Keynote Address of Commissioner Dawn D. Stump at the ISDA Annual Legal Forum, New York, NY
The Law Is Our Authority and Common Sense Our Judge
June 11, 2019
Thank you, Katherine, for the kind introduction and to ISDA for the opportunity to be here today at the Annual Legal Forum.
In addressing this collection of global derivatives law experts, I thought it appropriate to heed the principle of “The Law is King” in Thomas Paine’s Common Sense pamphlet from 1776. Despite the different time and intent of these writings, the concept of the law’s supremacy must remain a critical factor to consider when regulating global derivatives markets today.
That being said, after spending almost a decade as a Congressional policy advisor tasked with drafting legislation, I always like to recall that according to James Madison, the purpose of legislation is to deal with general principles. Therefore, the law requires a fair bit of interpretation and policy development, and here common sense should be applied to generate the best possible outcomes while adhering to the rule of law.
Our markets are dynamic, and regulatory policies must be reviewed and updated as appropriate. I feel that the role of our current Commission is just that, reviewing initial implementation of regulations and adjusting course based on data and lessons learned. Before I continue with the importance of, and this is noteworthy, both law and common sense, let me start with the standard disclaimer that the views I express today are my own and may differ from those of the Commission I am honored to serve upon.
I want to start with an issue that is all too familiar for many of us and acknowledge that there has been much discussion about the status of the position limits rulemaking in recent months. Position limits certainly feels like a never-ending saga. I worked on it during my time on Capitol Hill – even before the Dodd-Frank Act – and now, a decade later, I have joined the agency and it is still unresolved. As this audience knows well, since the passage of the Dodd-Frank Act, position limits have been the subject of a final rule, a court decision vacating that final rule, a new proposal, a supplemental proposal, and a re-proposal. And, we are currently in the process of trying once again.
With respect to the derivatives reform provisions of Dodd-Frank, I have said that it is important to look back at the objective that a particular provision was designed to achieve, and that applies to position limits as well. Shortly before the financial crisis hit with full force in September 2008, America endured a period of skyrocketing food and energy prices that peaked during that summer, and it was that experience that influenced Congress to amend the Commodity Exchange Act’s (CEA’s) position limits regime as part of Dodd-Frank.
While the debate has raged on over how the Commission should implement these provisions, and how much discretion the agency has in doing so, I believe we are best suited to consider a new position limits regime during times of less turbulent market conditions than those we faced in the summer of 2008. Yet, uncertainty over whether, when, and what the Commission will do about position limits is a constant concern for market participants. And analyzing and commenting on complex and ever-shifting proposals diverts human and financial resources from other business purposes.
As you know, the federal court that vacated the prior final rule remanded the issue back to the Commission to “fill in the gaps and resolve the ambiguities” as to whether the law mandated the agency to impose position limits or required such limits only upon a finding of necessity and appropriateness. Our staff is working diligently to fulfill that direction from the court.
Beyond that issue, though, I believe there are some common-sense principles that should guide our position limits rulemaking, and on which all should be able to agree.
First, the factors in determining appropriate limits must be current. Just as we need up-to-date swaps data to inform our policy determinations on implementing the OTC derivatives reforms of Dodd-Frank, we also need current deliverable supply information to inform the methodology for updated position limits.
Second, the Exchanges must play an integral role in the administration of the position limits regime. The Exchanges know their markets, and they know the hedging practices of traders in their markets. We must rely on that knowledge and expertise in order to make the position limits regime work effectively.
Third, one size will not fit all. The Commission has a long history of administering position limits for futures on certain agricultural commodities, but not for futures in the energy or metals sectors. Not all futures markets are the same. We cannot impose position limits on energy and metals transactions solely on the basis of how the Commission has imposed limits in agricultural commodities over the years, and we cannot subject our legacy agricultural contracts to a position limits regime that is best suited to the hedging needs of the energy markets.
I must emphasize that the next iteration of the Commission’s position limits rulemaking currently remains at the staff level. I have not seen a draft. Nevertheless, I am optimistic that it will be premised on common-sense principles such as those I have mentioned.
Given the vastly disparate viewpoints on this subject, I have no expectation that everybody will be happy with the ultimate product. But I do believe that, by adhering to common-sense principles, we can adopt position limits rules that finally provide needed clarity and certainty, and that market participants will accept as reasonable to the task of implementing the law.
