Remarks of CFTC Chief of Staff Michael Gill to the Futures Industry Association Japan
November 10, 2017
I am grateful to the Futures Industry Association for the opportunity to speak to you here in Tokyo. I especially wish to acknowledge the hard work of Yasuo Mogi and Michael Ross for organizing the event. Thank you, Yasuo and Michael for everything you have done to promote the futures industry here in Japan. I deliver my remarks here today in lieu of CFTC Chairman Christopher Giancarlo. My remarks are fully his views.
It is also a pleasure for me to follow President Trump’s visit to Japan. The United States stands behind Japan and its Asian partners in today’s uncertain world. As the President has emphasized, Japan and the United States are close allies and friends with many strong ties. These ties include deep trade and financial market relationships.
Adjustments as we walk the “Narrow Road to the Deep North”
Beloved 17th century poet Matsuo Bashō wrote a famed travelogue, The Narrow Road to the Deep North (or the Interior), of his five-month journey from Tokyo to a remote northeast region of Japan’s interior, Oku.1 One of the purposes of his trip was to see the old places memorialized in earlier Japanese poetry. But this journey was also part of poet Bashō’s effort to renew his art. As Bashō proceeded along the road with a fellow poet, Kawai Sora, Bashō describes making adjustments to his path, varying from his intended route. I imagine that he did so based on new opportunities, new experiences, and also based on his introspections during the journey.
This of course makes perfect sense to us, both in our roles as regulators and more generally in our lives as human beings. We seek to effect change, and as we engage in that journey of change, new and unexpected events occur. Our views are changed by what we see and experience. Ideally, we reflect and adjust course. As Bashō wrote, every day is a journey.2
As the CFTC works with our partners along the path towards full worldwide implementation of the G-20 reforms, the CFTC should shift its focus on how we regulate based on our experiences so far. We should be smarter and better-aligned with the transformative changes taking place all around us. We should, as Bashō did, reflect upon and renew our craft.
Today I would like to share with you Chairman Giancarlo’s thoughts on the CFTC’s needed adjustments along the road to reform. I want you to know our thoughts because, like Bashō, we do not walk this path alone.
Traversing the path in similar, but not identical, ways
The CFTC has long shared with Japan a common goal of innovative, efficient, and well-regulated derivatives markets. We are proud that the CFTC staff works closely and frequently with our colleagues from the Japanese Financial Services Agency and other Japanese authorities on international derivatives matters. Our interests and views are well-aligned.
Both the U.S. and Japan have been leaders in instituting key G-20 reforms and in undertaking key dialogues on regulatory coordination. CFTC and Japanese financial authorities also have led by example, engaging in close cooperation on specific projects. In 2015, the CFTC granted an exemption to the Japan Securities Clearing Corporation (JSCC) from registration under the Commodity Exchange Act as a Derivatives Clearing Organization.3 The scope of that exemption was expanded in May of this year to include any swaps under the CFTC’s jurisdiction.4 In 2016, the CFTC made a comparability determination for substituted compliance purposes for certain margin requirements for uncleared swaps. In all of these matters, there was detailed coordination between the CFTC, the JFSA, and others. During the respectful dialogue between the CFTC and Japanese authorities, we weighed the many similarities and occasional differences in our approaches to arrive at a resolution.
The poet Matsuo Bashō was, of course, a master of haiku. One of his poems can be translated:
Don’t imitate me;
it’s as boring
as the two halves of a melon.5
As we have proven often together, such as in the JSCC exemption and margin equivalence, we need not become two identical halves of a melon to come to a workable resolution. This is the craft of our cross-border work: harmonization without necessarily complete standardization.
This type of cooperation should be a model for our common interactions with the European Union. We – the U.S. and Japan – have harmonized our interests without insisting on identical approaches to all regulatory problems. Differences are fine, and can be managed and harmonized by partners of good faith. As regulators, we should look about the path we are on, and reflect upon our work so far, and together confront common challenges with solutions that accept and respect differences.
