FROM: COMMODITY FUTURES TRADING COMMISSION
Keynote Address by Commissioner Scott D. O’Malia, 2014 Bank of Canada International Economic Analysis Workshop on Financialization of Commodity Markets
Impact of the Dodd-Frank Act on Commodity Futures and Swaps Markets
March 21, 2014
I want to thank Bahattin for inviting me to speak at this workshop. The topic of today’s workshop is “Financialization of Commodity Markets.” As we all know, commodity prices have experienced an unprecedented rise from the early 2000s. During this time, investors poured large amounts of investment capital into the commodity markets. As such, there has been much written about whether the increased presence of financial investors in the commodity markets led to higher commodity prices and volatility, the so-called “financialization of commodities” debate. Many of today’s distinguished panelists have and will offer their insights on speculative activity in the commodity markets and its relationship to the financialization of these markets.
I would like to use this speech to frame the discussion of the impact of the Dodd-Frank Act and Commission regulations on commercial end-users who have historically used the commodity futures and swaps markets for risk mitigation and hedging. In this regard, I will first discuss the importance of hedging in the commodity markets, especially given volatile commodity prices. Next, I will discuss the impact that Dodd-Frank and Commission reforms have had on hedging in the commodity markets, including the “futurization” of swaps. I will then discuss the potential impact on hedging of upcoming Commission rulemakings. Finally, I will touch on the importance of the Commission’s utilization of data in its oversight of the commodity markets.
Importance of Hedging in the Commodity Markets
It is important to remember that the futures markets originated as a way for buyers and sellers to hedge price risk in the grain markets.1 Today, notwithstanding investor participants in the commodity markets, participants from producers to manufacturers to commercial end-users continue to rely on the futures and swaps markets in order to hedge their commodity price risk, which is essential in order to operate, invest, and grow their businesses.
As we all know, commodity prices are not static. A good example of this price risk is natural gas. Even with the boom in natural gas production,2 this long and harsh winter reminds us that increased demand and supply disruptions can result in regional price spikes despite what seems to be an endless supply of natural gas. For example, the extreme cold temperatures this winter greatly increased demand and impacted production, storage, and transportation supplies for natural gas, causing cash prices in the Northeastern U.S. to hit record levels in late January.3 Chart 1 shows that ICE day-ahead cash prices for Northeast natural gas spiked to over $120 per million British thermal units at the end of January before falling back to more reasonable levels. The March – April natural gas spread has been similarly volatile this winter as shown in Chart 2. This spread widened to $1.208 on February 20 before narrowing. Given the increased demand and supply issues for natural gas, storage levels of natural gas are the lowest in 11 years as shown in Chart 3. As of March 7, working gas in storage was 49 percent below last year’s level and 46 percent below the five-year average.
Weather also brought the worst drought in decades to Brazil this winter, causing coffee crop losses of up to 30 percent.4 May coffee futures peaked at $2.0975 a pound on March 12, the highest level since February 2012.5 Weather is not the only factor that can cause volatility in commodity prices. The PED6 virus, which has killed an estimated 5 million pigs in the U.S,7 has sent lean hog futures prices to record highs.8 Even the Crimean conflict contributed to increased wheat and corn prices this month.9
Given the volatility in commodity prices, hedging is an important function in the commodity markets so that participants can efficiently operate their businesses. Chart 4 provides an example of a potential consequence when a business does not hedge its exposure.10 Unfortunately, in this example, Clean Currents closed its business because this past winter’s “extreme weather … sent the wholesale electricity market into unchartered territories” and Clean Currents did not hedge this exposure.11 In this regard, the Commission must be mindful of the impact of its rules on the cost of hedging for end-users so that they are able to engage in legitimate hedging activities. I will next discuss the impact of the Commission’s swaps rules on hedging in the commodity markets.
Dodd-Frank Impact on the Commodity Markets
As you know, over the past several years the Commission has been busy implementing the Dodd-Frank Act. The Commission has completed 68 final rulemakings and 8 exemptive orders and the Commission staff has issued approximately 172 no-action relief letters and 34 guidance and advisories. The Commission now has 98 provisionally registered swap dealers, 19 temporarily registered swap execution facilities, and 4 provisionally registered swap data repositories. In a rush to complete the rulemaking process, the Commission preferred speed over precision. As a result, the Commission’s swaps rules have introduced unnecessary complexity, vagueness, and costs into the markets, including the commodity markets. These consequences have, in certain instances, led some hedgers to seek out alternatives, such as swap futures. This trend is commonly referred to as the “futurization of swaps.”
On October 12, 2012, the joint CFTC-SEC rule defining the term “swap” became effective,12 which triggered compliance requirements for a number of Commission swaps regulations. To avoid compliance with burdensome and costly swaps regulations, customers of both CME and ICE demanded that the commodity markets move to listed futures instead of swaps. In response, on October 15, 2012, ICE converted its cleared energy swaps into futures and CME began listing energy futures contracts.
Following this shift, CME Group and Eris Exchange launched interest rate swap futures in December 2012.13 Singapore Exchange began offering commodity futures for trading in April 2013.14 ICE launched credit index futures in June 2013.15 Earlier this year, Greenwich Associates noted that “a clear trend exists towards growing demand for FX futures in lieu of traditionally bilateral FX derivatives.”16 Market participants have cited the complexity and cost of complying with the new swaps rules as major drivers to the futures markets.17 Unlike the swaps markets, the futures markets have clear rules and provide market participants with regulatory certainty.
The Commission’s unjustifiably complicated swap dealer definition18 and unjustifiably expensive compliance requirements for market participants that meet this definition is one example of a Commission rule that has pushed market participants to the futures markets. In addition to brokers, many other market participants, including energy, agricultural, and commodity firms have to worry about being subject to this definition. Rather than providing a bright line test for determining whether a market participant is a swap dealer, the rule broadly applies the swap dealer definition to all market participants and then provides some limited conditional relief, but only if participants navigate through the complex set of hedging factors on a trade-by-trade basis and fall below the $8 billion de minimis level.
In a few years, the $8 billion de minimis level will fall to $3 billion if the Commission does not vote to change the threshold. Earlier this month, I asked the Commission staff how many additional entities would have to register as a swap dealer if the de minimis level moved to $3 billion today. The Commission staff could not answer this question. If the Commission cannot determine if an entity falls within the swap dealer definition, how can it expect end-users to navigate this complex rule?
Think about this in another way. If the Commission cannot identify swap dealers, how can it enforce this rule? The Commission’s data rules do not require a market participant to flag a trade as a dealing trade or a hedging trade. So, how will the Commission conduct compliance and oversight of this rule regardless of the de minimis level? I suspect that the Commission will add all trades executed by a market participant and see how close the total is to the de minimis level, and then ask questions to determine whether the economic purpose of each trade was dealing or hedging. This solution will be a nightmare for both the Commission and the end-users.
To provide end-users greater certainty, I propose a modest fix that would allow end-users to exclude all cleared trades from the calculation towards the de minimis threshold. This fix would encourage end-users to clear their trades and would reduce regulatory compliance costs for those end-users who choose to do so.
Moreover, as I noted before, once an entity is subject to the swap dealer definition, the cost of complying with the swap dealer regulations is high. Swap dealers must comply with an array of complex and costly rules in areas such as minimum capital requirements, business conduct, and trade reporting – giving participants a strong incentive to stay away from being labeled as a swap dealer. Participants in the futures markets do not have to comply with such onerous rules.
The downside of futurization for participants in the commodity markets is reduced hedging flexibility because futures contracts, unlike swaps, cannot be individually tailored to meet specific risk needs. Given the volatility of prices in the commodity markets, and the different needs, risks, time horizons, and incentives for end-users in these markets, customized hedging is especially important.19 Because of the Commission’s rules, these participants will have to accept imperfect hedges, endure the higher cost of swaps, or forego hedging all together. All of these alternatives are unacceptable.
For example, smaller natural gas producers rely on customized hedging solutions to mitigate their exposure to volatile natural gas prices, which enables them to invest in their drilling programs.20 There are more than 120 natural gas delivery locations in the U.S., which can vary significantly from the Henry Hub benchmark price traded on exchanges.21 In addition, producers may need the flexibility to enter into long-dated hedges; however, approximately 80% of Henry Hub futures volume is traded within a two-year maturation date.22 The lack of delivery locations and liquidity in long-dated hedges in the futures markets requires customized hedging solutions in many cases.23 If end-users are forced to use swap futures because the cost of using swaps is too high, these participants will have a less perfect hedge, which could result in additional risk or reduced capital investment.24
Upcoming Changes to the Commodity Markets
There are several upcoming Commission rulemakings that will impact hedging in the commodity markets. First, the Commission is considering a proposed futures block rule that will limit the availability of block trades, especially for energy futures. Exchanges have facilitated the transition from swaps to futures in the commodity markets by establishing extremely low threshold sizes for block trades in futures contracts. These thresholds are unlikely to stay at these levels with a Commission futures block rule. It remains to be seen how Commission rules would affect futurization in the commodity and other markets and the cost of hedging to end-users.
Second, the OTC margin and capital rules for uncleared swaps will increase the cost of hedging. It is important to note that the effort to establish a margin regime for uncleared swaps is a global effort. In September 2013, the Basel Committee on Banking Supervision and the International Organization of Securities Commissions released their final policy framework on margin requirements for uncleared derivatives.25 These rules will spare end-users from mandatory initial and variation margin exchange. However, banks will be hit with new capital charges to offset the risk posed by OTC trades. Banks will pass these costs on to end-users. The Commission will need to finalize these rules, which will increase the cost of hedging for end-users in the commodity markets.
Third, the Commission staff is working on mandatory clearing determinations for additional interest rate swap contracts and non-deliverable forward (“NDF”) contracts. As I previously mentioned, it appears that there is already growing demand for FX futures in lieu of traditionally bilateral FX derivatives. Only time will tell if mandatory clearing and trading accelerate the move of NDFs to futures. While mandatory clearing for commodity swaps is likely a year or more away, commodity market participants should keep a close eye on clearing and trading in the interest rate, credit default, and NDF markets to determine how commodity markets may react in the future with the advent of mandatory clearing and trading. Commodity market participants should also watch for any impacts on the cost of hedging.
