July 23, 2018

CFTC’s Giancarlo and Tuckman Respond to Vatican Criticism of Derivatives

Washington, DC – Commodity Futures Trading Commission (CFTC) Chairman J. Christopher Giancarlo and Chief Economist Bruce Tuckman penned a letter in defense of derivatives in response to the Bollettino published by the Vatican’s Congregation for the Doctrine of the Faith and Dicastery for Promoting Integral Human Development on May 17, 2018, titled “Oeconomicae et Pecuniariae Quaestiones: Considerations for an Ethical Discernment Regarding Some Aspects of the Present Economic Financial System.” Giancarlo and Tuckman address derivatives broadly, as well as the specific criticism of credit default swaps (CDS) contained within the Vatican’s Bollettino.  

“We write to you as finance professionals striving to lead moral lives,” Giancarlo and Tuckman begin the letter. “We encourage market participants, particularly leaders in the business, academic, and government communities, to read and seriously consider the contents of the Bollettino.  It is an important and caring commentary on modern finance.  Yet, we also feel obligated to respond and defend derivatives and, in particular, credit default swaps, from various censures in the Bollettino. The Bollettino’s criticisms have received outsized attention in the popular press, despite the fact that the relevant section of the Bollettino is limited to a few paragraphs. Our response to these criticisms is made in the spirit of honest dialogue (so eloquently promoted and encouraged by Blessed Pope Paul VI) and we hope it will lead to greater discernment and understanding.”

The CFTC is the world’s only derivatives-specific regulatory agency. The CFTC has overseen the U.S. exchange-traded derivatives markets for over 40 years and has been recognized for its principles-based regulatory framework and econometrically-driven analysis, as well as its depth of derivatives expertise and breadth of regulatory oversight.

Giancarlo and Tuckman outline the social utility of derivatives, explaining that derivatives products serve the needs of society to help moderate price, supply and other commercial risks to free up capital for economic growth, job creation and prosperity. Derivatives allow the risks of variable production costs, such as the price of raw materials, energy, foreign currency and interest rates, to be transferred from those who cannot afford them to those who can.

The letter addresses the impact of derivatives on vulnerable populations, offering examples of how well-functioning financial and derivatives markets play a crucial role in feeding the world’s growing population, concluding, “[i]n many ways, the greatest beneficiaries of global derivatives activities may well be the world’s hungriest and most vulnerable. These are the people that Pope Francis has so powerfully advocated for by calling our attention to the “peripheries” of the world. They would certainly suffer the most from the extreme price volatility in basic food and energy commodities that would result if derivatives trading were to suddenly cease.”

Giancarlo and Tuckman classify the Bollettino’s censure of CDS markets as focused on three issues: information asymmetries, speculation, and profiting from the ruin of others. They address these criticisms as follows:

• Information Asymmetries: The economy at large benefits from high-quality information about the credit quality of corporations, and financial professions who collect raw data, analyze relevant factors, and make valuable conclusions in the hopes of earing superior financial returns also disseminate the information they generate to the broader market. This information contributes to a healthy financial system, which, in the words of the Bollettino, “requires the maximum amount of information possible, so that every agent can protect his or her interests in full, and with complete freedom.”

• Speculation: Speculation contributes to the societally beneficial generation of information and the dissemination of that information to the public at large. Additionally, whatever uses of CDS are considered appropriate and unobjectionable require a counterparty on the other side of the trade, and speculators fulfill this role.

• Profiting from the Ruin of Others: Governments, for example, actually benefit from the availability of CDS on their sovereign securities, as research has shown that the initiation of CDS trading on sovereign bonds lowers countries’ cost of debt and increases the information efficiency of their bond markets. Furthermore, it must be acknowledged that national governments do not always conduct their financial affairs in the best interests of their people or with the highest degree of fiscal competence or integrity, and the prices of government bonds, or of CDS on sovereign nations, are an important check on poor fiscal management.

Giancarlo and Tuckman conclude their letter by emphasizing their commitment as regulators to policing the derivatives markets “with the view, in the words of the Bollettino, of advancing liberty, truth, and justice.”

“We do not claim that the CDS market is free from both economic and ethical challenges,” Giancarlo and Tuckman write in closing. “We agree with the Bollettino in being skeptical of overly complex derivative products, like CDS tranches on mortgage-backed securities, which traded in great volume in the run-up to the 2007-2009 financial crisis. And we also agree that buyers of CDS protection, who stand to gain from defaults, must not be allowed to conspire to cause those same defaults or make them more likely. Such activity has recently drawn our regulatory scrutiny and censure.”