Common challenges, harmonized paths
What work lies before us? We know this is a question Japanese regulators have thought and spoken about at some length. As JFSA’s Commissioner Mori has observed: we need to be mindful of the cumulative impact of the many forms of medicine that regulators have delivered to the economy and we should consider whether our reform efforts are addressing the root causes of the financial crisis and meeting the goals of the G-20 reforms.6
It is time to retool our global regulatory framework to ensure that we have well-crafted, practical rules and regulations that encourage participation, growth, and innovation in our markets. We strongly believe we can do this and remain steadfastly committed to the G-20 reforms.
As a result, I very much welcome this opportunity to share with you the priorities of Chairman Giancarlo. This re-examination and re-adjustment of our path requires a 21st century regulatory approach, an approach that fits the dynamics of our rapidly changing markets. And I seek to highlight the harmony of our current thoughts with those of Japanese regulators and to invite dialogue with all of you on the CFTC’s interesting journey.
We want to make sure we reduce regulatory burdens as we continue to make progress on G-20 reforms. We are looking back here on our regulatory journey so far, and, with due introspection, considering what we should improve.
Chairman Giancarlo has introduced Project KISS. K_I_S_S stands for “Keep It Simple Stupid.” Project KISS is an agency-wide review of CFTC rules, regulations, and practices to see where the CFTC can make our regulatory approach simpler, less burdensome, and less costly. We asked the public to submit comments to the CFTC about where we can simplify and modernize our rules. At the end of our comment period, we received over 40 comments and are actively reviewing the submissions.
This exercise is not about identifying existing rules for repeal, but rather, taking the existing rules as they are and seeking simpler and less burdensome approaches where appropriate. We have sought and received excellent comments from the public on registration, reporting, clearing, trade execution, and other topics. We hope to learn much from the comment letters. We want to make sure we are identifying the correct problem and using the right tool for the job, to ensure efficient and effective regulation.
Here, we again find ourselves acting in agreement with Commissioner Mori’s observations on effective regulation. There are times when a backward-looking, form-focused approach or discrete checks are less desirable than a more forward-looking and holistic view of the complex financial marketplace we regulate.7 There are times when an overly specific regulation may be costly and yet not effective and supervision or other regulatory approaches can achieve better results more efficiently. As Commissioner Mori has observed, “A brake pedal alone cannot guarantee safety.”8
Swaps Reform Regulation 2.0
Relatedly, Chairman Giancarlo is also conducting an internal regulatory review that he calls “Swaps Reform 2.0.“ If we think of our swaps regulations to date as Regulation 1.0, we should consider what changes – regulatory, statutory, or policy – we wish to make.
There are many reasons to do this.
There is the challenge of whether the amount of capital that prudential regulators have required financial institutions to take out of capital markets is calibrated to the amount of capital needed to be kept in global capital markets. Our concerns are quite similar to those articulated by Commissioner Mori in last year’s annual ISDA general meeting in Tokyo. He has advocated that the JFSA’s supervisory approach be transformed to assess and strengthen the regulatory framework based upon challenges on the horizon, moving from static to dynamic regulation, noting the limitation of fixed rules on capital reserve in the complex financial marketplace.9 The dual goals of financial stability and growth require us to carefully consider the unintended aggregate consequences of multiple regulatory measures on capital requirements and leverage ratios.
In particular, at the CFTC we are considering whether the “supplementary leverage ratio” or SLR, has impaired the ability of derivatives end-users to hedge risk and reduce volatility. We are witnessing structural changes to our own markets and we need to reflect and react to these changes. In 2002, there were 100 futures commission merchants registered with the CFTC. As of early 2017, there were 55 futures commission merchants registered. Of these, just 19 were holding customer funds for swaps clearing. Large banks, such as State Street, Nomura, Bank of New York-Mellon, Deutsche Bank, and RBS, have exited the futures commission merchant business.
In considering these and other challenges, Chairman Giancarlo is very much guided by the U.S. Treasury’s Report on Capital Markets, which was published last month and with thoughtful input from the CFTC team. The recommendations provided within the Report will help foster financially sound markets and encourage broad-based economic growth. With respect to swaps trading, he has long argued that there is a mismatch between the CFTC’s swaps trading framework and the swap market’s fundamental structure. The CFTC must create a framework that is better aligned with swaps market dynamics and liquidity, and more closely adheres to the express language and spirit of Dodd-Frank. The revised swaps trading framework should be more flexible and allow market participants to choose the manner of swap trade execution suited to their business. It should better align regulatory oversight with inherent characteristics of the swap market. Most importantly, the CFTC’s revised swaps trading framework should facilitate healthy risk hedging activities in the private sector that are essential for broad-based economic growth and revival.
