The following update prepared by Delta Strategy Group:

On November 5, CFTC Chairman Timothy Massad and Commissioner Sharon Bowen gave keynote presentations at the Futures Industry Association Expo 2014.  Please see below for a summary of their remarks.

The speeches can be found here:

Chairman Massad Keynote Presentation

Commissioner Bowen Keynote Presentation

Chairman Massad provided his current and future views on Dodd-Frank implementation, cross-border issues, cybersecurity, enforcement, and CFTC resources.

Key Points:

  • The Commission will the extend no-action relief letters previously issued and set to expire on November 15, 2014, in order to phase-in the requirement to trade on SEFs swaps executed as part of certain package transactions.
  • The Commission will extend no-action relief with respect to the cross-border guidance when a foreign SD that engages in certain conduct in the US is subject to US transaction requirements.
  • The CFTC and European Commission are considering changes to further harmonize rules regarding clearinghouse equivalence, and Massad said he was pleased that the EC has decided to postpone the imposition of higher capital charges on banks clearing through US-based central counterparties.

Implementing the New Regulatory Framework

  • Status updates on the four key commitments on derivatives regulation embodied in Dodd-Frank and agreed to by the leaders of the G-20 nations:

o   Increased oversight of major market players, with 106 Swap Dealers (SDs) and 2 Major Swap Participants (MSPs);

o   Increase in clearing of standardized swaps, with 74% of outstanding transactions, measured by notional value, cleared in September 2014, an increase from only 16% of transactions in December 2007;

o   Increase in transparent trading of standardized swaps on 22 temporarily registered Swap Execution Facilities (SEFs), with an increase in total notional volume up 42% month over month from September 2014 versus August; and

o   Increased market transparency from new reporting requirements.

  • Remaining rules to be completed in the future:

o   Margin requirements for uncleared swaps:  The CFTC will work closely with bank regulators in finalizing the rule on margin for uncleared swaps so that the rules are substantially the same;

o   Capital requirements for SDs for uncleared swap transactions;

o   Position limits:  The CFTC must get this right to make sure the market works for commercial end-users hedging routine business risks through the bona fide hedging exemption language.

  • Fine-tuning current rules:

o   In September 2014, the Commission amended rules pertaining to special entities to allow local, publicly-owned utility companies to continually hedge their risks in the energy swaps market;

o   This week, the Commission revised rules to clarify the deadline for futures commission merchants (FCMs) to post “residual interest” will not move to earlier than 6PM on the following day after the trade, without affirmative Commission action, to codify no-action relief exempting certain recordkeeping requirements under Regulation 1.35(a), and to clarify the interpretation of when an agreement, contract, or transaction that contains embedded volumetric optionality falls within the forward exclusion from being considered a swap;

o   The Commission will the extend no-action relief previously issued related to the  trading mandate for swaps executed as part of certain package transactions.

Cross-Border

  • With regard to the rule on margin requirements for uncleared swaps, the CFTC is working with regulators in Europe and Japan to implement similar rules.
  • The Commission will extend no-action relief with respect to the cross-border guidance when a foreign SD that engages in certain conduct in the US is subject to US transaction requirements.
  • Clearinghouse equivalence:

o   The CFTC has agreed to consider changes that would further harmonize US rules with European rules governing clearinghouses and is pleased that the EC has decided to postpone the imposition of higher capital charges on banks clearing through US-based central counterparties.

o   The CFTC is working closely with the Fed to make sure clearinghouses operate transparently, meet necessary standards and safeguards, do not pose risks to financial stability, and that contingency planning is sufficient.

Cybersecurity

  • The CFTC Core Principles for clearinghouses, exchanges, and other market infrastructure entities have been modernized in recent years to address cyber and information security – and system safeguards require these entities to have four important things:

o   Program of risk analysis and oversight to identify and minimize sources of cyber and operational risk;

o   Automated systems that are reliable, secure and have adequate scalable capacity;

o   Emergency procedures, backup facilities, and a business continuity-disaster recovery plan;

o   Regular, objective, independent testing to verify system safeguards fulfill regulatory responsibilities.

