I’m very pleased to be back with you all today.
My journey to New York began yesterday – in Shanghai. I had the pleasure of spending the past week and a half in Asia, where I met with a number of regulators and market participants, and also participated in the U.S.-China Strategic and Economic Dialogue in Beijing. I have been very focused on enhancing cooperation with regulators across the globe, so it was good to have this opportunity. But it’s always good to be back home.
In my speech here last year, I discussed the CFTC’s work to implement the four key reforms of the over-the-counter swaps market called for by the G-20 leaders and Dodd-Frank. Those are central clearing of standardized swaps, oversight of market participants, regular reporting, and transparent trading on regulated platforms. I also spoke at length about automated trading, as one example of our efforts to look forward and address new challenges and opportunities in our markets.
To prepare remarks for this year’s conference, I looked at my remarks from last year. And I was pleased to see that we have done most of the things I said we would try to accomplish.
So today, I’d like to review what we’ve done, and talk about what I would like to accomplish in the months ahead.
Central Clearing on Regulated Platforms
Let me begin with the Dodd-Frank reforms, first with regard to clearing.
Equivalence accord with European Commission. Last year, I discussed the need to resolve our differences with European regulators regarding their recognition of clearinghouses in the U.S. Today, that is done.
In February, European Commissioner Jonathan Hill and I announced an agreement that resolves these issues. This means that European market participants will be able to continue clearing derivatives on U.S. clearinghouses. That will ensure that the global derivatives market can continue to be a global market. And our agreement helps bring our regulatory regimes closer together, and helps ensure that central clearing counterparties (CCPs) on both sides of the Atlantic are held to high standards. That contributes to financial stability and the potential for growth.
With respect to clearing, we have taken some additional steps to promote international cooperation and harmonization since I met with you last year. Eurex is now registered with us, and we have issued exemptive orders to several foreign CCPs, which allow them to clear proprietary swap trades for their U.S. members and the members’ affiliates without having to register with the CFTC. We have done this for clearinghouses in Australia, Hong Kong, Japan and Korea. And just yesterday, I met with the Chairman of the Shanghai Clearing House, which is in the process of seeking a permanent exemption. Earlier this month, CFTC staff granted Shanghai Clearing House no-action relief, so that it may clear certain swaps subject to mandatory clearing in China on an interim basis.
Additional Proposed Clearing Mandate. Our equivalence agreement with Europe and these orders reflect the increased importance of central clearing in the global financial system. The G-20 leaders agreed to mandate central clearing of standardized swaps. We have made great progress implementing that commitment in just a few short years. Originally, we mandated clearing of interest rate swaps in four currencies—U.S. dollar, Euro, British sterling and Japanese yen. Today, I am pleased to announce that the Commission has unanimously proposed to mandate clearing for interest rate swaps in several additional currencies, where local jurisdictions have mandated or are expected soon to mandate clearing. These jurisdictions include Australia, Canada, European Union, Mexico, Hong Kong, Singapore and Switzerland. And by doing so, we will further implement the G-20 commitment to mandate clearing of standardized swaps and harmonize with our counterparts abroad. We look forward to public comment on our proposal.
Clearinghouse Resilience. The global reforms mandating more clearing make it essential for us to enhance the resilience of clearinghouses. There has been much progress here as well.
Since the crisis, the CFTC has taken a number of actions domestically to enhance clearinghouse resilience. We are also actively participating in a number of international efforts that I want to briefly discuss.
Last year the chairs of the Financial Stability Board, the Committee on Payments and Market Infrastructures (CPMI), the International Organization of Securities Commissions (IOSCO) and the Basel Committee on Banking Supervision agreed to a CCP work plan that has four major elements. We are co-chairing some of this work and participating in all of it.
The first element involves examining whether regulatory standards should be enhanced to increase CCP resilience, such as the standards on margin methodologies and the resources available to a clearinghouse in the event of a default. The second is to assess the adequacy of CCP recovery tools and plans. The third is developing credible resolution plans. And the fourth element is examining the interdependencies between CCPs and large clearing members.