The goal of CFTC Swaps Reform 2.0 will be a regulatory framework that is adjusted and engineered to better support market durability and fair and efficient markets.
Rapidly Changing Technologies and Market Infrastructure
Financial regulation in the 21st century must account for ever-changing markets and technologies. Gone are the days of trading pits. Our markets are now electronic. New technologies are wide-ranging in scope: cloud computing, algorithmic trading, distributed ledgers, artificial intelligence, machine learning, network cartography, and many others. These technologies have the potential for a significant or even transformational impact on CFTC regulated markets and the agency itself.
We are at the advent of exponential growth in digital technologies, which have altered trading, markets, and the entire financial landscape with far-ranging implication for capital formation and risk transfer. And this wave of transformational technologies is coupled with the ongoing automation of our markets, a process which already has had significant consequences. There have been cost savings and efficiencies. But not all of the changes in how our markets operate have been desirable. Derivatives markets are known for efficient price discovery. But since the passage of the Dodd-Frank Act, with increased automation of our CFTC-regulated derivatives markets, there have been at least twelve major flash crashes and at least several dozen minor flash crashes.
We are re-thinking how we should approach regulation of technology-driven markets. We should ensure our regulatory framework is sufficiently flexibility to adapt to and react to this wave of technological change.
To monitor, learn from, and guide this rapid change in the derivatives markets, the CFTC has recently launched LabCFTC, a hub for the agency’s engagement with the FinTech innovation community. LabCFTC's mission is twofold: (1) to promote responsible FinTech innovation to improve the quality, resiliency, and competitiveness of our markets; and (2) to accelerate CFTC engagement with FinTech and RegTech solutions that may enable the CFTC to carry out its mission responsibilities more effectively and efficiently.
LabCFTC will be part of the CFTC’s push to be proactive and forward-thinking as FinTech applications continue to develop. All the while, we continue to be active in international efforts to coordinate and consult on regulatory responses. These are global markets and these are global changes. It is important to ensure that applications of new technology meet industry needs and are subject to appropriate controls and safeguards, satisfy resiliency and other relevant standards. Experimentation and innovation is welcome, but customers should and will be protected.
Another crucially important technological evolution in the automation of our markets is cybersecurity. Cybersecurity is undoubtedly the most important single issue facing our markets today in terms of market integrity and financial stability.
In light of the relentlessness of cyber attacks, we have taken several steps to combat this serious threat. Chairman Giancarlo meets monthly with the CFTC’s Chief Cybersecurity Officer to review all recent cyber incidents and agency responses as well as to discuss anticipated threats. With respect to the markets we oversee, I note that in September 2016 the CFTC unanimously adopted system safeguards and cyber resilience standards for clearinghouses, contract markets, swap execution facilities, and swap data repositories. We recognize the great expertise in cybersecurity within the firms we regulate and proactively seek ways to support their frontline defense in cyber security and cyber resilience.
In addition, Chairman Giancarlo has recently agreed to chair a new Board-level task force on cybersecurity for the International Organization of Securities Commission. It is critical that cybersecurity be a priority for all regulators, and we believe IOSCO can play an important role in helping market regulators around the world improve their cyber-resiliency practices.
Swaps Data Reporting
At the heart of the 2008 financial crisis was the inability of regulators to assess and quantify the counterparty credit risk of large banks and swap dealers. The legislative solution was to establish trade repositories, what we call in the U.S. swap data repositories (SDRs), under the Dodd-Frank Act. Although much hard work and effort has gone into establishing SDRs and supplying them with swaps data, trade repositories worldwide generally still cannot provide regulators with a complete and accurate picture of bank counterparty credit risk in global markets.
In part, that is because international regulators have not yet harmonized global reporting protocols and data fields across international jurisdictions. The CFTC is co-leading several global initiatives to harmonize derivatives reporting along with fellow overseas regulators via the Committee on Payments and Infrastructures-IOSCO (CPMI-IOSCO) and the Financial Stability Board (FSB). This international work must remain on schedule. No implementation of harmonized data standards will be perfect, but the CFTC is exercising sustained leadership in the international community to hasten initial implementation for at least some of these data standards in the next year. We must timely complete this work.
