Keynote Remarks of Chairman Timothy Massad before the Institute of International Bankers Annual Washington Conference
March 7, 2016
Thank you, Roger, for that kind introduction. And congratulations on this, the IIB’s 50th anniversary. The IIB has been an active participant in many of our issues for some time. We always appreciate your input, and I look forward to continuing to work together in the future.
When I spoke here last year, I discussed several of the CFTC’s priorities for the year ahead. It included cross-border harmonization, clearinghouse resiliency, margin for uncleared swaps, and cybersecurity.
In all of these areas, there has been a great amount of progress. One of the most significant achievements took place just last month, when European Commissioner Jonathan Hill and I announced that we have reached an agreement that resolves the “equivalence” issue with respect to clearinghouse recognition.
Today I’d like to take a little time to explain that agreement, and discuss the progress we’ve made in the other areas I discussed with you last year—as well as some priorities for the months ahead. Then I’d be pleased to take your questions.
Common Approach for Transatlantic CCPs
First, let me say a few words about the agreement with Commissioner Hill. It sets forth a common approach regarding requirements for central clearing counterparties, or CCPs. And it resolves the issues that were standing in the way of Europe “recognizing” U.S. CCPs.
Our accord means that European market participants will be able to continue clearing derivatives on U.S. CCPs without incurring higher capital charges. That will allow CCPs and firms in the U.S. to remain competitive, and the global derivatives market to continue to efficiently serve the many businesses that use it to hedge commercial risk.
Most important, our agreement helps ensure that CCPs on both sides of the Atlantic are held to high standards. That contributes to a global derivatives market that functions safely and efficiently. And that promotes global financial stability.
This agreement involves actions by each side, which is the nature of a good compromise. It followed extensive analyses to understand whether differences in our regulatory regimes were significant. This process revealed some areas where the CFTC’s requirements could be considered more stringent and some where the same could be said for EMIR requirements. And our agreed upon approach involves each of us making some modest changes, which are aimed at bringing our regimes closer together and reducing the risk of regulatory arbitrage.
From the beginning, I wanted to avoid imposing undue burdens on the commercial end-users who rely on the derivatives markets to hedge routine risk—and who were not a cause of the financial crisis.
So what did we agree to?
First, clearinghouses located in the U.S. that want recognition will have to show that their rules require the collection of house margins for futures in an amount that is sufficient to take into account a two-day liquidation period, which is the European standard. Meanwhile, Europe is considering changing its rules to permit European CCPs to use a one-day liquidation period for futures, provided that customer margin is collected on a gross basis, which is the U.S. practice. If the EU does so, we expect that the European Commission and ESMA will also address a significant difference in the treatment of affiliates of clearing members. Currently, Europe allows them to be treated like customers, whereas we prohibit them from being treated like – or being commingled with – customers. If Europe permits one-day gross for the customer account, this would not apply to house affiliates. This would minimize the risk of regulatory arbitrage and enhance protection of customers.
In addition, U.S. CCPs that want recognition will need to show their rules and procedures are designed to limit procyclicality, whether that is using the measures called for by EMIR or other equivalent measures, and that they meet a “cover two” standard. We believe most CCPs that will seek recognition already meet these standards.
Finally, the CFTC will soon consider a “substituted compliance” determination that will permit European CCPs to comply with many of our rules by adhering to the corresponding EMIR requirements. We would also streamline the process for registration. This will further harmonize our regimes.
I expect that we will act on this substituted compliance determination soon. We and our CCPs are already working with ESMA to submit any additional information that is required to complete their applications. So I think there should be no problem completing the recognition process for any CCP that clears swaps in advance of June 21, when the European clearing mandate begins.
In short, this agreement helps promote cross-border harmonization of derivatives regulation. It provides a foundation for cooperation among regulators in the oversight of the global clearinghouses that are so important in our financial system today. And it helps make sure that the U.S. and European derivatives markets can continue to be dynamic, with robust competition and liquidity across borders.
Margin for Uncleared Swaps
The equivalence deal compliments another important achievement: the Commission’s approval of a final rule setting margin requirements for uncleared swaps.
Last year when I was here, I noted the fact that the margin rule is one of the most important 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 help ensure that those uncleared trades do not generate excessive risk to the system. I also underscored my commitment to harmonizing our proposed rule as much as possible with international standards, as well as with the rules that were concurrently being considered by our bank regulators.
We have now adopted a strong and sensible rule, and we have harmonized it with international standards and the rules of our bank regulators. We’ve focused it on where the primary risk is – the uncleared swaps between large financial institutions, because we want to minimize the chance that one default leads to further defaults, given the interconnectedness of our financial system. The rule requires swap dealers and major swap participants to post and collect margin with financial entities with whom they have significant exposures. It requires initial margin, which is designed to protect against potential future loss on a default, as well as variation margin, which serves as mark-to-market protection.
