Remarks of DSIO Director Joshua B. Sterling Before the District of Columbia Bar Association

New Day Rising:  Focusing the Division of Swap Dealer and Intermediary Oversight to Embrace Today’s Challenges and Tomorrow’s Opportunities

September 25, 2019

Good afternoon.  I wish to thank the D.C. Bar for inviting me to participate in this important conversation, and for the hospitality extended by our hosts at Reed Smith today.  Bar associations serve a pivotal role in overseeing the practice of law in its many forms.  In that way, they are a fundamental part of civil society, helping to keep the United States of America a nation of free people treated equally under laws that are rooted in our founding principles.  We will spend some time today talking about the importance of principles and their role in carrying out another important task – the proper administration of law by the CFTC and its staff.

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It was in the closing days of the 1992 presidential campaign that the great American patriot, Admiral James Bond Stockdale, uttered his now famous lines,  “Who am I?  Why am I here?” on the debate stage.

Largely regarded as gaffe since, those questions merit a moment of reflection today.  Was the good Admiral just joking about a seeming lack of vice presidential timber?  Or was he driving at a more fundamental question about the nature of public service?  Suffice to say, the good Admiral’s opening words made quite an impression.  They have become all the more meaningful since the day that Chairman Tarbert appointed me Director of DSIO.

In this new role, I have to ask — who are we, and what are we doing here?  None of us who serve the United States of America do it to mark time.  Indeed, as the Chairman has said, the time for action is now.  So let us talk today, in plain terms, about what I hope to accomplish during my tenure.

But first, as if starting with the Stockdale quote didn’t make it clear enough, these remarks reflect solely my personal views and not those of the Commission or its staff.

Guiding Principles for My Tenure.

An institution is known by the values that sustain it and make it an enduring force for good in the world.  Those values are discernible in many ways, notably from the actions of an institution’s members that take their cue from those foundational ideas.

Let me paraphrase two of those values, which also adorn the halls of one of our country’s great universities:

• Laws without values are hollow.
• The Law is unknown to those that do not understand its reasons; and the certainty of the law is the safety of all.

These are among the best statements I’ve found that explain, in this role, who we are and what we will be doing here — vested as we are with a public trust, in furtherance of the public good.  What else would we do?  How else would we act?

My staff and I are guided by these values.  So you should expect that our actions will be purposeful (rather than hollow) and clear (rather than ambiguous) in furthering the principles that underlie the Commodity Exchange Act and the Commission’s regulations.  You should also expect that our actions will provide market participants certainty.  In this context, “certainty” means that the reasons for what we do will be clear, so that all similarly-situated market participants will be able to understand better our actions and to rely more firmly on our pronouncements.  I refer to you the recent Joint Statement by Director Hutchison and me concerning the treatment of separate accounts of the same beneficial owner as an example the purposeful and certain way in which we will act.[1]

Applying Our Principles to Today’s Challenges.      

In articulating our plan to move forward under these principles, we must pause and understand the current state of play.  In that spirit, let’s talk briefly about the law as it exists today, particularly Title VII of Dodd-Frank:

• What are its purposes?
• Have those purposes been carried out effectively in the rules and guidance that have followed from it?
• Have we given enough thought to how the tools that the law has provided to the Commission can be deployed with an eye toward the future?

Let’s take each of these in turn:

First: The Purposes.  The principal goals of Dodd-Frank in our space were as follows:

• Create transparency in the swaps markets through reporting, clearing, and on-facility trading.
• Subject significant market participants to registration, oversight, capital, and conduct requirements.
• Take more meaningful measures of swaps-related risks and exposures, again principally through reporting.

