Remarks of CFTC Commissioner Rostin Behnam at the ISDA 34th Annual General Meeting, Grand Hyatt Hong Kong, Hong Kong 

Sowing the Seeds of Success in 2020

April 9, 2019

[Delivered in Hong Kong April 10, 2019] 

Introduction

Thank you for the kind introduction; it is a great pleasure to be here.  I want to thank Eric Litvack, Scott O’Malia, and the International Swaps and Derivatives Association (“ISDA”) for inviting me to join you today.  Before I begin, please allow me to remind you that the views I express today in these remarks and discussion to follow are my own and do not represent the views of the Commodity Futures Trading Commission (the “CFTC” or “Commission”) or my fellow Commissioners. 

I last had the pleasure of addressing ISDA members in late October or autumn of last year during the 2018 ISDA Annual Japan Conference.^[1]  Six months later, it is now spring.  Like many cities across the globe, spring is a time of renewal and beauty in Washington, D.C.  Part of Washington’s splendor this time of year is due to the gift of 3,020 Japanese cherry trees to the American people over 100 years ago from the Mayor of Tokyo, Yukio Ozaki.  Mr. Ozaki offered the gift as a gesture to recognize the growing relationship between the Japanese and American people. 

More personally, the blooming of the cherry trees represents an exciting time for me.  To coincide with the cherry blossom bloom, the first Sunday of April always marks the annual Cherry Blossom Ten Mile Run.  The race course weaves through the city’s captivating monuments, including the Tidal Basin where Thomas Jefferson sits among a cloud of blossoms.  I have run that course every year that I’ve called Washington, D.C. my home.

Before coming to Hong Kong, I spent a few days in Tokyo, spending time at the Japanese Financial Services Agency (“JFSA”), and visiting market participants including Tokyo-based ISDA members.  Unfortunately, arriving in Tokyo Saturday evening meant that I missed the Cherry Blossom Ten Miler for the first time in eight years.  However, I had my own cherry blossom run this year – in Tokyo.  As I ran around Tokyo Sunday and Monday morning, the beautiful blossoms gave me a sense of familiarity and comfort.

Seeing cherry blossoms blooming in Japan for the first time, I recognized subtle and not so subtle differences in the trees, specifically their size and shape as compared to the ones I have grown familiar with in Washington.  The cherry trees in Washington are situated close together around a discreet part of the city.  As a result, many of the trees, over the course of their lives, have developed a distinct shape and size.  In contrast, I noticed that many of the cherry trees in Tokyo, despite having the same beautiful blossoms and familiar smell, are far larger, having a much wider canopy, spreading broadly like a bird’s wings.

It occurred to me as I ran in Tokyo that these similarities and differences recall Mayor Ozaki’s original gesture, and personify, in many ways, the current relationship among U.S. and Asian financial regulators.  As we all have taken different approaches in implementing the G20 reforms since the financial crisis, cherry blossoms are a good reminder that despite our differences, the foundations and driving principles are the same.  Regional differences, shaped by culture, climate, and history should not cloud the core similarities we all share and have invested in.  It’s these commonalities that are driving a fresh look at cross-border harmonization that will, in my mind, lead to safer, stronger, and more transparent markets across the globe.

In October, I talked about the collective strength within the CFTC, brought by the expertise and diversity among its five member-commissioners, and the collective strength in the global collaborative efforts among regulators and market participants in addressing challenges such as benchmark reform, initial margin phase-in, cross-border regulation, Brexit, and emerging financial technologies.  In considering those issues, I acknowledged that an uncomfortable level of uncertainty cannot deter us from taking action.  As American aviation pioneer Amelia Earhart once said, “The most difficult thing is the decision to act, the rest is merely tenacity.”

