Regulating banks and other firms that deal in swaps is central to financial reform. Prior to 2008, it was claimed that swap dealers did not need to be specifically regulated for their swaps activity, as they or their affiliates already were generally regulated as banks, investment banks, or insurance companies. The crisis revealed the inadequacy of relying on this claim. While banks were regulated for safety and soundness, including their lending activities, there was no comprehensive regulation of their swap dealing activity. Similarly, bank affiliates dealing in swaps, and subsidiaries of insurance and investment bank holding companies dealing in swaps, were not subject to specific regulation of their swap dealing activities. AIG, Lehman Brothers and other failures of 2008 demonstrate what happens with such limited oversight.
The CFTC is well on the way to implementing reforms Congress mandated in Dodd-Frank to regulate dealers and help prevent another AIG. The Commission has finished sales practice rules requiring swap dealers to interact fairly with customers, provide balanced communications and disclose conflicts of interest before entering into a swap. In addition, the Commission has finalized internal business conduct rules to require swap dealers to establish policies to manage risk, as well as put in place firewalls between a dealer’s trading, and clearing and research operations. Staff will shortly provide to commissioners for consideration recommendations on a final rule on swap relationship documentation, confirmations and portfolio compression.
We completed in April a joint rule with the SEC further defining the terms “swap dealer” and “security-based swap dealer.”
Based upon completed registration rules and the recently completed joint rule further defining the term "swap," we anticipate dealers will begin registering with the National Futures Association (NFA) in the early fall.
The CFTC has been working with the Federal Reserve, the other U.S. banking regulators, the SEC, and international regulators and policymakers to align margin requirements for uncleared swaps. It is essential that we align these requirements globally, particularly between the major market jurisdictions. The international approach to margin requirements in the consultative paper (sponsored by the Basel Committee on Banking Supervision and the International Organization of Securities Commissions) released this month is consistent with the approach the CFTC laid out in its margin proposal last year. It would lower the risk of financial entities, promote clearing and help avoid regulatory arbitrage. Consistent with the CFTC’s proposal, it also excludes non-financial end-users from margin requirements for uncleared swaps.
The CFTC reopened the comment period on our margin proposal so that we can hear further from market participants and the public in light of the work being done to internationally harmonize margin rules. As we work with international regulators on this coordinated approach, I would anticipate that the Commission would only take up the final margin rules toward the end of this year.
Following Congress’ mandate, the CFTC also is working with our fellow financial regulators to finalize the rulemaking to implement the Volcker Rule. In adopting the Volcker Rule, Congress prohibited banking entities from engaging in proprietary trading, an activity that may put taxpayers at risk. At the same time, Congress permitted banking entities to engage in certain activities, such as market making and risk mitigating hedging. One of the challenges in finalizing a rule is achieving these multiple objectives.
Staff also has provided to commissioners recommendations in two other areas. The first relates to proposed exemptions for certain transactions in the electricity markets. In particular, this includes possible exemptive orders for certain transactions executed on regional transmission organizations, as well as between and among rural electric cooperatives and municipal public power providers. Second, now that the Commission made significant progress on swaps market reforms, we will consider completing a number of conforming rules.
Market Integrity/Position Limits
Financial reform also means investors, consumers, retirees and businesses in America will benefit from enhanced market integrity. Congress provided the Commission with new tools in Dodd-Frank to ensure the public has confidence in U.S. swaps markets.
Rules the CFTC completed last summer close a significant gap in the agency’s enforcement authorities. The rules implement important Dodd-Frank provisions extending our enforcement authority to swaps and prohibiting the reckless use of manipulative or deceptive schemes. Thus, for example, the CFTC has clear anti-fraud and anti-manipulation authority regarding the trading of credit default swaps indices.
Also, the CFTC now can reward whistleblowers for their help in catching market misconduct.
Congress also directed the CFTC to establish aggregate position limits for both futures and swaps in energy, agricultural and other physical commodities. In October 2011, the Commission completed final rules to ensure no single speculator is able to obtain an overly concentrated aggregate position in the futures and swaps markets. With the recently completed joint rule further defining "swap," compliance for all spot-month limits will go into effect in approximately two months.
The Commission approved a proposed rule in May that would modify the CFTC’s aggregation provisions for limits on speculative positions. The proposal would permit any person with a 10 to 50 percent ownership or equity interest in an entity to disaggregate the owned entity’s positions, provided there are protections and firewalls in place to ensure trading decisions are made independently of one another.
Two associations representing the financial industry are challenging the agency’s final rule establishing position limits in court. The Commission is vigorously defending the Congressional mandate to implement position limits in court.