There will be public reports on these workstreams, beginning later this summer with a report on the resilience issues.
Let me highlight just a few of the important issues that will be raised in this work, though each of these deserves much fuller attention. First, I expect you will hear more about standards for CCP stress testing as well as regulatory stress testing. The latter refers to tests where regulators apply a common set of stressful conditions concurrently to more than one clearinghouse. The objective is to look at how stressful scenarios will affect multiple clearinghouses and their members across borders at the same time.
Second, there will be extensive discussion regarding the appropriate tools for recovery. In addition, there will be questions of whether the tools for resolution should be distinct—that is, should a resolution authority have separate tools and resources to draw from. However that question is ultimately answered, we must make certain that resolution planning does not create incentives that undermine the chances of successful recovery. This could occur if participants believe they might get a better deal in resolution than recovery. For example, they may be less willing to step up to bid in an auction or take on positions of a defaulting member if they believe that under resolution, they would absorb fewer losses. And needless to say, while recovery and resolution planning is important, we hope there is never a need for either. It is the daily, ongoing risk management and risk surveillance that are critical to avoiding ever having such a problem.
Oversight of Major Market Participants
Now I’d like to turn to the oversight of swap dealers. Last year, I spoke about the progress we had made putting a regulatory framework in place. I also highlighted the need to finalize our rule setting margin for uncleared swaps. Today, that too is completed.
Margin for uncleared swaps. Margin requirements for uncleared swaps are one of the most significant elements of swaps market regulation set forth in the Dodd-Frank Act. There will always be a large part of the market that is not cleared, and margin requirements protect against excessive risk buildup in the system.
Last December, we adopted a strong, sensible rule. It focuses on where the greatest risk exists– in the transactions between large financial institutions. Importantly, our rule exempts commercial end-users.
We worked very hard to harmonize our rule with the rules of the prudential regulators, as well as with international standards. There were many differences in the proposals when I first took office, and we succeeded in making the rules very similar.
Recently we also adopted a cross-border approach for the implementation of this rule. It will ensure, for example, that our rule, or a comparable international measure, applies to the uncleared swap transactions of swap dealers that are foreign consolidated subsidiaries of a U.S. parent. That is, we make sure a strong rule applies whether or not those transactions are explicitly guaranteed by the U.S. parent.
At the same time, the rule also provides for a broad scope of substituted compliance. Not only will non-U.S. swap dealers be eligible for substituted compliance, so will U.S. swap dealers with respect to the margin they post to non-U.S. persons.
I’m very pleased we not only finished this important rule, but also reduced significantly the potential for conflict with other international rules.
De minimis threshold. Let me note quickly that we are also addressing the swap dealer de minimis threshold, as I promised we would last year. As many of you know, the limit—which defines who must register as a swap dealer—will decline at the end of 2017 from $8 billion to $3 billion in notional amount of swaps over the year -- unless the Commission takes action. We are examining this and have not yet decided whether to take any action.
Swap Data Reporting
And we are taking several steps to improve the reporting of swap data. Last year, I talked about the need to clarify some of our reporting rules, harmonize data reporting standards and improve the quality of the data. We are doing all those things. In particular, I hope that we can soon finalize the rule we proposed last year to clarify reporting obligations with respect to cleared swaps. These clarifications will help eliminate unnecessary reporting requirements, and ensure that there are not multiple records of a swap that can lead to erroneous double counting. It will also ensure that accurate valuations of swaps are provided on an ongoing basis.
In addition, the Commission has taken action to improve data quality. Last December, our staff suggested technical specifications for the reporting of 120 priority data elements. This will help standardize reporting to swap data repositories (SDRs), as well as by SDRs to the CFTC.
And we are leading international efforts on data harmonization, including work on developing so-called “unique product identifiers” and “unique transaction identifiers.” These will allow us to identify swaps and swap activity by product type and transaction type, respectively, throughout the swap life cycle.
Transparent Trading
Now let me turn to trading. Last year I discussed the need to fine-tune our rules to improve swap trading.
I believe our goal should be not just to implement the trading mandate in the law and achieve the basic goals of transparency and fairness in trading. We should also strive to create conditions which attract participation and build liquidity.