Swap Execution Facilities (SEFs)
The Commission published a notice of proposed rulemaking on SEFs in November of last year. I voted to issue the proposal in order to solicit public feedback, consider whether changes to the SEF rules were warranted (and, if yes, what and how), and then ultimately determine appropriate next steps. I find the notice-and-comment process to be an incredibly informative dialogue that affords regulation the greatest chance of success. The Commission gets to analyze whether it hit a home run or struck out.
To those who commented, thank you for the walk down memory lane, as I have not heard so many diametrically opposed viewpoints since my time considering the merits of establishing SEFs in legislation while working on Capitol Hill. The feedback received was mixed in that different folks liked and disliked various aspects of the proposal, but overall consensus concerning some of the more structural changes was not achieved. Now, the Commission must heed the lessons learned and comments received while adhering to the Rule of Construction in Section 5h(e) of the CEA which reads: “The goal of this section is to promote the trading of swaps on swap execution facilities and to promote pre-trade price transparency in the swaps market.” This is clearly a two-part test, and neither aspect can be prioritized at the expense of the other.
In promoting SEF trading we must remember that price transparency is best achieved when market participants are drawn to a trading venue because it provides the most liquidity, best service offering, efficient functionality, or some other added value. An entire set of cleared products should not be mandated to trade on-platform, in a one-size-fits-all approach, without considering the characteristics and market dynamics at play. Market participants and products should be drawn to a liquidity pool like moths to a flame rather than repentant children, kicking and screaming.
Developing a new regulated market structure from scratch is challenging and the process will evolve as the market matures, but it should not surprise anyone who was around for the conversations in 2008 and 2009 that there remain vastly different viewpoints as to the best method of execution. It is safe to say that the law did not contemplate only central-limit-order-book (CLOB) or request-for-quote to three (RFQ-3) market mechanisms, just as it did not mean to speak in absolute terms with any and all types of trading being deemed de facto compliant. There is more work to be done here, and we welcome the views you have shared on this particular topic.
In the spirit of promoting swap execution on SEFs, I believe a reasonable improvement would be to encourage new types of market participants to transact on-platform without major structural, organizational, or regulatory obstacles that impose substantial costs and barriers to entry.
While advancing a comprehensive SEF overhaul is a tall order, we have learned much through this process and perhaps we have identified some elements ripe for refinement. We have also recognized elements that are serving market participants well and must be preserved. While the next steps in this process are unclear, the existing SEF structure, which required considerable time and effort to create, has increased pre-trade price transparency, fostered competition, and allowed SEF trading volumes to display a positive growth trend. A common sense option at the Commission’s disposal could be to pursue a more limited rulemaking simply to codify the myriad of no-action and guidance letters that were required to operationalize this new market structure and to address a limited subset of the less divisive topics, such as financial resources and registration/examination of SEF professionals.
Non-US Central Counterparties (CCPs)
Just last week, Chairman Giancarlo discussed rule changes under consideration by the Commission concerning the treatment of non-US CCPs. I have long been a proponent of resetting the manner in which global regulatory authorities apply their reach in foreign jurisdictions.
To be clear, I believe the Commission can do more to show the appropriate level of deference to our regulatory colleagues overseas. Previous Commissions wrestled with first mover disadvantage and deemed it necessary to require registration of foreign CCPs utilized by US persons, maybe due to the fact that other jurisdictions had yet to enact post-crisis, G-20 reforms and the subsequent enhanced CCP resilience measures. However, many regulators have now implemented commensurate policies in the clearing space, thus aligning our regulatory principles, just as the G-20 envisioned at the Pittsburgh Summit in 2009.
In 2010, Congress recognized the global nature of these markets, and the G-20 commitments made in 2009, when it determined that consistency, rather than regulatory duplication, around the world is the best way to achieve a more secure system. For this reason, Dodd-Frank amended the CEA to provide: “The Commission may exempt, conditionally or unconditionally, a derivatives clearing organization from registration… for the clearing of swaps if the Commission determines that the derivatives clearing organization is subject to comparable, comprehensive supervision and regulation by….the appropriate government authorities in the home country of the organization. . .”