Second: The Effectiveness of Implementation.  It’s no great insight to say that the work of the CFTC to implement Dodd-Frank is nearly done, and that market participants have largely adapted their conduct to conform with the new requirements.  But we should not consider “done” as a synonym for “complete.”  Nor does the adaptation of conduct to rules, by itself, say anything about the efficacy of the rules being followed in that way.  After all, “hard but doable” is not the same thing as “effective and useful” in every case.  As with nearly all things, there are areas for improvement born from collective experience.  I will reserve on specifics for now, and simply ask that you let us know soon what you see as clear priorities for improvement that will benefit all market participants.

The same goes for other developments during the rollout of Dodd-Frank, notably the expansion of the Commission’s Part 4 regime in 2012 to a much broader host of fund sponsors, asset managers, and investment advisors.  Sure, we know them as CPOs and CTAs, but those terms encapsulate a large swath of money management and advisory shops that have been substantially regulated for decades by the SEC and other agencies worldwide.  There’s a reform proposal outstanding, but I think we need to take a deeper look at what Part 4 means to achieve and how we can get to a better result that yields more effective outcomes.

In considering potential reforms, the theme of “harmonization” often arises.  I think harmonization is a fine thing, if two conditions are met – first, the thing with which you are harmonizing is better than what you’ve got right now; and second, you’re sure that you can’t do any better than pull up even.  I suspect there is much we can do to simplify our rules and promote good outcomes that will not depend exclusively on harmonization.

Take, for example, our CPO reports on Form CPO-PQR.  We could scrap the whole thing and try to rely on Form PF instead, which the SEC administers.  Or maybe we try to make those forms look about the same, share defined terms, and so forth.  Instead, I’d rather look at whether we can have an approach to CPO oversight that uses market data and yields better outcomes than does either form.  In that spirit, the Division is considering whether to provide targeted relief from certain Form CPO-PQR reporting requirements while we assess potential alternative approaches for their merits.

Third: Training an Eye Toward the Future.  We all know where the law stands today, and we remain mindful still of the events that precipitated it.  Accepting that the law must not merely support a better audit trail if the last crisis replicates itself, our task must be to consider how the tools at our disposal can be refined and used to understand better where risks lie and how they may be transmitted, amplified, converted, hedged, priced, tested, and monitored.

We must review, examine, and inspect the current ecosystem.  Let’s consider what we have learned and, after due reflection, make concrete plans that we can reasonably expect to enhance our oversight of such a dynamic group of market participants.  These steps are necessary because of the deep connections between derivatives markets and the broader economy.  They are also essential to maintaining the remarkable comparative advantage that our strong financial system affords the United States.

In this spirt, we will be taking a very focused look at selected key issues from a programmatic perspective.  This programmatic approach will give greater shape and dimension to how DSIO operates.  It is intended to persist beyond our approach to any one issue and the tenure of any one Director.  We mean to enhance the Division’s ability to perpetuate its core values, leaving it an even better place than we found it.

The Next Step for DSIO: Our Five Building Blocks Program.

We’ve dubbed our programmatic approach the Five Building Blocks.  Each building block reflects a core piece of a complete regulatory program that will further our values at the Agency – notably, to strengthen the resilience and integrity of our markets, to enhance the regulatory experience for market participants, and to be tough on those who break our rules.  They embody the core concept that a regulator should gather facts and assess them, in order to provide guidance, to ensure that the laws are being followed, and to revise rules or adopt new ones based on an informed understanding of the relevant issues.

The Five Building Blocks are as follows:

The Examination Program.  Working closely with NFA, we are designing a program of targeted thematic reviews of select large swap dealers and CPOs that will commence in the first quarter of 2020.  These reviews will be carried out directly by Division staff.

Like FCMs, swap dealers and CPOs hold or transact in counterparty, customer, and client funds.  This makes them important actors in our markets.  They provide liquidity and, in doing so, transmit, amplify, convert, hedge, price, test, and monitor certain key risks.  As such, we need to take a thematic approach to understanding better how the big shops approach key compliance issues like risk management and risk reporting.  Our thematic reviews will focus only on selected key issues and will not duplicate or replace NFA’s ongoing efforts.  We anticipate reporting out to the market our general observations later next year, after our first round of reviews is complete.