The Commission has taken a number of steps toward that goal. For example, since January the Commission has granted permanent registration status to 21 SEFs.
We also worked to improve trading on SEFs in a number of areas, and soon I will ask the Commission to adopt as permanent rules a number of the “no action” letters and guidance staff issued over the past 18 months. These pertain to such matters as error trades and simplifying procedures regarding confirmations, which I discussed here last year.
We will also consider some additional changes, such as the “made available to trade” – or MAT – determination process. This identifies products that must be traded on SEFs. Some market participants have suggested that the CFTC play a larger role in this process, and I would like the Commission to consider it.
Finally, we are looking at ways to harmonize our rules further with those of other countries.
Europe’s rules are still evolving, and have not yet been implemented. But I am hopeful that as their rules take shape, and as we look for ways to fine-tune ours, we can work together to ensure greater harmonization.
We are taking some steps to improve cross-border regulation when it comes to futures trading as well.
We now have a formalized process so that foreign exchanges seeking to provide direct electronic access to U.S. citizens officially register with us as a foreign board of trade, or FBOT. To this end, less than two weeks ago the CFTC approved the registration of two exchanges as FBOTs: BM&F Bovespa, located in Brazil, and Cleartrade Exchange, based in Singapore. We have approved seven others and we are currently reviewing additional applications.
Position Limits
One final piece of Dodd-Frank-related rulemaking is position limits, and I want to finalize our rules this year. As you may know, in the Dodd-Frank Act Congress directed us to adopt federal position limits, and in December 2013 the Commission proposed rules for 28 physical commodity contracts. Neither I nor my fellow Commissioners were in office when these rules were proposed. And given the complexity and importance of this rule, we have been taking time to listen to market participants and consider the issues very carefully.
Two weeks ago, we unanimously proposed modifications that would permit the exchanges to grant exemptions from position limits—subject to Commission oversight—for bona fide hedging that is not specifically enumerated in the rules. This is a critical piece of our effort to finish this rule by year’s end. Another key piece of this effort was our 2015 proposal to streamline the process for waiving aggregation requirements when one entity does not control another’s trading, even if they are under common ownership. We are also working to review exchange estimates of deliverable supply, so that spot month limits may be set based on current data. I hope to report further progress on this rule in the months to come.
Other Current Priorities
Let me turn to some other priorities. Regulators must often look back to address the causes of past failures or problems. But we also must look forward. Markets constantly evolve, and we must strive to create a regulatory framework that works for the new challenges and opportunities ahead. So I’d like to talk about two of the most important changes in recent years in our markets—automated trading and cybersecurity.
Automated Trading. Last June, I discussed the issue of automated trading in the derivatives markets in some detail. I described some of our concerns – and the measures we were considering. Last November, the Commission took action, unanimously proposing rules to address the increased use of automated trading.
Our proposal focuses on minimizing the risk of disruptions or other operational problems that can be caused by automated trading. It builds upon the steps we and the exchanges have already taken on this front. It relies on a principles-based approach that codifies many industry best practices.
Our proposal requires pre-trade risk controls such as message throttles and maximum order size limits, and other measures such as “kill switches,” which facilitate emergency intervention in the case of malfunctioning algorithms. But it does not prescribe the parameters or limits of such controls, because we believe market participants are the ones who should determine those specifics. Our proposal sets general requirements pertaining to the design, testing and supervision of automated trading systems, but it leaves the details of those to market participants.
We also included measures addressing self-trading and proposals related to exchanges’ trade matching systems.
We have received a lot of feedback on this proposal. Let me discuss our next steps.
Tomorrow, staff will hold an all-day roundtable to explore several issues. These include, how do we properly define “direct electronic access” and who is subject to the rule? In that regard, one of the options we will discuss is using quantitative criteria to establish thresholds for who must implement risk controls.
We will also discuss our proposal regarding preservation of source code. This issue has attracted a lot of comment, and let me reiterate my commitment to a final rule that respects and protects confidentiality while at the same time ensuring that source code is preserved and is available to us when we need to reconstruct market events.
