Welcome to Kansas City, Missouri. First, I would like to thank our hosts at the University of Missouri-Kansas City. I am also glad that we could have this meeting in conjunction with AgCon, and I want to thank the Chairman for continuing the tradition of holding AgCon here in the Kansas City area. I am looking forward to the conference and I hope that you all can stay for it as well.

Sinclair Lewis, the first American novelist to win the Nobel Prize in Literature, observed that every state has its “historical treasures, small, precious, and mislaid.”[1] The same may be said about this city which boldly calls itself, “Paris on the Plains.” Here in Kansas City, Missouri, the life and art of Thomas Hart Benton is one of those mislaid treasures.

In 1934, Thomas Hart Benton became the first American painter to appear on the cover of Time Magazine as the leading proponent of a new style of painting called American Regionalism.[2] Today, you might not know who Benton was, but if you don’t, you surely know his regionalist colleague Grant Wood and Wood’s famous painting, American Gothic.[3]

In the 1930s, Grant Wood from Iowa, John Steuart Curry from Kansas, and Thomas Hart Benton from Missouri made up what was called the “American Regionalist Triumvirate.”[4] They all studied and lived for periods of time outside the Midwest, but as Wood said in defense of their travels, “I had to go to France to appreciate Iowa.”[5] They fought nationally and internationally for the idea that in an art world dominated by Paris and New York, there was a place for artists who lived, worked, and depicted American subjects like Wood’s pitchfork-holding Iowa farmer and his daughter.[6]

Among our financial regulatory peers, I like to think of the CFTC as taking a similar path. In an industry dominated by large cities and financial concerns, the CFTC was created to protect and give a voice to people who live in places like Iowa, Kansas, and Missouri (not to mention my home State of South Dakota) in major financial hubs and among global regulators.

Like the CFTC, Benton also straddled several different worlds. He was born in the small town of Neosho, Missouri, in 1889, but after his father was elected to Congress, he spent his early years moving back and forth between Missouri and Washington, DC, before being placed in a military academy in anticipation of a future career in politics.[7] After disappointing his family by becoming an artist instead of a politician, Benton studied in Chicago and Paris before achieving his long-desired success in New York.[8]

Then in 1935, he did something truly radical. He left New York for Missouri and returned home to teach at the Kansas City Art Institute where he remained until his death in 1975.[9]

Thomas Hart Benton’s art focused on the everyday people and moments in life across America, a focus we are striving to achieve through the work of this advisory committee as well.

One of our panels will examine the current state of the crude oil derivatives markets.

Painting in the 1920s and 30s, oil was a subject that fascinated Benton. In 1928, he traveled to Borger, Texas, to see the spectacle of a town and industry quickly cropping up around the discovery of crude oil.[10] From that trip came his painting, Boomtown, which in his memoir, An Artist in America, Benton described by saying: “Out on the open plain beyond the town a great thick column of black smoke rose as in a volcanic eruption from the earth to the middle of the sky.”[11]

Today we will also learn about the construction of our electric grid and the costs of large-scale electrification, which will further inform our work on derivatives markets for electric power.

Electric power was also a subject of interest for Benton. In his mural Instruments of Power, which is currently on display at the Metropolitan Museum of Art, he depicts everything from power plants and hydroelectric dams to high tension wires and gas turbines.[12]

Also, after EEMAC’s discussion of the proposed Basel III Endgame at our last meeting, a Committee member requested that we devote a panel to some different views on the implementation of Basel III. To that end, we have a panel that discusses the Endgame, but from a different perspective that is more supportive of the Federal Reserve’s current proposal. As I have said previously, we should not shy away from discussing difficult issues where viewpoints differ. We are all better informed when we understand and appreciate all sides of an issue.

Sadly, few painters have taken the time to depict the intricacies of bank capital standards, and even Thomas Hart Benton shied away from the subject. That said, when his father served in Congress, he was a populist in the tradition of William Jennings Bryan and an ardent opponent of large banks and industrialists, so he may have been sympathetic to our Endgame panelist’s point of view.[13]

In addition, we will receive further progress reports on our subcommittees from Professor Ian Lange, the Chair of EEMAC’s Role of Metals Markets in Transitional Energy Subcommittee and Professor Timothy Fitzgerald, the Chair of EEMAC’s Physical Energy Infrastructure Subcommittee.

Before we get started, I also want to recognize EEMAC’s own triumvirate of dedicated staff – Secretary Lauren Fulks and Assistant Secretaries, Lillian Cardona and JonMarc Buffa – as well as EEMAC Chair, Dena Wiggins and to recognize our newest Associate Member, Annette Hugh from S&P Global Commodity Insights.

Thank you to our members, associate members, and guests for attending today. I look forward to another informative meeting.

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[1] Lewis, Sinclair. (1949). The God-Seeker. Random House.

[2] TIME Magazine. 24 Dec. 1934, https://content.time.com/time/covers/0,16641,19341.

[3] Wood, Grant. American Gothic 1930, Art Institute of Chicago, Chicago, Illinois.

[4] Watson, Keri. “Cultivating Citizens: The Regionalist Work of Art in the New Deal Era.” Panorama, Journal of the Association of Historians of American Art. Fall 2019.

[5] Semuels, Alana. “At home in a piece of history.” Los Angeles Times, April 30, 2012.

[6] Letter from Wood, Grant to Sudduth, Nellie. March 21, 1941.

[7] Wolff, Justin. (2012). Thomas Hart Benton: A Life. Farrar, Straus and Giroux.

[8] Id.

[9] Id.

[10] Benton, Thomas Hart. Boomtown, 1928. Memorial Art Gallery, Rochester, NY.

[11] Benton, Thomas Hart. (1951). An Artist in America. University of Kansas City Press.

[12] Benton, Thomas Hart. Instruments of Power, 1931. Metropolitan Museum of Art, New York, NY.

[13] Wolff, Justin. (2012). Thomas Hart Benton: A Life. Farrar, Straus and Giroux.

Introduction

Good morning, I am honored to welcome you to the first Market Risk Advisory Committee (MRAC) meeting of 2024. At this meeting, the MRAC will introduce formal recommendations, reports, and presentations with insightful guidance to improve the integrity and stability of our markets. These include an unprecedented analysis of the state of intermediated clearing markets and the significant reduction in the number of FCMs providing trade execution services over two decades. The Market Structure Subcommittee will also examine the U.S. Treasury cash-futures basis trade and risk management implications. The Future of Finance Subcommittee’s AI and Risk Management workstream will share it’s working plan, outlining initial observations and potential suggestions for navigating the complex landscape of AI integration in financial markets.

Today, we continue the long tradition of this Committee’s engagement with the Commission, its valuable insight into the concerns that shape the stability and integrity of global derivatives markets, and its collaboration toward developing ways that the industry and the Commission can prepare for and mitigate the most critical risks facing our markets today. The work of this Committee influences industry standards and best practices and provides thought leadership on many of the most important issues that will impact citizens and businesses in every corner of the world by shaping the direction of the development of markets.

CCP Risk and Governance

The Central Counterparty Risk and Governance Subcommittee, co-chaired by Alessandro Cocco, Vice President in the Financial Markets Group at the Federal Reserve Bank of Chicago, on detail as Senior Policy Advisor at the Department of Treasury and Alicia Crighton, Chair of the Futures Industry Association Board of Directors will share a presentation, a report, and recommendations on behalf of the Recovery & Resolution workstream. The recommendations reflect the collective work of the Subcommittee, whose members include diverse stakeholders, including representatives from derivatives clearing organizations (“DCOs”), clearing members, end-users, public interest advocates and academics.

As the report notes:

CCPs are fundamental market structures in derivatives markets and gained further prominence following the post-2008 financial crisis reforms. The G20 nations committed to have all standardized OTC derivatives, where appropriate, cleared through CCPs by 2012.[1] In 2010, the Dodd-Frank Act reformed the legislative framework for U.S. CCPs.[2] Title VII of the Dodd-Frank Act sets core principles for DCOs.[3] Lawmakers addressed CCP resilience by requiring CCPs to have adequate financial, operational, and managerial resources to discharge their responsibilities and to have in place appropriate risk management tools and procedures. The Dodd-Frank Act also created a novel type of regulated entity, a systemically important DCO. Title VIII of the Dodd-Frank Act, in fact, gave the Financial Stability Oversight Council (“FSOC”) the authority to designate as systemically important those clearing entities (e.g., DCOs) that “are or are likely to become, systemically important”.[4] Systemically important DCOs (“SIDCOs”) are subject to enhanced prudential and risk management standards and procedures.[5] In addition, Title VIII introduced an enhanced supervisory regime for SIDCOs that imposed on the CFTC the obligation to conduct annual examinations of these firms.[6]

In addition to the domestic reforms adopted under the Dodd-Frank Act, since 2010, international standard-setting bodies have been very active in adopting principles, guidance, and standards to support and inform national policymakers in the regulation of CCPs. The Committee on Payments and Market Infrastructures (“CPMI”), the Committee on Payment and Settlement Systems (“CPSS”) and the International Organization of Securities Commissions (“IOSCO”) (together, “CPMI-IOSCO” and “CPSS-IOSCO”, respectively), and the Financial Stability Board (the “FSB”) have published extensive reports on CCP resilience, recovery, and resolution. In 2012, CPSS-IOSCO published the Principles for Financial Market Infrastructures (“PFMI”),[7] a set of 24 principles that should apply to financial market infrastructures, including CCPs, with the ultimate goal of enhancing their safety and efficiency.

Many of the PFMIs address the resilience of CCPs and their capacity to manage financial risk. The PFMI approach to CCP resilience builds on four aspects, developed in an ad hoc additional guidance report:[8] (1) governance arrangements of CCPs;[9] (2) comprehensive risk management frameworks;[10] (3) financial resources allocated to loss absorption;[11] and (4) stress testing for both credit and liquidity exposures.[12] CPMI-IOSCO acknowledges that it is vital for CCPs to have sufficient resilience to withstand clearing member failures and other stress events—and this is even more critical in the current market landscape, characterized by the mandatory central clearing of certain standardized OTC derivatives. To complement the resilience guidelines, CPMI-IOSCO also published a report on the recovery of CCPs.[13] The recommendations on recovery focus on CCPs’ adoption of transparent and effective recovery plans, where the interests of all affected stakeholders are considered, and that contain different recovery tools appropriate to meet different recovery objectives.

At the international level, the FSB has been quite active as well. In 2017, the FSB published guidelines for CCP resolution and resolution planning.[14] In March 2022, in the aftermath of the Covid-19 pandemic, the FSB, together with the CPMI and IOSCO, commenced new work to assess CCP financial resources in the context of recovery and resolution.[15] The FSB acknowledged the increased systemic importance of CCPs in markets that embraced central clearing and evaluated the operation of recovery mechanisms. However, the FSB concluded by admitting the necessity of additional input from stakeholders on the sufficiency of the existing toolkit for CCP resolution, in particular on non-default loss scenarios. The FSB further noted the need for potential alternative financial resources and tools for CCP resolution, along with an analysis of the costs and benefits (including effectiveness and impact on incentives) of such alternatives. In September 2023, the FSB launched a public consultation on financial resources and tools for CCPs.[16] The consultation, that ended in November 2023, proposed a regulatory toolbox approach as a global standard for CCPs resolution. “In this approach, home resolution authorities for systemically important CCPs should have access to a set of resolution-specific resources and tools to meet the objectives for financial resources to support resolution, in addition to the use of recovery[17]

The FSB is working on finalizing its report, taking into account comments received during the consultation period. As discussed above, since 2008, domestic lawmakers and international standard-setting bodies have established regulations and standards that have substantially enhanced the resilience of CCPs. Such resilience has been demonstrated by the successful performance of CCPs during extreme stress events, including a historic global pandemic. Attention has more recently turned toward CCP recovery and wind-down as international standard standard-setting bodies issue various forms of guidance.

