SPEECHES & TESTIMONY

Remarks of CFTC Chairman J. Christopher Giancarlo at the West Texas Legislative Summit 

Angelo State University, San Angelo, Texas

August 2, 2018

Introduction

I want to thank House Agriculture Committee Chairman Mike Conaway for the opportunity to be with you today.  His leadership and strong support for agriculture and energy derivatives markets have been important…really vital … for our work.  I am especially grateful for his trust in my leadership and support for our agency’s budget request.  His moral fastness and powerful, positive thinking have been a major contribution to our country. 

I also want to acknowledge two other voices of leadership:  Senator Charles Perry and Representative Drew Darby.  You are fortunate to have such fine, outstanding representation here in Texas and in Washington.  And, of course, I would be remiss not to recognize your fine governor (and my law school classmate), Greg Abbott, who has worked hard to see Texas be a national leader in job creation and economic growth.

I am so glad to be with you in West Texas. 

You know, I love Western Swing and American Country music.  I play the banjo and guitar.  I grew up listening to Waylon Jennings and J.D. Southern.  Today, I am here in the melody of America.  It is thrilling to think about it.  Lubbock’s own Buddy Holly influenced most of the great rock and rollers.  And, Roy Orbison from Odessa influenced my state’s own Bruce Springsteen.  Of course, from right here in San Angelo, the legendary Ernest Tubbs and the fabulous Los Lonely Boys got their start.  Amazing!

It is a pleasure more than just musically.  As a football fan, I know I am in the heart of American football.  It’s a part of life, a way of looking at life.  My first football memories: Joe Namath throwing to the great wide receiver, Don Maynard, who played high school football in nearby Colorado City.  When I grew up in the 1960s, all the kids wanted to be Joe Namath.  But I wanted to be Don Maynard, with his long sideburns and Texas stride.  One hundred yards per game.  He never dropped a pass.

And, like football, academics are strong here.  Look around the room.  San Angelo University equals success.  I have been very impressed that the Princeton Review and other publications rank San Angelo University as one of the best academic institutions in America.  This helps explain why job growth is steady here and the transition from manufacturing to business and personal services has been workable.  Education is one of the reasons.

San Angelo graduates are great employees and the economy responds to their preparation, hard work, and innovation.  That is one reason why jobs and job growth are more prevalent here than in many other cities.  In fact, Governor Abbott made this point in his “State of the State Address in 2017,” when he noted that Midland, Texas had surpassed San Francisco in the percentage of jobs created by startups.  West Texas is an innovation model for the rest of the country.

The Shale Revolution

West Texas is also the scene of another episode of American greatness, the epicenter of a stunning accomplishment of American exceptionalism – and a recent one.

I am talking about the shale revolution – a combination of American technological innovation, North American geology, U.S. property law, the skilled and entrepreneurial American workforce and our dynamic capitalist economy.  That combination has led to one of the greatest economic success stories the world has ever seen.  And, it has happened just in the past few years.

The first ingredient is the innovative breakthrough of horizontal drilling and hydraulic fracturing, a spectacular accomplishment of American technology. 

The second ingredient is the geological presence of porous shale rock holdings of enormous oil and gas hydrocarbons adjacent to large amounts of accessible water that can be forced into the rock at high pressure so as to form countless tiny cracks.  Sand mixed in with the water props these cracks open so oil and gas can flow out.

The third ingredient is privately-owned, rather than government-owned, mineral rights, a unique legal construct compared to the rest of the world.  This allowed for property owners to expedite development without government bureaucracy and protracted political opposition.

The fourth ingredient is the American energy industry’s highly skilled labor force and extensive midstream infrastructure network.  That ingredient combined with American entrepreneurialism and culture of new business formation permitted smaller independent energy producers to prosper alongside integrated oil majors.

The final ingredient is direct access to creative financing methodologies and Wall Street capital to underwrite the enormous cost of innovation and development. 

Combining these five factors led to the dramatic rebirth in U.S. output of oil and natural gas. 

Yet, even with this remarkable combination, there were two years when success or failure hung in the balance.  From 2014 to 2016, the Organization of the Petroleum Exporting Countries (OPEC) and Russia had tried to thwart American competition by bankrupting America’s emerging shale industry, by turning up their own production and driving down global prices to unprofitable levels.  They bet that a few years of prolonged low prices would drive the new U.S. producers out of business and allow them to benefit as U.S. output slowed.