We recently announced that starting tomorrow, we will reopen the comment period for two weeks on these and other topics the roundtable will cover.
Let me also note my willingness to finalize our proposal in phases. While this will of course be subject to a decision of the full Commission, I would like to finalize a rule to implement the risk controls I just mentioned this year. The Commission would consider the proposals related to self-trading and exchanges’ trade matching systems thereafter.
I look forward to a robust discussion at tomorrow’s roundtable and to working with many of you to finalize our rule.
Cybersecurity. I would also like to finalize our proposed rules related to cybersecurity in the coming months. The threat of a cyberattack is perhaps the greatest single threat to the orderly functioning of our markets today. In late 2015, the Commission unanimously proposed rules designed to make sure that the private companies which run the core infrastructure under our jurisdiction—such as exchanges, clearinghouses, and swap data repositories – are doing adequate evaluation of cybersecurity risks and testing of their own cybersecurity and operational risk protections.
We’re currently considering the feedback we have received thus far, and are preparing to take final action on these proposals.
Market Liquidity
Finally, I’d like to briefly discuss one last subject that is talked about a lot these days, and that is market liquidity.
There has been a lot of discussion as to whether liquidity has deteriorated in recent years. Often times, people point the finger at regulation – particularly the regulatory actions taken since the financial crisis.
I think it’s good to discuss and examine this issue. But we must make sure the analysis is data-driven, and not just based on supposition or anecdotes. Our staff has been looking at this, and in particular we are interested in comparing liquidity levels before and after the crisis. But this remains a challenge, given the lack of sufficient data for the pre-crisis period.
I can’t do the topic justice today, but I would like to note a few points that I think we need to keep in mind when we get into these discussions. As operators of or participants in exchanges, these may seem obvious to you, but they are not always remembered in the public debate.
The first is that, as you know, liquidity is shaped by many factors, including market structure, technological change, and general economic conditions, in addition to regulation. It can be very hard to separate the effects of these various factors. That doesn’t mean we shouldn’t try, but rather that we must bring a critical eye to any analysis.
Second, it’s important to define what we mean by “liquidity.” Different liquidity metrics may not point in the same direction. In the swaps market, for example, we often hear that bid-ask spreads have tightened, but participants are executing smaller trades. A decline in trade size, however, may simply be a product of higher transparency levels, a key policy goal. Participants don’t wish to reveal size, so they break up trades into smaller pieces.
And it’s important to be specific about the market in question. Liquidity conditions can differ enormously by asset class, and markets for the same asset class can vary widely by jurisdiction. That may be obvious to those in this room, but it’s often overlooked in the public discussion.
Third, just because there are changes in liquidity provision—and some firms are not as active—does not necessarily mean that liquidity is worse overall. Over many years, for example, we have seen a change in the futures markets, away from a traditional dealer-centric or floor trader-centric model to one in which all participants meet through centralized, electronic order books. This has contributed to—and perhaps been caused in part by—the increased use of automated trading. This transition also has opened access to our markets for a larger number and greater variety of market participants. This is evidenced by the round-the-clock trading of various benchmark contracts listed in our markets. These developments have changed the dynamics of liquidity provision.
Some have said it means liquidity is characterized by tighter bid-ask spreads and faster execution, but maybe also an increased potential for volatility. So there may be situations where liquidity is not clearly better or worse, just different.
Finally, let us not forget that we have undertaken regulatory reforms to make the system more resilient, particularly in times of stress. Thus any claim about the adverse impacts of regulation on liquidity must also recognize this benefit.
Conclusion
As you can see, we have been very busy over the past 12 months, and we have a lot on our plate today. I want to thank our dedicated staff for their hard work. I also want to thank Commissioners Bowen and Giancarlo. We have worked together very constructively, and I value and appreciate their contributions and judgment.
Let me thank all of you for your comments on our proposals and for your involvement in our work. I know you all appreciate how vital these markets are—and the need for good regulation and oversight to keep them that way.
Thank you very much for inviting me here today. It’s been a pleasure to be with you. And I welcome any questions you may have.