Since 2013, SIDCOs and Subpart C DCOs have been subject to the requirement to develop and submit recovery and resolution plans. In July 2016, the staff of the CFTC’s Division of Clearing and Risk (“DCR”) issued an advisory letter (“guidance”) regarding the content of a SIDCO’s and Subpart C DCO’s recovery and orderly wind-down plans. In response to CFTC regulations and such guidance, SIDCOs and Subpart C DCOs spent considerable time, in collaboration with DCR, analyzing scenarios that could prevent a DCO from being able to meet its obligations and to provide its critical operations and services; developing and implementing recovery tools, wind-down scenarios and options; analyzing interconnections and interdependencies; evaluating agreements to be maintained during recovery and wind-down; reviewing financial resources, governance arrangements, and notification policies; establishing a framework for regular policy updates; and conducting testing. This analysis resulted in significant revisions to DCO policies and practices to address recovery and wind-down.

SIDCOs and Subpart C DCOs have spent considerable time responding to guidance and have taken material steps to reduce systemic risk within the financial system. The Commission is now proposing to codify some of that guidance in the proposed rule. The Commission believes that most, if not all, of the proposals are already incorporated into the plans submitted by SIDCOs and Subpart C DCOs. But the proposed requirements will be new for other DCOs. Informal guidance and rules do not have the same weight, as guidance is non-binding, nor is guidance subject to public consultation. Moreover, the rule applies to all DCOs whereas the guidance applies to SIDCOs and Subpart C DCOs.

Pursuant to Title VII and VIII of the Dodd-Frank Act, and taking into account the international standards set by CPMI-IOSCO and the FSB, the CFTC adopted a proposed rule for DCOs recovery and orderly wind-down plans. The CFTC is “proposing, among other things: (1) for SIDCOs and Subpart C DCOs, that they should incorporate certain subjects and analyses in their viable plans for recovery and orderly wind-down; and (2) for all other DCOs, that they should maintain viable plans for orderly wind-down that incorporate substantially similar subjects and analyses as the proposed requirements for SIDCOs and Subpart C DCOs.”[18]

The report includes a number of important recommendations, which, if adopted by MRAC, can be used by the Commission to inform the development of the final rule on DCO resilience, recovery, and orderly wind-down. The recommendations include:

First, implementation of supervisory stress tests:

• Commission staff should adopt and implement supervisory stress testing of credit and liquidity risks for all DCOs.
• Commission staff should adopt and implement operational and other non-default risk stress testing, leveraging industry exercises covering these risks, where appropriate.
• Commission staff should include reverse stress tests in their supervisory stress tests.
• The results of the supervisory stress tests should be made available to the public, in a level of detail determined to be appropriate by Commission staff, within a reasonable time after the stress tests have been concluded.
• Subcommittee members representing end users, FCMs and academia believe these stress test should be required to take place at least annually. Subcommittee members representing DCOs do not believe that the frequency of reverse stress tests should be annual but rather that the frequency of reverse stress tests should be determined by Commission staff.

Second, regarding recovery scenarios and analysis:

• In the final rule, the text of CFTC Regulation 39.39(c)(2) should be amended to require that DCOs conduct scenario analysis that includes extreme but plausible scenarios that could trigger recovery or wind down.
• The final rule should require that SIDCOs include in their plans an assessment of (1) the financial resources and tools available in the event of recovery and wind-down, and (2) how they would address the scenarios identified that could trigger recovery and wind-down.

Third, regarding non-default losses:

• The Commission should retain the proposal to require a DCO that is neither a SIDCO nor a Subpart C DCO to maintain and submit to the Commission viable plans for orderly wind-down necessitated by default losses as well as NDLs.
• The Commission should retain the proposed definition of NDL as applied to all DCOs.

Fourth, regarding the provision of data for resolution planning:

• Subcommittee members believe that the Commission and FDIC should develop an inter-agency task force to discuss the sharing of information for resolution planning purposes. However, Subcommittee members representing DCOs believe that coordination already occurs between the FDIC and CFTC with respect to SIDCOs, that an interagency task force is not necessary, and that coordination can and will continue to occur through existing channels.

And, finally, regarding challenges to porting of customer positions and collateral during resolution:

• The Commission should develop an inter-agency task force, which should include the National Futures Association (NFA) to discuss and address impediments to the porting of customer position and collateral in the context of a DCO resolution and clearing member default.

Throughout the years, I have maintained an unwavering commitment to researching and proposing regulatory solutions for AI in financial markets, driven by a steadfast dedication to ensure integrity and stability in this rapidly evolving landscape. Five years ago, I began to convene and participate in convenings of AI developers, adopters, academics, government and industry researchers, regulators, and public interest organizations.

In 2020, a co-author and I received invitations to publish two books, one of which examines the ethical implications of AI across diverse sectors of our society. In two recent speeches, a speech last month before the New York Bar Association and a speech at Japanese Fintech Week in Tokyo, Japan, I have advocated for the CFTC to begin to identify best practices for integrating AI in our markets. Last week while in South Africa, I offered remarks at the South African Reserve Bank’s Fintech Summit about the regulation of novel financial products as well as the rapid development and deployment of generative AI and its impact on financial markets.

While the use of AI in financial markets may hold the potential for substantial benefits, such use may also introduce unprecedented risks concerning market integrity, customer protection, governance, data privacy, bias, and cyber threats.[19] The derivatives market provides many potential applications for AI. Accordingly, given the Commission’s mandate to promote responsible innovation while safeguarding market integrity, effective risk management is essential to address these concerns.

In January of this year, the Commission issued a request for comment (RFC) to “to assess the benefits associated with the use of AI in CFTC-regulated markets, to inform staff’s supervisory oversight and to evaluate the need for any future guidance and rulemakings.”[20] The RFC solicits responses to 20 questions that cover a wide range of topics, including the definition of AI, general and specific use-cases, market manipulation, and consumer protection.

Three weeks ago, the Future of Finance Subcommittee held a public meeting on March 15, 2024, which focused on the use of artificial intelligence (“AI”) in CFTC-regulated markets. This meeting supports work initiated at the MRAC meetings over nearly two years. The MRAC meetings have long served as an effective venue for exchanging diverse viewpoints on critical issues facing futures and derivatives markets. Dating back to the first MRAC meeting of 2022, the panel recognized the transformative innovation in the market of digital assets, where broad collaboration and information sharing were deemed to be essential for financial institutions to mitigate significant risks associated with digital assets.[21]

In 2017, the Financial Stability Board (FSB) issued a report on market developments related to AI and the financial stability implications. The Financial Stability Oversight Council (FSOC) and the Financial Industry Regulatory Authority (FINRA) have published recommendations that offer guidelines for governing AI. More recently, the International Organization of Securities Commissions issued a report following a consultation on the use of AI by market intermediaries. These efforts include a number of common threads, suggesting that, while many questions remain, there are important areas of consensus regarding the right approach to AI in financial markets. A few of these commonalities include:

• A focus on the governance of AI models. FSOC “recommends monitoring the rapid developments in AI, including generative AI, to ensure that oversight structures keep up with or stay ahead of emerging risks to the financial system while facilitating efficiency and innovation.”[22] Similarly, IOSCO has recommended that“[r]egulators should consider requiring firms to have designated senior management responsible for the oversight of the development, testing, deployment, monitoring and controls of AI and [machine learning]. This includes a documented internal governance framework, with clear lines of accountability.”[23]
  
  CFTC regulations, for example, introduce important governance obligations for registered market participants. Designated Clearing Organizations must establish a Risk Management Committee “comprised of clearing members and customers of clearing members on matters that could materially affect the risk profile of the DCO” and Risk Management Working Groups composed of market participants.[24] Enhanced risk management oversight and governance best practices will play an important role in managing the development and implementation of AI.
• Promoting the explainability of AI models. Many AI models are “black-box” models, meaning that it may be difficult, and in some cases impossible, to explain their decision-making processes. Accordingly, FSOC, IOSCO, the FSB, and FINRA have all emphasized the importance of addressing the explainability challenge.[25] As FINRA put it, [i]ncorporating explainability as a key consideration in the model risk management process for AI-based applications.”[26]
• The need for data controls. Data quality, security and privacy are central concerns for regulators as market participants adopt AI models. FSOC recent report notes, “data controls like data quality, suitability, security, privacy, and timeliness are vital to sound AI use.”[27] Similarly, FINRA calls for “data governance efforts” including: “data review for potential bias,” “data source verification,” “data integration,” “data security,” and “data quality benchmarks and metrics.”[28]
• Implementing measures to address bias. In 2019, I testified before Congress and voiced my concerns that AI models trained on incomplete or inaccurate data may engender biased results. Consistent with these concerns voiced by civil rights advocates, the White House AI Bill of Rights emphasizes the need to ensure fairness and guard against bias. In its report, FSOC notes that “specific requirements to prevent discrimination or bias that apply to tools, models, or processes used in consumer compliance also apply to AI. This is an important consideration because without proper design, testing, and controls, AI can lead to disparate outcomes, which may cause direct consumer harm and/or raise consumer compliance risks.”[29]
• Testing and monitoring output. Protecting against bias, promoting explainability, and implementing governance strategies are only possible where models are properly tested and monitored. FSOC, IOSCO, the FSB, and FINRA have each emphasized the importance of testing. FSOC notes the responsibility of financial institutions to “monitor the quality and applicability of AI’s output” the ability of regulators to “help to ensure that they do so.”[30] Similarly, the FSB recognizes the importance of “[a]ssessing AI and machine learning applications for risks, including adherence to any relevant protocols regarding data privacy, conduct risks, and cybersecurity.”[31] Existing approaches to issues like cybersecurity offer some guidance.

Last year, in a statement regarding a proposed cyber resilience rulemaking, I noted the importance of comprehensive regulation in this area, including regulations that capture mission-critical third-party service providers.[32] Model testing and oversight, which concerns cybersecurity, and much more, must similarly be comprehensive in the parties and the issues that it captures.

I have advocated interventions for the Commission to foster responsible use of AI in financial markets. First, I have encouraged greater visibility and transparency regarding our registrants’ use of AI by expanding our annual systems examination questionnaire to incorporate questions that directly inquire about the adoption of AI and related risks. Additionally, I have proposed for the development of a principles-based framework. In consultation with members of this working group of the Market Risk Advisory Committee, I look forward to exploring a principles-based regulatory framework that underscores intelligibility, risk management, compliance, oversight, market responsibility, notice, and explainability.

Further, I have advocated for the Commission to consider introducing heightened penalties for those who intentionally use AI technologies to engage in fraud, market manipulation, or the evasion of our regulations. Finally, the Commission should lead in creating an inter-agency task force focused on information sharing and composed of market and prudential regulators including the CFTC, SEC, Federal Reserve System, OCC, CFPB, FDIC, FHFA, and NCUA. The task force would support the AI Safety Institute in developing guidelines, tools, benchmarks, and best practices for the use and regulation of AI in the financial services industry. It may also provide recommendations to the AI Safety Institute as well as evaluate proposals coming out of the Institute.

