Good morning. I thank the Futures Industry Association for inviting me to speak today, and I thank John Damgard for that very kind introduction. Since I last spoke before the FIA, Congress passed historic reform to bring comprehensive oversight to the swaps marketplace.
Before I discuss the details of reform, I'd like to thank my fellow Commissioners and CFTC staff for all of their hard work on the Dodd-Frank Wall Street Reform and Consumer Protection Act and on its implementation. I’d also like to recognize my fellow Commissioners in the audience: Mike Dunn, Jill Sommers and Bart Chilton.
In bringing oversight to the swaps market, Congress built upon strengths from the futures marketplace. Futures and swaps are both derivatives. It is only natural that Congress would treat them similarly and apply similar protections to both markets.
While the swaps marketplace has only been around since the 1980s, the futures marketplace has existed since the 1860s. The CFTC and its predecessor agencies have been regulating and working with the futures markets since the 1920s. The regulation of the swaps markets included in the Dodd-Frank Act builds upon the strengths found within the regulation of the futures markets. It builds upon the benefits of clearing in the futures markets. It builds upon the transparency that centralized trading brings to the futures markets. It builds upon the concept that intermediaries should be regulated to lower risk in the markets.
Implementing the Dodd-Frank Act
The Dodd-Frank Act requires the CFTC and the Securities and Exchange Commission (SEC) to write rules generally by July 15, 2011. For those of you keeping track, we have 255 days left.
Two principles are guiding us throughout the rule-writing process. First is the statute itself. We intend to comply fully with the statute’s provisions and Congressional intent to lower risk and bring transparency to these markets.
Second, we are consulting heavily with both other regulators and the broader public, including many participants in the futures markets. We are working very closely with the SEC, the Federal Reserve and other prudential regulators. To date, CFTC staff and Commissioners have had nearly 200 meetings with our fellow regulators on Dodd-Frank implementation.
We also are actively consulting with international regulators to harmonize our approach to swaps oversight. Just yesterday, I joined Michel Barnier, European Commissioner for Internal Market and Services, for the day here in Chicago. Our meetings built upon the U.S.’s strong partnership with the European Commission with regard to regulation of the swaps markets. Working together, I am confident that we will bring consistent regulation to both the European and U.S. markets.
We also are soliciting broad public input into the rules. Many individuals have asked for meetings with either our staff or Commissioners to discuss swaps regulation. As of yesterday, we have had at least 325 such meetings. Just as we believe in bringing transparency to the swaps markets, we also have added additional transparency to our rule-writing efforts. We are now posting on our website a list of all of our meetings, as well as the participants, issues discussed and all materials given to us.
We are in the process of publishing proposed rules, using regular public Commission meetings for this purpose. So far, we have had three public meetings and published 11 proposed rules, two final rules and three advanced notices of proposed rulemaking. Our next two meetings are scheduled for November 10 and November 19.
Now I will address three areas where the CFTC will take cues from the current regulatory structure of the futures markets. The first is with regard to clearinghouses.
Futures clearinghouses came together in the 1890s to lower risk to the markets. In fact, though I’m not sure the term was used then, before clearinghouses came together there was the equivalent of bilateral futures. Just as we wish to lower the risk of bilateral swaps today, pioneers in the derivatives market in an earlier era did so with clearinghouses 120 years ago. So far, the CFTC has published proposed rules relating to clearing in four areas: governance, financial resources, the CFTC’s process for reviewing and approving clearinghouse rules and the process for determining what swaps will be subject to mandatory clearing. Ahead of us are rules with regard to risk management, segregation of customer funds and other topics. The Dodd-Frank Act says that, just as in the futures market, for a swap to be cleared by a clearinghouse it must be submitted by a futures commission merchant (FCM).
What we’ve learned from the futures marketplace is that clearinghouses work well when they are broadly inclusive of many members, facilitating FCMs who are part of large dealers as well as independent FCMs clearing customer transactions. Swaps clearinghouse membership should be open to parties other than derivatives dealers. Assuming a party meets the rigorous risk-management, operational and financial requirements of a clearinghouse, it should be permitted to become a direct member of that clearinghouse. Non-dealer financial institutions or asset managers, for example, may choose in certain circumstances to become clearinghouse members to reduce their counterparty risk or to best manage their business. Membership criteria should be transparent, objective and nondiscriminatory.
