Good afternoon. I’d like to thank the American Bar Association’s Committee on Derivatives and Futures Law for inviting me to speak today. Thank you, Susan, for that introduction.
As we gather here in South Florida, one doesn’t have to travel far to see what happened to America as a result of the 2008 financial crisis. Three years later, foreclosures remain rampant in Florida neighborhoods, and the state still faces unemployment of nearly 10 percent. When I was with you two years ago, I had just visited some friends in Immokalee, Florida’s largest farm working community. I can tell you that these farmers who pick and package tomatoes are still feeling the effects of the economic downturn, as are so many other Americans. The 2008 crisis led to eight million jobs lost and millions of families losing their homes.
It’s the real economy – the non-financial side – that provides most Americans with jobs. Between 2007 and 2010, the real economy supplied 94 percent of full and part-time private sector jobs, according to the U.S. Bureau of Economic Analysis.
The financial system has an important role to play as well. It helps to allocate capital and risk throughout the economy, as well as to provide a place to save and invest. Each part of our economy relies on a well-functioning derivatives marketplace. This market is essential so that producers, merchants and other end-users can manage their risks. At approximately $300 trillion, the domestic swaps market represents more than $20 of swaps for every dollar of goods and services produced in the U.S. economy. And it is important for the public to have confidence in the integrity of these markets.
As important as the financial sector is, however, at times, it hurts the real economy. In 2008, the financial system and the financial regulatory system failed America. And though the financial sector plays a critical role, it is the real economy that is the true engine of economic recovery.
While the crisis had many causes, it is clear that swaps played a central role. The swaps market helped build up risk in the financial system that spilled over into the real economy, affecting businesses and consumers across America. And let me ask, how many of those millions of people who lost their jobs or homes do you think ever heard of swaps, let alone ever used one?
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) was the President and Congress’ response to the financial crisis. Two very important goals were to bring transparency and competition to the swaps market and to prevent risks in the financial sector from again so infecting the real economy.
Why does the Dodd-Frank Act really matter? And to whom does it matter?
Dodd-Frank matters as it brings transparency and competition and lowers the risk of the swaps market to the real economy. It matters as well to users of derivatives within the financial sector, also called the buy side.
The swaps market, given its current lack of transparency, could aptly be called the largest dark pool in our financial markets. Bringing greater transparency and competition to the swaps market is about lowering costs for companies and their customers.
Companies – in the real economy – can lock in the price of products they’re selling or buying or a rate they paying, thus lowering their risk. This allows businesses to focus on what they do best – job creation and economic investment.
Segments of the financial sector – the buy side – also benefit from greater transparency and competition in the swaps market. Whether it’s pension funds, mutual funds, community banks or insurance companies, they all will benefit from the lower costs and greater pricing information that would come from a more transparent and competitive swaps market.
Almost every part of our economy benefits from Dodd-Frank reform – with the possible exception of some of your clients, as some of the information advantage they may now have shifts to the broader public.
Dodd-Frank reform also matters because it will lower the risks that Wall Street, from time to time, poses to the rest of us. Standardized swaps will be moved into central clearing, lowering the risk of an interconnected swaps market. And for the first time, dealers will be comprehensively regulated for their swaps activities.
CFTC Progress on Rules
To date, the CFTC has made a real down payment on reform in finalizing 25 rules of the road for the swaps market. We have benefited from significant public input – over 27,000 comment letters, over 1250 meetings, and 14 public roundtables. I recognize many of you who have represented clients at these meetings. I am just curious, has the ABA yet tallied up who amongst you has submitted the most comment letters?
With an eye on why Dodd-Frank reforms really matter, let me review some highlights of what has been finalized, as well as upcoming matters before the Commission.
The CFTC has completed seven key reforms to make the swaps marketplace more transparent. For the first time, the public and regulators will have specific information on the swaps markets, in aggregate and transaction-by-transaction.
This July, when real-time reporting begins for much the swaps market, it will bring post-trade transparency to the market and give the public critical information on the pricing of transactions.
Also in July, regulators will benefit from a window into the risks of the swaps market, as swaps transactions will be required to be reported to trade repositories. Based on completed registration rules, three swap data repositories already have filed with the CFTC.
The agency also began, for the first time last fall, to get position information for large traders in the swaps markets for agricultural, energy and metal products.
Furthermore, based upon a provision in completed clearinghouse rules, this month clearinghouses must make their settlement prices public on a daily basis for every swap.
By this fall, based on the just completed external business conduct rules, dealers will be required every day to tell their counterparties the mid-market mark of their outstanding bilateral swaps.