In consultation with members of this Subcommittee, I look forward to exploring the ways in which the Commission can ensure that oversight structures keep up with or stay ahead of emerging risks to the financial system while facilitating efficiency and innovation.

Building on our productive dialogue over the last year and a half, we will hear from Gary Kalbaugh, deputy general counsel and director at ING Financial Holdings Corp., who will outline for us the ambitious workplan that the Subcommittee has adopted for its AI workstream.

This workplan will guide the Subcommittee’s development of recommendations for this Committee on the use of AI in CFTC-regulated markets.

The Subcommittee endorses FSOC’s recommendation to monitor the “rapid developments in AI, including generative AI, to ensure that oversight structures keep up with or stay ahead of emerging risks to the financial system while facilitating efficiency and innovation.”[33]

Based on its review of the statements and materials presented at its inaugural meeting, the Subcommittee has developed a work plan. This is an initial plan only: the Subcommittee intends to further review, research and develop the plan for future presentation to the full committee and, as appropriate, the Commission:

1. Conducting a Survey on the Use of AI in CFTC-regulated Markets. The Subcommittee believes that it may be useful for the Commission to conduct a survey[34] of CFTC registrants’ use of AI in CFTC-regulated markets. The survey could be designed to inform the Subcommittee, the full committee, as well as the Commission and its staff on how different types of AI are being used, how its risk are being mitigated, and by which CFTC registered market participants.
   
   The Subcommittee would further consider the design of the survey, including: (1) whether such a survey should be incorporated into Commission and divisional staff examinations and other oversight and monitoring tools and mechanisms;[35] and (2) whether the survey would be mandatory for CFTC registered market participants. The Subcommittee will provide a recommendation on this matter and present it to the full Committee for potential presentation to the Commission.
    
2. Recommendations on New Guidance, Advisories or Rulemaking. The Subcommittee may advance a recommendation that the staff should consider new guidance, advisories or formal rulemaking, based on how CFTC market participants are using AI to conduct regulated activities and any gaps identified in existing regulations and guidance. Areas of focus may include, without limitation:
   1. Framing the Risk of AI Models. Whether CFTC registrants should be required to disclose or explain[36] key attributes and risks of those models, including those created by third parties.[37] This may include enhanced requirements for registrants that are using AI for critical requirements such as compliance, client-facing business activities, or market regulation functions.
   2. Robust Monitoring and Testing of AI Models. Whether CFTC market participants should adhere to additional requirements regarding testing and monitoring of AI models as used in CFTC-regulated activities.[38] Potential areas of testing and monitoring may include cybersecurity, data controls, bias, privacy, and output consistency.
   3. Oversight and of AI Models. Whether additional guidance is appropriate to clarify oversight and governance expectations for AI models used in CFTC-regulated activities. Such arrangements that the subcommittee may consider include a comprehensive governance framework and designated personnel focused on AI oversight, including senior management with functional understandings of AI to permit adequate supervision.[39] The subcommittee will consider the degree to which a materiality standard is appropriate, as well as concentration[40] and other risks.

With sincerest gratitude, I would like to acknowledge the hard work put in by the Subcommittee members to advance this workplan and special thanks to Gary for presenting it here today.

Market Structure

Next, we will hear presentations from members of the Market Structure Subcommittee, co-chaired by Ann Battle, Senior Counsel, Market Transitions & Head of Benchmark Reform at ISDA, and Biswarup Chatterjee, Managing Director and Head of Innovation for the Global Markets Division at Citigroup. The FCM Capacity Workstream will present a cover letter attaching a data analysis examining current state of the market for futures commission merchants (FCMs). FCMs serve as critical intermediaries in cleared markets. The workstream created and analyzed a database of publicly available financial information for FCMs, and noted industry consolidation and an increased concentration in the market for FCM services.

Treasury workstream

The Treasury Reform workstream will provide a presentation on U.S. treasury cash-futures basis trades and risk management considerations. This presentation will be delivered by Nathaniel Wuerffel, Head of Market Structure, at Bank of New York Mellon. This presentation underscores issues raised during the December 11, 2023 MRAC meeting when the Subcommittee provided a general overview of the state of the U.S. treasury markets, including the role of the basis trade in U.S. treasury markets, risk-management practices that are intended to limit leverage, oversight and transparency, and regulatory changes impacting these markets. Today’s presentation explores the mechanics of these trades, the benefits and risks, and potential ways to manage risks associated with these trades.

PTRR and Block Trade

We will also hear brief updates from two other workstreams of the Market Structure Subcommittee. The post-trade risk reduction workstream will provide an update on its work and plans to further develop proposed recommendations in order ensure that any recommended changes preserve the systemic risk and financial market stability goals of Title VII. The block trade workstream will provide a brief update in light of industry-wide efforts to conduct a centralize data analysis to inform block trade policy.

Climate-Related Market Risk

In December of last year, the CFTC issued Proposed Guidance Regarding the Listing of Voluntary Carbon Credit Derivatives Contracts and issued a request for comment from the public on the proposed guidance. As I said at the time that it was difficult to overstate the importance of the guidance, and trumpeted how “[o]nce again, the CFTC is demonstrating leadership in the novel carbon credit markets.”[41] I remain excited about how the guidance might evolve going forward, particularly in light of the extensive public engagement that the Commission received in response.

As I also said at the time of the Guidance, however, “I find the Proposed Guidance to be necessary, but insufficient,”[42] and that I hoped that it would be the beginning of robust consideration of how the CFTC might be able to use its authority to foster and improve the market going forward. The Climate-Related Market Risk Subcommittee convened a roundtable on March 15, 2024 and expert speakers offered guidance on their understanding of the foundational issues challenging the market for carbon credits.

The roundtable focused on three main topics related to the carbon credit markets: (1) market integrity, disclosure, transparency and enforcement, (2) market design and intermediation, and (3) product design and reliability.

Regarding market integrity, Holly Pearen of the Environmental Defense Fund, who we will be hearing from again today, warned the Subcommittee that poorer quality voluntary carbon credits are overwhelmingly bought and sold in over-the-counter and less transparent carbon credit transactions. Panelists also argued that the CFTC should ensure that crediting programs properly implement social safeguards so that credits created with co-benefits for local communities do in fact go to the intended communities.

The second panel of the roundtable focused on how market design and intermediation can make carbon credit markets stronger. Panelists from diverse viewpoints as exchanges and a dairy industry association were consistent that robust and liquid markets for carbon credits and their derivative products promote greater integrity of the underlying credits through the market’s reflection of the quality of the credits in their price. The third panel focused on the design of the products themselves, including a discussion of the legal nature of carbon credits, and the importance of integrity standards that focus on results and use data to analyze the quality of the voluntary carbon credits.

Across the board, the roundtable participants were enthusiastic for the CFTC to create more robust standards. If carbon credits are going to be a force for good in the monumental task to limit anthropogenic atmospheric carbon, a firmer hand from regulators and standard-setting bodies will be critical.

Today we will hear from three different speakers regarding voluntary carbon markets. The first will be the unique perspective of Dale Lewis, joining us from Zambia, who is the CEO of Community Markets for Conservation, or COMACO. Mr. Lewis and his company do the on-the-ground work in Zambia of building the various carbon-limiting projects that are the source of voluntary carbon credits currently being traded. We will also hear from two people who spoke at the March 15 roundtable as well: Holly Pearen from the Environmental Defense Fund, and Jessica Garcia from Americans for Financial Reform Education Fund. Both Ms. Pearen and Ms. Garcia will be sharing their thoughts on the critical issues facing the voluntary carbon markets today, and discuss what they think the subcommittee should be studying going forward.

Conclusion

Today’s meeting is an opportunity to roll up our sleeves and begin to chart a course for the development and completion of the important work that the MRAC Subcommittees have and will explore this year. I am hopeful for an open and meaningful discussion among MRAC members regarding the critical issues facing our markets.

Allow me to thank our MRAC Chair and Chair of the FIA Board, Alicia Crighton; MRAC Designated Federal Officer (DFO) Tamika Bent; and MRAC Alternate DFO Peter Janowski. I also thank each of the ADFOs who support MRAC—Rebecca Lewis Tierney and Julia Welch.

I also want to thank the CFTC logistics and administrative staff and contractors who ensured that our physical conference room and our virtual conference room were ready to go for our members and our invited speakers, including Altonio Downing, Monae Mills, Andy Brighton, Keane McBride, Venise Raphael-Constant, Margie Yates, Jean Cespedes, Pete Santos, and Ty Poole.

Thank you so much for joining us today. I look forward to a robust and informative discussion.

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[1] Group of 20 (G20), Leader’s Statement, The Pittsburgh Summit (Sep. 24-25, 2009), https://www.oecd.org/g20/summits/pittsburgh/G20-Pittsburgh-Leaders-Declaration.pdf.

[2] See Dodd-Frank Wall Street Reform and Consumer Protection (Dodd-Frank) Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010) (codified as amended in scattered sections of 7, 12, and 15 U.S.C.).

[3] See Dodd-Frank Act § 725(c); 7 U.S.C. 7a-1(c)(2).

[4] See Dodd-Frank Act § 804; 12 U.S.C. 5463.

[5] See Dodd-Frank Act § 805; 12 U.S.C. 5464.

[6] See Dodd-Frank Act § 807; 12 U.S.C. 5466.

[7] Comm. on Payment and Settlement Sys. (CPSS)—Int’l Org. of Sec. Comms. (IOSCO), Principles for Financial Market Infrastructures (April 16, 2012), https://www.bis.org/cpmi/publ/d101.htm; see also Committee on Payments and Market Infrastructures (CPMI)-IOSCO, Resilience and Recovery of Central Counterparties (CCPs): Further Guidance on the PFMI—Consultative Report(August 2016), https://www.bis.org/cpmi/publ/d149.htm; CPMI-IOSCO, Implementation monitoring of PFMI: Level 3 assessment—Report on the Financial Risk Management and Recovery Practices of 10 Derivatives CCPs (August 2016), https://www.bis.org/cpmi/publ/d148.htm.

[8] CPMI-IOSCO, Resilience of Central Counterparties (CCPs): Further Guidance on the PFMI—Final Report(July 2017), https://www.bis.org/cpmi/publ/d163.htm.

[9] Id. (specifically Principle 2).

[10] Id. (specifically Principle 3, 4, 7, 13, 14, 17).

[11] Id. (specifically Principles 5, 6).

[12] Id. (specifically

[13] CPMI-IOSCO, Recovery of financial market infrastructures (October 2014, revised July 2017) https://www.bis.org/cpmi/publ/d162.htm.

[14] Financial Stability Board (FSB), Guidance on Central Counterparty Resolution and Resolution Planning (July 2017) https://www.fsb.org/2017/07/guidance-on-central-counterparty-resolution-and-resolution-planning-2/.

[15] FSB, Central Counterparty Financial Resources for Recovery and Resolution (March 10, 2022) https://www.fsb.org/2022/03/central-counterparty-financial-resources-for-recovery-and-resolution/.

[16] FSB, Financial Resources and Tools for Central Counterparty Resolution: Consultation report (September 2023) https://www.fsb.org/2023/09/financial-resources-and-tools-for-central-cou.nterparty-resolution-consultation-report/.