Finally, the position limits re-proposal has the potential to negatively impact end-users legitimate hedging activities. Setting position limits is not an easy task, especially with unusable data as I will discuss next. The Commission is supposed to stop excessive speculation and manipulation, but must also protect the essential price discovery process and hedging function in the markets. Unfortunately, the Commission’s position limits re-proposal may curtail end-users hedging activities as it scales back the bona fide hedging exemption. The current bona fide hedging exemption has been in effect since the 1970s and, from my understanding, has worked well in the markets. In developing a final position limits rule, the Commission must ensure that it does not impact longstanding and legitimate hedging activities.
Commission’s View into the Commodity Markets
I would like to next discuss the importance of the Commission’s utilization of data in its oversight of the commodity markets. Two fundamental goals of the Dodd-Frank Act were to increase the transparency and integrity of the swaps markets. To achieve these goals, Dodd-Frank required market participants to report information about each swap transaction to a swap data repository.26 The Commission promulgated swap data reporting rules and swap dealers began reporting their trades in December 2012.27
As important as data is, the Commission does not have a clear picture into the commodity swaps markets or financial markets, for that matter. Let me be clear. The data is extraordinarily difficult to use and the Commission is not utilizing this data effectively, or as it was intended. Without usable data, the Commission cannot conduct surveillance, set appropriate position limits, or analyze systemic risk in these markets. The swaps data is not merged with futures data and cannot be analyzed together. Despite the fact that market participants trade across markets and across jurisdictions with little effort; the Commission continues to struggle to develop its own oversight capacity, unless the Commission makes this a top priority.
However, I am pleased that the Commission is taking steps to improve the quality and consistency of its data. The Commission’s Technology Advisory Committee, which I chair, started to perform work on data harmonization back in 2011. Based on this effort, the Commission is currently working with the swap data repositories to harmonize the data within the credit asset class and will then move on to the interest rate asset class. Commodities, unfortunately, are well down the road.
In addition, based on my suggestion, the Commission formed a cross-divisional data team in January of this year to identify and fix our data problems. The Commission, based on the data team’s work, this past Wednesday put out for comment approximately 70 questions addressing several swap data reporting issues. Based on the comments and its own self-evaluation of the current reporting regime, the cross-divisional data team will make recommendations to improve swap data reporting to the Commission this summer.
I cannot emphasize enough how important it is for the Commission to improve its data quality and utilization so that the Commission has an accurate and complete picture of the swaps markets. Without this view, the Commission cannot surveil the markets for manipulation and other abusive trading practices. In addition, the Commission will not be able to set credible position limits or determine whether end-users are hedging or speculating. The Commission’s ability to perform vital risk analysis will also be compromised.
Conclusion
It is probably appropriate that I conclude my remarks by emphasizing that it is crucially important for the Commission to improve and effectively utilize its data so that the Commission develops a complete picture of both the swaps and the futures markets. In many respects, many of the questions regarding the impact of financialization on the commodity markets would be answerable if the Commission had a complete picture of market participants and their trading strategies.
In addition, the Commission must be mindful of the impact that its regulations have on the cost of hedging in the markets. This is especially true in the commodity markets where a wide range of participants hedge because of the volatility in commodity prices and specialized business needs. If the cost of hedging becomes too expensive, these participants may choose not to hedge or enter into less perfect hedges, which impairs efficient business operations.
Therefore, looking forward, the Commission must strive to issue clear, consistent, and cost effective rules that are informed by data and that do not interfere with hedging in the markets. Finally, the Commission must re-visit rules that have proved unworkable or overly burdensome. I am encouraged that the Commission has taken the first step by re-visiting its data rules. I encourage the Commission to not stop there and continue to re-visit rules that have impacted legitimate hedging activities.
Thank you very much for your time.
Note: Presentation is available under Related Links.
1 See Timeline of CME Achievements, available at http://www.cmegroup.com/company/history/timeline-of-achievements.html.
2 Annual Energy Outlook 2013, U.S. Energy Information Administration, April 2013, page 79, available at, http://www.eia.gov/forecasts/aeo/pdf/0383(2013).pdf. The EIA report shows an increase in natural gas production since the mid-2000s and predicts a further 44 percent increase in production from 2011 to 2040, with shale gas providing the largest source of growth.
3 Freezes hit U.S. natural gas output, California supply, Reuters, February 3, 2014, available at, http://www.reuters.com/article/2014/02/06/energy-natgas-weather-idUSL2N0LB1I420140206. Supply constraints also contributed to price spikes. Northeastern Winter Natural Gas and Electricity Issues, U.S. Energy Information Administration, January 7, 2014, available at, http://www.eia.gov/special/alert/east_coast/pdf/energy_market_alert_Jan_7_2014.pdf.
4 Rains to end Brazil coffee drought, but damage done, Reuters, February, 13, 2014, available at http://www.reuters.com/article/2014/02/13/brazil-coffee-rains-idUSL2N0LI1DY20140213.
5 Coffee, sugar fall on producer selling, cocoa eyes expiry, Reuters, March 14, 2014, available at http://www.cnbc.com/id/101494777.
6 Porcine epidemic diarrhea virus.
7 Pork Industry Launches Three-Prong Strategy to Stem PEDV Spread, National Pork Board, March 11, 2014, available at, http://www.pork.org/News/4575/PorkIndustryLaunchesThreeProngStrategytoStemPEDVSpread.aspx.
8 Is virus-inflated U.S. hog market bubble about to burst?, Reuters, March 14, 2014, available at, http://www.reuters.com/article/2014/03/14/us-usa-pork-hogs-analysis-idUSBREA2D1YW20140314.
9 Wheat jumps 2 pct on U.S. weather, Ukraine concerns, Reuters, March, 14, 2014, available at, http://www.reuters.com/article/2014/03/14/markets-grains-idUSL3N0MB3CX20140314.
10 See Clean Current’s website, available at, http://www.cleancurrents.com/; Clean Currents turns off its lights after January’s polar vortex spiked energy prices, The Washington Post, February 3, 2014, available at, http://www.washingtonpost.com/business/capitalbusiness/clean-currents-turns-off-its-lights-after-januarys-polar-vortex-spiked-energy-prices/2014/02/03/8f9cde1e-8cf6-11e3-98ab-fe5228217bd1_story.html.
11 Id.
12 Further Definition of “Swap,” “Security-Based Swap,” and “Security-Based Swap Agreement”; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 77 FR 48208 (Aug. 13, 2012).
13 Deliverable Interest Rate Swap Futures, CME Group, available at, http://www.cmegroup.com/trading/interest-rates/files/dsf-overview.pdf. Eris Exchange to Launch New, Margin-Efficient Interest Rate Swap Futures, Eris Exchange, December 5, 2012, available at, http://www.erisfutures.com/EE/Eris_Exchange_to_Launch_New_Margin_Efficient_Interest_Rate_Swap_Futures.pdf.
14 SGX to Introduce Iron Ore Futures as Investors Bet on China, Bloomberg, April 5, 2013, available at, http://www.bloomberg.com/news/2013-04-05/sgx-to-introduce-iron-ore-futures-as-investors-wager-on-china.html.
15 Credit Index Futures on ICE, available at, https://www.theice.com/credit.jhtml.
16 Futurization of FX Derivatives, Greenwich Associates, January 14, 2014, available at, https://www.greenwich.com/greenwich-research/research-documents/greenwich-reports/2014/jan/is-spl-futfx-2013-gr. Why Regulatory Changes Will Drive FX Trading Volume to Futures, kevinonthestreet, January 14, 2014, available at, http://kevinonthestreet.com/why-regulatory-changes-will-drive-fx-trading-volumes-to-futures/.
17 Id. Futurization: Dodd-Frank Drives Swaps-to-Futures Migration, futuresINDUSTRY, January 2013, available at, http://www.futuresindustry.org/futures-industry.asp?iss=209&a=1531. Swaps Futurization Means Added Choice, Market Media, March 12, 2014, available at, http://marketsmedia.com/swaps-futurization-means-added-choice/.
18 Further Definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant,” “Major Security-Based Swap Participant,” and “Eligible Contract Participant,” 77 FR 30595 (May 23, 2012).
19 The Role of Banks in Physical Commodities, HIS Global Inc., 2013, at pages 4-5.
20 Id. at 24-25.
21 Id. at 24.
22 Id. at 25.
23 Id.
24 Id.
25 Basel Committee on Banking Supervision and Board of the International Organization of Securities Commissions, Margin requirements for non-centrally cleared derivatives, September 2013, available at, http://www.bis.org/publ/bcbs261.pdf.
26 Sections 727 and 728 of the Dodd-Frank Act. Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).
27 17 C.F.R. parts 43, 45, and 46.
Showing posts with label SWAPS. Show all posts
Showing posts with label SWAPS. Show all posts
Sunday, March 23, 2014
Friday, February 7, 2014
CFTC CHAIRMAN WETJEN'S TESTIMONY BEFORE SENATE COMMITTEE
FROM: COMMODITY FUTURES TRADING COMMISSION
Testimony of Acting Chairman Mark P. Wetjen Before the U.S. Senate Committee on Banking, Housing & Urban Affairs, Washington, DC
February 6, 2014
Good morning Chairman Johnson, Ranking Member Crapo and members of the Committee. Thank you for inviting me to today’s hearing on the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) and customer information security. I am honored to testify as Acting Chairman of the Commodity Futures Trading Commission (“CFTC”). I also am pleased to join my fellow regulators in testifying today.
Now is a good time for not only this Committee, but all stakeholders in the CFTC to reflect on the agency’s progress in implementing financial reform and what the future might bring for this agency and the markets it oversees.
