Thank you very much. It is an honor to be here. It’s also a challenge to speak at this point in the program. First, you have the fact that preceding me were former Speaker John Boehner, Chuck Todd, David Axelrod, and Karen Hughes. They all gave very insightful commentary on what lies ahead for our country after one of the greatest political upheavals of our lifetime. And following my remarks is the cocktail hour. That’s always appealing and perhaps even more so as we all try to digest what has happened. So yes, I am the only thing between you and the bar.
On top of that, my topic is derivatives regulation. It’s not exactly a “barn burner” of an issue—even in normal times. And it’s clearly not one of the top issues on anyone’s mind right now. And if you’re looking for the inside track on what President-elect Trump wants to do in this area, I’m not your guy.
So should we just adjourn now and head to the bar? Well, indulge me for a few minutes. Because derivatives regulation does matter to your businesses. And as I enter my last few months as chair, let me offer a few thoughts on what you might expect in the next few years.
First, I’d like to echo the comments of President Obama last week on the importance of an orderly transition. I am committed to doing all I can to ensure a smooth transition at the CFTC. I have spoken with both of my fellow Commissioners—Chris Giancarlo and Sharon Bowen—and I know they are committed to this as well.
I regret that derivatives regulation was not more of a focal point of policy discussion during the election. Most Americans would have found the subject boring, of course, but that might have been a welcome relief, given the topics often discussed. But it was a campaign in which the Dodd-Frank Wall Street Reform Act was certainly mentioned, and repeal of Dodd-Frank is being cited now as a priority of the Trump administration. So should we expect a wholesale repeal, including the provisions that reformed the swaps market?
I do not think so. And that’s because I believe there’s a growing consensus that the reforms made to bring transparency and oversight to the swaps market made sense.
My fellow Commissioners and I all joined the CFTC at the same time—June of 2014. At that time, the agency already had done a lot of good work to implement these reforms. But there were many who were critical of that work. There were concerns from commercial end-users that swaps reforms were placing inappropriate burdens on them. There were concerns regarding international harmonization—that the CFTC needed to work more closely with international regulators. There were concerns about the insufficient harmonization with the rules of domestic regulators as well. There were concerns that rules were too prescriptive and unworkable in some respects. There were also concerns that we had not done enough to address the risks posed by swaps activity that were revealed by the crisis.
Some of these concerns are not surprising in light of the enormous task Congress gave the agency, which was to implement an entirely new framework for swaps regulation in a short amount of time—and without a significant increase in resources.
By the time we took office in 2014, we faced a different challenge— to build on and improve the work that had been done to date. So we took a number of steps to fine-tune and improve the framework. We addressed many concerns of commercial end users, to make sure they can continue to use these markets efficiently. We worked to keep the focus of regulation on those who create the most risk. For example, we adopted margin requirements for uncleared swaps, and we worked hard to harmonize rules internationally and domestically. We have also worked hard to strengthen relationships with international regulators in numerous areas, including solving a longstanding dispute over clearinghouse regulation.
My purpose today is not to take a victory lap on what we have accomplished, but rather to describe it generally as a preface to looking ahead. I and my fellow Commissioners have often been in agreement on the actions we have taken. Yes we have had our differences, but the fault lines of our debates have been largely about the details of regulation, not overall goals. They have been more about the specific means and less about the ends.
Under a new chairman, I would expect changes to some rules. Some may even be things we would have considered anyway. But I will not offer any predictions; I will let that new chairman outline that vision. Today, I’d like to talk briefly about three general areas that have been important during my tenure and that I believe will continue to be important in shaping how the CFTC performs its mission in today’s markets. All of these are areas where I believe there is more that unites us than divides us.
The Implications of Technological Changes in Our Markets
The first is the implications of technological changes in our markets. I want to mention a couple aspects of this—cybersecurity, automated trading, and financial technology.
Let me start with the risk of cyberattacks. This is perhaps the greatest single threat to financial stability today. We have made this a priority at the CFTC. As you may know, we adopted some rules recently to make sure the companies that run the critical infrastructure in our markets engage in sufficient testing of their systems. We also focus on it in our examinations.
I think you will see a continued focus on this, not in the adoption of additional rules but in a continuation of the work we are doing to bring industry and government together to tackle this problem. There is a lot that has occurred across the federal government over the last couple years in this regard; and today there is much greater sharing of information on threats and preparations to prevent attacks. For example, just two weeks ago the CFTC hosted an exercise involving participants from several government agencies—including law enforcement agencies and Homeland Security—as well as CME, ICE, clearing firms, and trading firms to discuss what would happen if derivatives trading platforms were hit by a cyberattack. The scenario was hypothetical, no actual firms were used. But it was a very useful discussion for all of us—and I think it will help all of us in our planning and in our understanding of how such an attack could unfold.