[17] Id. at iii.

[18] 88 Fed. Reg. 48968 at 48969.

[19] CFTC, Request for Comment on the Use of Artificial Intelligence in CFTC-Regulated Markets (Jan. 25, 2024), CFTC Staff Releases Request for Comment on the Use of Artificial Intelligence in CFTC-Regulated Markets | CFTC.

[20] Id.

[21] Kristin N. Johnson, Commissioner, CFTC, Opening Statement Before the Market Risk Advisory Committee Meeting (Sept. 28, 2022), Opening Statement of Commissioner Kristin N. Johnson Before the Market Risk Advisory Committee Meeting | CFTC

[22] Financial Stability Oversight Council (FSOC), 2023 Annual Report at 93, (Dec. 14, 2023), https://home.treasury.gov/system/files/261/FSOC2023AnnualReport.pdf.

[23] IOSCO, The use of artificial intelligence and machine learning by market intermediaries and asset managers at 17 (Sept. 2021), FR06/2021 The use of artificial intelligence and machine learning by market intermediaries and asset managers (iosco.org).

[24] 88 Fed. Reg. 44675.

[25] FSOC, 2023 Annual Report supra note 22, at 92.

[26] Financial Industry Regulatory Authority (FINRA), Report on Artificial Intelligence (AI) in the Securities Industry (June 2020), https://www.finra.org/sites/default/files/2020-06/ai-report-061020.pdf.

[27] FSOC, 2023 Annual Report, supra note 22, at 92.

[28] FINRA, Report on Artificial Intelligence (AI) in the Securities Industry, supra note 26.

[29] FSOC, 2023 Annual Report, supra note 22, at 92.

[30] Id.

[31] FSB, Artificial intelligence and machine learning in financial services: Market developments and financial stability implications at 34 (Nov. 1, 2017), https://www.fsb.org/wp-content/uploads/P011117.pdf.

[32] Kristin N. Johnson, Commissioner, CFTC, Statement Regarding the CFTC’s Notice of Proposed Rulemaking on Operational Resilience Program for FCMs, SDs, and MSPs (Dec. 18, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement121823.

[33] Financial Stability Oversight Council, Annual Report 2023 at 93, available at ‌https://home.treasury.gov/‌system/files‌/261‌/‌FSOC2023AnnualReport.pdf.

[34] Committee will discuss related issues, including whether the survey will be mandatory.

[35] At the meeting, a spokesperson from the Futures Industry Association noted that its members use AI for: (1) Trading strategies; (2) Hedging/risk mitigation; and (3) Compliance tools.

[36] This could be at the time of integration or adoption of an AI model or significant amendment to one.

[37] For more on explainability, see FINRA, Artificial Intelligence (AI) in the Securities Industry (June 2020), available at https://www.finra.org/rules-guidance/key-topics/fintech/report/‌artificial-intelligence-in-the-securities-industry‌/‌key‌-challenges, suggesting that parties consider: “Incorporating explainability as a key consideration in the model risk management process for AI-based applications.” See also, Financial Stability Oversight Council, Annual Report 2023 at 92, available at https://home.treasury.gov/system/files/261/FSOC2023AnnualReport.pdf.

[38] For example, AI technologies with automated elements may require “compliance by design, i.e., technology with built in features that prevent ex ante compliance violations. For the similar “transparency by design” and “AML by design” concepts from which this is partially derived, see Sandy Pentland, Robert Mahari, and Tobin South, Transparency by Design for Large Language Models, Network Law Review (May 25, 2023), available at https://www.networklawreview.org/computational-three/, and Robert Z. Mahari, Thomas Hardjono, and Alex Pentland, AML by Design: Designing a Central Bank Digital Currency to Stifle Money Laundering, MIT Science Policy Review 57 (Aug. 29, 2022), available at https://sciencepolicyreview.org/2022/07/mitspr-191618003020/.

[39] For example, IOSCO has recommended that “[r]egulators should consider requiring firms to have designated senior management responsible for the oversight of the development, testing, deployment, monitoring and controls of AI and [machine learning]. This includes a documented internal governance framework, with clear lines of accountability.” Board of the International Organization of Securities Commissions, The Use of Artificial Intelligence and Machine Learning by Market Intermediaries and Asset Managers (Sept. 2021), available at https://www.iosco.org/library/pubdocs/pdf/IOSCOPD684.pdf.

[40] “Concentration” here is broad and could be, among others, concentration among vendors or concentrations due to model availability, hardware or software limitations, or intellectual property rights.

[41] Kristin N. Johnson, Commissioner, CFTC, Statement Regarding Commission Guidance Regarding Listing of Voluntary Carbon Credit Derivative Contracts (Dec. 4, 2023), Statement of Commissioner Kristin Johnson: Commission Guidance Regarding Listing of Voluntary Carbon Credit Derivative Contracts | CFTC.

[42] Id.

Commodity Futures Trading Commission (CFTC) Commissioner Caroline D. Pham today released the following statement regarding the CFTC’s complaint filed March 26, 2024 in the U.S. District Court for the Southern District of New York:

“The CFTC has filed another aggressive enforcement action exercising our authority to pursue alleged unregistered crypto asset derivatives trading platforms and other violations of law. I commend the Division of Enforcement’s vigilance in protecting our markets. However, I note that the complaint appears to assert that fund shares held by investors—namely, securities—can themselves constitute leveraged trading pursuant to section 2(c)(2)(D) of the Commodity Exchange Act. This interpretation fails to distinguish between an investment in a fund, which would typically be a security under the jurisdiction of the SEC, and the trading activities of a fund, alleged here to be under the CFTC’s jurisdiction. The CFTC’s approach may infringe upon the SEC’s authority and undermine decades of robust investor protection laws by conflating a financial instrument with a financial activity, disrupting the foundations of securities markets. Owning shares is not the same thing as trading derivatives.”

Today, the Commodity Futures Trading Commission (CFTC or Commission) announced the approval by the Southern District of Florida of a Consent Order to resolve claims against a Ponzi-scheme operator that fraudulently solicited more than $19 million from at least 220 individuals in the U.S. and abroad.

For more than seven years from 2013 through 2020, Joseph Carvajales (Carvajales), along with the W Trade Group LLC (WTG) and Larry Ramos Mendoza (Ramos, and collectively, Defendants), fraudulently solicited customers, mainly other Spanish-speakers, by phone, the internet, and U.S. mail, to trade, among other things, commodity futures, forex and options. Defendants solicited customers by making numerous false and misleading statements concerning their alleged trading successes and methods. In particular, they falsely represented that they were successful traders and promised customers would see profits of up to 4% by virtue of a commodity trading algorithm Ramos had developed. They also falsely told investors that WTG operated on major exchanges and that any trading done in the U.S. was supported by SIPC. In reality, while WTG did open a trading account in its own name, it never traded the account, and WTG never opened a single trading account for its customers. Defendants created fraudulent account statements to cover up their fraud and made Ponzi-style payments to certain investors to perpetuate the scheme.

Based upon these fraudulent solicitations, WTG received approximately $19 million from at least 220 customers. WTG and Ramos misappropriated these funds to pay personal expenses, including salaries for Ramos and Carvajales. Though Ramos was indicted, he removed his ankle monitoring device and fled. The FBI has been unable to determine Ramos’ whereabouts and suspects he may have fled the country. Under the Consent Order announced today, Carvajales faces permanent trading and registration bans and must pay $2.4 million in restitution and an additional $1 million as a civil monetary penalty.

Throughout my time as a Commissioner, I have frequently advocated for greater customer protection for the most vulnerable investors in our marketplace.[1] As I have previously noted:

“I am deeply committed to raising alarms regarding fraud that targets vulnerable investors based on relationships, kinship, or other social network connections.  Affinity-based fraud schemes targeting vulnerable individuals within a specific community based on a shared characteristic seek to exploit the trust generated within the community.”[2]

In the current case, the fraudsters used a shared native language to gain the trust of their victims. Further, the fraudsters assured their customers that their investments would receive the protections available through registered trading activity.

The CFTC must take decisive action in cases where fraudsters target vulnerable investors by turning pillars of strength, such as shared identity or robust regulatory protections, into ammunition.

I applaud the efforts of the CFTC’s Division of Enforcement and would like to recognize the staff bringing this litigation: Nia Vroustouris, Kevin Samuel, Alison B. Wilson, and Rick Glaser.

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[1] See, e.g., Kristin N. Johnson, Commissioner, CFTC, Statement Regarding CFTC Charges in “Pig Butchering” Case, Jan. 19, 2024, https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement011924#_ftn8; Kristin N. Johnson, Commissioner, CFTC, Statement Regarding CFTC Consent Order Imposing $1.7 Billion in Restitution against South African Commodity Pool Operator (Sept. 7, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement090723; Kristin N. Johnson, Commissioner, CFTC, Statement Regarding CFTC Action Against Retail Forex Ponzi Scheme Targeting Spanish Speakers in Puerto Rico and the Continental United States, Feb. 14, 2023, https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement021423.

[2] Kristin N. Johnson, Commissioner, CFTC, Statement on Enforcement Action To Stop Bitcoin Fraud Targeting the Spanish-Speaking Community, https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement052423.

Today, the Commodity Futures Trading Commission (CFTC or Commission) announced the filing of a Proposed Consent Order to resolve claims against a Ponzi-scheme operator that fraudulently solicited more than $41.6 million from at least 12,500 individuals in the U.S. and abroad.

From at least September 2020 through February 2022, Defendant Empires Consulting Corp. (Empires Consulting) and co-Defendants Emerson Pires, Flavio Goncalves, and Joshua Nicholas solicited funds from customers in the U.S. and abroad through commodity interest pools under the name of “EmpiresX.” Pool participants understood their funds were being invested into “futures products” such as commodity futures and binary options, as well as stocks and other products traded on multiple markets and available 24 hours a day. In fact, Defendants deposited only $1 million of participant funds in a futures trading account at Interactive Brokers. Defendants also used participant funds to hold or trade digital asset commodities, including bitcoin (BTC), ether (ETH), and tether tokens (USDT).

Throughout the scheme, Defendants made numerous misrepresentations, including creating fake websites that mimicked real trading websites, misrepresenting their trading success on weekly update calls, and creating statements for pool participants with false account balances and investment returns. Defendants also misrepresented that their registration status with the Commission. Defendants misappropriated over 75% of the customer funds deposited with their enterprise. The misappropriated funds were used for luxury travel, fine dining, expensive car leases, and retail shopping to facilitate celebrity-like lifestyles.

Nicholas is currently serving a 51-month prison sentence in Florida for securities fraud committed as a part of this scheme. Pires and Goncalves are believed to be in Brazil and the Department of Justice continues to seek their extradition.

On June 30, 2022, the CFTC charged Empires Consulting with violations of Sections 4m(1), 4o(1)(A) and (B), and 6(c)(1) of the Commodity Exchange Act. Empires Consulting is currently controlled by a receiver appointed by a Florida state court in a putative class action regarding the same conduct.

Under the Proposed Consent Order announced today, Empires Consulting faces permanent trading and registration bans and must pay $32 million in restitution and an additional $32 million as a civil monetary penalty. The Consent Order also requires Empires Consulting to continue to cooperate with the CFTC in the ongoing litigation and in any related future investigation or action.