Due to Dodd-Frank and the efforts of my colleagues and staff at the CFTC, today there is both pre-trade and post-trade transparency in the swaps market that did not exist before. The public now can see the price and volume of swap transactions in real-time, and the CFTC’s Weekly Swaps Report provides a snapshot of the swaps market each week. The most liquid swaps are being traded on regulated platforms and exchanges, with a panoply of protections for those depending on the markets, and regulators themselves have a new window into the marketplace through swap data repositories (“SDRs”).
Transparency, of course, is helpful only if the information provided to the public and regulators can be usefully employed. Therefore, the CFTC also is taking steps to protect the integrity of that data and ensure that it continues to be reliable and useful for surveillance, systemic risk monitoring, and the enforcement of important financial reforms.
These transparency rules complement a number of equally important financial reforms. For example, the counterparty credit risks in the swaps market have been reduced as a large segment of the swaps market is now being cleared – as of last month, about 70 percent of new, arm’s-length swaps transactions were being cleared. Additionally, nearly 100 swap dealers and major swap participants (“MSPs”) have registered with the CFTC, bringing their swaps activity and internal risk-management programs under the CFTC’s oversight for the first time. We also have strengthened a range of futures and swaps customer protections.
As it has put these reforms in place, the CFTC has consistently worked to protect liquidity in the markets and ensure that end-users can continue using them to hedge risk as Congress directed.
The CFTC, in short, has completed most of its initial mandate under Dodd-Frank and has successfully ushered in improvements to the over-the-counter derivatives market structure for swaps, while balancing countervailing objectives.
Volcker Rule
In recent weeks, the Commission finalized the Volcker Rule, which was one of our last major rules under Dodd-Frank. The Volcker Rule was exceptional on account of the unprecedented coordination among the five financial regulators.
Congress required the banking regulators to adopt a joint Volcker Rule, but it also provided that the market regulators – the Securities and Exchange Commission (“SEC”) and the CFTC – need only coordinate with the prudential banking regulators in their rulemaking efforts. One of the hallmarks of the final rule is that the market regulators went beyond the congressional requirement to simply coordinate. In fact, the CFTC’s final rule includes the same rule text as that adopted by the other agencies. Building a consensus among five different government agencies was no easy task, and the level of coordination by the financial regulators on this complicated rulemaking was exceptional.
This coordination was thanks in no small part to leadership at the Department of the Treasury. Secretary Lew, Acting Deputy Secretary Miller, and others were instrumental in keeping the agencies on task and seeing this rulemaking over the finish line. Along with the other agencies, the CFTC received more than 18,000 comments addressing numerous aspects of the proposal. CFTC staff hosted a public roundtable on the proposed rule and met with a number of commenters. Through weekly inter-agency staff meetings, along with more informal discussions, the CFTC staff and the other agencies carefully considered the comments in formulating the final rule.
Differences with Proposal
The agencies were responsive to the comments when appropriate, which led to several changes from the proposed Volcker Rule I would like to highlight.
The final Volcker Rule included some alterations to certain parts of the hedging-exemption requirements found in the proposal. For instance, the final rule requires banking entities to have controls in place through their compliance programs to demonstrate that hedges would likely be correlated with an underlying position. The final rule also requires ongoing recalibration of hedging positions in order for the entities to remain in compliance.
Additionally, the final rule provides that hedging related to a trading desk’s market-making activities is part of the trading desk’s financial exposure, which can be managed separately from the risk-mitigating hedging exemption.
Another modification to the proposal was to include under “covered funds” only those commodity pools that resemble, in terms of type of offering and investor base, a typical hedge fund.
CFTC Volcker Rule Implementation and Enforcement
The CFTC estimates that, under its Volcker regulations, it has authority over more than 100 registered swap dealers and futures commission merchants (“FCMs”) that meet the definition of “banking entity.” In addition, under Section 619, some of these banking entities may be subject to oversight by other regulators. For example, a joint FCM/broker-dealer would be subject to both CFTC and SEC jurisdiction and in such circumstances, the CFTC will monitor the activities of the entity directly and also coordinate closely with the other functional regulator(s).
In this regard, Section 619 of the Dodd-Frank Act amended the Banking Holding Company Act to direct the CFTC itself to write rules implementing Volcker Rule requirements for banking entities “for which the CFTC is the primary financial regulatory agency” as that term was defined by Congress in Dodd-Frank. Accordingly, as Congress directed, the CFTC’s final rule applies to entities that are subject to CFTC registration and that are banking entities, under the Volcker provisions of the statute.
To ensure consistent, efficient implementation of the Volcker Rule, and to address, among other things, the jurisdiction issues I just mentioned, the agencies have established a Volcker Rule implementation task force. That task force also will be the proper vehicle to examine the means for coordinated enforcement of the rule. Although compliance requirements under the Volcker Rule do not take effect until July 2015, the CFTC is exploring now whether to take additional steps, including whether to adopt formal procedures for enforcement of the rule. As part of this process, I have directed CFTC staff to consider whether the agency should adopt such procedures and to make recommendations in the near future.
Volcker Rule: Lowering Risk in Banking Entities
The final Volcker Rule closely follows the mandates of Section 619 and strikes an appropriate balance in prohibiting banking entities from engaging in the types of proprietary trading activities that Congress contemplated when considering Section 619 and in protecting liquidity and risk management through legitimate market making and hedging activities. In adopting the final rule, the CFTC and other regulators were mindful that exceptions to the prohibitions or restrictions in the statute, if not carefully defined, could conceivably swallow the rule.
Banking entities are permitted to continue market making—an important activity for providing liquidity to financial markets—but the agencies reasonably confined the meaning of the term “market making” to the extent necessary to maintain a market-making inventory to meet near-term client, customer or counterparty demands.
Likewise, the final rule permits hedging that reduces specific risks from individual or aggregated positions of the banking entity.
The final Volcker Rule also prohibits banking entities from engaging in activities that result in conflicts of interest with clients, customers or counterparties, or that pose threats to the safety and soundness of these entities, and potentially therefore to the U.S. financial system.
The final Volcker rule also limits banking entities from sponsoring or owning “covered funds,” which include hedge funds, private equity funds or certain types of commodity pools, other than under certain limited circumstances. The final rule focuses the prohibition on certain types of pooled investment vehicles that trade or invest in securities or derivatives.
Finally, and importantly, the final Volcker Rule requires banking entities to put in place a compliance program, with special attention to the firm’s compliance with the rule’s restrictions on market making, underwriting and hedging. It also requires the larger banking entities to report key metrics to regulators each month. This new transparency, once phased-in, will buttress the CFTC’s oversight of swap dealers and FCMs by providing it additional information regarding the risk levels at these registrants.
TruPS Interim Final Rule
Even with resource constraints, the CFTC has been responsive to public input and willing to explore course corrections, when appropriate. With respect to the Volcker Rule, the CFTC, along with the other agencies, last month unanimously finalized an interim final rule to allow banks to retain collateralized debt obligations backed primarily by trust-preferred securities (TruPS) issued by community banks. The agencies acted quickly to address concerns about restrictions in the final rule, demonstrating again the commitment of the agencies at this table to ongoing coordination. In doing so, the CFTC and the other agencies protected important markets for community banks, as Congress directed.
Implementation Stage of Dodd-Frank
Looking ahead through the lens of what already has been done, it is clear that the Commission and all stakeholders will need to closely monitor and, if appropriate, address the inevitable challenges that will come with implementing the new regulatory framework under Dodd-Frank.
For the CFTC, only a few rulemakings remain to be re-proposed or finalized in order to complete the implementation of Dodd-Frank. Indeed, in just a matter of days, the compliance date for perhaps the last remaining, major hallmark of the reform effort will arrive: the effective date of the swap-trading mandate.
Rules the Commission is working to address in the coming months include capital and margin requirements for un-cleared swaps, rulemakings intended to harmonize global regulations for clearinghouses and trading venues, and finalizing position limits.
There are other important matters in the months ahead as well.
Allow me to mention some of these matters before the Commission as we move forward with Dodd-Frank implementation.
Made Available to Trade Determinations
As a result of the trade execution mandate, many swaps will, for the first time, trade on regulated platforms and benefit from market-wide, pre-trade transparency. These platforms are designed to improve pricing for the buy-side, commercial end-users, and other participants that use these markets to manage risk. Additionally, SEFs, as registered entities, are required to establish and enforce comprehensive compliance and surveillance programs.
The Commission’s trade execution rules complement our other efforts to streamline participation in the markets by doing away with the need to negotiate bilateral credit arrangements and removing impediments to accessing liquidity. This not only benefits the end-users that the markets are intended to serve, but also new entrants seeking to compete for liquidity who now are able to access the markets on impartial terms. In essence, the Commission’s implementation of the trade execution mandate supports a transparent, risk-reducing swap-market structure under CFTC oversight.
In recent weeks, the “Made Available to Trade Determinations” filed by four swap execution facilities (“SEFs”) have been deemed certified, making mandatory the trading of a number of interest rate and credit default swaps on regulated platforms.
There have been some questions in this context about the trading of so-called “package transactions,” which often include a combination of financial instruments and at least one swap that is subject to the trade execution requirement. I have directed Division of Market Oversight (“DMO”) staff to hold an open-to-the-public roundtable, which will take place February 12, and to further examine these issues so that the CFTC can further consider the appropriate regulatory treatment of basis trades falling within the meaning of a “package transaction.”
Data
In order for the Commission to enforce the significant Dodd-Frank reforms, the agency must have accurate data and a clear picture of activity in the marketplace.
Last month, with the support of my fellow commissioners, I directed an interdivisional staff working group to review certain swap transaction data, recordkeeping and reporting provisions under Dodd-Frank. The working group, led by the director of DMO, will formulate and recommend questions for public comment regarding compliance with Part 45 reporting rules and related provisions, as well as consistency in regulatory reporting among market participants.