Harmonization work can be difficult, but it interesting and critically important. Specifically, we seek to harmonize:
- Unique transaction identifiers (or UTIs) to identify uniquely an individual OTC derivative and thus avoid double-counting when analyzing swaps data;
- Unique product identifiers (or UPIs) to identify an OTC derivative by its product type, including the instrument underlying the derivative; and
- Critical data elements (or CDEs), to harmonize other basic information about the swap transaction, such as notional amount, price, and collateral movements.
For those outside the derivatives markets, this work might seem as boring as two halves of a melon. But for us, and certainly for many on our staff, derivatives data standards harmonization work is very exciting. In technology-driven markets, having standardized data elements is critical to aggregating and analyzing swaps data globally, so this work is a direct link to the G-20 reform goal of analyzing systemic risk with transparency across the globe.
Thus it is that we have many, and not just a few, CFTC staff members who would happily spend an entire day discussing with you why single-sided reporting leads to superior data quality for regulators at a lower cost to industry than double-sided reporting. For Chairman Giancarlo and all of us in leadership at the CFTC, this is a wonderful problem to have. Our staff is right about this, by the way. Regulators should all require single-sided reporting.
Harmonization of swaps data is not the same thing as complete legal standardization of our respective legal regimes. Different countries have different legal requirements and structures for processes such as clearing. Here, we cannot standardize all the applicable laws of different countries. Such an approach will only lead to delay and frustration. Nor will we be able to solve the problem by using data standards to force complete legal harmonization. Instead, we are called to harmonize data standards involving different legal regimes, making changes to our regulations where possible, and find practical workarounds that accommodate legal differences.
While we pursue this work, the CFTC is also in parallel asking for public comment on a swaps data reporting “Roadmap.”10 We are looking to improve upon the current processes for swaps reporting that were put in place back in 2012 and 2013. The CFTC has received 20 comment letters on the Roadmap that were overwhelmingly well informed and supportive. Our staff is carefully considering them. A major focus of implementing the Roadmap will be incorporating harmonized UTI, UPI, and CDE guidance into our reporting regime.
Just two weeks ago, Chairman Giancarlo announced a “Common Approach on Trading Platform Equivalence” with European Commission Vice President Dombrovskis as well as a decision by the European Union to grant equivalence on margin requirements. These announcements show Chairman Giancarlo’s desire to work closely with key foreign counterparts to ensure that our rules to do not conflict and fragment the global marketplace.
Our regulatory regimes are not standardized or uniform across the globe. We are not halves of a melon. We need not imitate each other. What we must do, and what we have seen work so well with our Japanese counterparts, is harmonize with each other and defer when appropriate to different paths toward the same journey’s end. Our global economy in many ways benefits when regulators focus on harmonization and comity, not uniformity. This approach strengthens our ability to hasten the progress of the G-20 reforms.
I want to express my sincere gratitude to all of you for taking the time out of your demanding schedules to listen to me today. We walk this path with good friends who understand and respect each other well. We look forward to continuing, and strengthening, our work together, regulators and market participants alike. Thank you.
1 “Oku no Hosmichi” (奥の細道) is variously translated as “The Narrow Road to the Deep North” or “The Narrow Road to the Interior.” It is a famous travelogue and a major text of classical Japanese literature. Many Japanese and tourists retrace the poet’s journey.
2 Bashō, Narrow Road to the Interior and other writings, Boston, 2000, p.4 (transl. Sam Hamill).
5 Bashō, Don’t Imitate Me (translated by Robert Hass).
6 Rethinking Regulatory Reform, speech before the 6th Ann. Pan Asian Regulatory Summit (Oct. 2015 Hong Kong).
7 A holistic approach to future-proofing the financial system, Financial Times (May 26, 2017).
8 A brake pedal alone cannot guarantee safety, speech before the Spring Membership Meeting of the Institute of International Finance (May 2017 Tokyo).
9 From static regulation to dynamic supervision, speech before the ISDA General Meeting (April 2016 Tokyo).
Last Updated: November 14, 2017