As we enter the second quarter of 2019, I’m pleased to say that our various jurisdictions chose to act.  We have persisted towards resolving LIBOR and the “big bang” that will be the final phases of the uncleared margin rules.  In the U.S., the Commission and the prudential regulators are actively addressing the possibility of a “no-deal Brexit” by putting measures in place to provide certainty and working with our international counterparts to preserve the stability of trade execution and clearing relationships.^[2]  We’ve continued to re-evaluate the reforms put in place in the wake of the financial crisis and to consider whether they remain fit for purpose in addressing new and emerging risks.  To that end, conversations continue to evolve and build consensus around cross-border regulation of swap dealing activities.  The Commission also has continued the important work of considering the effectiveness of our rules governing swap execution facilities (“SEFs”), issuing both a rule proposal on SEF regulation generally and a request for comment regarding the practice of “Post-Trade Name Give Up.”^[3]

As I have said before, regulators should avoid becoming overconfident in the systems we’ve built and remain nimble in our reconsideration of past policies and practices and vigilant as we prepare for the challenges to come.  I believe we are on the right course as we prepare for 2020 and beyond.

A new Chairman will lead the Commission into 2020.  The current expectation is that Chairman Giancarlo will depart before completion of the SEF overhaul and before putting a complete slate of cross-border rule proposals before the Commission to initiate the formal rulemaking process.  I expect that his successor, Dr. Heath Tarbert, who currently serves as Assistant Secretary for International Markets at the U.S. Department of Treasury, will be equally bold in his approach to finalizing and fine-tuning our regulatory landscape as it applies domestically and abroad.    

During Dr. Tarbert’s March 13^th nomination hearing before the United States Senate Committee on Agriculture, Nutrition, & Forestry, in addressing questions about completing the financial reform efforts, Dr. Tarbert stressed the importance of ensuring that “the seeds of the next crisis are not sown in response to the last one.”^[4]  For example, he noted that as we push more derivatives to centralized clearing, we need to make sure that those clearing houses are safe and sound and have the risk management practices that they need.  I wholeheartedly agree and am equally committed to ensuring that we don’t weaken our rules to undermine safeguards put in place by our predecessor commissioners. 

Turning back to where we are today, I’d like to deliver some brief remarks before sitting down with Mr. O’Malia for a less formal discussion.  I think it’s best to provide some updates on how the Commission has been addressing our greatest challenges of the moment—LIBOR, margin, approaches to cross-border regulation, and SEF reform—and where we may be heading towards 2020.

The State of LIBOR Transition

No issue embodies the need to embrace change like the transition from the London Interbank Offered Rate (“LIBOR”) and other “IBORs” to alternative risk-free rates (“RFRs”).  With no guarantee of LIBOR’s continuation beyond 2021 as a representative benchmark, developing alternatives that are fit for purpose has launched our industry into uncharted territory.  Since the LIBOR manipulation scandals first came to light amidst the financial crisis, there has been a slow building hum of activity in pockets around the globe as regulators, international bodies, and market participants identify alternative RFRs and develop transition plans.  We’ve chosen to act; but we need to be tenacious in approach because what we’ve learned over this last decade is that the pervasiveness of LIBOR gave us a false sense of stability.  We did not anticipate that the underlying market for LIBOR submissions would dissipate or that structural vulnerabilities would inspire widespread misconduct.  Our collective overconfidence in the system we built led us to this point in transition.  We must now address how most fallback language in underlying contracts simply either does not anticipate or does not adequately address a situation where LIBOR will be permanently unavailable.^[5]  Fortunately, ISDA, at the request of the Financial Stability Board’s Official Sector Steering Group, is leading the effort and updating the definitions of USD LIBOR and other IBORs used in derivative contracts to include new fallbacks and is planning to publish a protocol to allow market participants to include fallbacks within legacy contracts to address benchmark cessations.^[6]

In the United States, a group comprised of market participants called the Alternative Reference Rates Committee or “ARRC” convened to (1) identify an alternative RFR for use primarily in derivatives contracts; (2) prepare a plan to facilitate the acceptance and use of the selected alternative RFR on a voluntary basis; and (3) consider best practices for contract design to ensure that contracts are resilient to a possible cessation or material alteration of existing or new benchmarks.^[7]  In 2017, the ARRC identified the Secured Overnight Financing Rate or SOFR as its recommended alternative to USD LIBOR.  SOFR Futures began trading at the Chicago Mercantile Exchange (“CME”) and ICE Futures Europe, in May 2018 and October 2018, respectively.  In the ten months since launch at CME, SOFR Futures have traded the equivalent of nearly $4 trillion in notional value with cumulative volume exceeding 2 million contracts.^[8]  LCH and CME began clearing SOFR-based over-the-counter (“OTC”) overnight index and basis swaps in July 2018 and October 2018, respectively.^[9]  Just last month, trading in SOFR-linked swaps surged with about $13.6 billion changing hands, a number that is almost twice its previous high from January 2019.^[10]