We have seen an incredible shift to a transparent, regulated swaps marketplace, and this is an appropriate review to ensure the data we are receiving is of the best possible quality so the Commission can effectively oversee the marketplace. I have asked the working group to review the incoming public comments and make recommendations to the Commission in June.
Concept Release on Risk Controls and System Safeguards for Automated Trading Environments
The CFTC’s Concept Release on Risk Controls and System Safeguards for Automated Trading Environments provides an overview of the automated trading environment, including its principal actors, potential risks, and responsive measures taken to date by the Commission or industry participants. It also discusses pre-trade risk controls; post-trade reports; system safeguards related to the design, testing and supervision of automated trading systems; and additional protections designed to promote safe and orderly markets. Within the release, the Commission asks 124 questions and is seeking extensive public input.
To give the public more time to provide comments, the CFTC extended the comment period, which continues through February 14.
Position Limits
The futures markets have a long history of embracing speculative position limits as a tool to reduce unwarranted price fluctuations and minimize the risk of manipulation, particularly in the spot month, such as corners and squeezes. Our proposed position limits rule builds on that history, increases transparency, and lessens the likelihood that a trader will accumulate excessively large speculative positions.
The Commission’s proposed rule respects congressional intent and addresses a district court decision related to the Commission’s new position-limits authority under Dodd-Frank.
The comment period on the re-proposed rule closes February 10, and I look forward to reviewing the public input.
International Coordination
Given that the U.S. has nearly delivered on its G20 commitments to derivatives reform, and the European Union is close behind, financial regulators recently have focused more time on the developing global market structure for swaps.
The G20 commitments were a reaction to a global financial crisis. Although the causes of that crisis are not as clear as some suggest, few would disagree that liquidity constraints at certain firms were at least exacerbated by exposures to derivatives.
The plain truth is that risk associated with derivatives is mobile and can migrate rapidly across borders in modern financial markets. An equally plain truth is that any efforts to monitor and manage global systemic risk therefore must be global in nature.
Risk mobility means that regulators in the U.S. and abroad do not have the luxury of limiting their oversight to financial activities occurring solely within their borders. Financial activities abroad may be confined to local markets in some cases, but the financial crisis, and more recent events, make clear that the rights and responsibilities that flow from these activities often are not.
Perhaps as important, Congress reacted to the financial crisis by authorizing the CFTC to oversee activities conducted beyond its borders in appropriate cases. It could have limited the CFTC’s oversight to only those entities and activities located or occurring within our shores, but it did not. In fact, Congress recognized in Dodd-Frank that even when activities do not obviously implicate U.S. interests, they can still create less obvious but legally binding obligations that are significant and directly relevant to the health of a U.S. firm; and which in the aggregate could have a material impact on the U.S. financial system as a whole.
So it is clear to me that the CFTC took the correct approach in adopting cross-border policies that account for the varied ways that risk can be imported into the U.S. At the same time, the CFTC’s policies tried to respect the limits of U.S. law and the resource constraints of U.S. and global regulators. That is in part why, last December, the CFTC approved a series of determinations allowing non-U.S. swap dealers and MSPs to comply with Dodd-Frank by relying on comparable and comprehensive home country regulations, otherwise known as “substituted compliance.”
Those approvals by the CFTC reflect a collaborative effort with authorities and market participants from each of the six jurisdictions with registered swap dealers. Working closely with authorities in Australia, Canada, the EU, Hong Kong, Japan, and Switzerland, the CFTC issued comparability determinations for a broad range of entity-level requirements. And in two jurisdictions, the EU and Japan, the CFTC also issued comparability determinations for a number of key transaction-level requirements.
It appears at this time that the substituted compliance approach has been successful in supporting financial reform efforts around the globe and a race-to-the-top in global derivatives regulation. Last month, for example, the European Union (“EU”) agreed on updated rules for markets in financial derivatives, or the Markets in Financial Instruments Directive II (“MiFiD II”), reflecting great progress on derivatives reform in the EU. Other jurisdictions that host a substantial market for swap activity are still working on their reforms, and certainly will be informed by the EU’s work and the CFTC’s ongoing coordination with foreign regulators.
As jurisdictions outside the U.S. continue to strengthen their regulatory regimes and meet their G20 commitments, the CFTC may determine that additional foreign regulatory requirements are comparable to and as comprehensive as certain requirements under Dodd-Frank.
The CFTC also has made great progress with the European Commission since both regulators issued the Path Forward statement last summer, and we are actively working with the Europeans to ensure that harmonized regulations on the two continents promote liquidity formation and sound risk management. Fragmented liquidity, and the regulatory and financial arbitrage that both drives and follows it, can lead to increased operational costs and risks as entities structure around the rules in primary swap markets.
Harmonizing regulations governing clearinghouses and trading venues, in particular, is critical to sound and efficient market structure. Even if firms are able to navigate the conflicts and complexities of differing regulatory regimes, regulators here and abroad must do what they can to avoid incentivizing corporate structures and inter-affiliate relationships that will only make global financial firms more difficult to understand, manage, and unwind during a period of market distress.
Conversely, this translates to open, competitive derivatives markets. It means efficient and liquid markets. A global regime is the best means to avoid balkanization of risk and risk management that may expose the U.S. financial system over time to risks that are unnecessary, needlessly complex, and difficult to predict and contain.
In light of the CFTC’s swaps authority, and the complexities of implementing a global regulatory regime, the Commission is working with numerous foreign authorities to negotiate and sign supervisory arrangements that address regulator-to-regulator cooperation and information sharing in a supervisory context. We currently are negotiating such arrangements with respect to swap dealers and MSPs, SDRs, SEFs, and derivatives clearing organizations.
As a final note on cross-border issues, on February 12 the Global Markets Advisory Committee (“GMAC”), which I sponsor, will meet to discuss the November 14, 2013, CFTC staff advisory on applicability of transaction-level requirements in certain cross-border situations.
The CFTC and Customer Information Security
The CFTC takes our responsibility to protect against the loss or theft of customer information seriously. However, the CFTC’s funding challenges, and thus our limited examinations staff, have an impact on the agency’s ability to examine and enforce critical rules that protect customer privacy and ensure firms have robust information security and other risk management policies in place.
The Gramm-Leach-Bliley Act was enacted in 1999 to ensure that financial institutions respect the privacy of their customers. Part 160 of the CFTC’s regulations was adopted pursuant to the Gramm-Leach-Bliley Act and addresses privacy and security safeguards for customer information. Under the law, swap dealers, FCMs and other CFTC registrants must have “policies and procedures that address administrative, technical and physical safeguards for the protection of customer records and information.” These policies and procedures are designed to protect against unauthorized access to customer records or information.
The CFTC is working to strengthen our registrants’ compliance with the law. The agency is poised to release a staff advisory to market participants outlining best practices for compliance. The advisory recommends, among other best practices, that registrants should assess existing privacy and security risks; design and implement a system of procedures and controls to minimize such risks; regularly test privacy and security controls, including periodic testing by an independent party; annually report to the board on these issues; and implement an incident response program that includes notifying the Commission and individuals whose information was or may be misused. In addition, the CFTC has recently issued new customer protection regulations that include, among other regulations, new requirements for risk management by firms. Security safeguards are an element of risk management that needs to be addressed by this new regulation.
Last year, the CFTC also issued interpretive guidance, mirroring that of other financial agencies, clarifying that reporting of suspected financial abuse of older Americans to appropriate law enforcement agencies does not violate the privacy provisions within Part 160 of the Commission’s rules.
Though enforcement of CFTC Part 160 rules is a challenge given our limited resources, we have enforced them in the past. In one instance, the CFTC settled a case with an FCM when an employee of that FCM placed files containing sensitive personally identifiable information on a public website, and the FCM did not have effective procedures in place to safeguard customer information.
In addition to Part 160, the CFTC’s Dodd-Frank rules for DCMs, SEFs and SDRs require these entities to notify the CFTC of all cybersecurity incidents that could potentially or actually jeopardize the security of information.
Last spring, the CFTC and SEC adopted final “red flags” rules under the Dodd-Frank Act requiring CFTC and SEC registrants to adopt programs to identify and address the risk of identity theft. As the law required, our rules establish special requirements for credit and debit card issuers to assess the validity of change of address, but currently, the CFTC entities that must follow these identity theft rules do not issue credit or debit cards. A number of firms, however, do accept credit and debit cards for payment, which presents a different type of risk.
The CFTC also has adopted a rule regarding the proper disposal of consumer information requiring reasonable measures, such as shredding, to protect against unauthorized access.
Retail Payment Systems
The Commission’s new customer protection rules on risk management require FCMs to develop risk management policies that address risks related to retail payment systems, such as anti-money laundering, identity theft, unauthorized access, and cybersecurity.
The CFTC currently does not have the resources to conduct any direct examinations of retail payment systems. The CFTC does indirectly look at the risks of retail payment systems through designated self-regulatory organizations (DSRO). The DSRO covers the operational aspects of the money movement through their risk-based programs. Additionally, DSROs perform a review of anti-money laundering at FCMs looking at a number of aspects of a retail payment system – source of funds, cash transactions, customer identity, money laundering and staff training.
For the vast majority of our registrants, the retail payment system is through normal banking channels, such as wire transfers. Only a few of our registrants accept credit or debit cards, and none currently accept virtual currency payment systems. Virtual currency, however, does present new risk, as a firm would be interacting outside of bank payment channels, increasing the risk of hacking or fraud, among other cybersecurity issues. The CFTC is working with registrants that are seeking to accept virtual currencies to educate them about best practices.
Data Breach Response
The CFTC’s response to a data breach incident would include immediately assessing the situation with the registrant to understand the magnitude of the breach and its implications on customers and the marketplace. We would coordinate with other regulators and law enforcement and together determine the appropriate course of action. Our response would include an analysis of the data compromised, immediate notification to affected customers (unless law enforcement prohibits that notification), supporting customers by having the firm provide free credit monitoring services, ensuring customers know how to change user IDs and passwords, and having the firm closely monitor customer activity to look for signs of identity theft.
