Remarks by DSIO Director Joshua B. Sterling Before the Alternative Investment Management Association (AIMA)

October 30, 2019

Don’t Flip Your Wig: Contextualizing the Thematic Review Program for Registered Firms

Good morning.  I wish to thank AIMA for inviting me to participate in this important conversation, and for the hospitality extended by our hosts at Schulte Roth & Zabel today. 

For years, AIMA has successfully represented asset managers in their continued efforts to raise capital, invest client funds, and comply with different rule sets across the globe.  Since the asset management industry is ever more global each day, this mission is critical to the success of its members as they pursue value creation and value preservation for their own clients.

Chances are, your “alternative” investment firm trades derivatives subject to the CFTC’s jurisdiction.  And it’s even more likely – since you’re sitting here today – that your firm has registered with the CFTC as a commodity pool operator (CPO) and commodity trading advisor in order to take full advantage of the opportunities provided by trading in our strong and resilient derivatives markets.  In this vein, you may have heard that the Division of Swap Dealer and Intermediary Oversight (DSIO) will be undertaking on-site visits of select large CPOs and swap dealers, and that these visits will be thematic reviews as part of DSIO’s Examination Program.

We will spend some time today talking about these plans, and how they fit into broader efforts to recast DSIO’s world-class talent under our Five Building Blocks Program.[1]

Before I continue, please note that these remarks reflect solely my personal views and not necessarily those of the Commission or its staff.

Taking Action to Gather Facts, in Pursuit of Better Rules and Principles

Like many of you here, I am a child of the 1980s.  That was definitely a different world than the one in which we live today, no doubt rendered more fondly through the gauze of happy childhood memories.  There was so much to enjoy then – Transformers, Van Halen, E.T., and Cheers, to name a few.  And, my beloved Cleveland Browns even made it to three AFC title games.  On that last score alone, it seemed like anything was possible.

That decade also spawned one of my favorite quips about the role of government.  Perhaps you even know it – it’s the one about “the nine most terrifying words in the English language.”  As President Reagan then put it, those foreboding words were, “I’m from the government and I’m here to help.”[2] 

Always the steadfast advocate for smaller and more responsive government, the President was actually speaking of important practical steps that arguably departed from his philosophy – namely, measures to support America’s farmers in the face of adverse economic conditions.  So, while espousing a general skepticism of government intervention, President Reagan still saw the wisdom in targeted but powerful action to support a vital sector of the American economy.

His words resonate with me today, as I come before you to speak in more detail about my Division’s upcoming thematic reviews of CPOs and swap dealers.  To adapt old Dutch’s canny witticism to this purpose, I’m from the CFTC and I’m here to help. 

More to the point, my staffers are from the CFTC, too, and they will be visiting a handful of firms in order to learn more about a few key things.  Their work will be important to supporting the continued vibrancy, resiliency, and strength of our derivatives markets.  After all, your firms are vital to ensuring that our markets work for all participants.  So it’s just common sense for us to get our hands around a few key areas relevant to how your firms operate and interact with each other in our markets.  That’s particularly true now, as we start to think about how our CPO and swap dealer rule sets can be better suited to their purposes. 

It’s also an important thing to do, as we look to lessen our reliance on the no-action relief process:  If we are seeing fewer fact patterns coming in the door on an ad hoc basis, we’ll want to have a programmatic and transparent way of going to the market to gather the facts we need to run the Division’s programs and support the CFTC’s mission of promoting strong, resilient, and vibrant markets through sound regulation. 

Our Vision:  Improving Our Industry Sightlines, With a View Towards Principles-Based Regulation

For the first time in the CFTC’s nearly 45‑year history, we have a clear vision statement:  to be the global standard for sound derivatives regulation.  As the Chairman has indicated, to promote and achieve sound regulation, we need to use the right tools, at the right time, for the right reason.[3]

To understand when and how best to use those tools, we need to have a comprehensive understanding of the markets that we oversee, as well as the activity of our registrants in those markets.  Whenever we have the potential for blind spots in our oversight, there is a risk that we will fail to provide for sound regulation.

Here is the issue, simply stated:  DSIO has not itself conducted direct reviews of CPOs and swap dealers, yet we are the registrant oversight division of the federal regulator for the derivatives markets.  Through targeted thematic reviews, we hope to both mitigate the potential for blind spots in our oversight and enhance our engagement with registrants.  The reviews will support our efforts to take a principles-based approach to registrant oversight when possible. To articulate clear principles, after all, we first need to have a better handle on how CFTC rules affect our registrants.

Now, let’s dig in.

What Do We Want?  A Brief List

It’s been a few weeks since we announced the refashioning of our Examination Program to include thematic reviews of CPOs and swap dealers.[4]  That Program is part of our Five Building Blocks Program, which we are using to optimize the efforts of my Division’s world-class staff to advance the CFTC’s mission.  The Five Building Blocks have a simple purpose:  Working together, they will help the Division gather facts to inform better rules and guidance.

Since the time of our announcement, several questions have arisen about what we’re planning to do.  That’s fair enough.  Although we intend to be targeted in these reviews, it’s a big change in our overall posture.