On the issue of harmonization, last year there were many differences pertaining to threshold amounts, scope of coverage, acceptable forms of collateral and other matters. We worked very hard to harmonize the rules, and we while there are still some differences, have succeeded overall.
Soon, the Commission will take up the last remaining element of our margin rule – which is its cross-border application. I will return to this subject when I discuss our future priorities.
Clearinghouse Resiliency
Last year I also discussed the importance of addressing clearinghouse resiliency. We have made clearinghouses even more important in the global financial system, so we must make sure they are strong and resilient. While the equivalence agreement is one part of our work in this area, there has been a lot of other activity, both domestic and international, that I want to share with you.
Domestic Efforts. Here in the U.S., we at the CFTC have been involved in the oversight of clearinghouses for many years. And since the crisis, we have done a major overhaul of that oversight. We have substantially strengthened our requirements regarding risk management and transparency. We did an extensive revision of our rules after the passage of Dodd-Frank, and incorporated international standards into our regulations. We also strengthened customer protection measures. And we have expanded and enhanced our examination, compliance, and risk surveillance programs.
With the adoption of the new margin rules, we are now expanding our risk surveillance efforts so that we can look at activity and risk for major institutions in both cleared and uncleared products.
We are also actively working with other domestic and international regulators on recovery, resolution and crisis management planning. These efforts include looking at stress testing and the adequacy of resources and procedures applicable in the event of a major problem. We are working with the major clearinghouses to review their recovery plans and rule changes, and are engaged in discussions with them and other market participants on how significant problems would be handled. That includes exploring auction procedures to increase efficiency and participation; considering under what circumstances, and to what extent, gains-based haircutting is an appropriate tool to allocate losses; examining the tools available to a clearinghouse, such as partial tear-ups, in order to re-establish a matched book; and discussing the governance mechanisms over the use of recovery tools—and the transparency regarding the potential use of those tools.
We are engaging with market participants in this process. As an example, last March the CFTC held a public roundtable to discuss issues related to recovery and the orderly wind-down of clearinghouses. The forum provided a good opportunity to gather views from a variety of stakeholders including clearinghouses, clearing members, their customers and others.
Let me just add that while we must engage in recovery and resolution planning, our goal is never to get to a situation where either of those is necessary. And that is why risk management is so important. Sometimes in the current discussions about clearinghouse resiliency, the activities that comprise ongoing risk management don’t get much attention. But those activities—the daily margining practices, the stress and back testing, the oversight and ongoing risk surveillance—are critically important. Those activities—carried out by the clearinghouses and the clearing members as well as ourselves as market regulators – are essential. No recovery plan—and no set of rules that kick in when there is a problem—can take the place of these everyday activities.
International Efforts. On the international front, the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) are looking at a number of issues pertaining to clearinghouse strength and stability. This group has made significant progress in recent months.
This work by CPMI-IOSCO is undertaken by two subcommittees, the Implementation Monitoring Standing Group (IMSG) and the Policy Standing Group (PSG), under the close supervision of the Steering Group.
The IMSG has been monitoring and assessing the implementation of the Principles for Financial Market Infrastructures, or PFMIs. It has looked at the progress of jurisdictions in adopting policies to implement the PFMIs, and determining how complete and consistent those policies are. Now it is conducting an assessment at ten representative CCPs to determine the adequacy of the outcomes of those policies. It will produce a report by mid-2016 that will discuss these outcomes generally, not by specific CCP. For example, the IMSG has been reviewing the surveyed CCPs’ implementation of liquidity risk frameworks and recovery plans, in accordance with the PFMIs and other CPMI-IOSCO guidance.
The PSG, which is co-chaired by the CFTC, is examining whether further granularity or guidance is needed with respect to the PFMIs on a wide range of issues. This includes margin methodologies and the resources available to a clearinghouse in the event of a default, including “skin in the game” and the adequacy of “cover-one” versus “cover-two” standards. It includes looking at standards for stress tests, which are the critical element in measuring required levels of resources. The PSG is also looking at guidance with respect to the liquidity of CCPs; the size and adequacy of the CCP’s financial resources; and CCP governance. Its work has benefitted from responses to two extensive surveys submitted by more than 30 CCPs.
The PSG is also on track to issue a report on these issues by mid-2016.
The CFTC is also involved in additional efforts led by the Financial Stability Board to examine resolution planning for clearinghouses, including international coordination. Another group that also includes the CFTC is examining the interdependencies among global clearinghouses and major clearing members. We also participate in the Cross-Border Crisis Management Group for financial market infrastructures, which provides a forum for regulators to discuss these issues.
Finally, clearinghouse resiliency also depends on having a robust clearing member industry.