Looking ahead, the Commission is considering implementing rules under Gramm-Leach-Bliley to expand upon our current customer protection regulations with more specificity regarding the security of customer information.
Resources
To be effective, the CFTC’s oversight of these registrants requires technological tools and staff with expertise to analyze complex financial information. On that note, I am pleased that the House and Senate have agreed to an appropriations bill that includes a modest budgetary increase to $215 million for the CFTC, lifting the agency’s appropriations above the sequestration level that has been challenging for planning and orderly operation of the agency. The new funding level is a step in the right direction. We will continue working with Congress to secure resources that match the agency’s critical responsibilities in protecting the safety and integrity of the financial markets under its jurisdiction. We need additional staff for surveillance, examinations, and enforcement, as well as investments in technology, to give the public confidence in our ability to oversee the vast derivatives markets.
Conclusion
For the CFTC, the Volcker Rule was one of the last remaining rulemakings required by Dodd-Frank. Only a few rulemakings remain to be re-proposed or finalized in order to complete the implementation of the legislation. Indeed, in just a matter of days, the compliance date for perhaps the last remaining major hallmark of the reform effort will arrive: the effective date of the swap-trading mandate. Looking forward, the agency will continue working to ensure an orderly transition to, and adoption of, the new market structure for swaps, and adjusting as necessary.
Thank you again for inviting me today. I would be happy to answer any questions from the Committee.
Last Updated: February 6, 2014
Testimony of Acting Chairman Mark P. Wetjen Before the U.S. Senate Committee on Banking, Housing & Urban Affairs, Washington, DC
February 6, 2014
Good morning Chairman Johnson, Ranking Member Crapo and members of the Committee. Thank you for inviting me to today’s hearing on the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) and customer information security. I am honored to testify as Acting Chairman of the Commodity Futures Trading Commission (“CFTC”). I also am pleased to join my fellow regulators in testifying today.
Now is a good time for not only this Committee, but all stakeholders in the CFTC to reflect on the agency’s progress in implementing financial reform and what the future might bring for this agency and the markets it oversees.
Due to Dodd-Frank and the efforts of my colleagues and staff at the CFTC, today there is both pre-trade and post-trade transparency in the swaps market that did not exist before. The public now can see the price and volume of swap transactions in real-time, and the CFTC’s Weekly Swaps Report provides a snapshot of the swaps market each week. The most liquid swaps are being traded on regulated platforms and exchanges, with a panoply of protections for those depending on the markets, and regulators themselves have a new window into the marketplace through swap data repositories (“SDRs”).
Transparency, of course, is helpful only if the information provided to the public and regulators can be usefully employed. Therefore, the CFTC also is taking steps to protect the integrity of that data and ensure that it continues to be reliable and useful for surveillance, systemic risk monitoring, and the enforcement of important financial reforms.
These transparency rules complement a number of equally important financial reforms. For example, the counterparty credit risks in the swaps market have been reduced as a large segment of the swaps market is now being cleared – as of last month, about 70 percent of new, arm’s-length swaps transactions were being cleared. Additionally, nearly 100 swap dealers and major swap participants (“MSPs”) have registered with the CFTC, bringing their swaps activity and internal risk-management programs under the CFTC’s oversight for the first time. We also have strengthened a range of futures and swaps customer protections.
As it has put these reforms in place, the CFTC has consistently worked to protect liquidity in the markets and ensure that end-users can continue using them to hedge risk as Congress directed.
The CFTC, in short, has completed most of its initial mandate under Dodd-Frank and has successfully ushered in improvements to the over-the-counter derivatives market structure for swaps, while balancing countervailing objectives.
Volcker Rule
In recent weeks, the Commission finalized the Volcker Rule, which was one of our last major rules under Dodd-Frank. The Volcker Rule was exceptional on account of the unprecedented coordination among the five financial regulators.
Congress required the banking regulators to adopt a joint Volcker Rule, but it also provided that the market regulators – the Securities and Exchange Commission (“SEC”) and the CFTC – need only coordinate with the prudential banking regulators in their rulemaking efforts. One of the hallmarks of the final rule is that the market regulators went beyond the congressional requirement to simply coordinate. In fact, the CFTC’s final rule includes the same rule text as that adopted by the other agencies. Building a consensus among five different government agencies was no easy task, and the level of coordination by the financial regulators on this complicated rulemaking was exceptional.
This coordination was thanks in no small part to leadership at the Department of the Treasury. Secretary Lew, Acting Deputy Secretary Miller, and others were instrumental in keeping the agencies on task and seeing this rulemaking over the finish line. Along with the other agencies, the CFTC received more than 18,000 comments addressing numerous aspects of the proposal. CFTC staff hosted a public roundtable on the proposed rule and met with a number of commenters. Through weekly inter-agency staff meetings, along with more informal discussions, the CFTC staff and the other agencies carefully considered the comments in formulating the final rule.
Differences with Proposal
The agencies were responsive to the comments when appropriate, which led to several changes from the proposed Volcker Rule I would like to highlight.
The final Volcker Rule included some alterations to certain parts of the hedging-exemption requirements found in the proposal. For instance, the final rule requires banking entities to have controls in place through their compliance programs to demonstrate that hedges would likely be correlated with an underlying position. The final rule also requires ongoing recalibration of hedging positions in order for the entities to remain in compliance.
Additionally, the final rule provides that hedging related to a trading desk’s market-making activities is part of the trading desk’s financial exposure, which can be managed separately from the risk-mitigating hedging exemption.
Another modification to the proposal was to include under “covered funds” only those commodity pools that resemble, in terms of type of offering and investor base, a typical hedge fund.
CFTC Volcker Rule Implementation and Enforcement
The CFTC estimates that, under its Volcker regulations, it has authority over more than 100 registered swap dealers and futures commission merchants (“FCMs”) that meet the definition of “banking entity.” In addition, under Section 619, some of these banking entities may be subject to oversight by other regulators. For example, a joint FCM/broker-dealer would be subject to both CFTC and SEC jurisdiction and in such circumstances, the CFTC will monitor the activities of the entity directly and also coordinate closely with the other functional regulator(s).
In this regard, Section 619 of the Dodd-Frank Act amended the Banking Holding Company Act to direct the CFTC itself to write rules implementing Volcker Rule requirements for banking entities “for which the CFTC is the primary financial regulatory agency” as that term was defined by Congress in Dodd-Frank. Accordingly, as Congress directed, the CFTC’s final rule applies to entities that are subject to CFTC registration and that are banking entities, under the Volcker provisions of the statute.
To ensure consistent, efficient implementation of the Volcker Rule, and to address, among other things, the jurisdiction issues I just mentioned, the agencies have established a Volcker Rule implementation task force. That task force also will be the proper vehicle to examine the means for coordinated enforcement of the rule. Although compliance requirements under the Volcker Rule do not take effect until July 2015, the CFTC is exploring now whether to take additional steps, including whether to adopt formal procedures for enforcement of the rule. As part of this process, I have directed CFTC staff to consider whether the agency should adopt such procedures and to make recommendations in the near future.
Volcker Rule: Lowering Risk in Banking Entities
The final Volcker Rule closely follows the mandates of Section 619 and strikes an appropriate balance in prohibiting banking entities from engaging in the types of proprietary trading activities that Congress contemplated when considering Section 619 and in protecting liquidity and risk management through legitimate market making and hedging activities. In adopting the final rule, the CFTC and other regulators were mindful that exceptions to the prohibitions or restrictions in the statute, if not carefully defined, could conceivably swallow the rule.
Banking entities are permitted to continue market making—an important activity for providing liquidity to financial markets—but the agencies reasonably confined the meaning of the term “market making” to the extent necessary to maintain a market-making inventory to meet near-term client, customer or counterparty demands.
Likewise, the final rule permits hedging that reduces specific risks from individual or aggregated positions of the banking entity.
The final Volcker Rule also prohibits banking entities from engaging in activities that result in conflicts of interest with clients, customers or counterparties, or that pose threats to the safety and soundness of these entities, and potentially therefore to the U.S. financial system.
The final Volcker rule also limits banking entities from sponsoring or owning “covered funds,” which include hedge funds, private equity funds or certain types of commodity pools, other than under certain limited circumstances. The final rule focuses the prohibition on certain types of pooled investment vehicles that trade or invest in securities or derivatives.
Finally, and importantly, the final Volcker Rule requires banking entities to put in place a compliance program, with special attention to the firm’s compliance with the rule’s restrictions on market making, underwriting and hedging. It also requires the larger banking entities to report key metrics to regulators each month. This new transparency, once phased-in, will buttress the CFTC’s oversight of swap dealers and FCMs by providing it additional information regarding the risk levels at these registrants.
TruPS Interim Final Rule
Even with resource constraints, the CFTC has been responsive to public input and willing to explore course corrections, when appropriate. With respect to the Volcker Rule, the CFTC, along with the other agencies, last month unanimously finalized an interim final rule to allow banks to retain collateralized debt obligations backed primarily by trust-preferred securities (TruPS) issued by community banks. The agencies acted quickly to address concerns about restrictions in the final rule, demonstrating again the commitment of the agencies at this table to ongoing coordination. In doing so, the CFTC and the other agencies protected important markets for community banks, as Congress directed.
Implementation Stage of Dodd-Frank
Looking ahead through the lens of what already has been done, it is clear that the Commission and all stakeholders will need to closely monitor and, if appropriate, address the inevitable challenges that will come with implementing the new regulatory framework under Dodd-Frank.
For the CFTC, only a few rulemakings remain to be re-proposed or finalized in order to complete the implementation of Dodd-Frank. Indeed, in just a matter of days, the compliance date for perhaps the last remaining, major hallmark of the reform effort will arrive: the effective date of the swap-trading mandate.
Rules the Commission is working to address in the coming months include capital and margin requirements for un-cleared swaps, rulemakings intended to harmonize global regulations for clearinghouses and trading venues, and finalizing position limits.