A second aspect of technological evolution is how electronic and specifically automated trading has changed our markets. We’ve taken a number of steps in this regard. We have modernized our surveillance efforts through the in-house development of sophisticated analytical tools and the increased use of message data. We have issued a rule proposal that would make sure there are risk controls to prevent disruptions from automated trading. Our economists have been studying its effects on market liquidity. We have increased our enforcement efforts with respect to new forms of improper behavior like spoofing. Just last week our case against Navinder Sarao for spoofing was settled, and he pleaded guilty to criminal charges related to his activity at the time of the “flash crash” of 2010, as well as on other occasions. There is more that can and should be done in these areas. There may be changes in exactly what steps the Commission takes in the future, but there is no question in my mind that going forward, a focus on the implications of automated trading will be important. This will include its impact on liquidity, which I will address in a moment.
A final aspect of technological change is financial technology, and specifically what is known as blockchain technology. We are probably still a ways away from meaningful applications of this technology in our markets. But we already have some work in progress to update rules in anticipation of these developments. For example, we are looking at the rules describing how books and records must be kept, recognizing that these rules are outdated and will simply become more so if and when developments like “smart contracts” become a reality.
Analyzing the Effects of Reform: Clearinghouse Risk and Market Liquidity
Let me turn to a second area. Amidst the call to repeal Dodd-Frank, one would think it might be prudent to first engage in some data-driven analysis on the effects of reforms. But the political process is not always as deliberate or analytical as some might like. Sometimes there is a tendency to “shoot first and ask questions later.” So we will see what “repeal” means. If repeal means we increase the likelihood that a globally significant financial institution’s failure will take down our economy—or require a federal bailout—that would not seem to deliver on promises made to working class voters who believe the government has been captured by powerful interests and has forgotten about them. On the other hand, it may mean focusing on how Dodd-Frank impacts those who weren’t the cause of the crisis, such as community and smaller banks and commercial companies.
The CFTC has been doing some of this as part of the natural evolution of regulation. As I noted, we took many actions to address the concerns of commercial end-users regarding the inappropriate effects of these reforms. We postponed lowering the threshold to register as a swap dealer, in part because of concerns about its effects on smaller banks. And our staff is about to launch a review of swap trading rules. There is more that could be done in all these areas. But let me highlight two areas in particular where we are looking at the effects of reforms that I would expect to continue.
Nowhere perhaps is it more important to look at the effects and the consequences of reforms than with central clearing. We have mandated increased use of central clearinghouses. I believe that is a good thing, but some have raised questions about whether we have just created new concentrations of risk, and new systemic points of potential failure. So with this increased use of clearing comes the responsibility to make sure clearinghouses are strong and resilient. We have been doing a lot here, and I expect the agency will continue to do so, domestically and internationally.
On Wednesday of this week, we will release the results of a series of supervisory stress tests our staff has conducted on five clearinghouses under our jurisdiction, both in the U.S. and abroad. These tests assess the impact of stressful market scenarios across these clearinghouses and across the largest clearing members. I think you will find the results very interesting, and I encourage you to visit our website, cftc.gov on Wednesday to watch the webcast.
These tests are a good first step in looking at default risk across multiple clearinghouses. I hope the Commission will do this regularly. And I hope the Commission continues to focus on other types of risk—such as liquidity risk, operational risk, and cybersecurity.
There has been a lot of discussion about whether the various reforms to enhance the capital of our largest banks, and put limits on certain activities, have adversely affected liquidity. I would expect a lot of attention here. But liquidity is shaped by many factors beyond regulation, such as market structure, technological change, and general economic conditions. It can be very hard to separate the effects of these various factors. So I hope there is data-driven analysis, not just action based on supposition or anecdote.
The issue of liquidity is related to the issue of automated trading. I meet with market participants of all types, and I find that many traditional commercial end-users, such as those in the agricultural markets, are particularly questioning whether the markets still work for them. Can they still hedge effectively?
Some would say a lot of the activity in our markets today doesn’t really facilitate a transfer of risk. For example, many high frequency traders want to be flat at the end of the day. Others say the nature of liquidity is simply different: you may have to break up a large order into a series of small orders, but the average price is still as good—or better than before. And what happens to liquidity in stressful times? These are all questions worth looking at.
Clearinghouse resiliency—and market liquidity—also depend on having a robust clearing member industry. I’ve previously discussed my concerns about the effects of some capital reforms on the clearing member industry, and there has been international attention to this. Have we properly aligned regulations to strengthen bank capital with the policy of promoting central clearing? So this issue may get further attention.
Finally, cooperation and coordination among regulators internationally will continue to be very important. I have made it a priority to work closely with other regulators—to harmonize rules as much as possible, to work together on oversight and similar matters, and to improve our relationships around the world generally. Our efforts are not confined to Europe and the UK. We are working with China and India on possible recognition of clearinghouses. We are working with Japan and other regulators on automated trading. We are working with Asian Pacific jurisdictions on a variety of issues.
We cannot have modern regulation of global markets without extensive international cooperation and coordination, and so I hope this will continue to be a priority.
Let me conclude with this thought. I believe the issues I have outlined will be important regardless of the political composition or leadership of the CFTC. These issues pertain to fundamental changes in our markets; I hope that they can be addressed without partisan divisions. The derivatives industry needs and deserves consistent regulation—regulation that deals with the problems we identified in the crisis, and also confronts the new challenges ahead that come with constantly evolving financial markets. We have accomplished a lot in the last thirty months. And in the time remaining there are still a few things I hope we can complete. Then it will be up to new leadership.