Another Example of a Ponzi Scheme

Despite the high-tech gloss, the scheme here is simply garden-variety fraud and an old-school Ponzi scheme. This case represents yet another in a recent line of similar cases.[1] As I have previously noted,

[t]his age-old sleight of hand gained its contemporary moniker “Ponzi scheme” from the 1920’s financial fraud perpetuated by Charles Ponzi.[2] For proof of the enduring and pernicious legacy of fraudsters such as Ponzi and his predecessors, recall the revelation of Bernie Madoff’s $50 billion Ponzi scheme.[3] Prosecutors continue to work today—a decade after Madoff confessed that his investment advisory fund was “all just one big lie” —to compensate victims.[4]

The CFTC has appropriately taken a strong stance in this matter, which reflects an intent to effectively address fraud in our markets, with a laser focus on eliminating fraud schemes that target retail customers. I have repeatedly made clear that protection of customer funds is one of the CFTC’s core missions:

creating and enforcing effective, well-tailored rules governing the custody, investment, and preservation of customer funds must be among the Commission’s highest priorities. Without these rules and rigorous enforcement, our markets would lack the foundation of trust upon which every transaction is built.[5]

The CFTC must act preemptively to protect customer funds through appropriate regulation, and I have continuously advocated for the preservation and extension of such customer-focused regulation. When misuse of funds and fraud nevertheless occurs, as here, the CFTC must forcefully respond with enforcement action.

I want to expressly recognize the hard work of the Division of Enforcement staff on this case, including Ben Sedrish, Heather Dasso, Elizabeth Pendleton, Scott Williamson, and Robert Howell.

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[1] See, e.g., CFTC Release No. 9706-23, CFTC Charges Five Defendants with Fraudulent Digital Assets Trading Scheme, May 24, 2023, https://www.cftc.gov/PressRoom/PressReleases/8706-23; Statement of Commissioner Kristin N. Johnson: Enforcement Action To Stop Bitcoin Fraud Targeting the Spanish-Speaking Community, May 24, 2023, https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement052423; CFTC Release No. 8660-23, CFTC Charges California-based Company and Its CEO with Fraudulent Solicitation and Misappropriation of Digital Asset Commodities, Feb. 16, 2023, https://www.cftc.gov/PressRoom/PressReleases/8660-23; Statement of Commissioner Kristin N. Johnson Regarding Fraud and Misappropriation by a Digital Asset Ponzi Scheme, Feb. 16, 2023, https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement021623; CFTC Release No. 8656-23, CFTC Charges Three Puerto Rico Residents and Their Companies with Misappropriating Over $13 Million in Connection with Commodity Pool Ponzi Scheme, Feb. 13, 2023, https://www.cftc.gov/PressRoom/PressReleases/8656-23; Statement of Commissioner Kristin N. Johnson Regarding CFTC Action Against Retail Forex Ponzi Scheme Targeting Spanish Speakers in Puerto Rico and the Continental United States, Feb. 14, 2023, https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement021423.

[2] In addition to careful academic scholarship and investigative journalism revealing the impact of Charles Ponzi’s scheme, popular television and film continue reference Ponzi’s scheme. For example, one finds colorful explanations of Ponzi’s scheme and descriptions of investors who suffered losses as a result of the scheme in Comedy Central, Drunk History, “Scoundrels,” Downton Abbey; and Boardwalk Empire.

[3] Diana Henriques, The Wizard of Lies: Bernie Madoff and the Death of Trust (2011).

[4] See U.S. Dep’t Just., Justice Department Announces Total Distribution of Over $4 Billion to Victims of Madoff Ponzi Scheme, Sept. 28, 2022, https://www.justice.gov/opa/pr/justice-department-announces-total-distribution-over-4-billion-victims-madoff-ponzi-scheme. See Statement of Commissioner Kristin N. Johnson Regarding CFTC Action Against Retail Forex Ponzi Scheme Targeting Spanish Speakers in Puerto Rico and the Continental United States (Johnson Ponzi Statement), Feb. 14, 2023, https://www.cftc.gov/PressRoom/SpeechesTestimony/ johnsonstatement021423.

[5] Kristin N. Johnson, Commissioner, CFTC, Statement on Preserving Trust and Preventing the Erosion of Customer Protection Regulation (Nov. 3, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnstatement110323.

[6] See id.

Good morning. It is my pleasure to welcome you to the Market Risk Advisory Committee’s (MRAC) Future of Finance (FoF) Subcommittee meeting.

The Promise and Peril of AI

Increasingly, diverse industries and sectors of our economy identify opportunities to integrate aspects of the assemblage of technologies that we commonly describe as artificial intelligence or AI technologies. AI enables doctors to diagnose and map diseases earlier, faster, and with greater accuracy than ever before in the history of medicine.[1] Farmers who cultivate crops that feed our nation may integrate AI to better manage access to vital resources such as freshwater, enabling more efficient irrigation, fertilization, and crop rotation leading to more sustainable farming.

In our markets, AI offers similar efficiencies for faster trade execution and settlement, more accurate pricing prediction, and more precise risk management oversight.[2] Markets have witnessed increased adoption of AI including AI-driven investment advising, trade execution, risk management, and market surveillance.[3]

Notwithstanding this promise, we must account for the potential perils of integrating innovation without proper guardrails. A few years ago, a branch manager of a Japanese company in Hong Kong received a call from the director of his parent business.[4] The instructions delivered during the call indicated that, in connection with a pending acquisition, the bank employee should transfer $35 million to a designated account. Having received emails confirming the legitimacy of the transaction, and because he spoke with the director by phone often and recognized his voice, the branch manager kindly obliged, followed the instructions, and transferred the funds. The calls and emails were deep fakes that relied on, among other technologies, AI voice-cloning technology and the transfer was an Oceans-Eleven style scam.

As this final use case illustrates, the ability of machines or more specifically supervised and unsupervised machine learning algorithms to process vast quantities of data to address disease, water management, or food scarcity is only part of the story.

Regulators have identified notable concerns regarding the development, testing, and deployment of AI.[5] Multiple standard setting authorities note the need for increased oversight regarding “governance, development, testing, monitoring, data quality and bias, transparency and explainability, outsourcing; and ethical concerns.”[6]

As a primary concern, it is imperative to increase market and prudential regulators’ understanding of how the underlying technology operates, the integrity of the inputs that it relies upon, the potential for neutral technologies to engender biased outcomes, and legal obligations to ensure that outcomes comply with principles of fairness and transparency.

Regulatory Responses

In October 2022, the White House Office of Science and Technology Policy published The Blueprint for an AI Bill of Rights (“AI Bill of Rights”) to “support the development of policies and practices that protect civil rights and promote democratic values” in the development of artificial intelligence systems.[7] The White House engaged in significant collaboration with the public through panel discussions, public listening sessions, requests for information, and other informal means of engagement prior to publication to help guide the drafting of the AI Bill of Rights. Though it is non-binding, the AI Bill of Rights offers guidance to the American public on how to safely and responsibly deploy AI.The AI Bill of Rights outlines five key principles to guide the use and regulation of AI. These principles involve: (1) protection from unsafe and ineffective systems; (2) avoiding algorithmic discrimination; (3) data privacy protection; (4) notice and explanation and (5) opportunities to opt out and access to humans who can consider and remedy problems.

AI Safety Institute

At the end of last year, the Biden Administration announced the creation of an AI Safety Institute, housed within the Commerce Department, which will be established within NIST, the National Institute of Standards and Technology.[8] NIST was founded in 1901 and is one of the nation’s oldest physical science laboratories. Congress established NIST to “promote U.S. innovation and industrial competitiveness by advancing measurement science, standards, and technology.”[9]

The AI Institute will “operationalize” NIST’s existing AI Risk Management Framework to “create guidelines, tools, benchmarks, and best practices for evaluating and mitigating dangerous capabilities and conducting evaluations including red-teaming to identify and mitigate AI risk.”[10] These guidelines will include “technical guidance that will be used by regulators considering rulemaking and enforcement on issues such as authenticating content created by humans, watermarking AI-generated content, identifying and mitigating against harmful algorithmic discrimination, ensuring transparency, and enabling adoption of privacy-preserving AI.”[11]

To support the AI Institute, NIST announced this month the creation of the AI Safety Institute Consortium, which will gather together hundreds of stakeholder organizations across the public and private sectors to “develop science-based and empirically backed guidelines and standards for AI measurement and policy, laying the foundation for AI safety across the world.”[12] The Consortium members will contribute work in areas such as developing guidelines for identifying and evaluating AI capabilities, with a focus on capabilities that could potentially cause harm and developing tools, methods, protocols for the testing and development of AI, among several other planned workstreams.[13]

We are not alone in our efforts to ensure responsible innovation. International standard setting authorities and other market and prudential regulators have outlined similar principles.

Domestic and International Standards—A Principles-Based Framework

As early as 2017, the Financial Stability Board (FSB) issued a report on market developments related to AI and the financial stability implications. The Financial Stability Oversight Council (FSOC) and the Financial Industry Regulatory Authority (FINRA) have published recommendations that offer guidelines for governing AI.

More recently, the International Organization of Securities Commissions issued a report following a consultation on the use of AI by market intermediaries. These efforts include a number of common threads, suggesting that, while many questions remain, there are important areas of consensus regarding the right approach to AI in financial markets. A few of these commonalities include:

• A focus on the governance of AI models. FSOC “recommends monitoring the rapid developments in AI, including generative AI, to ensure that oversight structures keep up with or stay ahead of emerging risks to the financial system while facilitating efficiency and innovation.”[14] “Regulators should consider requiring firms to have designated senior management responsible for the oversight of the development, testing, deployment, monitoring and controls of AI and [machine learning]. This includes a documented internal governance framework, with clear lines of accountability.”[15]
  
  CFTC regulations, for example, introduce important governance obligations for registered market participants. Designated Clearing Organizations must establish a Risk Management Committee “comprised of clearing members and customers of clearing members on matters that could materially affect the risk profile of the DCO” and Risk Management Working Groups composed of market participants.[16] Enhanced risk management oversight and governance best practices will play an important role in managing the development and implementation of this new technology.
• Promoting the explainability of AI models. Many AI models are “black-box” models, meaning that it may be difficult and in some cases impossible, to explain their decision-making processes. Accordingly, FSOC, IOSCO, the FSB, and FINRA have all emphasized the importance of addressing the explainability challenge.[17] As FINRA explains put it, [i]ncorporating explainability as a key consideration in the model risk management process for AI-based applications.”[18]
• The need for data controls. Data quality, security and privacy are central concerns for regulators as market participants adopt AI models. FSOC recent report notes, “data controls like data quality, suitability, security, privacy, and timeliness are vital to sound AI use.”[19] Similarly, FINRA calls for “data governance efforts” including: “data review for potential bias,” “data source verification,” “data integration,” “data security,” and “data quality benchmarks and metrics.”[20]
• Implementing measures to address bias. In 2019, I testified before Congress and voiced my concerns that AI models trained on incomplete or inaccurate data may engender biased results. The White House AI Bill of Rights appropriate emphasizes the need to ensure fairness and guard against bias. In its report, FSOC notes that “specific requirements to prevent discrimination or bias that apply to tools, models, or processes used in consumer compliance also apply to AI. This is an important consideration because without proper design, testing, and controls, AI can lead to disparate outcomes, which may cause direct consumer harm and/or raise consumer compliance risks.”[21]
• Testing and monitoring output. Protecting against bias, promoting explainability, and implementing governance strategies are only possible where models are properly tested and monitored. FSOC, IOSCO, the FSB, and FINRA have each emphasized the importance of testing. FSOC notes the responsibility of financial institutions to “monitor the quality and applicability of AI’s output” – the ability of regulators to “help to ensure that they do so.”[22] Similarly, the FSB recognizes the importance of “[a]ssessing AI and machine learning applications for risks, including adherence to any relevant protocols regarding data privacy, conduct risks, and cybersecurity.”[23] Existing approaches to issues like cybersecurity offer some guidance. Last year, in a statement regarding a proposed cyber resilience rulemaking, I noted the importance of comprehensive regulation in this area, including regulations that capture mission-critical third-party service providers.[24] Model testing and oversight, which concerns cybersecurity, and much more, must similarly be comprehensive in the parties and the issues that it captures.