  • The CFTC conducts system safeguard examinations to determine compliance with Commission Regulations, but are limited due to a lack of resources.  Some key areas the Commission focuses on are governance, resources and capabilities, policies and procedures, and vigilance and responsiveness to identified weaknesses and problems.
  • Dodd Frank provided the Commission with new statutory tools to combat manipulation and practices that can distort markets and the CFTC is using that authority.  For example, civil and criminal actions have been brought in the past year against firms for spoofing, one of the new enforcement tools provided by Dodd Frank.
  • “Going forward, market participants should understand that we will use all the tools at our disposal to ensure compliance with the law.”
  • The CFTC “will do what we can, with what we have, where we are,” but the current budget limits the Commission’s ability to fulfill its responsibilities in a way most Americans would expect.
  • Without additional resources, the markets cannot be as well supervised, customers cannot be as well protected, and market transparency and efficiency cannot be fully achieved.

Enforcement and Compliance

CFTC Resources

 

Commissioner Bowen gave her perspective on the broad principles that will guide her decision making as a Commissioner and discussed several issues under consideration currently and moving forward.

Key Points:

  • It is important for the Commission to finalize rules such as position limits and margin requirements for uncleared swaps, while also looking out for new potential threats to the financial markets.
  • The newly established Market Risk Advisory Committee has received several common themes from the industry such as cybersecurity, clearinghouse resolution and recovery, accurate reporting, and the prominence of unregulated third-party service providers that could be priorities going forward, but asked the industry for more feedback.

Current and Future Issues Under Commission Consideration

  • Margin requirements for uncleared swap transactions:  this rule is important for protecting customers and addressing financial risks and will look forward to reviewing the comments received and finalizing the rule in the near future.
  • Regulation 1.35 and Residual Interest Deadline:  The CFTC announced rule proposals to exclude certain end-users from certain recordkeeping requirements under Regulation 1.35 and tweaked the compliance deadline of the residual interest rule by taking a “common-sense, practical approach” to address concerns about unnecessary costs and burdens to market participants.
  • Position Limits:  The Commission needs to complete the final rule in a way that both “realizes Congressional intent in mandating position limits and maintains companies’ ability to manage their commercial risks.”
  • Resources:  The CFTC budget is insufficient to regulate a market totaling approximately $400 trillion dollars, and this situation jeopardizes the Commission’s ability to effectively fulfill its regulatory responsibilities.
  • New Industry Practices:  The CFTC has an obligation to make sure new practices such as high frequency trading, colocation, and entities such as pension funds making speculative investments in futures and options are regulated appropriately.

Six Core Guiding Principles to Address Future Financial Risks

  • First, it is critical to allow financial actors to take reasonable risks, but cannot allow firms to take risks that endanger the entire financial system or the broader economy.  Protections such as position limits, margin requirements, and well-run clearinghouses must ensure that one company’s risky bet does not throw the entire system into chaos.
  • Second, the CFTC has to address the gaps that exist between the regulators and in between regulations.  The Commission must know what is going on in each sector of the financial industry and cannot have systemically significant markets developing in non-transparent markets.
  • Third, the rules and guidance must be as clear as possible to make sure they are easily understood by the industry.  With rules that are clear and easy to implement, financial actors can reduce unnecessary costs and make the markets more accessible to the average investor.
  • Fourth, the rules released by the CFTC must fix the problems they were crafted to solve.
  • Fifth, the CFTC must be ready to identify the next potential crisis and prevent it while cleaning up the last one.
  • Finally, no one is above the law, and if someone breaks the law, they will be prosecuted and face criminal sanctions.  The Commission will make criminal referrals to the appropriate authorities when necessary.