Remarks of Chairman Timothy Massad before the DerivOps North America 2015
April 22, 2015
As Prepared For Delivery
Thank you for inviting me today, and I thank Diane for that kind introduction. It’s a pleasure to be here.
Yesterday was actually the 40th anniversary of the CFTC. The CFTC was formed as a separate agency on April 21, 1975, having been part of the Department of Agriculture prior to that time. What the agency has accomplished during that time is a credit to the CFTC staff. We have an incredibly dedicated and talented team whose tireless efforts have greatly benefitted the American public. I also thank my fellow commissioners for their efforts, particularly their willingness to work constructively together.
The growth of the derivatives markets over the last 40 years is really astounding. The sensible regulatory framework created by the CFTC for the futures market was a foundation for that market’s success. It has helped insure integrity and transparency while facilitating growth and innovation. Today we face a similar challenge in the swaps market – we must create a regulatory framework that achieves the goals of transparency and integrity while enabling the market to continue to grow and thrive.
And today, I want to update you on where we stand on creating that framework.
The New Regulatory Framework
Now unlike the futures and options market, the swaps market grew to be a global market in the absence of regulation. Moreover, while regulation of the futures and options market occurred gradually over time as the market evolved, the decision to create a regulatory framework for the swaps market occurred as a result of the worst financial crisis since the Great Depression. So these differences make our task particularly challenging.
- As you know, the G-20 nations agreed to bring the over-the-counter derivatives market out of the shadows through four key commitments: central clearing, market oversight, transparent trading, and data reporting. Congress enacted those four G-20 commitments in the Dodd-Frank Act, and gave primary responsibility to the CFTC. Over the last five years, we have made substantial progress implementing each.
- Clearing through central counterparties is now required for most interest rate and credit default swaps. About 75% of the transactions in our market, measured by notional amount, are cleared, compared to about 15% in December 2007.
- We have increased oversight of major market players through our registration and regulation of swap dealers – more than 100 are now provisionally registered – and major swap participants.
- Swaps transactions must now be reported to registered swap data repositories. There are now four data repositories in the U.S., and more than 20 others internationally, and thousands of participants are providing trade data which improves price discovery, increases market transparency, and enhances supervisory oversight.
- Transparent trading of swaps on regulated platforms has begun. We currently have 22 swap execution facilities temporarily registered with 3 more applications pending. According to information compiled by the International Swaps and Derivatives Association, SEF trading accounted for about half of total volume in 2014.
But there is more work to do in all these areas. Let me briefly note some of the general issues we have been working on, and then talk specifically about some trading and data issues that I think will be of great interest to you.
Over the last ten months, one of our priorities has been to work on fine-tuning the new rules so that the new framework works effectively and efficiently for market participants. In particular, we have made a number of changes to address concerns of commercial end-users who depend on these markets to hedge commercial risk day in and day out, because it is vital that these markets continue to serve that essential purpose. This has included adjustments to reporting requirements and measures to facilitate access to these markets by end-users. We will continue to do this where appropriate. With reforms as significant as these, such a process is to be expected. We are also working on finishing the few remaining rules mandated by Dodd-Frank, such as margin for uncleared swaps and position limits.
Oversight of clearinghouses has been another key priority. Under the new framework, clearinghouses play an even more critical role than before. So we have also been focused on making sure clearinghouses operate safely and have resiliency. We did a major overhaul of our clearinghouse supervisory framework over the last few years. Today we are focused on having strong examination, compliance and risk surveillance programs. And while our goal is to never get to a situation where recovery or resolution of a clearinghouse must be contemplated, we are working with fellow regulators, domestically and internationally, on the planning for such contingencies, in the event there is ever a problem that makes such actions necessary.
We also remain committed to a robust surveillance and enforcement program to prevent fraud and manipulation. Whether holding some of the world’s largest banks accountable for attempting to manipulate key benchmarks or stopping crooks from defrauding seniors through precious metal scams and Ponzi schemes, our goal is to make sure that the markets we oversee operate fairly for all participants, regardless of their size or sophistication.
Yesterday, you may have seen that the Commission and the Department of Justice brought civil and criminal charges against an individual whose actions we believe contributed to the market conditions that led to the flash crash of 2010. We believe this individual, using algorithmic trading strategies, sought to manipulate the E-mini S&P 500 on repeated occasions. The individual was arrested and taken into custody in London yesterday morning, and in addition to the Justice Department, I want to thank the FBI, U.K. Financial Conduct Authority, and Scotland Yard for their help on this case. As this case illustrates, we will do everything in our power to pursue those who attempt to engage in fraud or manipulation in our markets, whether through electronic trading or conventional schemes. There is nothing more important than the integrity of our markets.