If clearinghouses that are regulated in the U.S. seek to be allowed to do business in Europe, they’re going to have to meet the most rigorous international standards. This is particularly important as the European Commission has recommended that only clearinghouses that meet risk management and oversight standards equivalent to European standards will be allowed to be used in Europe.
There are some differences between swaps clearing and futures clearing. In the swaps marketplace, Congress included a requirement that clearinghouses have nondiscriminatory open access. The CFTC through rule-writing will seek to promote competition amongst trading platforms whereby clearinghouses will not be able to discriminate amongst or between trading venues.
Further, while 100 percent of futures must be cleared and traded on exchanges, only standardized swaps must be cleared by a clearinghouse while customized swaps could still transacted bilaterally. A determination must be made by both the clearinghouse and the regulator before the mandatory clearing takes effect. Even for those swaps that are deemed clearable, the Dodd-Frank Act includes an exemption for non-financial end-users hedging or mitigating commercial risk.
We also are building upon the successes from the futures markets as we write rules to oversee swaps trading platforms. Designated contract markets (DCMs) that trade futures have been regulated since the 1930s. Under the new law, DCMs also will be able to offer swaps for trading. The Dodd-Frank Act also establishes a new category of trading platforms called swap execution facilities (SEFs), which are only permitted to trade swaps. While the retail public can access DCMs to trade futures, SEFs are only open to eligible commercial participants.
The Dodd-Frank Act mandates that clearable swaps trade on exchanges or SEFs if they are made “available for trading.” This brings significant benefits to users of derivatives and to the American public. The more pre-trade transparency there is, the more likely there will be additional competition in the markets and tighter pricing for end-users.
Some have asked: what is a swap execution facility? I think the statute says it well. It is “a trading system or platform in which multiple participants have the ability to execute or trade swaps by accepting bids and offers made by multiple participants.”
Congress also has been very specific that market participants and end-users will benefit from real time reporting. Such post-trade transparency must be achieved “as soon as technologically practicable” after a swap is executed to enhance price discovery. Just as in the futures marketplace, block trades for swaps will be reported with some delay. I don’t know where the proposed rule will come out, but I might note that in the futures market the delay is currently five minutes.
The Dodd-Frank Act brings post trade transparency to the swaps market by requiring real time reporting for both cleared swaps and bilateral swaps. The transparency brought about both pre-trade through SEFs and DCMs and post-trade through real time reporting also enhances clearinghouses’ ability to appropriately manage their risk.
The Dodd-Frank Act builds upon the CFTC’s current oversight of intermediaries in the futures marketplace. We currently regulate FCMs, commodity pool operators (CPOs), commodity trading advisors (CTAs) and introducing brokers (IBs). The new statute adds new comprehensive oversight over swap dealers and major swap participants, including capital and margin requirements, business conduct standards and recordkeeping and reporting requirements. The statute also broadens the definitions of FCMs, CPOs, CTAs and IBs to include their swaps activity in addition to their futures activity.
As we work through proposed rules, we are necessarily looking at our existing rules regarding currently regulated intermediaries to determine if and how they should be adjusted given the inclusion of swaps.
Before I conclude, I will address two topics related to implementation. First, how long will the markets have to implement changes in response to the Dodd-Frank Act? Second, what resources will the CFTC need to oversee the swaps markets?
The legislation generally gives regulators until July 15 of next year to write the rules. The statute outlines a minimum transition period of 60 days. The Commission also will consider the transition needs of entities, as appropriate, that are currently regulated and those that will soon come under regulation.
Though we have the resources to write the rules required by Dodd-Frank, we will need more staff to implement and enforce them in the years to come. To fully implement the Dodd-Frank reforms, the Commission will require approximately 400 additional staff over that which we need to fulfill our pre-Dodd-Frank mission.
The futures marketplace that the CFTC currently oversees is a $33 trillion industry in notional amount. The swaps market has a far larger notional amount, with estimates ranging from $217 trillion to $300 trillion in the United States alone, or roughly seven to nine times the size of the futures markets. Though I’m not suggesting that we need that type of increase in our budget, we do anticipate that we’ll have between 300 and 400 new registrants, including swap dealers, SEFs, swap data repositories, major swaps participants, new FCMs and retail foreign exchange dealers.
The challenge before the agency is significant, but manageable, provided we have sufficient resources. Given the new responsibilities for the CFTC to regulate the swaps market, our current funding is far less than what is required to properly fulfill our significantly expanded role.
The CFTC faces challenges in the months ahead, but we look forward to meeting those challenges.