According to one observer:

“It turned out to be a colossal miscalculation, which led to the spectacular triumph of American free-market capitalism over 40% of the world’s oil output.  The U.S. shale industry responded to the existential threat by innovating, cutting costs and becoming ruthlessly efficient.  It was the only way they were to survive. They drilled deeper, and longer.  They adopted multi-pad wells, which were vastly more productive.  They crunched enormous amounts of data to refine their techniques, and made substantial IT investments.  As a result, U.S. output dipped but didn’t collapse.”[1]

It worked.  By October 2016, OPEC threw in the towel.  American shale producers had not only survived, but had become more efficient, more productive, and more innovative than their overseas competitors.  American shale producers were the new global energy upstarts, on their way to be the world’s biggest oil producers by the end of 2019.[2]  In so doing, they have changed not just the structure of global energy markets, but geopolitical strategies as well.[3]

America’s newfound energy independence is the product of entrepreneurship and free enterprise.  Undoubtedly, there are new challenges on the horizon today, including a looming “supply crunch” resulting from a pick up in global growth.  Yet, the shale revolution remains a shining example of the ability of America’s dynamic capitalist economy to benefit a new generation of Americans. 

And since we are having a national debate this year about the merits of socialism, let’s admit that the shale revolution could never have happened in a socialist economy, such as Venezuela.  Their oil output is collapsing at an accelerating pace, deepening an economic and humanitarian crisis. [4]  By contrast, in democracies like ours, innovation leads to prosperity, higher standards of living and, eventually, to greater equality.”[5]

There is one facet of this amazing success story that should also be highlighted.  That is the key role that financial hedges and commodity derivatives played in helping the industry and its financial backers withstand the cartel squeeze.  Without the ability to efficiently hedge depressed energy prices and variable costs of production, America’s shale producers may well have succumbed to OPEC’s concerted efforts and failed to secure our country’s growing energy independence.

The Role of the CFTC

America’s energy and commodity derivatives markets are overseen by a small, but important, independent Federal agency, the Commodity Futures Trading Commission (known as the CFTC).  It is an agency of which I have the honor to serve as Chairman. 

The CFTC was established under the Commodity Exchange Act (CEA) as the legal authority over America’s derivatives markets.  The law has been amended several times since it was passed in 1936.  The CEA establishes the statutory framework under which the CFTC operates, both judicial and legislative.

The CFTC is composed of 5 Commissioners, chosen by the President and confirmed by the Senate.  No more than three of the five Commissioners can be of the same political party as the President.  The Commission is a creation of Congress, which has delegated power to us. 

The CFTC has close to seven hundred career staff.  It regulates markets for derivatives trading, such as exchange-traded futures and options on wheat, corn, gold, silver, oil, natural gas and other commodities.  It also oversees some of the world’s largest financial markets in listed futures and over-the-counter swaps on rates of interest, credit default and foreign exchange.  The CFTC has been in the news lately because of its regulation of new futures contracts on Bitcoin.  You may have read about that.

21st Century Financial Markets

I’d like to speak to you this morning about other long-range technological and market developments that continue to hang in the balance of evolution.  Since this is a legislative summit, let’s together focus on the challenges we face.  In so many ways and in such a rapid pace, the future is devouring the past, forging a new agenda, and threatening to move ahead of regulators, financial institutions, and government.  That is why we need 21st century regulation for a 21st century world.

Technology is leading us into a world that is much different than the world we knew five or ten years ago.  So much today – from information to manufacturing to transportation to commerce to agriculture – is undergoing a digital transformation.  It, therefore, should be no surprise that our derivatives trading markets are going through the same digital revolution.

Technology has far-ranging implications for capital formation and risk transfer.  These technologies include machine learning and artificial intelligence, algorithm-based trading, data analytics, “smart” contracts valuing themselves and calculating payments in real-time and distributed ledger technologies, which over time may come to challenge traditional market infrastructure.

These technologies are having an equally transformative impact on U.S. derivatives markets.  One thing is certain: ignoring these changes in the market would be profoundly imprudent.  They will not go away.  Rather, the rate of change will accelerate.  Nor is ignorance a responsible regulatory strategy.  We cannot respond in a reactive way -- chasing to catch up with technology.  We must be proactive with a regulatory and statutory framework that is ahead of the curve, gives clarity and coherence to this often-complex technology, and anticipates its evolution.  We must offer a rational response to the needs of the market.  The same technology can give us advantages in market regulation. 