There are other important matters in the months ahead as well.
Allow me to mention some of these matters before the Commission as we move forward with Dodd-Frank implementation.
Made Available to Trade Determinations
As a result of the trade execution mandate, many swaps will, for the first time, trade on regulated platforms and benefit from market-wide, pre-trade transparency. These platforms are designed to improve pricing for the buy-side, commercial end-users, and other participants that use these markets to manage risk. Additionally, SEFs, as registered entities, are required to establish and enforce comprehensive compliance and surveillance programs.
The Commission’s trade execution rules complement our other efforts to streamline participation in the markets by doing away with the need to negotiate bilateral credit arrangements and removing impediments to accessing liquidity. This not only benefits the end-users that the markets are intended to serve, but also new entrants seeking to compete for liquidity who now are able to access the markets on impartial terms. In essence, the Commission’s implementation of the trade execution mandate supports a transparent, risk-reducing swap-market structure under CFTC oversight.
In recent weeks, the “Made Available to Trade Determinations” filed by four swap execution facilities (“SEFs”) have been deemed certified, making mandatory the trading of a number of interest rate and credit default swaps on regulated platforms.
There have been some questions in this context about the trading of so-called “package transactions,” which often include a combination of financial instruments and at least one swap that is subject to the trade execution requirement. I have directed Division of Market Oversight (“DMO”) staff to hold an open-to-the-public roundtable, which will take place February 12, and to further examine these issues so that the CFTC can further consider the appropriate regulatory treatment of basis trades falling within the meaning of a “package transaction.”
Data
In order for the Commission to enforce the significant Dodd-Frank reforms, the agency must have accurate data and a clear picture of activity in the marketplace.
Last month, with the support of my fellow commissioners, I directed an interdivisional staff working group to review certain swap transaction data, recordkeeping and reporting provisions under Dodd-Frank. The working group, led by the director of DMO, will formulate and recommend questions for public comment regarding compliance with Part 45 reporting rules and related provisions, as well as consistency in regulatory reporting among market participants.
We have seen an incredible shift to a transparent, regulated swaps marketplace, and this is an appropriate review to ensure the data we are receiving is of the best possible quality so the Commission can effectively oversee the marketplace. I have asked the working group to review the incoming public comments and make recommendations to the Commission in June.
Concept Release on Risk Controls and System Safeguards for Automated Trading Environments
The CFTC’s Concept Release on Risk Controls and System Safeguards for Automated Trading Environments provides an overview of the automated trading environment, including its principal actors, potential risks, and responsive measures taken to date by the Commission or industry participants. It also discusses pre-trade risk controls; post-trade reports; system safeguards related to the design, testing and supervision of automated trading systems; and additional protections designed to promote safe and orderly markets. Within the release, the Commission asks 124 questions and is seeking extensive public input.
To give the public more time to provide comments, the CFTC extended the comment period, which continues through February 14.
Position Limits
The futures markets have a long history of embracing speculative position limits as a tool to reduce unwarranted price fluctuations and minimize the risk of manipulation, particularly in the spot month, such as corners and squeezes. Our proposed position limits rule builds on that history, increases transparency, and lessens the likelihood that a trader will accumulate excessively large speculative positions.
The Commission’s proposed rule respects congressional intent and addresses a district court decision related to the Commission’s new position-limits authority under Dodd-Frank.
The comment period on the re-proposed rule closes February 10, and I look forward to reviewing the public input.
International Coordination
Given that the U.S. has nearly delivered on its G20 commitments to derivatives reform, and the European Union is close behind, financial regulators recently have focused more time on the developing global market structure for swaps.
The G20 commitments were a reaction to a global financial crisis. Although the causes of that crisis are not as clear as some suggest, few would disagree that liquidity constraints at certain firms were at least exacerbated by exposures to derivatives.
The plain truth is that risk associated with derivatives is mobile and can migrate rapidly across borders in modern financial markets. An equally plain truth is that any efforts to monitor and manage global systemic risk therefore must be global in nature.
Risk mobility means that regulators in the U.S. and abroad do not have the luxury of limiting their oversight to financial activities occurring solely within their borders. Financial activities abroad may be confined to local markets in some cases, but the financial crisis, and more recent events, make clear that the rights and responsibilities that flow from these activities often are not.
Perhaps as important, Congress reacted to the financial crisis by authorizing the CFTC to oversee activities conducted beyond its borders in appropriate cases. It could have limited the CFTC’s oversight to only those entities and activities located or occurring within our shores, but it did not. In fact, Congress recognized in Dodd-Frank that even when activities do not obviously implicate U.S. interests, they can still create less obvious but legally binding obligations that are significant and directly relevant to the health of a U.S. firm; and which in the aggregate could have a material impact on the U.S. financial system as a whole.
So it is clear to me that the CFTC took the correct approach in adopting cross-border policies that account for the varied ways that risk can be imported into the U.S. At the same time, the CFTC’s policies tried to respect the limits of U.S. law and the resource constraints of U.S. and global regulators. That is in part why, last December, the CFTC approved a series of determinations allowing non-U.S. swap dealers and MSPs to comply with Dodd-Frank by relying on comparable and comprehensive home country regulations, otherwise known as “substituted compliance.”
Those approvals by the CFTC reflect a collaborative effort with authorities and market participants from each of the six jurisdictions with registered swap dealers. Working closely with authorities in Australia, Canada, the EU, Hong Kong, Japan, and Switzerland, the CFTC issued comparability determinations for a broad range of entity-level requirements. And in two jurisdictions, the EU and Japan, the CFTC also issued comparability determinations for a number of key transaction-level requirements.
It appears at this time that the substituted compliance approach has been successful in supporting financial reform efforts around the globe and a race-to-the-top in global derivatives regulation. Last month, for example, the European Union (“EU”) agreed on updated rules for markets in financial derivatives, or the Markets in Financial Instruments Directive II (“MiFiD II”), reflecting great progress on derivatives reform in the EU. Other jurisdictions that host a substantial market for swap activity are still working on their reforms, and certainly will be informed by the EU’s work and the CFTC’s ongoing coordination with foreign regulators.
As jurisdictions outside the U.S. continue to strengthen their regulatory regimes and meet their G20 commitments, the CFTC may determine that additional foreign regulatory requirements are comparable to and as comprehensive as certain requirements under Dodd-Frank.
The CFTC also has made great progress with the European Commission since both regulators issued the Path Forward statement last summer, and we are actively working with the Europeans to ensure that harmonized regulations on the two continents promote liquidity formation and sound risk management. Fragmented liquidity, and the regulatory and financial arbitrage that both drives and follows it, can lead to increased operational costs and risks as entities structure around the rules in primary swap markets.
Harmonizing regulations governing clearinghouses and trading venues, in particular, is critical to sound and efficient market structure. Even if firms are able to navigate the conflicts and complexities of differing regulatory regimes, regulators here and abroad must do what they can to avoid incentivizing corporate structures and inter-affiliate relationships that will only make global financial firms more difficult to understand, manage, and unwind during a period of market distress.
Conversely, this translates to open, competitive derivatives markets. It means efficient and liquid markets. A global regime is the best means to avoid balkanization of risk and risk management that may expose the U.S. financial system over time to risks that are unnecessary, needlessly complex, and difficult to predict and contain.
In light of the CFTC’s swaps authority, and the complexities of implementing a global regulatory regime, the Commission is working with numerous foreign authorities to negotiate and sign supervisory arrangements that address regulator-to-regulator cooperation and information sharing in a supervisory context. We currently are negotiating such arrangements with respect to swap dealers and MSPs, SDRs, SEFs, and derivatives clearing organizations.
As a final note on cross-border issues, on February 12 the Global Markets Advisory Committee (“GMAC”), which I sponsor, will meet to discuss the November 14, 2013, CFTC staff advisory on applicability of transaction-level requirements in certain cross-border situations.
The CFTC and Customer Information Security
The CFTC takes our responsibility to protect against the loss or theft of customer information seriously. However, the CFTC’s funding challenges, and thus our limited examinations staff, have an impact on the agency’s ability to examine and enforce critical rules that protect customer privacy and ensure firms have robust information security and other risk management policies in place.
The Gramm-Leach-Bliley Act was enacted in 1999 to ensure that financial institutions respect the privacy of their customers. Part 160 of the CFTC’s regulations was adopted pursuant to the Gramm-Leach-Bliley Act and addresses privacy and security safeguards for customer information. Under the law, swap dealers, FCMs and other CFTC registrants must have “policies and procedures that address administrative, technical and physical safeguards for the protection of customer records and information.” These policies and procedures are designed to protect against unauthorized access to customer records or information.
The CFTC is working to strengthen our registrants’ compliance with the law. The agency is poised to release a staff advisory to market participants outlining best practices for compliance. The advisory recommends, among other best practices, that registrants should assess existing privacy and security risks; design and implement a system of procedures and controls to minimize such risks; regularly test privacy and security controls, including periodic testing by an independent party; annually report to the board on these issues; and implement an incident response program that includes notifying the Commission and individuals whose information was or may be misused. In addition, the CFTC has recently issued new customer protection regulations that include, among other regulations, new requirements for risk management by firms. Security safeguards are an element of risk management that needs to be addressed by this new regulation.
Last year, the CFTC also issued interpretive guidance, mirroring that of other financial agencies, clarifying that reporting of suspected financial abuse of older Americans to appropriate law enforcement agencies does not violate the privacy provisions within Part 160 of the Commission’s rules.
Though enforcement of CFTC Part 160 rules is a challenge given our limited resources, we have enforced them in the past. In one instance, the CFTC settled a case with an FCM when an employee of that FCM placed files containing sensitive personally identifiable information on a public website, and the FCM did not have effective procedures in place to safeguard customer information.
In addition to Part 160, the CFTC’s Dodd-Frank rules for DCMs, SEFs and SDRs require these entities to notify the CFTC of all cybersecurity incidents that could potentially or actually jeopardize the security of information.