The importance of that is obvious when we think about what happens if there is a default by a clearing member. For example, when firms like Lehman Brothers and MF Global collapsed, clearinghouses were able to transfer customers’ positions to other FCMs quickly, and to liquidate house positions promptly. If you cannot transfer customer positions, you must liquidate them, which can put more pressure on asset prices. So portability of customer positions in a default is critical, and this depends on the willingness of clearing members to take on additional customers and positions quickly during a time of stress. We must also continue to have the ability to run prompt and successful auctions of house positions, and, if necessary, of customer positions that can’t be transferred. It’s also important that we have a robust industry so that access to clearing is not restricted.
There are many factors that affect the health of the clearing member industry. Time does not permit me to discuss this subject in any detail. But this is an issue that is very much on our minds at the CFTC and we are happy to continue to engage with market participants on this.
Cybersecurity
Let me turn now to cybersecurity—which of course is vital not only to clearinghouse safety, but to the safety of financial market infrastructure generally. Last year when I was here, I discussed our intention to look at what we could do to enhance protections against cyberattacks. Our resources are limited—most major financial institutions spend far more on cybersecurity than the CFTC’s entire budget. But late last year, the Commission unanimously proposed new rules that would enhance cybersecurity protections by making sure the private firms that run the critical infrastructure in our markets – the exchanges, swap execution facilities, clearinghouses and swap data repositories—follow best practices when it comes to testing their cybersecurity defenses and other protections against similar technological risks. Our proposed rules are principles-based; we would require firms to follow best practices when it comes to specific types of testing that are essential to having good protections—such as controls testing, penetration testing and vulnerability testing. But we would leave the details and administration of those tests to those firms. We hope to finalize these rules later this year.
Current Priorities
Let me also outline some of our other current priorities.
Late last year, the Commission unanimously proposed a new rule on automated trading, which has dramatically expanded in recent years. Our proposal seeks to minimize the risk that automated trading will result in disruptions in the markets by requiring adequate risk controls, monitoring and other measures. Once again, it is principles based and it builds upon industry best practices – as well as the work that we and the exchanges have already done in this area. We would require certain types of controls but again, we would leave the details of those controls to the private firms. We hope to finalize these rules later this year also.
Soon, we will take up our proposal on the cross-border application of the recently adopted margin rule. Our proposal is designed to address the possibility that risk created offshore can flow back into the U.S. And it would therefore apply our margin rule to a swap dealer that is a foreign subsidiary of a U.S. parent, if that entity is consolidated with the U.S. parent, regardless of whether the transactions are guaranteed by the parent. But at the same time, non-U.S. swap dealers registered with us, whose obligations are not guaranteed by a U.S. person, could avail themselves of full substituted compliance – unless the counterparty was a U.S. swap dealer or a swap dealer guaranteed by a U.S. person.
I believe this approach is sensible, and it is consistent with that taken by our prudential regulators. And following this effort, I will ask the Commission to consider reproposing our rule on capital for swap dealers. This is a very important complement to the margin rule.
We are also focused on issues concerning trading on swap execution facilities (SEFs). Recently, we announced the permanent registrations of 18 SEFs.
This spring, I will ask the Commission to consider a number of rule changes to enhance SEF trading and participation. It is my desire to formalize through notice-and-comment rulemaking a number of the “no-action” positions the staff has taken, such as simplifying the confirmation process, streamlining the process for correcting error trades, and others. We will also consider some additional issues, such as whether the Commission should play a greater role in the “made available to trade” determination process, and the standards for it.
And now that ESMA has published the MiFiD II technical standards, we are working with our European counterparts to look at differences in our respective rules – in order to make progress toward harmonization.
We’re also working to finalize important rules related to position limits. There are many complex aspects to these rules, such as standards for bona fide hedging, the standards and process for hedging exemptions, and deliverable supply estimates. We understand the significance of these rules to the ability of commercial end-users to continue to use the markets efficiently for risk management and price discovery. So we are taking time to listen to end-users and other market participants and consider the proposals very carefully.
Finally, we are taking many steps to improve swaps data reporting, to ensure that the data we receive is accurate, consistent and useful. We’ve come a long way in just a few short years on this front in terms of actually having meaningful data on this market. The recent preliminary report on the de minimis threshold for determining who must register as a swap dealer is a good example of that. The transaction information that is available to market participants—which helps ensure good pricing and competition—is another example. And we are working hard to bring further standardization and harmonization to data reporting, and to simplify reporting obligations.
Conclusion
There is even more going on at the Commission. But in the interest of taking a few of your questions, let me conclude here.
The importance of these markets to businesses, and to the prices that people pay for a wide range of goods and services is not always discussed, but cannot be overstated. I know you all appreciate how vital these markets are--and the need for good regulation and oversight to keep them that way.
Again, thank you so much for inviting me here today.
Last Updated: March 7, 2016