For more than a century, Americans have relied on U.S. derivatives markets to stabilize the cost of living.  As we have seen, derivatives help mitigate the volatility of energy prices and costs of production. 

The Importance of Derivatives for Financial Stability

Derivatives are the reason why American consumers enjoy stable prices, not only in the supermarket, but in all manner of consumer finance, from auto loans to household purchases to gasoline to oil.  Derivatives markets influence the price and availability of heating in American homes, the energy used in factories, interest rates, investments, capital formation, and equipment costs.

More than 90% of Fortune 500 companies use derivatives to manage commercial or market risk in their worldwide business operations.  These markets allow the risks of variable production costs, such as the price of raw materials, energy, foreign currency, and interest rates, to be transferred from those who cannot afford them to those who can.

Even Americans not actively participating in commodity derivatives markets are affected by the prices generated by them.  Commodity derivatives markets provide a critical source of information about future energy prices.  In short, derivatives serve the needs of American society to help moderate price, supply and other commercial risks to free up capital for economic growth, job creation and prosperity.  While often derided in the tabloid press as “risky,” derivatives – when used properly – are tools for efficient risk transfer and mitigation.  It has been estimated that the use of commercial derivatives added 1.1% to the size of the U.S. economy between 2003 and 2012.  American derivatives markets are the world’s largest, most developed, and most influential.

Many of the world’s most important agricultural, mineral, and energy commodities are priced in U.S. dollars in the U.S. derivatives markets.  Dollar pricing of the world’s commodities provides a tremendous advantage to American producers in global commerce, an advantage well recognized by competing economies abroad. 

American derivatives markets are the world’s best regulated.  The U.S. is the only major country in the Organization for Economic Co-operation and Development to have a regulatory agency specifically dedicated to derivatives market regulation: the CFTC.  The CFTC has overseen the U.S. exchange-traded derivatives markets for over 40 years.  The agency is recognized for its principles-based regulatory framework and econometrically-driven analysis.  The CFTC is recognized around the world for its depth of expertise and breadth of capability. 

This combination of regulatory expertise and competency is one of the reasons why U.S. derivatives markets continue to serve the needs of participants around the globe to hedge price and supply risk safely and efficiently.

Foreign Competition

Now, let’s look to the future.  As you know, in the first quarter of this year, the Shanghai International Energy Exchange launched a Yuan-denominated crude oil contract allowing non-Chinese market participants to trade for the first time in Chinese commodity markets.  Early in the second quarter, China opened a Yuan-denominated iron ore contract to international traders.  There is also talk of China allowing international market participants to trade Chinese futures contracts in fuel oil, copper and even soybeans.

China is the world’s largest consumer of oil and fuel and a major global purchaser of iron ore for its world leading steel production.  The opening up of China’s domestic futures markets to international participation is part of a long-term strategy by the Chinese government to expand China’s influence over the pricing of key industrial commodities.

The development of Chinese commodity futures markets has competitive implications for the United States.  We cannot be complacent about the historical primacy of our derivatives markets.  Our best response for U.S. commodity market participants and, indeed, for global markets, is to ensure that derivatives markets in the United States are unrivaled in their openness, orderliness, and liquidity.  This requires, of course, that the regulation of U.S. markets continue to be of the highest quality.

We don’t want to give up our world leadership.  We must be worthy of the challenge.  The CFTC must undertake its regulatory mission in ways that support American derivatives markets in continuing to attract the world’s needs to efficiently and safely hedge variable commodity prices and financial benchmarks.  To achieve this, the CFTC must have suitable resources to continue to serve its mission to foster open, transparent, competitive, and financially sound U.S. derivatives markets that remain the envy of the world.

Smart Regulation

It is essential that government regulators, whether in Washington or Austin, keep industry rules and regulations simple and straightforward.  That includes making sure that regulations actually solve problems – real problems, not invented ones.

Four years ago[6], I developed an analysis formula contained in a simple mnemonic: “SMART-REG.”