Last spring, the CFTC and SEC adopted final “red flags” rules under the Dodd-Frank Act requiring CFTC and SEC registrants to adopt programs to identify and address the risk of identity theft. As the law required, our rules establish special requirements for credit and debit card issuers to assess the validity of change of address, but currently, the CFTC entities that must follow these identity theft rules do not issue credit or debit cards. A number of firms, however, do accept credit and debit cards for payment, which presents a different type of risk.
The CFTC also has adopted a rule regarding the proper disposal of consumer information requiring reasonable measures, such as shredding, to protect against unauthorized access.
Retail Payment Systems
The Commission’s new customer protection rules on risk management require FCMs to develop risk management policies that address risks related to retail payment systems, such as anti-money laundering, identity theft, unauthorized access, and cybersecurity.
The CFTC currently does not have the resources to conduct any direct examinations of retail payment systems. The CFTC does indirectly look at the risks of retail payment systems through designated self-regulatory organizations (DSRO). The DSRO covers the operational aspects of the money movement through their risk-based programs. Additionally, DSROs perform a review of anti-money laundering at FCMs looking at a number of aspects of a retail payment system – source of funds, cash transactions, customer identity, money laundering and staff training.
For the vast majority of our registrants, the retail payment system is through normal banking channels, such as wire transfers. Only a few of our registrants accept credit or debit cards, and none currently accept virtual currency payment systems. Virtual currency, however, does present new risk, as a firm would be interacting outside of bank payment channels, increasing the risk of hacking or fraud, among other cybersecurity issues. The CFTC is working with registrants that are seeking to accept virtual currencies to educate them about best practices.
Data Breach Response
The CFTC’s response to a data breach incident would include immediately assessing the situation with the registrant to understand the magnitude of the breach and its implications on customers and the marketplace. We would coordinate with other regulators and law enforcement and together determine the appropriate course of action. Our response would include an analysis of the data compromised, immediate notification to affected customers (unless law enforcement prohibits that notification), supporting customers by having the firm provide free credit monitoring services, ensuring customers know how to change user IDs and passwords, and having the firm closely monitor customer activity to look for signs of identity theft.
Looking ahead, the Commission is considering implementing rules under Gramm-Leach-Bliley to expand upon our current customer protection regulations with more specificity regarding the security of customer information.
Resources
To be effective, the CFTC’s oversight of these registrants requires technological tools and staff with expertise to analyze complex financial information. On that note, I am pleased that the House and Senate have agreed to an appropriations bill that includes a modest budgetary increase to $215 million for the CFTC, lifting the agency’s appropriations above the sequestration level that has been challenging for planning and orderly operation of the agency. The new funding level is a step in the right direction. We will continue working with Congress to secure resources that match the agency’s critical responsibilities in protecting the safety and integrity of the financial markets under its jurisdiction. We need additional staff for surveillance, examinations, and enforcement, as well as investments in technology, to give the public confidence in our ability to oversee the vast derivatives markets.
Conclusion
For the CFTC, the Volcker Rule was one of the last remaining rulemakings required by Dodd-Frank. Only a few rulemakings remain to be re-proposed or finalized in order to complete the implementation of the legislation. Indeed, in just a matter of days, the compliance date for perhaps the last remaining major hallmark of the reform effort will arrive: the effective date of the swap-trading mandate. Looking forward, the agency will continue working to ensure an orderly transition to, and adoption of, the new market structure for swaps, and adjusting as necessary.
Thank you again for inviting me today. I would be happy to answer any questions from the Committee.
Last Updated: February 6, 2014
Friday, January 17, 2014
CFTC OFFICIAL'S TESTIMONY REGARDING FUTURES MARKET OVERSIGHT
FROM: COMMODITY FUTURES TRADING COMMISSION
Testimony of Vincent McGonagle, Director Division of Market Oversight, Commodity Futures Trading Commission Before the Financial Institutions and Consumer Protection Subcommittee Senate Committee on Banking, Housing, and Urban Affairs
January 15, 2014
Chairman Brown, Ranking Member Toomey, and Members of the Subcommittee, thank you for the opportunity to appear before you today. I am Vincent McGonagle and I am the Director of the Division of Market Oversight of the Commodity Futures Trading Commission (CFTC).
Background on Commodity Exchange Act and the CFTC Mission
The purpose of the Commodity Exchange Act (CEA) is to serve the public interest by providing a means for managing and assuming price risks, discovering prices, or disseminating pricing information. Consistent with its mission statement and statutory charge under the CEA, the CFTC is tasked with protecting market participants and the public from fraud, manipulation, abusive practices and systemic risk related to derivatives – both futures and swaps – and to foster transparent, open, competitive and financially sound markets. In carrying out its mission and statutory charge, and to promote market integrity, the Commission polices derivatives markets for various abuses and works to ensure the protection of customer funds. Further, the agency seeks to lower the risk of the futures and swaps markets to the economy and the public. To fulfill these roles, the Commission oversees designated contract markets (DCMs), swap execution facilities (SEFs), derivatives clearing organizations, swap data repositories, swap dealers, futures commission merchants, commodity pool operators and other intermediaries.
The CEA has for many years required that any futures transaction, unless subject to an exemption, be conducted on or subject to the rules of a board of trade which has been designated by the CFTC as a DCM. Sections 5 and 6 of the CEA and Part 38 of the Commission’s regulations provide the legal framework for the Commission to designate DCMs, along with each DCM’s compliance requirements with respect to the trading of commodity futures contracts. With the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), DCMs were also permitted to list swap contracts. Along with this expansion of product lines that can be listed on DCMs, the Dodd-Frank Act also amended various substantive DCM requirements, under CEA Section 5, and adopted a new regulatory category for exchanges that provide for the trading of swaps (SEFs).1 The Commission revised its DCM regulations to reflect these new requirements, and also adopted regulations to implement the Dodd-Frank Act’s SEF requirements.
Under the CEA and the Commission’s contract and rule review regulations, all new product terms and conditions, and subsequent associated amendments, are submitted to the Commission before implementation. In submitting new products and associated amendments, DCMs and SEFs are legally obligated to meet certain core principles; one of the most significant being the prohibition, in DCM and SEF Core Principle 3, on listing contracts that are readily susceptible to manipulation.2 DCMs and SEFs self-certify most of their products to the Commission, as allowed under the CEA,3 and self-certified contracts may be listed for trading shortly after submission.4 The Commission has provided Guidance to DCMs and SEFs on meeting Core Principle 3 in Appendix C to Part 38 of the Commission’s regulations. Failure of a DCM or SEF to adopt and maintain practices that adhere to these requirements may lead to the Commission’s initiation of proceedings to secure compliance.
Among other things, a DCM or SEF that lists a contract that is settled by physical delivery should design its contracts in such a way as to avoid any impediments to the delivery of the commodity in order to promote convergence between the price of the futures contract and the cash market value of the commodity at the time of delivery. The specified terms and conditions considered as a whole should result in a deliverable supply that is sufficient to ensure that the contract is not susceptible to price manipulation or distortion.5 The contract terms and conditions should describe or define all of the economically significant characteristics or attributes of the commodity underlying the contract, including: quality standards that reflect those used in transactions in the commodity in normal cash marketing channels; delivery points at a location or locations where the underlying cash commodity is normally transacted or stored; conditions that delivery facility operators must meet in order to be eligible for delivery, including considerations of the extent to which ownership of such facilities is concentrated and whether the level of concentration would render the futures contract susceptible to manipulation; delivery procedures that seek to minimize or eliminate any impediment to making or taking delivery by both deliverers and takers of delivery to help ensure convergence of cash and futures at the expiration of a futures delivery month.
Commission staff utilizes considerable discretion and can request that DCMs and SEFs provide full explanations of their compliance with the Commission’s product requirements. Commission staff may ask a DCM or SEF at any time for a detailed justification of its continuing compliance with core principles, including information demonstrating that any contract certified to the Commission for listing on that exchange meets the requirements of the Act and DCM or SEF Core Principle 3.
Expansion of CFTC Enforcement Authority Under Dodd-Frank
The Commission’s responsibilities under the CEA include mandates to prevent and deter fraud and manipulation. The Dodd-Frank Act enhanced the Commission’s enforcement authority by expanding it to the swaps markets. The Commission adopted a rule to implement its new authorities to police against fraud and manipulative schemes. In the past, the CFTC had the ability to prosecute manipulation, but to prevail, it had to prove the specific intent of the accused to affect prices and the existence of an artificial price. Under the new law and rules implementing it, the Commission’s anti-manipulation reach is extended to prohibit the reckless use of manipulative schemes. Specifically, Section 6(c)(3) of the CEA now makes it unlawful for any person, directly or indirectly, to manipulate or attempt to manipulate the price of any swap, or of any commodity in interstate commerce, or for future delivery on or subject to the rules of any registered entity. In addition, Section 4c(a) of the CEA now explicitly prohibits disruptive trading practices and the Commission has issued an Interpretive Guidance and Policy Statement on Disruptive Practices.6
In addition, the Dodd-Frank Act established a registration regime for any foreign board of trade (FBOT) and associated clearing organization who seeks to offer U.S. customers direct access to its electronic trading and order matching system. Applicants for FBOT registration must demonstrate, among other things, that they are subject to comprehensive supervision and regulation by the appropriate governmental authorities in their home country or countries that is comparable to the comprehensive supervision and regulation to which Commission-designated contract markets and registered derivatives clearing organizations are respectively subject.
CFTC Coordination with Foreign and Domestic Regulators
The Commission recognizes that commodity markets are international in nature and, accordingly, regularly consults with other countries’ regulators. In particular, staff regularly consult with staff of the FCA (the LME’s home regulatory authority) as to market conditions with respect to products of mutual interest, including the LME’s recent introduction of warehouse reforms. The two agencies also participate in mutual information-sharing agreements for both market surveillance and enforcement purposes.