Five years ago, I began to convene and participate in convenings of AI developers, adopters, academics, government and industry researchers and regulators and public interest organizations. In 2020, a co-author and I received invitations to publish two books, one of which examines the ethical implications of AI across diverse sectors of our society. In two recent speeches, a speech last month before the New York Bar Association and a speech at Japanese Fintech Week in Tokyo, Japan, I have advocated for the CFTC to begin to identify best practices for integrating AI in our markets.

I have advocated for greater visibility and transparency regarding our registrants’ use of AI by expanding our annual systems examination questionnaire to incorporate questions that directly inquire about the adoption of AI and related risks.

I have also advocated for the development of a principles-based framework. In consultation with members of this working group of the Market Risk Advisory committee, I look forward to exploring a principles-based regulatory framework that underscores intelligibility, risk management, compliance, oversight, market responsibility, notice, and explainability.

I have advocated for the Commission to consider introducing heightened penalties for those who intentionally use AI technologies to engage in fraud, market manipulation, or the evasion of our regulations.

Finally, the Commission should lead in creating an inter-agency task force focused on information sharing and composed of market and prudential regulators including the CFTC, SEC, Federal Reserve System, OCC, CFPB, FDIC, FHFA, and NCUA.

The task force would support the AI Safety Institute in developing guidelines, tools, benchmarks, and best practices for the use and regulation of AI in the financial services industry. The task force may provide recommendations to the AI Safety Institute as well as evaluate proposals coming out of the Institute.

We are fortunate to have Jessica Reiner, MRAC Member and Future of Finance Subcommittee Member and Managing Director and Head of Digital Finance at the Institute of International Finance (one of the institutions that will help advance the development and deployment of safe, trustworthy AI under the AI Safety Institute.

Today’s Subcommittee Meeting

Today’s meeting represents an important part of this work. I am excited about each of our panels and speakers. We will hear from several panels of invited guests from across the public and private sectors discussing the following four topics:

1. AI in Financial Markets Today;
2. Current Financial Markets Rules Are Implicated by AI;
3. AI-Related Risks;
4. What We Anticipate in the Near Future.

Alessandro Cocco, Vice President in the Financial Markets Group at the Federal Reserve Bank of Chicago, on detail at the U.S. Department of the Treasury will lead our first panel - AI in Financial Markets Today; this panel includes:

• David Palmer, Senior Supervisory Financial Analyst, Division of Banking Supervision and Regulation at the Federal Reserve Board of Governors;
• Kevin Werbach, Liem Sioe Liong, First Pacific Company Professor and Chair of the Department of Legal Studies and Business Ethics at The Wharton School, The University of Pennsylvania;
• Jessica Renier, Managing Director and Head of Digital Finance, Institute of International Finance; and
• Lisa Schirf, Managing Director, Global Head of Data and Analytics, Tradeweb.

The panel will discuss use cases for this technology its interaction with financial markets, as well as market structure and characteristics.

Petal Walker, former counsel to CFTC Commissioner Sharon Bowen and current Member of the Advisory Board of Liquidity Lock Global Markets, will moderate a panel discussing Current Financial Markets Rules Are Implicated by AI.

The panel will feature:

• Jason Harrell, Managing Director, Operational and Technology Risk and Head of External Engagement, Depository Trust & Clearing Corporation;
• David Felsenthal, Counsel to CFTC Chairman Rostin Behnam, Commodity Futures Trading Commission; and
• Chen Arad, Co-founder & Chief External Affairs Officer, Solidus Labs, Inc.

The panel will engage in conversation on the state of regulatory engagement with AI.

Rebecca Rettig, Chief Legal and Policy Officer, Polygon Labs will moderate a panel discussing AI-Related Risks. Panelists include:

• Yesha Yadav, Professor of Law, Milton R. Underwood Chair and Associate Dean, Vanderbilt Law School;
• Pauline Kim, Daniel Noyes Kirby Professor of Law, Washington University in St. Louis;
• Tamika Bent, Chief Counsel to Commissioner Kristin Johnson, Commodity Futures Trading Commission; and
• Dr. Eammon Hart, PhD, Mathematics, Drexel University.

The panel will discuss the risks attendant to the use of AI technology.

Finally, Gary Kalbaugh, Deputy General Counsel and Director, ING Financial Holdings Corp. will moderate a panel discussing What We Anticipate in the Near Future.

Panelists include:

• Purvi Maniar, General Counsel, FalconX Holdings Ltd.;
• Natalie Tynan, Associate General Counsel, Head of Technology Documentation Strategy, Futures Industry Association, Inc.; and
• Robert Mahari, Doctoral Candidate, Harvard Law School and the MIT Media Lab.

The panel will discuss what may be on the horizon for AI use and potential responses by both regulators and market participants.

I would like to express my appreciation to our MRAC Chair Alicia Crighton, my staff, including Julia Welch, ADFO for the FOF Subcommittee, Tamika Bent and Peter Janowski, DFO and ADFO for MRAC and Rebecca Lewis ADFO for two other MRAC Subcommittees as well as each of the moderators, panelists and committee members for their presence today and their continued work in these areas. I look forward to today’s important discussions.

Good morning.  Thank you to everyone who has joined this meeting, both in person here in Washington, D.C., and virtually, and thank you to my fellow Commissioners.  I want to thank the CFTC’s Global Markets Advisory Committee (GMAC) leadership team—Amy Hong, Darcy Bradbury, Brad Tully, Michael Winnike, Allison Lurton, Tara Kruse, Caroline Butler, and Sandy Kaul—for your continued hard work and commitment to tackling some of the biggest challenges facing global markets, particularly in light of macroeconomic factors, geopolitical dynamics, and the changing world around us.  I especially want to recognize the members of the GMAC’s Subcommittees and the workstream leads who contributed substantial time and resources to developing the recommendations that we will hear today.

I also want to thank my team—Harry Jung, the GMAC Designated Federal Officer, and Nicholas Elliot, the GMAC Alternate Designated Federal Officer, as well as Meghan Tente and Taylor Foy for their tireless efforts and dedication to excellence.  And, as always, many thanks to all the CFTC staff who are hosting and supporting the GMAC’s meeting today. 

Looking back, it was just over a year ago that we kicked off the newly-reconstituted GMAC[1].  At that time, I noted that it was the 50^th anniversary of the Federal Advisory Committee Act, which is the genesis of the GMAC and the hundreds of other advisory committees sponsored by government agencies.

This year, we will mark the 50^th anniversary of the enactment of the Commodity Futures Trading Commission Act of 1974, the legislation that created the current iteration of this agency[2].  I look forward to celebrating the CFTC’s proud history and stewardship of our markets.  I particularly want to commend the CFTC staff over the years who have worked hard to uphold the CFTC’s mission in safeguarding market integrity.  At last year’s Chairman’s Awards ceremony, we recognized employees with 45 years of service, and it was my privilege to present the awards in our New York regional office as the first Commissioner to ever hire staff from a regional office instead of DC headquarters.  It is amazing to think about the continuity and institutional knowledge that we have here at the agency.  I think that historical perspective reminds us of our roots in agriculture over a hundred years ago, and helps us stay true to the trust placed in us by the American people.  The CFTC is a special place steeped in culture and tradition, and that’s why I am honored to serve at the agency for the fourth time in my career.

The GMAC’s Progress

As you all know, in the real world you are evaluated on results.  I’d like to take a moment to highlight what the GMAC set out to do, what we’ve accomplished, and what’s to come.  I think it’s clear to see that the GMAC has delivered results and proposed pragmatic solutions to real-world problems.

Last year, we relaunched the GMAC with a public request for feedback on the GMAC’s agenda[3] and performed a global stock-take of the most significant issues in markets, as each of you sat in this room and presented[4].  It was incredible to have representation from such a broad swath of market participants, market infrastructures, service providers, commercial end users, and regulators flying in to join us in Washington, DC from over a dozen cities all over the world.

From there, the GMAC published a proposed two-year work program to identify and examine key issues and assess and inform international standards through engagement with international policymakers and authorities in other jurisdictions[5].  The proposed work program included global market structure issues, such as U.S. Treasury market reform; asset-liability management and funding markets; market volatility controls; improving liquidity across asset classes with respect to capital, clearing, and collateral requirements; and international alignment of trading and clearing obligations to address market fragmentation.

Proposed technical issues included international standardization and amalgamation of trade reporting for market oversight; global coordination of market events such as closures, drills, or recovery from disruption; efficiencies in post-trade processes; and other infrastructure issues that impact cross-border activity and access to markets.

And, proposed digital asset markets issues included industry standards and best practices for tokenized asset markets including (i) digital assets taxonomy, (ii) pre-trade, execution, and post-trade requirements, and (iii) governance, risk, and control frameworks; the regulation of non-fungible tokens (NFTs) and utility tokens; and other issues in digital finance and tokenization of assets, non-financial activities and Web3, and blockchain technology.

The GMAC and its Subcommittees wasted no time getting to work.  Last fall, the GMAC met to advance eight recommendations to the Commission[6] – the most of any CFTC advisory committee at a single meeting.  Those recommendations have already had real impact.  The Technical Issues Subcommittee’s work on swap data reporting was part of the Commission’s consideration when it approved proposed amendments to swap data requirements in December[7], and the Subcommittee submitted its recommendations to the public comment file for the proposed rules.

Today’s GMAC Meeting

We are again covering significant territory today with presentations and recommendations from each of our Subcommittees.

I want to thank Financial Stability Board (FSB) Secretary General John Schindler for providing today’s keynote on the FSB’s work program and priorities in 2024.  Secretary General Schindler joined the FSB in February 2023, after more than 20 years at the Federal Reserve Board (FRB), most recently as a Senior Associate Director in the FRB’s Division of Financial Stability.  It is an honor to have you here with us today.  As part of its mandate, the GMAC and its work program are very much aligned with the work programs of the FSB, International Organization of Securities Commissions (IOSCO), and other international standard setters, so your international perspective is very much appreciated here today. 

We’ll then hear from Michael Winnike on the Global Market Structure Subcommittee’s recommendation regarding the use of U.S. Treasury exchange-traded funds (ETFs) as eligible initial margin for uncleared swaps.  Michael is a Director and Head of U.S. Market Structure at BlackRock.  It is timely for the eligibility of U.S. Treasury ETFs to be considered within the uncleared margin collateral framework given their potential benefits in enhancing market resiliency, liquidity, and efficiency, among other things.