So, let me provide some clarity about our plans.  I hope this exercise will help quell at least some of your concerns:

What is a thematic review?  It is simply a targeted look into specific areas of interest to my Division.   Each area of interest relates to potential rules and rule amendments that the Division is interested in evaluating.  Thematic reviews can be distinguished from other types of examinations in the following respects:

• First, they are targeted.  Our teams will focus on just a few issues that the Division may consider recommending to the Commission for potential action in the coming months.  They are not “all areas” reviews of firms, nor are they “event driven” sweeps at this point.
• Second, they are informational.  We are looking to gather information from individual firms, assess that information on an individual basis, and compare our assessments across firms to identify potential better ways of doing things.  While this process will involve assessing what we find, we will not be issuing deficiency letters.  We would expect to publish an examination manual that would give firms an understanding of our process before doing so.
• Third, they are educational. 
  • We intend to take what we’ve learned from our assessment and share our findings on potential areas of improvement in a general report of review.  That report will explain our scope, describe the general nature of the types of firms selected, and compare and contrast the different ways firms tackle the issues involved.  If we spot potential better ways of doing things, we’ll flag them for registrants.  In this way, the thematic reviews will have a leveraging effect.  That is, we will look at a few firms and use what we find to educate all firms. 
  • The “lessons learned” that we communicate will not be one size fits all.  We anticipate that any findings about good practices will be unlikely to fit every firm because firms have different businesses and structures.  Since the characteristics of the population we review probably won’t line up with the characteristics of every firm out there, firms will have flexibility to decide whether or how to implement our guidance as result.  To insist otherwise would not promote smart, effective, and practical regulation of our registrants.
• Finally, they are confidential, much like other types of reviews and examinations to which your firms have been subject.
   

Onto a few questions that we’ve heard through the grapevine:

Why are you conducting these reviews – what are your goals?  

• We have two principal goals for these reviews – to communicate better ways of doing things to the industry, and to gather information that can inform potential rule changes for CPOs and swap dealers.  We want our rules to be smart, effective, and practical, so gathering facts about how the rules work in the real world can only help us do a better job of achieving that goal.

What is the anticipated scope of these reviews, in terms of timing?  

• Our plan is to conduct each review within five business days onsite.  We expect to request some documents in advance, and to have some lead time to review those materials before we arrive.  We do not plan to have follow-up requests or follow-up visits as part of this process, as we expect good cooperation from the registrants involved.  Of course, if a particular firm does want to have further communications with us, we will be happy to continue the conversation.

How many firms will be selected? 

• We do not yet have precise figures, but you can expect that a limited number of CPOs and swap dealers will be reviewed.  We want to be smart about this initial phase of our reviews and focus our resources on doing the best possible job in a handful of cases, rather than spread our resources too wide.
• At the same time, we want to have a sample of CPOs and swap dealers sufficient to derive lessons learned that can provide a solid basis for communicating our views on market practices and for considering those practices as we evaluate potential future rule changes.

Is there any specific profile of firms you’ll be selecting? 

• We will attempt to select firms for the review process that are likely to have a significant impact on the derivatives markets.  Certainly, the size of the firm and the relative amount of its derivatives trading will be important considerations for us at this stage. 
• This approach makes intuitive sense to us, as we consider the fact that the CFTC is principally a market regulator.  We should consider the potential market impact of registrant-focused rules in assessing how firms operate and whether those rules should be revised in any way.

Will you be duplicating or replacing NFA examinations?  

• No.  The thematic reviews will have more focused and tailored scopes than the broader compliance examinations that NFA undertakes, which are important in their own right and vital to the successful oversight of all registrants.  The thematic reviews are looking at key issues across firms for the purpose of providing general guidance and informing potential future rulemakings.

Are you really just going out to look for matters to refer to the Division of Enforcement?

• No, we are not.  Nor will the Division of Enforcement participate in the review teams.  That said, DSIO communicates regularly with Enforcement, as do other policy-making Divisions, as part of the Commission’s ongoing work.
• In addition, under our Guidance Program, we are developing processes for registrant oversight that will enable us to retain the ability – within clearly established parameters – to determine that particular indications of non-compliance do not warrant referral to Enforcement based on the available facts and circumstances.  We expect to discuss those decisions with Enforcement periodically, so that we can confirm that our assessments are consistent with the separate roles of DSIO, as an overseer of registrants, and Enforcement, as the enforcer of the Commission’s requirements.
• Having said all this, my Division retains complete flexibility in setting course and changing tack as the circumstances of any specific review or multiple reviews dictate.

* * * * *

To sum up, our thematic reviews are intended to enhance our oversight abilities.  They will be targeted, educational, and informational, and our review process will respect your legitimate interests in confidentiality.  We will do what’s necessary to make sure that this initial wave of thematic reviews is successful and yields good outcomes, in terms of guidance to registrants and inputs for potential future rulemakings. 

Thank you for your time.  I really do hope this discussion sheds some light on our thinking and can help you begin to prepare for our upcoming thematic reviews.  My world-class staff and I look forward to working with you.

Thank you all again.