As SOFR gains significant liquidity, the ARRC is promoting the use of SOFR on a voluntary basis and recommending more robust fallback language in new contracts referencing LIBOR.^[11]  As I explained back in October, neither the Federal Reserve nor U.S. regulators will mandate an alternative RFR for use in new contracts or in fallback language.  Authorities do stand ready to facilitate these efforts by helping to avoid market dislocations, but our policies, mandates, and missions do not always support requiring compulsory industry standard setting or change through regulation.  However, we can best minimize basis risk, ease hedging, and avoid market fragmentation if we take a common approach.^[12]  

For my part, as the sponsor of the CFTC’s Market Risk Advisory Committee (“MRAC”), I convened the full Committee last July to focus on benchmark reform.^[13]  Following the meeting, the Commission established the Interest Rate Benchmark Reform Subcommittee (“Subcommittee”) to provide reports and recommendations to the MRAC regarding efforts to transition U.S. dollar derivatives and related contracts to SOFR and the impact of such transition on the derivatives markets.^[14]  Towards a goal of providing input and recommendations to the MRAC relating to policy changes that may impact LIBOR reform, the Subcommittee aims to: (1) remove hurdles to the transition to SOFR; (2) provide incentives for market participants to transition to SOFR; and (3) avoid the inadvertent creation of a safe harbor in policy changes the Subcommittee recommends.^[15]  To further its efforts, the Subcommittee intends to focus on three work streams covering initial margin, clearing, and disclosures.  In a few short hours, the Financial Stability Board will host a benchmark reform roundtable at the CFTC’s offices in Washington, D.C., where the MRAC will present an update on its work.

Initial Margin—Engineering Implementation

September 2020 marks the deadline for the final step in the five-step phase-in period for the exchange of initial margin, or “IM,” referred to as the “IM big bang.”  Trade associations, including ISDA, estimate that over 1,100 additional counterparties and 9,500 relationships with new documentation requirements will result from the IM big bang.^[16]  Since April of 2018, the Working Group on Margin Requirements (“WGMR”) Monitoring Group, which includes representatives from more than 20 regulatory authorities around the globe,^[17] has put forth and completed a stocktaking exercise and internal report to the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) on the implementation status of the margin standards focused on the 2020 phase-in. 

On March 5, 2019, BCBS/IOSCO issued a statement addressing two areas of challenge identified by the Monitoring Group.^[18]  First, BCBS/IOSCO recognized that the impending replacement of interbank offered rates such as LIBOR may require market participants to amend legacy contracts, potentially creating new contracts subject to margin requirements that would have otherwise been out of scope.  To address any uncertainty, which may have discouraged market participants from amending such contracts, BCBS/IOSCO clarified that amendments to legacy derivatives made solely to address interest rate benchmark reforms do not require the application of the margin requirements for the purpose of the BCBS/IOSCO framework.  Second, BCBS/IOSCO recognized that the remaining phases will bring a large number of financial and other end users into the scope of the IM requirements with the attendant difficulties associated with beginning to exchange IM with a large number of counterparties.  Accordingly, BCBS/IOSCO highlighted that the framework does not specify documentation, custodial, or operational requirements if the bilateral IM amount does not exceed the framework’s €50 million IM threshold.   Essentially, while covered entities are expected to act diligently when their exposures approach the threshold, they may continue to trade without compliant documentation and relevant arrangements in place until they exceed it.

To be clear, the CFTC is currently considering the March 5^th BCBS/IOSCO guidance.  We are engaging with the U.S. prudential regulators and anticipate issuing additional information relevant to clarifying the timing of the documentation period.  In the interim, the Commission continues work with the WGMR monitoring implementation.  The various concerns expressed by stakeholders such as those put forth by ISDA and SIFMA (the Securities Industry and Financial Markets Association),^[19] are being closely monitored.  The CFTC remains committed to implementing its IM rules consistent with their original intent in a feasible manner.  We continue to engage and provide leadership in the WGMR towards identifying and implementing the most effective solutions.