Wendy Yun will provide an update on the Subcommittee’s Swap Block and Cap Size Recommendation[8].  Wendy is a Managing Director at Goldman Sachs Asset Management.  She’s also our SIFMA AMG representative.  The Subcommittee has spent considerable time thinking about ways to engage with the Commission in this area to enhance market liquidity and promote financial stability, and I look forward to hearing the update on what next steps could hold.

From the Technical Issues Subcommittee, we’ll hear from Charles DeSimone on the recommendation to publish a T+1 securities settlement transition resource document crafted by the Subcommittee.  Charles is a Managing Director at SIFMA.  I am looking forward to what I am sure will be an incredible resource for the industry during such a significant transition that has global implications.  It truly reflects the dedication of the Subcommittee in helping inform and prepare market participants for regulatory implementation.

I’m looking forward to our panel discussion on Basel III Endgame: Perspectives from Derivatives Market Participants.  Our panelists include:

• Reggie Griffith, Global Chief Compliance Officer at Louis Dreyfus Company;
• Dan Gallagher, Director of Commodity Sales and Trading at Basin Electric Power Cooperative, speaking on behalf of the National Association of Rural Electric Cooperatives;
• Elisabeth Kirby, Head of Market Structure at Tradeweb; and
• Joseph Hwang, Managing Director at Goldman Sachs. He is representing FIA and ISDA.

I greatly appreciate the diverse perspectives on the panel, especially from commercial end users, given that the derivatives markets originally came to exist in order to facilitate risk management and price discovery for U.S. producers, growers, merchants, and other key pillars of the real economy.  If the CFTC needs to act in this area—in particular for impacted end users—this panel’s insights could help inform and facilitate any CFTC engagement.  I appreciate the recent discussion hosted by the CFTC’s Environmental and Energy Markets Advisory Committee (EEMAC), sponsored by Commissioner Summer Mersinger, to explore the impact of the Basel III endgame proposal on energy markets, and I’m glad we can continue that discussion.

Finally, we’ll hear from the Digital Asset Markets Subcommittee on its highly anticipated digital asset taxonomy proposal.  Presenting this recommendation are:

• Caroline Butler, Global Head of Digital Assets at BNY Mellon;
• Sandy Kaul, Senior Vice President and Head of Digital and Industry Advisory Services at Franklin Templeton;
• Adam Farkas, Chief Executive Officer of GFMA and Chief Executive Officer of AFME;
• Diana Barrero Zalles, Head of Research and Sustainability at Global Blockchain Business Council; and
• Ninad Nirgudka, Consultant at Boston Consulting Group

The Subcommittee’s work coincides with and will help inform the modernization of clearing, settlement, and post-trade processes, and is an important first step in creating a common framework that will grow and adapt over time.

Looking Ahead

I think the takeaway from this meeting today is that the GMAC’s work is having a real impact on the policy approach to developing pragmatic solutions to address the most significant issues in global markets.  I have shared the GMAC’s recommendations to promote the resiliency and efficiency of global markets with international standard setters and regulatory counterparts around the world, and there has been great interest in the GMAC’s work since it is aligned with key international priorities of the FSB and IOSCO.  I hope that the GMAC recommendations can be considered as part of key international working groups and task forces, as you heard earlier today.   I have also discussed with Chairman Behnam whether some of these recommendations could become new rules here at the CFTC, and I appreciate his leadership in overseeing our markets.  I look forward to working with the Chairman and my fellow Commissioners on proposing rules where appropriate. 

Next month will mark my two-year anniversary as a Commissioner, and I re-watched our confirmation hearing[9] and re-read my testimony[10] to reflect on our journey so far. I wanted to be a Commissioner to make a difference and to make our markets better.  Through all of your efforts, the GMAC is delivering on what we set out to do, and I want to thank you for helping me to make a difference through my leadership as a Commissioner.

Good morning.  I’m pleased to welcome you to the CFTC for the first Global Market Advisory Committee meeting of 2024.  I am very grateful for the service of the members, as well as Commissioner Pham for her leadership of this Committee, and the CFTC staff.

I am always reminded that commodity derivatives markets are truly global markets—markets that can have local impacts on end users and consumers.  Lately, I have followed how shifting weather patterns in West Africa have driven cocoa futures to record highs, and chocolate producers like Nestle have reportedly warned about price increases.[1]  Even Cookie Monster recently expressed concerns that the size of his favorite product, which includes chocolate as a key input, is shrinking.[2]

It is important to consumers, end users, and everyone else, that global commodity derivatives markets function well and are resilient to setbacks.  In many ways, these markets provide opportunities.  They provide opportunities to help manage one-off global shocks like the pandemic and Russia’s war against Ukraine.  They provide opportunities to weather stresses from a cyber-attack or from climate events.  They also provide opportunities for end users to discover prices, manage risk, and plan future investments.

It matters to end users producing food and fuel that these markets are resilient.  It matters, as well to regular people who shop at the grocery store, heat their home, and drive their car.

Last year, I told you that in order to build resilience, we should expect the unexpected.  By expecting market stresses, the collective “we” can plan for it.  We can build in measures to ensure that there is adequate liquidity in times of stress.  We can build in measures designed to ensure market stability.  And we can build in measures to ensure that commodity prices are not artificially increased, but instead reflect market fundamentals of supply and demand.

Commodity derivatives markets have performed well under remarkably stressful conditions.  I remain positive about the resilience of these markets.  We should always keep our eye on the goal of resilience.

In the last few years, the local impact of geopolitical events in global markets has been made clear.  We continue to see ongoing impacts on supply chains, transportation, and other inputs remaining from the pandemic.  And while the high volatility and high prices of oil, natural gas, and wheat caused by Russia’s war with Ukraine have subsided, the war continues to impact markets.  Attacks in the Red Sea have disrupted shipping traffic, including in the crucial Suez Canal channel, affecting inputs.

Additionally, these markets have seen local impact from sustained drought during the hottest year on record.  I have met with several CFTC registrants who have told me about how they are evolving to manage the changing economic and physical conditions from severe climate events.

Given the local impact from these global commodity markets, this is the time to plan for future market stresses and build resilience.  Market participants can take advantage of this opportunity while markets perform well to review lessons from the past, forecast future stresses, and review access to liquidity, in particular short-term liquidity.

The CFTC also has opportunities to review lessons from the past, plan for future market stresses, and build resilience.  The CFTC has proposed an operational resilience rule for swap dealers and brokers (futures commission merchants) that would also help plan for the unexpected, including for cyber events or other events that impact operations.

CFTC surveillance is particularly important when falling prices in our markets have not always translated to falling prices for the consumer.  I previously called on the CFTC to shore up its surveillance practices by conducting deep dive studies into certain major commodities during periods of high volatility and high prices to ensure that they were not driven by manipulation, excess speculation or other practices.[3]  The CFTC is well positioned to support whole of government efforts to ensure that the prices consumers pay reflect market supply and demand, rather than fraud, manipulation, or excess speculation.

Global market participants and the CFTC need to keep working together to expect the unexpected and plan to keep our markets resilient.  That is why I am grateful for your service on this Committee.

I am voting to publish the Notice of Proposed Rulemaking on Requirements for Designated Contract Markets (DCMs) and Swap Execution Facilities (SEFs) Regarding Governance and the Mitigation of Conflicts of Interest Impacting Market Regulation Functions (DCM and SEF Conflicts of Interest Proposal or NPRM) because the public must have an opportunity to weigh in on these important issues that raise serious concerns. I would like to thank Lillian Cardona, Jennifer Tveiten-Rifman, Marilee Dahlman, Swati Shah, and Rachel Berdansky in the Division of Market Oversight for their time and efforts, and I take this opportunity to recognize the importance of their rule enforcement reviews program for DCMs and SEFs. I appreciate the staff working with me to make revisions to address my concerns. Unfortunately, while the NPRM has been improved, it is far from perfect.

Overall, I believe the public comment process is a critical component of good government. That is why, although I have serious concerns about the DCM and SEF Conflicts of Interest Proposal, I am voting to publish it for transparency and public engagement on this flawed rulemaking.

The CFTC cannot haphazardly codify guidance as rules. That goes against the very essence of the statutory framework to regulate derivatives markets under the Commodity Exchange Act (CEA). Here, public input will serve as a valuable tool in refining the NPRM by providing insights that may not have been considered in changing the CFTC’s longstanding principles-based approach to oversight of self-regulatory organizations (SROs) such as DCMs and SEFs, who establish their own rule books and bring enforcement actions against market participants for violations.[1] In 2012, when the CFTC first adopted its DCM rules and decided to leave certain areas as guidance on acceptable best practices, the CFTC thoroughly examined each regulation and explained where guidance was more appropriate than a rule in recognition of the need to maintain flexibility for DCMs to establish rules that are appropriate for their products, markets, and participants, including associated risks.[2] I have serious concerns with the CFTC proceeding down a path to finalizing a rule that is overly prescriptive and unsupported by data or other evidence.

Specific Areas for Public Comment

Separately, I am highlighting two additional issues for commenters:

Material non-public information

The Commission is refusing to fix the references to “material non-public information” in Parts 37 and 38. Even though the NPRM cites Regulation 1.59(d) and its use of “material, non-public information,” and that the intent is to copy the requirements in Regulation 1.59(d) to Parts 37 and 38 purely for housekeeping purposes, the Commission is potentially creating a loophole by making a small but very substantive change in using “material non-public information” in Parts 37 and 38. The former—with a comma—broadly captures information that is material and non-public. The latter—with no comma—is an incorrect usage of a well-established term of art under securities laws that is too narrow to address the potential conflicts in derivatives markets, creates unnecessary confusion for market participants, and undermines robust compliance programs by introducing uncertainty.[3] “Consistency” is a goal repeated throughout the NPRM, and I do not understand why we are refusing to resolve the inconsistency here.

The Commission must protect all confidential information—not just material information—in order to effectively mitigate, prevent, or avoid conflicts of interest. In some circumstances, there must be a complete information barrier or segregation of activities between business units or personnel to protect sensitive and confidential information about customer trades or positions in order to prevent potential market manipulation or other abusive trading practices. The Commission’s misguided approach is not enough to protect our markets from misconduct.[4]

Revocation of registration

I am deeply concerned about proposed Regulations 37.5(c)(6) and 38.5(c)(6).[5] This is the first time that the CFTC has decided to promulgate a rule to revoke the registration of a registered entity since section 5e of the Commodity Exchange Act was enacted in 1998, with insufficient explanation to demonstrate a reasonable basis and reasoned decision-making as required by the Administrative Procedure Act,[6] and insufficient procedural safeguards to ensure due process for DCMs and SEFs. The government must ensure due process under the Constitution, including judicial review, before taking away the rights of the public in what may well be a death knell for trading venues. Anything less is an abuse of power.[7]

Further, the rules are clearly overbroad because the CFTC could revoke registration due to changes “in the ownership or corporate or organizational structure” of a DCM or SEF (emphasis added). This could include simple changes in headcount and other staffing reorganizations, making it all too easy for the CFTC to manufacture a reason to revoke registration. I sincerely hope that this is not the Commission’s intent. What is even more puzzling is that the CFTC is choosing to propose structural changes as cause to revoke registration, but not grave misconduct such as fraud, abuse, or manipulation. This is nonsensical. I urge commenters to pay close attention to the full import of the revocation of registration proposed rules.

