAC) released a landmark study warning that climate change poses a major risk to the U.S. financial system.[10]  More recently, Secretary of the Treasury Janet Yellen stated that climate change poses an “existential threat” to financial markets.[11]

Derivatives markets can play an important role in facilitating the transition to a low-carbon economy, but the CFTC will need to be vigilant to ensure that climate change does not threaten the stability of these markets.  The Subcommittee’s specific recommendations to the CFTC are a good starting point to address the climate-related risks affecting derivatives markets and the financial system more broadly.[12]  This work will require collaboration with other domestic and international regulators, as well as consultation with affected stakeholders.

In my view, there are three principal ways in which the CFTC, as a financial market regulator, should support the transition to a carbon-neutral economy.  First, the Commission is charged with protecting the integrity of the markets it regulates, and this includes markets for carbon derivatives, among other climate-related derivatives.  To do this effectively, the CFTC must be aware of how the various primary, secondary, and derivative carbon markets are interacting and how companies use these markets to meet their compliance obligations, manage risks, and discover prices.  Second, the CFTC should work with exchanges and market participants on the development and approval of new products that are intended to help companies hedge their climate-related risks.  And third, the CFTC should ensure appropriate management and disclosure of climate-related risks.[13]

Last week, the CFTC Energy and Environmental Markets Advisory Committee (EEMAC), which I sponsor, met to explore the role of carbon markets in the transition to a low-carbon economy.  The discussion of existing carbon markets and the future expansion of those markets indicates that carbon trading may provide a significant new asset class for climate-related risk management and investment purposes.

The success of a market-based mechanism for carbon reduction will depend upon timely, transparent, and accurate information about prices in the primary, secondary, and derivative carbon markets.  The CFTC should work with other regulators and stakeholders to ensure the effectiveness, and protect the integrity of, these inter-related markets.  This effort should include collaboration on the development of standards for products traded across these markets.  I encourage interested persons to view a recording of the EEMAC carbon markets meeting and the accompanying presentations available on the CFTC website and engage with the Commission on these issues.[14]

Decentralized Finance

Decentralized finance—or “DeFi”—is a rapidly-expanding technology related to cryptocurrency and the blockchain.  As of January 2021, approximately $20.5 billion in cryptocurrency was invested in DeFi, compared to approximately $1 billion at the beginning of 2020.[15]  According to the Financial Times, in 2021, private investors have already backed 72 DeFi companies.[16]  As the saying goes, “A billion here, a billion there, pretty soon, you’re talking real money.”  Given the explosive growth of this sector, federal regulators should become familiar with this new technology and its potential uses and be prepared to protect the public against misuse.

Wikipedia describes DeFi as follows:

[DeFi] is a blockchain-based form of finance that does not rely on central financial intermediaries such as brokerages, exchanges, or banks to offer traditional financial instruments, and instead utilizes smart contracts on blockchains, the most common being Ethereum.  DeFi platforms allow people to lend or borrow funds from others, speculate on price movements on a range of assets using derivatives, trade cryptocurrencies, insure against risks, and earn interest on savings-like accounts.[17] 

If you type “DeFi” into Google search, a top link is to a Coindesk article, “What is DeFi?”  The subtitle states, “DeFi is short for ‘decentralized finance,’ an umbrella term for a variety of financial applications in cryptocurrency or blockchain geared toward disrupting financial intermediaries.”[18]

A threshold question is whether the public will benefit from disrupting the current financial system that relies extensively on financial intermediaries.  Supporters of DeFi argue that cutting out intermediaries offers consumers more control over their investments.[19]  But intermediaries such as banks, exchanges, futures commission merchants, payment clearing facilities, and asset managers—such as many of you at this conference—have developed over the past two or three hundred years of modern banking and finance to reliably provide critical financial services to support the financial markets and the investing public.  Intermediaries provide information, analyses, and advice to the public seeking access to financial markets.  Intermediaries often have fiduciary or other legal duties to act in the best interests of their customers.  They provide liquidity to the markets and support the stability of the financial system in times of stress.  They provide custody of assets and safeguards for investments.  They are responsible for preventing money-laundering through financial markets.  Regulated and licensed intermediaries must meet established standards of conduct and can be held legally responsible for failing to meet those standards of conduct.  Intermediaries can be held accountable when things go wrong.

Today, the United States has the most effective and efficient capital formation and risk management markets in the world.  When people the world over want to invest their money or manage their risks in safe ways, they come to the U.S. financial system.  One of the key reasons our financial system is so strong is the legal protections that investors enjoy when they invest their money in U.S. markets, most often through intermediaries.  We have a system in which intermediaries are legally accountable for protecting customer funds.  In many instances, such as in the clearing system, if a counterparty fails to perform, an intermediary will make the customer whole.

In a pure “peer-to-peer” DeFi system, none of these benefits or protections exist.  There is no intermediary to monitor markets for fraud and manipulation, prevent money laundering, safeguard deposited funds, ensure counterparty performance, or make customers whole when processes fail.  A system without intermediaries is a Hobbesian marketplace with each person looking out for themselves.  Caveat emptor—“let the buyer beware.”

Not only do I think that unlicensed DeFi markets for derivative instruments are a bad idea, I also do not see how they are legal under the CEA.  The CEA requires futures contracts to be traded on a designated contract market (DCM) licensed and regulated by the CFTC.[20]  The CEA also provides that it is unlawful for any person other than an eligible contract participant to enter into a swap unless the swap is entered into on, or subject to, the rules of a DCM.[21]  The CEA requires any facility that provides for the trading or processing of swaps to be registered as a DCM or a swap execution facility (SEF).[22]  DeFi markets, platforms, or websites are not registered as DCMs or SEFs.  The CEA does not contain any exception from registration for digital currencies, blockchains, or “smart contracts.”

Apart from the legality issue, in my view it is untenable to allow an unregulated, unlicensed derivatives market to compete, side-by-side, with a fully regulated and licensed derivatives market.  In addition to the absence of market safeguards and customer protections in the unregulated market, it is unfair to impose the obligations, restrictions, and costs of regulation upon some market participants while permitting their unregulated competitors to operate wholly free of such obligations, restrictions, and costs.  Experience with the development of the “shadow banking” system shows that competition between regulated and unregulated entities in the same market can result in the regulated entities assuming either more risks in order to generate the higher yields necessary to compete with the unregulated competition, or seeking less regulation for themselves to level the playing field.[23]  Either of these reactions can introduce significant risks into the financial system.  For all these reasons, we should not permit DeFi to become an unregulated shadow financial market in direct competition with regulated markets.  The CFTC, together with other regulators, need to focus more attention to this growing area of concern and address regulatory violations appropriately.

Thank you again for this opportunity to discuss these issues of mutual importance.