Agenda Going Forward
Let me now highlight a few current agenda items that I believe will be of interest to you. I want to discuss some operational issues in swaps trading and data collection that we are working on. Many of you are responsible for operationalizing the new regulatory framework. So your understanding of these issues and your thoughts on how we might best achieve these regulatory objectives, are very important and helpful to us. And I look forward after I conclude my remarks to hearing your thoughts and questions.
Trading Issues
A key commitment of the G-20 nations embodied in the Dodd-Frank Act was exchange-based trading of swaps. In most jurisdictions, this has not yet occurred. Here in the U.S., as I already noted, the trading of swaps on regulated exchanges has begun, though it is still relatively new. It’s been just over a year since the first made available for trading determinations took place.
I noted earlier the ISDA data on overall volumes. Over the last year we have seen consistent use of these platforms, with weekly volumes in the $1.5 trillion range. Volumes of interest rate swaps have fluctuated both on and off SEFs, against a backdrop of low interest rates. In the case of swaps on CDS indices, SEF trading represented roughly two-thirds of trading. And participation on SEFs is increasing. One SEF recently confirmed that it had exceeded 700 buy side firms as participants. We have also seen a significant increase in non-U.S. market participants participating on SEFs for credit indices, now at about 20 percent from negligible levels this time last year.
So we are making progress. But there is more work to do. Last fall, I said the goal should be to build a regulatory framework that not only meets the Congressional mandate of bringing this market out of the shadows, but which also creates the foundation for the market to thrive. The regulatory framework must ensure transparency, integrity and oversight, and, at the same time, permit innovation and competition. I also said we would look at ways to improve the framework and rules to achieve this. Since that time, we have focused on some operational issues where we believe adjustments can improve trading. Today I want to note a couple of the things we have done and discuss some other adjustments that we intend to make over the coming months.
- Packages. Last year CFTC staff took action related to package trades, to allow market participants sufficient time to adapt to exchange-based trading. They worked with market participants to provide additional time for implementation and compliance, which varied by package type. Such phasing has been very useful. The market has developed technical solutions for many packages, and progress is continuing.
- Block Trades. Another area concerned block trades. Market participants expressed concern that technology limitations could impair a SEF’s ability to facilitate pre-trade credit checks where the trade is negotiated away from the exchange. Last September, CFTC staff provided no-action relief with respect to the so called “occurs away” requirement so that block transactions could continue to be negotiated between parties and executed on a SEF.
In the areas I’ve just noted, the staff believed it was appropriate in light of our regulatory objectives and the circumstances in the market to provide at least temporary relief or an adjustment through a no-action letter. This can give the market time to develop a solution, as well as allow the staff to explore with the Commissioners possible amendments to Commission rules to address some of these issues through a rulemaking.
Let me turn to some additional steps we plan to take. In some cases, the staff may again act by no-action letter to address an immediate issue, and the Commission may look to amend our rules thereafter.
Error Trades
The first area is to address how erroneous trades are handled. It is important for market participants to have a clear understanding of how corrections can be made where appropriate, while at the same time having certainty that trades they have executed are final. Today, our staff is issuing a no-action letter that will provide relief to enable market participants, SEFs, and DCMs to fix erroneous swap trades. This updates a previous no-action letter that expired last year, and extends the relief to June 15, 2016. Promoting trade certainty and straight-through processing for swaps transactions are critical components of the new market structure. However, there have been concerns that our rules resulted, in some cases, in the inability to resubmit or correct trades that either did not go through, or that did go through and contained correctable errors. There also have been concerns that the operational difficulty of resubmitting or correcting an erroneous trade has resulted in trades pending for surprisingly long periods of time in an affirmation process.
To address these concerns, the no-action letter provides relief that trades that have been rejected from clearing due to clerical or operational errors can be corrected within an hour after rejection. The SEF or DCM can then permit a new prearranged trade, with the same terms and conditions as the original trade, but corrected for any such errors, to be executed and submitted for clearing.
The letter also provides relief to enable SEFs and DCMs to permit new prearranged trades to offset and replace an erroneous trade that has already been accepted for clearing. We expect the industry to continue to take steps to reduce operational errors, as well as to meet the time frames contemplated in straight through processing for swaps.
Uncleared Swaps – SEF Confirmations and Confirmation Data Reporting
Market participants have also raised concerns about confirmations provided by SEFs to counterparties for swaps that are not cleared. As you know, the SEF may not have access to all the relevant non-economic terms of the transaction that are contained in an ISDA Master Agreement between the parties or other underlying documentation. Last year, the staff issued a no-action letter that permitted the SEF confirmation to incorporate by reference the ISDA Master Agreement. This provided temporary relief to SEFs from the requirement to maintain copies of the ISDA Master Agreements or other underlying documentation. Today, based on feedback from SEFs and market participants and our concern that the operational burdens of furnishing the ISDA agreements to the SEFs exceeded the benefits, this relief is being extended until March 31, 2016.