I believe that Congress recognized that a duplicative, confusing web of multiple regulatory agencies around the world asserting their overlapping regulation and supervision of global clearinghouses could serve to complicate, rather than improve, the system. Assuming we all remain committed to our shared goals from Pittsburgh, I believe we are best served by allowing a fair bit of deference to our global regulatory partners.
While the particulars of the non-US CCP rule amendments we are considering remain in flux, I wish to share my hopes for what these policy changes should accomplish. Market participants involved in swaps should be given a choice regarding how and where to conduct clearing business rather than having limited clearing services at their disposal. Sophisticated, institutional investors should be allowed a degree of flexibility in making a business-driven decision with an understanding of the risks involved based on information (including disclosures) regarding jurisdictional insolvency regimes, the role of intermediaries, registration status of entities in the clearing workflow, and protection of customer funds.
At the same time, CCPs should focus on managing risk rather than diverting resources to prepare for another set of exams, maintaining a duplicate set of books and records, and building reporting work flows to respond to different questions, different formats, and different timeframes, while still aiming to achieve the common policy outcome of a foreign jurisdiction and their home-country regulator. The likely result of such a system could be an exacerbation of risk and a threat to the stability of the CCP directly, and to the financial system overall.
I firmly believe that deference is the right answer for the Commission’s oversight of CCPs not located in the United States, just as I firmly believe that deference cannot be a one-way street. Other jurisdictions must share in the commitment. The alternative is counterproductive to the coordinated approach agreed to at the height of the financial crisis. If the Commission acts to right-size its cross-border footprint, then there is no excuse for other jurisdictions to disregard our efforts by moving in the opposite direction at the very time we are demonstrating greater respect for their regulatory oversight. The Commission would not portray commons sense principles if it applied less stringent regulations and oversight of third-country CCPs as a baseline whereas others refused to comport to deference.
We must refocus on the original mission, and the subject of this debate. Regulated CCP infrastructure was hailed as a means to alleviate problems presented by a previously undesirable web of interconnected bilateral OTC transactions. CCPs were not determined to be a contributing factor, but rather a potential solution, in responding to the financial crisis.
I have made my views on cross-border CCP matters known early and often in various ways during my time as Commissioner. I have always supported the legal powers that the U.S. Congress afforded the Commission to exempt certain CCPs when appropriate. I also want to ensure that the proposals represent the true meaning of deference and provide significant respect to fellow regulators that have rules and a supervisory system that are sufficiently robust. I struggle how to best achieve international harmony at this juncture with the publication of the ESMA consultation papers on EMIR 2.2 and the oversight of third-country CCPs on May 28th. I query whether exhibiting deference to other authorities will help or hinder the end result – should we hit the pause button, allow the European process to run its course, examine the approach finalized in Europe, and then decide what actions are appropriate? Or should we forge ahead by proposing a more deferential approach for public comment now, and then resurvey the entire landscape at a later date?
Cross-Border Swap Dealer
A cross-border swap dealer rule proposal has also been mentioned publicly as being on the near-term horizon for the Commission to consider. While I am still reviewing such and will therefore not speak to the specifics, generally I would like to note that the 2013 guidance was just that, guidance, whereas what the Commission might soon consider would be actual regulations. I have long believed that the guidance was designed to be temporary and that actual regulation is the more prudent course.
I also believe that CEA Section 2(i) limits the international reach of CFTC swaps regulations by affirmatively stating that they “shall not apply to activities outside the United States unless those activities – have a direct and significant connection with activities in, or effect on, commerce of the United States.” A common sense reading of this section, aptly titled “Applicability”, is that there is a limited reach of U.S. law and it does not stretch to infringe upon other rule sets unless the criteria are met.
The legal intent is to start with U.S. law not applying, and then continue to the limited conditions where extraterritoriality would be deemed appropriate. To the contrary, the law does not say that CFTC rules govern derivatives market activities around the world’s financial markets if there is any linkage or tie to the United States and should not be interpreted and abused as such. Rigorous analysis of the Section 2(i) test is warranted to ensure that the law is followed both to the letter and in spirit.
