Resources for Increased Economic Cost Benefit Analysis
The additional resources requested for economic analysis will be invested in building the Commission’s capacity to systematically analyze large volumes of trade data and improve our understanding of the markets.
The additional investment in economic capabilities will boost the CFTC’s analytical expertise and monitoring of systemic risk in the derivatives markets, in particular with regard to central counterparty clearinghouses. It includes the expansion of sophisticated econometric and quantitative analysis devoted to risk modeling, stress tests, and other evaluations necessary for market oversight. Furthermore, such analysis will help the CFTC fulfill the Presidential Executive Order on Core Principles for Regulating the U.S. Financial System, relating to the core principle of fostering economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk and market failures, such as moral hazard and information asymmetry.
A common criticism of the rule-making process has been the lack of quantitative assessments of costs and benefits. While there was a paucity of relevant data for Dodd-Frank implementation, we believe that market participants and the public expect the CFTC to leverage the data sources now available to inform future rulemaking. The current staff dedicated to economic analysis is inadequate to meet appropriate standards for econometric analysis required by a regulatory agency with oversight of more than 35 to 45 percent of the global derivatives markets.
Looking beyond rulemaking, the new data sets have opened up possibilities for more effective analysis of the U.S. derivatives markets. For example, Commission economists are focused on developing the capability to integrate activity and positions across futures and swaps markets, and thus gain a holistic view into the derivative exposures of market participants and the interaction between the futures and swaps markets.
There is growing awareness that just looking at the total notional size of activity in the market might not be representative of the true extent of risk transfer. We have taken some initial steps to convert notional amounts into risk-based measures; however, additional resources are necessary to develop these analytical capabilities. Without the requested increase, the CFTC will continue to rely on outdated, anachronistic models and metrics of studying our markets.
Resources for Examinations to Cover Increased DCOs
The Commission is also requesting additional resources that would strengthen the Commission's examinations capability and enable it to keep pace with the explosive growth in the number and value of swaps cleared by designated clearing organizations (DCOs), pursuant to global regulatory reform implementation. As the size and scope of DCOs has increased, so too has the complexity of the counterparty risk management oversight programs and liquidity risk management procedures of the DCOs under CFTC regulation here and abroad.
Currently, there are 16 DCOs registered with the Commission and there is one pending application for registration. The Commission projects that the number of DCOs will continue to expand in FY 2018, and volume will continue to grow at existing DCOs. Since the end of 2011, the total amount of initial margin held by registered DCOs for futures and swaps has grown by more than 168 percent from $119 billion to $320 billion. For swaps alone, the growth is even more dramatic. For example, at LCH Clearnet Ltd, the amount of initial margin held for swaps has grown by more than 600 percent since 2010.
The growth in volume has been accompanied by an increase in the complexity of products. For example, the risks posed by credit default swaps differ from those posed by interest rate swaps. Accordingly, DCOs have developed a large number of individualized margin models and other risk management tools to address these risks. This, in turn, generates a corresponding increase in the complexity of the Commission’s oversight responsibilities.
The Commission is seeking to position additional resources to enable it to continue to fulfill its responsibilities relating to systemic risk. Increases in the number of DCOs, the volumes cleared, and the complexity of the products necessitate increases in the resources devoted to the oversight of clearing, through timely and thorough examinations of DCOs. These examinations cover a range of issues from the size of financial resources, to margin, to treatment of customer funds, and cyber security. In addition, the Commission will also continue to develop capabilities for conducting stress testing and back testing to assess the impact of stressful market scenarios across the clearinghouses.
Many of the DCOs are expanding their registration in other jurisdictions around the world. Those jurisdictions look to the Commission to provide insight regarding the effectiveness of the programs implemented by the DCOs. The Commission supports the expanding market participant registrations through information sharing and compliance discussions in the areas of cybersecurity, liquidity risk management, default management and other high profile risk management issues.
Resources to Further Implement FinTech
Earlier in the year, President Trump issued an Executive Order establishing an American Technology Council. The President said, “It is the policy of the United States to promote the secure, efficient, and economical use of information technology to achieve its missions. Americans deserve better digital services from their Government. To effectuate this policy, the Federal Government must transform and modernize its information technology and how it uses and delivers digital services.”