I should note that the relief pertains to a SEF’s obligations. Under the SEF rulebooks, the parties to a swap must maintain relevant trade documents and make these agreements available to the SEFs and the CFTC upon request.
This no-action letter also provides relief for SEFs regarding their obligation to report Confirmation Data on uncleared swaps to SDRs. SEFs have expressed concern that to comply with their reporting obligations for uncleared swaps, they might be required to obtain trade terms from the same ISDA Master Agreements or other underlying documentation that, as I have just discussed, are not otherwise available to them. In light of these concerns, this relief clarifies that SEFs need only report such Confirmation Data for uncleared swaps as they already have access to without undergoing this additional burden. I would note that SEFs must to continue to report all “Primary Economic Terms” data for uncleared swaps – as well as the Confirmation Data they do in fact have – as soon as technologically practicable. I would also note that the counterparties to the trade have ongoing reporting obligations for uncleared swaps.
This is not the full list of issues pertaining to SEF trading that we are looking at, and we will continue to consider adjustments to our rules are needed in other areas.
I want to turn now to some related issues concerning data which are equally important.
Data
Today, under our rules, swap transactions, whether cleared or uncleared, must be reported to swap data repositories. Regular reporting is the cornerstone of transparency. You can now go to public websites and see the price and volume for individual swap transactions. And the CFTC publishes the Weekly Swaps Report that gives the public a snapshot of the swaps market. The availability of accurate data also means we can do much more to evaluate systemic risk and make sure that the markets operate fairly.
Although we have come a long way since the global financial crisis, there remains a considerable amount of work still to do to collect and use derivatives market data effectively.
We continue to focus on data harmonization, including by helping to lead some very active international work in this area, such as in the development of unique product identifiers and unique swap identifiers and guidance on standardizing reporting fields. We are also looking at clarifications to our own rules to improve data collection and usage. In that regard, we are taking steps that will clarify reporting obligations and at the same time improve the quality and usability of the data in the SDRs. You may recall that last year we issued a concept release seeking the public’s views on a variety of issues related to swap data reporting. We received a great many helpful comments, including letters from many of the organizations represented in this room, and we very much appreciate those. One particular issue stood out as a top priority for clarification – the reporting workflow surrounding cleared swaps.
Let me elaborate a bit on the issue. For a cleared swap trade, the original trade is submitted to the clearinghouse, at which point it is novated and two resulting swaps are created, with the clearinghouse as central counterparty to both sides. Thus, the original swap can result in multiple records. Additionally, the first trade may be reported to a different SDR than the two resulting swaps, so those records can reside in two locations. For example, the original or “alpha” swap may appear to remain as an open bilateral swap in one SDR, while in fact, it is subject to the clearing requirement and has been terminated and novated into two swaps that are open in another SDR.
We intend to proceed with a rulemaking in the near future on this issue. I expect the proposal will include the following key elements:
First, the proposed new rules will ensure consistency and clarity of the reporting workflow for cleared swaps. They will provide that when the original swap is accepted for clearing, terminated, and novated into two swaps, the clearinghouse must report a notice of termination to the original SDR and the original SDR will be required to accept and record that termination in its records. The proposed rules will identify clearinghouses as reporting counterparties for resulting swaps, which our original rules had not explicitly contemplated, and clarify that the clearinghouse will select the SDR to which the resulting swaps are submitted.
I also expect the proposed rules will mandate new data fields that will allow users of the data to easily link the original swap and the original SDR to the resulting swaps and any subsequent SDR.
I believe the proposed rule should also provide that daily valuations of cleared swaps need only be supplied to the SDRs from the clearinghouse, eliminating a requirement for certain counterparties to the trade to supply their valuations as well. This requirement created noise in the data and detracted from its clarity and usability without providing any meaningful benefit.
In addition, I expect this proposed rule on cleared swap reporting to eliminate the requirement to report “Confirmation Data” for the original alpha swaps that are intended to be cleared and then terminated upon acceptance for clearing. Confirmation Data related to extinguished “alpha” swaps that are intended to be cleared is simply not useful enough to justify the burden of a reporting requirement. For any resulting swaps generated when the trade is accepted for clearing as well as other swaps intended to be cleared, however, Confirmation Data will continue to be required.
Conclusion
Let me conclude by simply noting the United States has the best derivatives markets in the world – the most dynamic, innovative, competitive and transparent. They have been an engine of our economic growth and prosperity because, day in and day out, they have served the needs of a wide array of market participants.
I know this group understands the importance of making sure our markets continue to operate effectively and efficiently. I look forward to working with all of you to make sure that these markets continue to work well for the many businesses that rely on them in the years ahead.
Thank you for inviting me.
Last Updated: April 22, 2015