Thank you for that kind introduction. I’m pleased to be with you today, and I thank you for inviting me.
There is a lot going on at the CFTC. In the last six weeks, we have finalized important rules to enhance cybersecurity in critical market infrastructure. We have mandated additional clearing requirements for interest rate swaps that are, or will soon be, subject to a clearing mandate in another jurisdiction. We issued a proposal regarding the cross-border application of some of our swap rules, and ordered a one-year delay in the decrease of the swap dealer de minimis threshold. And there is a lot going on in the area of clearinghouse resilience, recovery, and resolution.
These are all important issues; and I have spoken in detail about them in recent weeks. Therefore today I would like discuss a few other areas, starting with the global implementation of uncleared margin rules. Then I would like to discuss a few issues that I hope the Commission will consider soon, including a reproposal of capital requirements for swap dealers and major swap participants, as well as our proposal addressing automated trading. I also will briefly discuss swap trading and the work of the Financial Stability Oversight Council on asset management.
Margin for Uncleared Swaps
So let me first turn to the implementation of uncleared margin rules. These rules are a critical component of the new regulatory framework for swaps trading that the leaders of the G-20 nations agreed to in response to the financial crisis. It is now eight years since the onset of the crisis. Think back to what it was like during October of 2008. It’s not an experience that any of us want to ever repeat. As governments around the world were grappling with how to respond it became very clear, very quickly that we were facing what would be a protracted, painful, and very difficult global crisis. And while governmental actions prevented the Great Recession from becoming another Great Depression, this crisis nevertheless meant over 8 million people lost their jobs in the U.S. alone. We have a responsibility to all Americans to finish the job and properly implement the reforms agreed upon in response.
Most of you know that on September 1, our rules on margin for uncleared swaps went into effect for the largest swap dealers, as did those in Japan and Canada. At that time, some called on us to delay implementation because of the European Commission’s announced delay. However we, and the U.S. prudential regulators, decided to stick to the timetable agreed to by international regulators in March of 2015. I believed we should move forward for several reasons. First, the September 1 deadline only applied to the largest swap dealers—about 20 or so globally, including many in Europe. That meant that European dealers transacting with U.S., Canadian, and Japanese institutions would in fact be subject to margin rules anyway, despite the European delay. I also believed the European delay would be short. And finally, I believed moving forward was the right thing to do, because our responsibility under U.S. law is to do what is best to protect our own financial system.
I also value global coordination, and so shortly after the European delay was announced, I met with the European Commission and European Parliament leaders to ask them to implement their standards as quickly as possible. I am pleased that the European Commission adopted its rules earlier this month, which become effective provided that the European Parliament and European Council do not object. I understand that this process is expected to be completed very soon, which means that the rules will be in place by early next year.
I want to thank Vice President Valdis Dombrovskis of the European Commission, as well as Roberto Gualtieri, chair of the European Parliament’s Committee on Economic and Monetary Affairs, for their leadership in this regard. This past summer, they both promised me they would move forward as quickly as possible to implement the standards, and they did. They have provided great leadership on this issue.
So, everyone should be getting ready. As you know, on March 1, variation margin requirements will apply to a large group of financial firms, probably including many here today. It is my hope that you have already been making preparations, as the schedule has been known for some time. If you have not, there are still four months to do so. Though this is ample time, I encourage you to not wait until the month before.
Let me also note that I expect that other jurisdictions will soon finalize their margin rules. We understand Switzerland will move forward with their rules. Australia has just announced their rules. And we are in touch with Hong Kong and Singapore, which are working on finalizing their rules.
Capital Requirements for Swap Dealers and Major Swap Participants
In addition to our margin rules, the Commission has been working to repropose our rule setting capital requirements for swap dealers and major swap participants.
While margin is the front line defense against a default, adequate capital is critical to the ability of swap dealers to absorb losses.
As with margin, the law provides that swap dealers for which there is a prudential regulator shall comply with the capital rules of the prudential regulators, and the CFTC must adopt capital rules for all others. This is not a one-size-fits-all issue. There are a few types of firms that act as swap dealers—such as bank affiliates, broker-dealers, and others primarily engaged in non-financial activities—and it is important that we have a rule that recognizes this diversity while still promoting safety and soundness. Indeed, if we were to require all firms to follow one approach, we may in fact favor one business model over another, and cause even greater concentration in the industry.
Therefore, I am asking my fellow Commissioners to consider a proposal that takes three approaches. First, for swap dealers that are affiliates of prudentially regulated firms, I believe there should be a method based on that of our banking regulators. Swap dealers that are also broker-dealers could use an approach that is based on the SEC’s net liquid assets approach. And for those dealers that are engaged primarily in non-financial activities, I believe there should be a third approach based on net worth.
I look forward to updating you on this as we make further progress.
We will also take action to address the challenges posed by automated trading in our markets. Now two weeks ago, we had another event in our markets, when the British Pound fell six percent against the U.S. dollar in about 30 seconds, before rebounding. This reminded some of the Treasury “flash rally” just over two years ago today, where prices made a very unusual round trip over about a 10 minute period. Should we think of these incidents as similar or quite different?
The sterling incident occurred in a market that is not nearly as liquid as Treasury futures, and at a time of day when liquidity was particularly low. While there was no particular news that triggered the Treasury rally, there had been news about Brexit in the preceding week that may have created market anxiety. That, of course, was coupled with the already high post-Brexit anxiety prior to the event—as well as thirty year lows in the price of the pound.
When these events occur, people often ask why they occur—and what they indicate about liquidity in our markets today. Last year, I gave a speech at a Federal Reserve conference noting that flash events were not new. In fact, we have had many in the futures markets. This coming Monday, there will be a follow up to that conference, and I will discuss these events—and share some of our analysis on trading in our markets during them that may be of interest to you.