Swap Data Reporting
Swap data reporting is another area of interest where a good dose of common sense would benefit the situation. The Commission recently published a rule proposal outlining ideas on how to confirm the accuracy of swap data reported to swap data repositories (SDRs). In issuing the proposal, I also shared some thoughts for public consideration related to potential areas of improvement, and I hope that you all will respond accordingly when you supply comments.
In addition, I expect that subsequent proposals of other rules will provide market participants with a holistic view into what the Commission is thinking for the entire swap data reporting ecosystem. I hope this includes reasonable streamlining of obligations, such as a significant harmonization with both the SEC and international regulators, a considerable decrease in the number of required reportable data elements, extending the time delay for part 45 regulatory reporting to 24 hours, and a reduction in the regulatory burden placed on end-users.
The lack of global harmonization in swap data reporting is an ongoing and substantial burden. Distinct reporting rules across jurisdictions increase costs and promote inefficiency by forcing trade repositories and counterparties to build and maintain different reporting mechanisms. International bodies, such as the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO), have achieved considerable progress with the development of technical standards. International regulators should cooperate to implement these standards in a coordinated manner expeditiously.
Phase V Initial Margin for Uncleared Swaps
Finally, I want to address the looming implementation of phase V initial margin (IM) for uncleared swaps. While the deadline for this last phase is September 2020, a tremendous amount of time and resources must be committed in preparation, and time is fleeting. By some estimates, around 700 counterparties are likely in scope and would need to execute documentation for potentially 10 times that number of custodial arrangements. The implicated market participants together account for only 11% of the Average Aggregate Notional Amount (AANA) across all phases of implementation of the margin requirements. Also, by some estimates, almost three-quarters of these phase V firms will not even be required to exchange IM for a significant period of time following the compliance date, if at all, further making this an exercise in futility, at least in the near term.
At the very least, the U.S. financial regulatory community should provide guidance to market participants relieving them of an obligation to put in place documentation and systems that they may never use, and rather require such only when entities reach the required $50 million threshold at which they are actually obligated to exchange IM. This type of action would provide some clarity and allow for resources to be directed towards counterparties that are more likely to exchange IM.
Let me conclude by saying that I applaud the current Japanese presidency of the G-20 for proposing that the Financial Stability Board (FSB) examine signs of market fragmentation. I also commend IOSCO for establishing a Follow-Up Group to the 2015 Task Force on Cross Border Regulation to better understand regulatory driven market fragmentation, where it occurs, and why. I hope to explore these issues further via my sponsorship of the CFTC’s Global Markets Advisory Committee.
Luckily, the challenges we face in designing the new market structure for swaps are not quite as daunting as those faced by the colonials as they sought to set up a new independent nation during the time of Thomas Paine and James Madison. However, as all of these topics illustrate, common sense can help us address the unique and complex challenges presented by our derivatives markets. While the law is always supreme, I expect the Commission to be nimble and leverage common sense wherever possible to generate the best regulatory framework for the global derivatives markets.
 Thomas Paine, Common Sense 103 (Bradford’s ed., 3d ed. 1776).
 Opening Statement of Commissioner Dawn D. Stump before the CFTC Open Meeting, November 5, 2018, available at https://www.cftc.gov/PressRoom/SpeechesTestimony/stumpstatement110518.
 Int’l Swaps & Derivatives Ass’n v. CFTC, 887 F.Supp.2d 259, 282 (D.D.C. 2012).
 CEA Sections 4a(a)(1)-(2), 7 U.S.C. §§ 6a(a)(1)-(2).
 Swap Execution Facilities and Trade Execution Requirement, 83 Fed. Reg. 61946 (proposed Nov. 30, 2018).
 CEA Section 5h(e), 7 U.S.C. § 7b-3(e) (emphasis added).
 CEA Section 5b(h), 7 U.S.C. § 7a-1(h).
 CEA Section 2(i), 7 U.S.C. § 2(i).
 Certain Swap Data Repository and Data Reporting Requirements, 84 Fed. Reg. 21044 (proposed May 13, 2019); see also Statement of Concurrence of Commissioner Dawn D. Stump, id. at 21118.
 See Richard Haynes, Madison Lau, and Bruce Tuckman, Initial Margin Phase 5 (Oct. 24, 2018), available at https://www.cftc.gov/sites/default/files/About/Economic%20Analysis/Initial%20Margin%20Phase%205%20v5_ada.pdf.