Cross Border—Making Progress

Six months ago, Chairman Giancarlo released his white paper on cross-border swaps regulation in which he shared his vision for updating the Commission’s current guidance-based cross-border application of its swap regime to a rule-based framework with greater regulatory deference to third-country regulatory jurisdictions that have adopted the G-20 swaps reforms.^[20]  Some of the suggested improvements include: (1) expanding the use of the CFTC’s exemptive authority for non-U.S. central counterparties (“CCPs”) that are subject to comparable regulation in their home country and do not pose “substantial risk” to the U.S. financial system; (2) exempting from SEF registration non-U.S. trading venues in jurisdictions that have adopted comparable G20 swaps reforms; and (3) reconsidering the criteria for determining when non-U.S. persons’ swap dealing activity poses a “direct and significant” risk to the U.S. financial system requiring swap dealer registration with the CFTC.^[21]

As I’ve pointed out, the prior Commission’s decision in 2013 to address cross-border swaps regulation through agency guidance as opposed to regulation was intended to ensure that it would leave future CFTC leadership with the flexibility to fine-tune and adapt its approach to cross-border swaps regulation as the remainder of the global regulatory landscape evolved.^[22]  I agree with the Chairman that it is an appropriate time to take stock of our global reforms and work together towards greater recognition of and deference to each other’s regulatory adoption and implementation of the G-20 reforms and approach to swaps regulation.

Last month, the Chairman announced that Commission staff was preparing the first formal proposals for rulemakings aimed at effectuating reforms outlined in his white paper, and stated his intention to put these proposals before the full Commission for formal vote before his departure.^[23]  As described by the Chairman, one proposal will address the registration of non-U.S. CCPs clearing swaps for U.S. persons.^[24]  Among other things, this proposal will provide for an alternative registration framework for non-U.S. CCPs that do not pose a substantial risk to the U.S. financial system.  These CCPs would still be able to offer customer clearing to U.S. person through futures commission merchants (“FCMs”).  Within this framework, the CCP’s home country regulator would continue to have supervisory primacy, with the CFTC more narrowly focused on U.S. customer protection. 

The proposal will also provide an option for non-U.S. CCPs to be exempt from CFTC registration as a derivatives clearing organization or “DCO.”  In contrast to the current CFTC approach, this proposal would permit exempt DCOs to offer customer clearing to U.S. eligible contract participants through foreign clearing members that are not registered as FCMs.^[25]  

Another proposal will address the registration and regulation of non-U.S. swap dealers and major swap participants.^[26]  As described by the Chairman, this proposal will shift the focus to the risk that non-U.S. swap dealing activity poses to the United States in a manner that ensures that our swap dealer rules only apply where the activity poses a “direct and significant” risk to the U.S. financial system, consistent with section 2(i) of the our governing statute, the Commodity Exchange Act (“CEA”).^[27]

I look forward to engaging with my fellow Commissioners, fellow global regulators, and the public as we consider Chairman Giancarlo’s proposals.  I will remain vigilant as we reconsider the Commission’s past interpretation of the extraterritorial reach of our statutory and regulatory swaps authority.  Such authority is limited to activities outside the U.S. where such activities have a “direct and significant connection with activities in, or effect on” U.S. commerce or are evasive.^[28]  As we explore what it means to have a “direct and significant connection” to the U.S. financial system in terms of risk, we must be diligent in our analyses of relationships and interconnections among markets and market participants as well as appropriately deferential to risk mitigating factors.  We must also remain vigilant and consider how any decisions we make could apply to new and emerging risks.  And as always, whatever interpretation we pursue must not run counter to clear Congressional intent.^[29]

SEFs—Some Needed Seeds of Change

The Commission also has continued the important work of considering the effectiveness of our rules governing SEFs.^[30]  Targeted SEF reforms can help market participants by providing certainty and eliminating unintended consequences.  Last November, the Commission publicly voted to propose for public comment various amendments to the rules applicable to SEFs, which appear in part 37 of our rules.  Despite reservations, I voted in favor of publishing the proposal for comment.^[31]  I fully recognize that our existing part 37 rules are not perfect and that we need to hear from market participants regarding how we can improve the regulatory framework for SEFs.   