Similarly, the Commission formally and informally consults and coordinates with other domestic financial regulators. For example, the CFTC and the Federal Energy Regulatory Commission (FERC) have had a memorandum of understanding (MOU) in place since 2005 that provides for information exchange related to oversight or investigations. Earlier this month, FERC and the CFTC signed two Memoranda of Understanding (MOU) to address circumstances of overlapping jurisdiction and to share information in connection with market surveillance and investigations into potential market manipulation, fraud or abuse. The MOUs allow the agencies to promote effective and efficient regulation to protect the nation’s energy markets and increased cooperation between the agencies.
Again, thank you for the opportunity to appear before the Subcommittee. I will be pleased to respond to any questions you may have.
1 In addition to the provisions regarding listing of swaps on DCMs and SEFs, the Dodd-Frank Act provides that, unless a clearing exception applies and is elected, a swap that is subject to a clearing requirement must be executed on a DCM, SEF, or SEF that is exempt from registration under CEA, unless no such DCM or SEF makes the swap available to trade.
2 DCM and SEF Core Principle 3 states, “Contract Not Readily Subject to Manipulation—The board of trade shall list on the contract market only contracts that are not readily susceptible to manipulation.”
3 For example, while contracts can be submitted for approval, of the almost 5,000 contracts submitted by DCMs and SEFs since the Dodd-Frank Act was enacted, all were submitted on a self-certification basis, and over 2,000 contracts were certified in calendar year 2013 alone.
4 A DCM or SEF need wait only one full business day after the contract has been submitted to list the contract for trading.
5 Deliverable supply means the quantity of the commodity meeting the contract’s delivery specification that reasonably can be expected to be readily available to short traders and salable by long traders at its market value in normal cash marketing channels at the contract’s delivery points during the specified delivery period, barring abnormal movement in interstate commerce.
6 Antidisruptive Practices Authority, 78 FR 31890 (May 28, 2013),
Last Updated: January 15, 2014
Testimony of Vincent McGonagle, Director Division of Market Oversight, Commodity Futures Trading Commission Before the Financial Institutions and Consumer Protection Subcommittee Senate Committee on Banking, Housing, and Urban Affairs
January 15, 2014
Chairman Brown, Ranking Member Toomey, and Members of the Subcommittee, thank you for the opportunity to appear before you today. I am Vincent McGonagle and I am the Director of the Division of Market Oversight of the Commodity Futures Trading Commission (CFTC).
Background on Commodity Exchange Act and the CFTC Mission
The purpose of the Commodity Exchange Act (CEA) is to serve the public interest by providing a means for managing and assuming price risks, discovering prices, or disseminating pricing information. Consistent with its mission statement and statutory charge under the CEA, the CFTC is tasked with protecting market participants and the public from fraud, manipulation, abusive practices and systemic risk related to derivatives – both futures and swaps – and to foster transparent, open, competitive and financially sound markets. In carrying out its mission and statutory charge, and to promote market integrity, the Commission polices derivatives markets for various abuses and works to ensure the protection of customer funds. Further, the agency seeks to lower the risk of the futures and swaps markets to the economy and the public. To fulfill these roles, the Commission oversees designated contract markets (DCMs), swap execution facilities (SEFs), derivatives clearing organizations, swap data repositories, swap dealers, futures commission merchants, commodity pool operators and other intermediaries.
The CEA has for many years required that any futures transaction, unless subject to an exemption, be conducted on or subject to the rules of a board of trade which has been designated by the CFTC as a DCM. Sections 5 and 6 of the CEA and Part 38 of the Commission’s regulations provide the legal framework for the Commission to designate DCMs, along with each DCM’s compliance requirements with respect to the trading of commodity futures contracts. With the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), DCMs were also permitted to list swap contracts. Along with this expansion of product lines that can be listed on DCMs, the Dodd-Frank Act also amended various substantive DCM requirements, under CEA Section 5, and adopted a new regulatory category for exchanges that provide for the trading of swaps (SEFs).1 The Commission revised its DCM regulations to reflect these new requirements, and also adopted regulations to implement the Dodd-Frank Act’s SEF requirements.
Under the CEA and the Commission’s contract and rule review regulations, all new product terms and conditions, and subsequent associated amendments, are submitted to the Commission before implementation. In submitting new products and associated amendments, DCMs and SEFs are legally obligated to meet certain core principles; one of the most significant being the prohibition, in DCM and SEF Core Principle 3, on listing contracts that are readily susceptible to manipulation.2 DCMs and SEFs self-certify most of their products to the Commission, as allowed under the CEA,3 and self-certified contracts may be listed for trading shortly after submission.4 The Commission has provided Guidance to DCMs and SEFs on meeting Core Principle 3 in Appendix C to Part 38 of the Commission’s regulations. Failure of a DCM or SEF to adopt and maintain practices that adhere to these requirements may lead to the Commission’s initiation of proceedings to secure compliance.
Among other things, a DCM or SEF that lists a contract that is settled by physical delivery should design its contracts in such a way as to avoid any impediments to the delivery of the commodity in order to promote convergence between the price of the futures contract and the cash market value of the commodity at the time of delivery. The specified terms and conditions considered as a whole should result in a deliverable supply that is sufficient to ensure that the contract is not susceptible to price manipulation or distortion.5 The contract terms and conditions should describe or define all of the economically significant characteristics or attributes of the commodity underlying the contract, including: quality standards that reflect those used in transactions in the commodity in normal cash marketing channels; delivery points at a location or locations where the underlying cash commodity is normally transacted or stored; conditions that delivery facility operators must meet in order to be eligible for delivery, including considerations of the extent to which ownership of such facilities is concentrated and whether the level of concentration would render the futures contract susceptible to manipulation; delivery procedures that seek to minimize or eliminate any impediment to making or taking delivery by both deliverers and takers of delivery to help ensure convergence of cash and futures at the expiration of a futures delivery month.
Commission staff utilizes considerable discretion and can request that DCMs and SEFs provide full explanations of their compliance with the Commission’s product requirements. Commission staff may ask a DCM or SEF at any time for a detailed justification of its continuing compliance with core principles, including information demonstrating that any contract certified to the Commission for listing on that exchange meets the requirements of the Act and DCM or SEF Core Principle 3.
Expansion of CFTC Enforcement Authority Under Dodd-Frank
The Commission’s responsibilities under the CEA include mandates to prevent and deter fraud and manipulation. The Dodd-Frank Act enhanced the Commission’s enforcement authority by expanding it to the swaps markets. The Commission adopted a rule to implement its new authorities to police against fraud and manipulative schemes. In the past, the CFTC had the ability to prosecute manipulation, but to prevail, it had to prove the specific intent of the accused to affect prices and the existence of an artificial price. Under the new law and rules implementing it, the Commission’s anti-manipulation reach is extended to prohibit the reckless use of manipulative schemes. Specifically, Section 6(c)(3) of the CEA now makes it unlawful for any person, directly or indirectly, to manipulate or attempt to manipulate the price of any swap, or of any commodity in interstate commerce, or for future delivery on or subject to the rules of any registered entity. In addition, Section 4c(a) of the CEA now explicitly prohibits disruptive trading practices and the Commission has issued an Interpretive Guidance and Policy Statement on Disruptive Practices.6
In addition, the Dodd-Frank Act established a registration regime for any foreign board of trade (FBOT) and associated clearing organization who seeks to offer U.S. customers direct access to its electronic trading and order matching system. Applicants for FBOT registration must demonstrate, among other things, that they are subject to comprehensive supervision and regulation by the appropriate governmental authorities in their home country or countries that is comparable to the comprehensive supervision and regulation to which Commission-designated contract markets and registered derivatives clearing organizations are respectively subject.
CFTC Coordination with Foreign and Domestic Regulators
The Commission recognizes that commodity markets are international in nature and, accordingly, regularly consults with other countries’ regulators. In particular, staff regularly consult with staff of the FCA (the LME’s home regulatory authority) as to market conditions with respect to products of mutual interest, including the LME’s recent introduction of warehouse reforms. The two agencies also participate in mutual information-sharing agreements for both market surveillance and enforcement purposes.
Similarly, the Commission formally and informally consults and coordinates with other domestic financial regulators. For example, the CFTC and the Federal Energy Regulatory Commission (FERC) have had a memorandum of understanding (MOU) in place since 2005 that provides for information exchange related to oversight or investigations. Earlier this month, FERC and the CFTC signed two Memoranda of Understanding (MOU) to address circumstances of overlapping jurisdiction and to share information in connection with market surveillance and investigations into potential market manipulation, fraud or abuse. The MOUs allow the agencies to promote effective and efficient regulation to protect the nation’s energy markets and increased cooperation between the agencies.
Again, thank you for the opportunity to appear before the Subcommittee. I will be pleased to respond to any questions you may have.
1 In addition to the provisions regarding listing of swaps on DCMs and SEFs, the Dodd-Frank Act provides that, unless a clearing exception applies and is elected, a swap that is subject to a clearing requirement must be executed on a DCM, SEF, or SEF that is exempt from registration under CEA, unless no such DCM or SEF makes the swap available to trade.
2 DCM and SEF Core Principle 3 states, “Contract Not Readily Subject to Manipulation—The board of trade shall list on the contract market only contracts that are not readily susceptible to manipulation.”
3 For example, while contracts can be submitted for approval, of the almost 5,000 contracts submitted by DCMs and SEFs since the Dodd-Frank Act was enacted, all were submitted on a self-certification basis, and over 2,000 contracts were certified in calendar year 2013 alone.
4 A DCM or SEF need wait only one full business day after the contract has been submitted to list the contract for trading.
5 Deliverable supply means the quantity of the commodity meeting the contract’s delivery specification that reasonably can be expected to be readily available to short traders and salable by long traders at its market value in normal cash marketing channels at the contract’s delivery points during the specified delivery period, barring abnormal movement in interstate commerce.
6 Antidisruptive Practices Authority, 78 FR 31890 (May 28, 2013),
Last Updated: January 15, 2014
Subscribe to:
Posts (Atom)