The fact is that in the futures markets today, most trading is automated. Given technological advances, and the fact that the futures market brings all buyers and sellers together on a single electronic central limit order book, it is not surprising that automated trading is so prevalent.
We cannot roll back technology. But we can and must focus on understanding the effects of automated trading in our markets. Our “Regulation AT” proposal is one important step in that regard. It is designed to address the risk of disruption posed by automation. We have received a lot of helpful feedback on the proposed rule we issued last November, and we will consider a supplemental proposal on certain issues related to this rule very soon.
I support issuing a supplemental proposal that would make a number of changes to our initial proposal. First, while our original proposal called for risk controls at three levels—the exchange, the futures commission merchant (FCM) and the trading firm—a number of commenters told us that was too many. They favored a two-tier structure, which I am willing to support. That is, I would support requiring risk controls at the exchange level, and either the trader or FCM level. A trading firm could have its own controls or opt in to the FCM controls, but we would not require both. In addition, many commenters said the controls should pertain to all electronic trading, not just algorithmic trading. I support making that change as well.
We also received many comments that our registration requirement was too broad and burdensome. Some claimed it would require thousands of firms to register. That was not our intent. Some argued that we should not require registration at all; we should simply require risk controls. Now I am not persuaded by this argument. The fact is that without a registration requirement, we cannot make sure that some of the biggest traders in our markets are following the basic risk controls that our proposal calls for.
Today in our markets, a small number of traders can represent a large volume of trading, especially in moments of volatility. For example, the evening after the Brexit vote, the ten most active firms represented approximately 60 percent of trade activity in British pound futures. Therefore, I support retaining the registration requirement, but I would support adding a volume-based quantitative test, so that our focus is on the most active firms.
Finally, when it comes to the issue of “source code,” I have previously said that
I support a rule that respects the proprietary value and confidentiality of source code, while at the same time ensuring that we have access to it when necessary. We are reviewing this this issue and I expect to say more about it in the near future.
So again, this is a very important measure, and I hope we can act on it soon.
Fine-Tuning Rules to Improve Trading
The requirement that certain swaps be traded on regulated platforms is another important pillar of swaps market reform. We have implemented a framework that is bringing greater transparency, better price information and greater integrity to the process.
Currently, we have 23 permanently registered swap execution facilities – or SEFs. And we continue to see strong participation and a high volume of trading on SEFs. In the course of approving registrations, we addressed some concerns that had been raised by market participants. This included, for example, approving facilities that used various execution methods—such as certain streaming protocols and certain types of auction or volume match methods of execution, so long as there is sufficient transparency regarding the process for setting the price.
Over the past year, Commission staff has also taken a number of actions to fine-tune our rules and enhance trading, by addressing the issues of block trades, correction of error trades and swap confirmations. We also provided no action relief with respect to the execution of package transactions, to allow for a phase-in of the requirement to trade these on SEFs. The market has developed technical solutions for many packages, and progress is continuing. We have been asked to extend relief for remaining packages, and I would support doing so.
We are also thinking about how we achieve greater international harmonization when it comes to trading requirements. We are working with our European colleagues on the process of how we recognize each other’s trading platforms. On our side, while a foreign platform could register as a SEF, the law also contemplates having “exempt” SEFs. I believe we should develop an exempt SEF approach that focuses on whether another jurisdiction’s laws and regulations for swaps-trading platforms achieve the same basic outcomes, and have the same basic objectives, as our laws and regulations. This would be similar to what we have done with exempt clearinghouses and foreign boards of trade.
I have also spoken before about my desire to review the made available to trade determination process, and to consider whether the Commission should play a greater role in it. I will ask the Commission to consider a proposal on this in the near future as well.
My fellow Commissioners, Bowen and Giancarlo, have also expressed views on further changes we should consider with respect to SEF trading. I am open to considering other steps; my goal is to find consensus.
FSOC Asset Management Project
Finally, I would also like to say a few words about the asset management project of the Financial Stability Oversight Council, or FSOC, as I know it is of interest to you. The Council is made of a very diverse group of financial agencies, whose experience in dealing with collective investment vehicles varies. The staffs of the various FSOC agencies have engaged in a great deal of information sharing and discussion to formulate a common approach.
After the initial FSOC report on asset management products and activities, our focus in the short-term has been on examining the role of leverage by hedge funds. Now, as I said at the time, one of my key concerns was simply how we define leverage and the metrics we use to measure it. To analyze the implications of leverage, we need to take into consideration a variety of factors that affect risk, from product type and offsetting positions to whether a transaction is cleared and whether margin is collected. We must look at other critical market structure details as well.
So it’s important that this be data driven. We can bring the data the CFTC holds for the futures markets, as well as the data now collected on the swaps markets, to bear on the issue, particularly on the cleared swaps market. This data has added greatly to the “Form PF” data collected by the SEC. It enables us to look at what proportion of the transactions of the largest hedge funds are cleared versus uncleared, a very important distinction. It enables us to look at whether the uncleared transactions are “exotic” in some way, or plain vanilla transactions that aren’t cleared for some reason. This effort has been very useful in understanding where the data gaps are and developing a more precise analytical approach as we look at these issues further.
Before concluding let me just reiterate these are my own views. I look forward to working with my fellow Commissioners, Bowen and Giancarlo, on all these measures.
And let me also say that this is just a small part of what we do every day at the CFTC. Our dedicated staff is always working hard on examinations, compliance, economic and market analysis, surveillance, and enforcement. And there is even more going on in the area of rules, which time does not permit me to discuss today.