I look forward to reviewing the comments on the DCM and SEF Conflicts of Interest Proposal.

---

[1] See Statement of Commissioner Caroline D. Pham Regarding Request for Comment on the Impact of Affiliations Between Certain CFTC-Regulated Entities (June 28, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/phamstatement062823; Statement of Commissioner Caroline D. Pham on Effective Self-Regulation and Notice of Proposed Rulemaking to Amend Part 40 Regulations (July 26, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/phamstatement072623b.

[2] See Core Principles and Other Requirements for Designated Contract Markets, 77 FR 36612, 36614 (June 19, 2012), https://www.federalregister.gov/documents/2012/06/19/2012-12746/core-principles-and-other-requirements-for-designated-contract-markets (explaining the process as “In determining whether to codify a compliance practice in the form of a rule or guidance/acceptable practice, the Commission was guided by whether the practice consisted of a commonly-accepted industry practice. Where there is a standard industry practice that the Commission has determined to be an acceptable compliance practice, the Commission believes that the promulgation of clear-cut regulations will provide greater legal certainty and transparency to DCMs in determining their compliance obligations, and to market participants in determining their obligations as DCM members, and will facilitate the enforcement of such provisions. Several of the rules adopted in this notice of final rulemaking largely codify practices that are commonly accepted in the industry and are currently being undertaken by most, if not all, DCMs.”).

[3] See Dissenting Statement of Commissioner Caroline D. Pham on Misappropriation Theory in Derivatives Markets (Sept. 27, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/phamstatement092723.

[4] Id.

[5] The language is the same for both SEFs and DCMs, so for brevity I will only include it for SEFs here: Reg. 37.5(c)(6) A change in the ownership or corporate or organizational structure of a SEF that results in the failure of the SEF to comply with any provision of the CEA, or any regulation or order of the Commission thereunder— (i) shall be cause for the suspension of the registration of the SEF or the revocation of registration as a SEF, in accordance with the procedures provided in sections 5e and 6(b) of the CEA, including notice and a hearing on the record; or (ii) may be cause for the Commission to make and enter an order directing that the SEF cease and desist from such violation, in accordance with the procedures provided in sections 6b and 6(b) of the CEA, including notice and a hearing on the record.

[6] The only justification provided is “[i]t is imperative that SEFs and DCMs, regardless of ownership or control changes, continue to comply with the CEA and all Commission regulations to promote market integrity and protect market participants.”

[7] See Statement of Commissioner Caroline D. Pham on Effective Self-Regulation and Notice of Proposed Rulemaking to Amend Part 40 Regulations (July 26, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/phamstatement072623b.

I object to the CFTC staff issuing a no-action letter rolling back critical Dodd-Frank Act reforms intended to address causes of the 2008 financial crisis. The Dodd-Frank Act directed the Commission to impose business conduct standards on swap dealers to reverse the caveat emptor nature of pre-crisis swaps markets. These business conduct rules promulgated by the Commission in 2012 include that swap dealers shall disclose to a potential counterparty material information that reasonably allows the counterparty to assess “the material incentives and conflicts of interest” the swap dealer may have before entering into a swap.  Those disclosures “shall include…the mid-market mark of the swap.”[1]

The rule contains no exceptions to these disclosure requirements, despite strenuous objections to the requirements by some in the industry. But the no-action letter creates an exception to swap dealers disclosing their conflicts of interest and material incentives through the pre-trade mid-market mark for certain products as long as there is some transparency in pricing of those products.[2] The no-action letter inappropriately shifts the burden of understanding swap dealer’s conflicts and incentives back onto counterparties, upending the Dodd-Frank Act’s intent.

The No-Action Letter Removes an Important Dodd-Frank Act Counterparty Protection Adopted by the Commission

Through this no-action letter the staff is removing for certain products an important counterparty protection adopted by the Commission. Regulation 23.431(d)(2) instructs swap dealers that mid-market marks “shall not include amounts for profit, credit reserve, hedging, funding, liquidity, or any other costs or adjustments.” As described in a relevant CFTC enforcement case: “By making such disclosures, swap dealers inform their counterparties of an approximate measure of the objective value of a swap prior to markup being added by the swap dealer.”[3] These disclosure rules “are intended to level the information playing field . . . to enable counterparties to make their own informed decisions about the appropriateness of entering into the swap.”[4]

I understand that banks and other swap dealers might prefer to not disclose this type of information, but it is not an appropriate use of a no-action letter for the staff to create an exception for all swap dealers from clear and well-established Dodd Frank Act reforms. As the Commission said during the post-crisis era while implementing the Dodd-Frank Act, the no-action process is “generally better suited for discrete, unique factual circumstances and for situations where neither the CEA nor the Commission's regulations address the issue presented.”[5] Here, there is no discrete or unique factual circumstances as the relief applies to all swap dealers and to a heavily traded product, and the CEA and Commission regulations squarely address the issue presented.

The no-action letter disturbs a carefully considered Commission rule. In developing the 2012 rule, the Commission held over two dozen external consultations, consulted with the SEC, prudential regulators, and foreign authorities, and considered over 120 comments from a wide range of interested parties, including public interest groups. Commenters made arguments both for and against a pre-trade mid-market mark. In contrast, this no-action letter is based only on a request of a working group representing some of the largest swap dealer banks. The letter repeats the perspective of large banks who have opposed this reform since the 2012 rulemaking and says that the relief is in part based on the working group’s representations, without including any independent CFTC analysis.

The no-action letter is particularly concerning because it rolls back an important Dodd Frank Act reform designed to reverse the caveat emptor nature of swaps markets that contributed to the 2008 financial crisis.[6] Even if there is some transparency in pricing (which is not clear as no independent analysis has been provided), the primary purpose of the Dodd Frank Act reforms for this rule was to establish business conduct rules for swap dealers, and provide counterparties with protections. There is no exception in the rule to those protections if there is some transparency in pricing.

Then-Chairman Gensler in the open meeting on the final rule said,

Congress really wanted to address protections for counterparties, and in particular, special entities—municipal governments, pension funds that are entrusted with trillions of dollars of assets on behalf of people's retirements, and I think this rule takes a balanced approach to it. I'm just going to mention three things. One is I think it's very important. It was a Congressional mandate, but I think we've got it right in the rule. The counterparties will get a daily what's the value of this outstanding swap, and I think that's particularly important for a lot of municipals and pension funds, but also small banks, small end users, midmarket companies that would not necessarily know what's the value of that—or at least what does their dealer think the value is on those bilateral swaps. And they'll get it midmarket before the profits or the charges that would be there. I think it's very critical. Two, I think it does help protect against fraud and other abuses in the market…[7]

The No-Action Letter Inappropriately Shifts the Burden of Understanding Swap Dealer’s Conflicts and Incentives Back onto Counterparties, Upending the Dodd-Frank Act’s Intent

Consumer Federation of America’s (“CFA”) comment letter to the 2012 rule said, “Getting the disclosures right is central to preventing the types of abuses that prompted Congress to provide the Commission with such broad authority to set business conduct standards.”[8] CFA commented that the business conduct rules would significantly enhance the integrity of the swaps markets and “better ensure that this market benefits rather than exploits the many commercial end users, government entities, endowments, and pension funds that reply on swaps to hedge risks.”[9]

The no-action letter removes the counterparty protection and shifts responsibility back to counterparties to inform themselves about swap dealers’ conflicts and incentives. The letter includes no independent analysis of the consequences of this shift in burden and removing this counterparty protection, and no discussion of engagement with other stakeholders such as counterparties or public interest groups who commented on the 2012 rule. For example, Better Markets described in their comment letter to the 2012 rule:

With grossly distorted compensation incentives, dealers create ever more complex products ostensibly customized to meet client needs, but are, in fact, designed not to be understandable by anyone other than a derivatives expert. As a result, the history of the derivatives market is littered with disasters and scandals arising from transactions sold by dealers to customers who never knew or understood the ramifications of the complex financial instruments they were sold. From industrial companies like Proctor and Gamble and Metallgeselschaft to financial entities like AIG, Long-Term Capital Management and Barings, enormous sums have evaporated from the balance sheets of major businesses through these instruments. And the losses to governmental entities like Orange County, California, Jefferson County, Alabama, the State of Wisconsin Investment Board, the State of West Virginia and the Denver school district have directly cost taxpayers tens of billions of dollars….The Dodd Frank Act established business conduct standards for SDs [swap dealers] and MSPs [major swap participants] in large part to protect the public from this mayhem. This provision and the proposed rules will greatly reduce the potential that customers will enter into arrangements without the full appreciation of the extraordinary risks associated with derivatives.[10]

Consumer Federation of America’s comment letter to the 2012 rule said,

Although the swaps market is theoretically closed to all but sophisticated parties, the reality is that the complexity and opacity of these transactions has made old notions of financial sophistication obsolete. All too often, corporations and government entities alike have failed to understand the magnitude of the risks they are taking on—a particularly egregious failing in a market the most important and valuable function of which is to help counterparties hedge risks.[11]

These comments highlight the importance of the rule through the viewpoint of the counterparties and the public—a viewpoint that is not reflected in the no-action letter.

The No-Action Letter Undermines the CFTC’s Enforcement Program

Additionally, the no-action letter undermines the CFTC’s enforcement program. The Commission has consistently voted to approve civil charges against swap dealers that failed to provide mid-market marks or provided inaccurate marks. In 2017, the Commission charged Cargill for providing inaccurate mid-market marks to counterparties that concealed up to ninety percent of Cargill’s markup out of concern that disclosing Cargill’s full markup would reduce Cargill’s earnings.[12] The Commission also brought charges for failure to provide accurate marks or to provide marks at all in every recent year:

2020 against the Bank of Nova Scotia for violations over nearly eight years,[13]

2021 against Société Générale for violations over seven years,[14]

2022 against ED&F Man Capital Markets for violations over seven years,[15]

2023 twice against Goldman Sachs for violations over nearly a decade involving one million marks, and charges against Stone X for violations over five years.[16]

These charges highlight the importance of the CFTC’s enforcement program in this area. The current Director of Enforcement has said, “The CFTC is committed to ensuring that swap dealers abide by these standards, so that swap counterparties receive disclosures allowing them to assess material aspects of the swaps before entering into them. As today’s penalty against Goldman demonstrates, the CFTC will aggressively pursue swap dealers that violate these business conduct standards.”[17] Given the fact that the Commission has aggressively gone after violations of pre-trade mid-market marks based on their importance to counterparties, the no-action letter undermines the CFTC enforcement program.

This Policy Decision Should Be Made by the Commission, not the Staff

The rationale of the no-action letter reflects a policy decision that should be made by the Commission, rather than the staff, and in fact has already been made by the Commission. It is inappropriate for the staff to create exceptions to Commission promulgated rules through a no-action letter in this area, particularly given our enforcement cases.

I caution against rolling back Dodd Frank Act reforms through this or another action. As Chairman Sherrod Brown and Senators John Fetterman and Tina Smith recently wrote in a letter to the CFTC Chairman, “The CFTC already faces significant resource constraints in its vital position regulating the derivatives market and should not increase risks to market stability. Now is not the time to peel back the important protections under Dodd-Frank. We urge the Commission to continue to focus on its vital work, preserving market integrity and protecting the public, uphold the letter and spirit of the Dodd-Frank Act….[18] I agree, and therefore, I object to the no-action letter.