Appendix 4. Industry Trends and CFTC Resource Requirements

Industry Trend 2: Increased Number of Market Participants is Driving Innovation in Derivatives Trading

More entities, more markets and more products (including more complex products) are subject to CFTC regulation than ever before. The industry is responding quickly to the competitive opportunities engendered by the shifting regulatory landscape—the introduction of futures contracts by DCMs that are economically equivalent to standardized swaps is one such example.  Innovation in the industry, which is likely to increase in pace with the addition of new entrants (SEFs), will continue to add complexity in ways currently unanticipated (for example, the Commission is seeing new methods for executing transactions that were not proposed in previous years).  While these changes will impact all of the CFTC mission activities, the near-term impacts will fall most heavily on the registration, product review, examinations and enforcement mission activities.

Registration

• The Commission performs a thorough review of the registration applications of all entities seeking to be registered as DCMs and (soon) SEFs.  Multi-disciplinary review teams of attorneys, industry economists, trade practice analysts, data analysts, and risk analysts are needed to ensure that the Commission undertakes a thorough analysis of such applications to ensure compliance with the applicable statutory core principles and Commission regulations.
• While CFTC anticipates that the "surge" in new trading registrants resulting from Dodd-Frank reforms will be substantively complete by FY 2014, continued innovation will require continued evaluation of registrants (and the rules they implement) for compliance with the statutorily-mandated core principles. The Commission must ensure it has subject matter experts who can respond to rapid changes in the marketplace.

Product Review

• The Commission conducts due diligence reviews of new contract filings to ensure that the contracts are not readily susceptible to manipulation or price distortion, and that the contracts are subject to appropriate position limits or position accountability. The Commission also analyzes amendments to contract terms and conditions to ensure that the amendments do not render the contracts readily susceptible to manipulation and do not otherwise affect the value of existing positions. Proliferation of products by industry and the inherently greater complexity of swaps contracts will demand new subject matter experts to keep pace with industry's innovations.
• In addition to reviewing contracts prior to trade, the Commission will need expanded resources to:
  • Evaluate transaction and pricing data collected by SDRs to determine appropriate block trade threshold levels that registered SEFs, DCMs, and market participants may use to delay public reporting of swap transaction data.
  • Perform mandatory clearing determinations, and assessing swaps presented to DCOs to determine their acceptability for clearing.

Examinations

• Examinations are formal, structured assessments of regulated entities' operations or oversight programs to assess on-going compliance with statutory and regulatory mandates.  Regular examinations are the most effective method of ensuring that the entities' are complying with the core principles established in the CEA (as amended).  Reviews of DCMs and SEFs (and SDRs) focus on the structural sufficiency of their self-regulatory and compliance programs.
• Examinations are performed by multi-disciplinary teams of attorneys, industry economists, trade practice analysts, risk analysts, data analysts, and accountants depending on the scope.  The Commission anticipates performing routine annual examinations of the largest DCMs and SEFs, with reviews of the less risky entities every two to three years as resources are available.  The ability to perform the biennial or triennial reviews will depend, in part, on the number of "for cause" examinations the Commission must undertake in a given time.
• Based upon its current understanding, the Commission projects that the number of DCMs and SEFs will grow from 18 at the end of FY 2012 to approximately 30 during FY 2014.  Adequate coverage for routine and "for cause" examinations of the trading entities is essential to protect market participants.

Enforcement

• The Commission has the authority to: 1) Shut down fraudulent operations and immediately preserve customer assets through asset freeze and receivership orders, 2) Terminate manipulative and disruptive schemes, 3) Bar defendants from trading and being registered in its markets, and 4) Seek restitution, disgorgement and monetary penalties up to the greater of three times the amount of a defendant's gain or a fixed statutory amount.  Commensurate with the Commission's experience with the RFEDs, registration-related enforcement actions are likely to be the "first wave" as new entities fail to comply with the new regulations for swap dealers and major swap participants.  Given the large number of new entities (swap dealers, MSPs, and soon SEFs), additional resources will be needed to effectively police the new regulatory space.
• Innovative products and practices within the industry, coupled with new anti-manipulation authority in the swaps and futures markets and the statutory prohibition on disruptive trading, the Commission anticipates more time-intensive and inherently complex investigations.  In order to investigate and litigate market-wide violations and those less complex but equally important retail fraud cases, the number of specialized enforcement experts must increase.
• The Commission also foresees an increase in multi-jurisdictional and multi-national investigations given the global nature of the swaps marketplace and the challenges associated with substitute compliance. The Commission is also experiencing an increase in international enforcement investigations in its traditional markets (the most significant being the international benchmark rate rigging cases).  These cases are inherently more resource intensive due to increased costs for travel, translations, and coordination.