In August, foreign boards of trade, currently operating under no-action relief, must begin the application process for registration.
As a whole, these seven completed reforms will bring much greater transparency and competition to the swaps market, benefiting both the real economy and the buy side.
Looking forward, we also hope to complete rules for designated contract markets (DCMs) and swap execution facilities (SEFs). These rules will be critical in bringing pre-trade transparency to the swaps market. Hedgers, investors and speculators will be able to meet in an open and competitive market, benefitting from seeing available bids and offers and gaining liquidity.
Lowering Risk to the Public through Clearing and Regulating Dealers
The CFTC also has completed many key reforms to lower the risk posed by the swaps market to the public.
Last year, the CFTC completed rules establishing robust risk management requirements, consistent with international standards, for derivatives clearing organizations (DCOs). We also completed rules on the process for clearinghouses to submit swaps that may be mandated for central clearing. Dodd-Frank reforms lower the risks of an interconnected financial system by mandating that standard swaps between financial entities move into central clearing. We are now working with the major clearinghouses as they prepare for submissions of swaps to be mandatorily cleared.
We also hope to finish two critical rules that will further promote the democratization of the swaps market. The rules for client clearing documentation and straight-though processing will provide users of swaps – both in the real economy and the buy side – more direct access to the markets.
The real economy and the buy side also will benefit from comprehensive regulation of swap dealers. This month, the CFTC began the reforms to regulate dealers.
We finalized a registration rule so the Commission, along with the National Futures Association, can monitor swap dealers and major swap participants. We also completed external business conduct rules to establish and enforce robust sales practices in the swaps market.
Next month, we hope to consider final internal business conduct rules that will lower the risk that dealers pose to the real economy. Looking forward, we will consider finalizing capital and margin rules, which will have the benefit of close consultation with other regulators, both domestic and international.
The CFTC also has focused on enhancing the protection of customer funds. The completed amendments to rule 1.25 bring customers back to protections they had prior to exemptions the Commission granted between 2000 and 2005. Importantly, it prevents in-house lending through repurchase agreements.
In addition, as part of completed rules, clearinghouses will have to collect margin on a gross basis. This means that as of this upcoming November, futures commission merchants (FCMs) will no longer be able to offset one customer’s collateral against another and then send only the net to the clearinghouse. Building upon this gross margining provision, we also just completed reforms that require FCMs and DCOs to segregate customer collateral supporting cleared swaps. For the first time, customer money must be protected individually all the way to the clearinghouse.
We are continuing to consider thoughtful input on how we might build upon these segregation protections. This review includes further safeguards for client collateral on an individual basis, as well as possibly considering for futures similar protections to what we approved for swaps. Staff plans roundtables to hear from the public, the first of which will be on February 29.
We’ve also made progress on key reforms enhancing market integrity. These reforms will better protect market participants from fraud, manipulation and other abuses.
Last summer, we finished rules giving the Commission more authority to effectively prosecute wrongdoers who recklessly manipulate the markets and to reward whistleblowers for their help in catching market misconduct. In addition, our external business conduct rules prohibit fraud and certain other abusive practices. Together, these rules will enable the CFTC to be a better cop on the beat.
We also completed Congressionally mandated speculative position limit rules that will, for the first time, limit aggregate positions in the futures and swaps market.
Further promoting market integrity, we are working to finish guidance limiting disruptive trading practices. As we finalize reforms for the trading platforms, I look forward to including provisions regarding DCM and SEF oversight responsibilities and their role in protecting orderly markets.
I also expect the Commission will consider putting out for comment a concept release concerning the testing and supervision of market participants with direct market access. These concepts will be designed to address potential market distortions that high frequency traders and others who have direct market access can cause.
In conclusion, the Dodd-Frank Act is about bringing transparency and competition to the swaps market and lowering risk to the real economy, the part of the economy that supplies 94 percent of private sector jobs. It is about doing the same for the buy side as well – representing all those Americans depending upon pension funds, mutual funds, community banks and insurance companies.
Thanks to the hard work of my fellow Commissioners and the CFTC staff, we’ve been able to make a real down payment on swaps market reforms, but there’s more work to be done. I have great confidence in the Commission and the staff that we will get these reforms done this year for the benefit of the American public.
Some have raised cost considerations about these reforms. But there are far greater costs – the eight million jobs lost, millions forced out of their homes, and the uncertainty throughout the economy that came from risk, which spilled over from Wall Street.
Thank you for inviting me to speak today.