It stands for: 

  • S             Solve for real problems, not anecdotes of bad behavior;
  • M            Measure success through a rigorous cost-benefit analysis;
  • A             Advance innovation and competition through flexible rules;
  • R             Represent the best approach among alternative courses of action;
  • T             Take into account evidence, rather than assumptions; 
     
  • R             Realistically set compliance deadlines;
  • E             Encourage employment of American workers;
  • G             Grounded in law.      

Since becoming Chairman under President Trump, I have emphasized greater care and precision in rule drafting, more thorough econometric analysis, and a reduced docket of new rules and regulations to be absorbed by market participants.  We have embraced the Trump Administration’s Reform Plan and have implemented in-depth organizational reviews to ensure that the agency is staffed to provide the most effective services to the American taxpayer. 

We also sought to work within the Administration’s efforts to reduce the regulatory burdens of government.  We started something called “Project KISS.”  The name comes from something my High School track coach would often say, “Keep it Simple, Stupid!”

Project KISS is an agency-wide review of our agency’s rules, regulations, and practices to make them simpler, less burdensome, and less costly.  The purpose is to remove duplicative, unnecessary, or outdated regulations.  It includes an invitation for public comment and has produced a range of proposed actions that will lessen regulatory burdens.  I believe that the American taxpayer expects nothing less from their government.

Conclusion

I started by talking about the contributions West Texas makes to the world.  Let me circle back to that.  In West Texas, you turn minerals into money, commodities into currency.  Here is the determined, hard work, and innovations that have made America into the world’s largest energy supplier. 

Here we can see the future and guide it.  As the world changes around us, we can direct its course.  We must be far-sighted to do that.  As the energy market evolves and takes us in mid-century, we must know where to take it.

The time has come to reduce regulatory barriers to economic growth.  The American people have elected President Trump to turn the tide of over-regulation.  Financial market regulators, like the CFTC, must pursue their missions to foster open, transparent, competitive and financially sound markets in ways that best foster American prosperity.

Through legislative summits like this, we can do that.  We can mold the consensus that keeps our economy strong and growing, propelling us into the future with stability and confidence.  And, we can maintain the regulatory response that maintains those markets. 

Last January, we witnessed a new beginning for our country and a renewed promise for broad-based economic growth.  This is a time to redouble our efforts to rebuild American prosperity:

  • To reduce regulatory burdens and flawed rules;
  • To enhance the health and vitality of trading markets;
  • To foster innovation and greater market intelligence; and
  • To lift the prospects of everyone for greater health and harmony.

I intend to do my part to oversee vibrant and durable markets for investment and risk transfer in this new, digital 21st century.

I ask for your help, your prayers and your support for the task ahead.

Thank you.

 

[1] Simon Lack, America’s Path to Energy Independence: The Shale Revolution, Forbes, June 4, 2018, available at: https://www.forbes.com/sites/simonlack/2018/06/04/americas-path-to-energy-independence-the-shale-revolution/#4470ab367554.

[2] Osamu Tsukimori, U.S. to Overtake Russia as Top Oil Producer by 2019 at latest: IEA, Reuters, Feb. 26, 2018, available at: https://www.reuters.com/article/us-energy-iea/u-s-to-overtake-russia-as-worlds-biggest-oil-producer-by-2019-latest-iea-idUSKCN1GB0C6.

[3] Alan Riley, The Shale Revolution's Shifting Geopolitics, The New York Times, Dec. 25, 2012, available at: https://www.nytimes.com/2012/12/26/opinion/global/the-shale-revolutions-shifting-geopolitics.html.

[4] Venezuelan oil output was down 29% in 2017, among the steepest national declines in recent history, driven by mismanagement and under investment at the state oil company.  Anatoly Kurmanaev and Kejal Vyas, Venezuela’s Oil Production Is Collapsing - Sharp drop in output increases the odds of a debt default, worsens economic crisis, Wall Street Journal, Jan. 18, 2018, available at: https://www.wsj.com/articles/venezuelas-oil-industry-takes-a-fall-1516271401.

[5] Amity Shlaes, Growth, Not Equality: American History Shows that Expanding the Economy Benefits Everyone, City Journal, Winter 2018, available at: https://www.city-journal.org/html/growth-not-equality-15643.html.

[6] J. Christopher Giancarlo, Re-Balancing Reform: Principles for U.S. Financial Market Regulation in Service to the American Economy, Remarks to the U.S. Chamber of Commerce, Nov. 20, 2014, available at: https://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlos-2.