Think of this as “step one” in our improving effort to take facts and produce better results.

The Reporting Framework.  We are actively assessing whether existing data inputs to the Agency can help DSIO do its part to ensure that we have a more holistic and dynamic view of our registrants’ market exposures, counterparty relationships, and risks.  We are assessing the relative value of historical data versus daily data feeds.  It is a fair question whether current data, if accurate, complete and sourced from fewer locations will better serve our oversight function than does more static, aged data that comes from several sources, likely based on different assumptions.  I am mindful of Commissioner Stump’s ongoing efforts to review these matters, which I fully support.

Think of this as “step two” in the Division using facts to produce better results.

The Guidance Program.  As we strengthen our efforts to gather facts through registrant reviews and better data analysis, we will be better able to convey our expectations about compliance requirements and emerging issues to market participants.  We will be formalizing our communications program for registrants, to provide more general guidance on a more frequent basis than in the past.

In turn, we expect to reduce our use of letter relief for specific parties.  As a matter of good government and regulatory economy, we will instead focus across registrant categories to provide guidance applicable to all, rather than taking on issues one by one for individual firms.  This will enable the Division to do a better job of interpreting the law in a way that applies to everyone, which will likely require the private bar to assume a greater role in solving client problems.  Given today’s audience, I expect that you get my drift.

Think of this as “step three” in our improving effort to take facts and produce better results.

The Relationship to Enforcement.  We are strengthening our relationship with the Division of Enforcement with a more focused approach to referrals, so that our coordination efforts become more programmatic.  If our reviews of the facts indicate a strong possibility of non-compliance by a registrant, we will make a clear presentation to our colleagues in the Division of Enforcement about why they should consider the matter.  In doing so, we will assess not only the issue in isolation but its potential impact on our efforts to strengthen industry ‑ wide compliance through our other programs.

We will also want to ensure that registrants continue to report all the material facts to the Commission as required by law.  Where the Division of Enforcement finds fault on this front, we will make sure any lessons learned about underlying failures and root causes are communicated broadly, by way of general guidance, to all registrants.

To be clear, referrals are not a new thing – mine is an “oversight” Division.  I only mean that we are going to be more focused and programmatic in what we do if we see potential red flags in the ordinary course of our reviews.  After all, Enforcement should reinforce our oversight function by holding registrants accountable, and we should support Enforcement by flagging potential problems that we encounter.  I am very pleased that Director McDonald and I will be collaborating closely to ensure that there is greater ongoing coordination between our Divisions.

Think of this as “step four” in the Division using facts to produce better results.

The Rulemaking Function.  Last, we get to “step five” of how we will use facts to produce better results.  We intend to use the outputs of our Examination Program, Reporting Program, Enforcement Referral Program, and Guidance Program to improve our rules.  That is, what we accomplish in our other high-functioning programs will tell us whether rule amendments should be proposed – whether because an existing rule isn’t working as intended, because a rule hasn’t kept up with the times, or for other practical reasons.

Of course, we must write rules when the law tells us to do so.  So we are also improving our rulemaking process to ensure that we take a linear path to get to the end result.  That will require earlier engagement with the public, which we fully invite.

If we work together in this endeavor, we will be judged to have done some good, at the end of it all.  If not, then we will have only marked time and will be found – perhaps someday soon – to have left too much undone, when we had so much at our disposal, at this point in history.

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Thank you for your time.  You now join the great company of my wife in having the courtesy to suffer politely through these remarks.

In closing, I invite you to come talk to us.  Tell us what you see and what you think — from the merely prosaic to what keeps you up at night.  Every data point and anecdote you offer will help.  Leave nothing out.  And, please, invite us to come speak with you.  We need to be out in the world if we are to have any chance to do our best work.

My world-class staff and I look forward to working with you.

Thank you all again.