We received more than 50 comments from market participants, and many of them drill down deeply on the rule and its implications.^[32]  CFTC staff is busily reviewing and considering the comments.  The comments express many concerns – they echo the numerous concerns that I raised at the open meeting and many additional concerns as well. 

One concern that we have heard repeatedly is regarding how the proposal will interact with any action that the Commission takes to reform our current cross-border rules and guidance.  Let me provide at least some reassurance here.  The CFTC has worked hard to address existing challenges in cross-border trading.  The Commission issued U.S./EU trading venue recognition in late 2017.^[33]  Just last month, the Commission issued similar trading venue recognition for Singapore.^[34]  My understanding is that, even in the unlikely event that the Commission was to approve a final SEF rule that exactly mirrors the proposal, the Chairman does not expect the SEF proposal to impact SEF registration exemptions already in place for EU and Singapore trading venues.^[35]  I am hopeful that this is the case.  But if we change the SEF rules significantly, there will be work to be done.  Obviously, we have determined that the EU and Singapore swap trading venue regimes subject SEFs in those jurisdictions to comparable, comprehensive supervision and regulation on a consolidated basis.^[36]  If we have a re-imagined SEF regime like that set forth in the SEF proposal, it will be necessary to revisit these determinations.  The Chairman’s statements give assurance that, when this analysis is done, the Commission will find that these regimes are still comparable. 

At the open meeting regarding the proposal, I expressed the concern that some products may be more appropriately traded off SEF.  I also raised the possibility of unintended consequences – it seemed to me that tying the trade execution requirement to the clearing requirement could actually discourage voluntary central clearing.  Many of the commenters, including ISDA, expressed similar concerns, and argued that “there should be an independent determination as to whether or not a particular swap possesses adequate liquidity to be trading on a SEF and that such determination should be made separate from the clearing determination.”^[37]  I also appreciate ISDA’s suggestion that the Commission’s Market Risk Advisory Committee could provide assistance in making MAT determinations.^[38]  I believe that the MRAC, with its broad range of market participants, would be an excellent forum for further discussion of how to improve the existing made-available-to-trade process. 

Looking at SEF reform as a whole, though, I have a broader over-arching concern.  Over and over, market participants tell me that targeted changes need to be made to the SEF regulatory regime.  They also tell me that they have spent a great deal of resources to build systems and businesses that comply with our existing SEF rules.  Asking market participants to make fundamental changes amounting to an overhauling of the entire system should only be done in circumstances where there is a regulatory concern that necessitates – demands – action. 

In 2008, the lack of transparency in the over-the-counter swaps market contributed to the financial crisis because both regulators and market participants lacked the visibility necessary to identify and assess swaps market exposures and counterparty relationships.^[39]  Expansive regulatory reform was necessary.  We are in a more mature regulatory position now and we should target our reforms to provide clarity and certainty for market participants, and to make improvements that add value to the existing framework.  To that end, there are a number of changes that I believe just about everyone agrees upon.  Most SEFs currently operate under multiple no-action letters granted by the CFTC’s Division of Market Oversight.  While the purpose of this targeted relief was often to smooth the implementation of the SEF framework, codifying or eliminating the need for existing no-action relief would provide market participants with greater legal certainty.  We should not allow issues with the broader vision of the SEF proposal to distract us from more targeted changes, like codifying no-action relief or making targeted improvement of the MAT process or permissible methods of execution.  But we also should remember that we do not need to accept the broader vision of the SEF proposal in order to provide market participants with the certainty they need and the SEF market they deserve.

Conclusion

Looking ahead to 2020, there is much to accomplish.  We are off to many good starts.  With ongoing dialogue and engagement, I believe our decisions to act will prove effective.  The tasks before us present great challenges, but we will persevere as the markets and the people they employ and serve need certainty.  I began these remarks with some thoughts on spring and the cherry blossoms as well as a quote from Amelia Earhart.  To bring us full circle, I will note that many people do not know that in 1915, the United States gave a reciprocal gift of flowering dogwood saplings to the city of Tokyo.  It took us a few years, but we delivered our own living symbol of renewal.  As for Ms. Earhart, she once remarked that, “[I]t is far easier to start something than to finish it.”  Yes, Ms. Earhart, we got it. 

Thank you.