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Senate Agriculture Committee on Derivatives Market and CFTC Reauthorization

Senate Agriculture Committee

“The State of the Derivatives Market and Perspectives for CFTC Reauthorization”

Tuesday, June 25, 2019

 

Key Topics

  • Automated Trading: Sexton replied that the NFA has tools in place to monitor members and volatility. Lukken responded that the CFTC has the adequate tools to guard against market changes due to manipulation, but that overall automated trading has brought liquidity to the market. Kelleher responded that though automated trading has brought liquidity into the market, the technology is far ahead of regulators and that due to limitations in funding and authority the CFTC may not be able to adequately handle associated issues.
  • CCP Equivalence in the EU: Lukken replied that the FIA fully supports the EU coming out with a full deference report, noting that CFTC regulation is very strong and equivalent to the EU’s. Lukken replied that the equivalence concept has largely been accepted as an international standard. Further, he opined that the EU should do the right thing and acknowledge the equivalence agreement made in 2016.
  • Cybersecurity: Sexton responded that the NFA views this problem as a high-risk area, and over the past few years it has significantly increased its technology personnel and budget to protect its systems while adopting policies for members to create plans to guard against threat.

Witnesses

 

Opening Statements

Chairman Pat Roberts (R-Kans.)

In his opening remarks, Roberts noted the importance of the Commodity Futures Trading Commission’s (CFTC) work in implementing law governing the world-wide derivative markets as authorized in the Commodity Exchange Act, and noted that the agency has operated without authorization since 2013. He acknowledged the rollout of Dodd-Frank-required regulations and also cautioned that legislative efforts in the European Union that could have the “unfortunate effect” of undoing agreed-upon mutual recognition of foreign-based clearinghouses, which would “likely create uncertainty” for global financial stakeholders.

Roberts stressed the importance of moving forward with reauthorization to provide the CFTC with certainty, while also listening to stakeholders to better understand how the agency’s rules are working and explore what provisions may need a legislative update to reflect current and future market dynamics.

Ranking Member Debbie Stabenow (D-Mich.)

In her opening remarks, Stabenow noted the decade-long gap between now and the last time the CFTC received congressional re-authorization and said the CFTC provides certainty in our futures and swap markets for Main Street investors, businesses, consumers and farmers. Stabenow commented that the financial crisis caused the American people to “lose faith” in the ability of banks to “do what’s right” and in the ability of the government to protect the economy. She stressed that as Congress considers re-authorizing the CFTC, it must not roll back important reforms implemented since the crisis, and it should also be forward-looking in considering issues on the horizon such as cybersecurity. She called cybersecurity “arguably the greatest systemic risk” that the financial system faces today and voiced concern over cyberattacks by foreign adversaries and other bad actors. Stabenow also emphasized that Congress must “do everything we can” to ensure the CFTC keeps markets strong and free of fraud, manipulation and disruptive practices.

Testimony

Thomas W. Sexton, President & CEO, National Futures Association (NFA)

Sexton began his testimony by emphasizing NFA’s role as the industry self-regulatory organization (SRO) for the derivatives market under the CFTC’s oversight. He stated that the NFA strongly supports the CFTC’s re-authorization and urged the Committee to amend Section 20 of the Commodity Exchange Act (CEA) to ensure that customers have priority if there is a shortfall in consumer funds.  Sexton continued by giving an overview of the changes to NFA’s oversight responsibility since the Dodd-Frank Act, including the assumption of regulatory authority over swap dealers and swap execution facilities. Sexton also highlighted the critical importance of cybersecurity and customer protection issues

Walter L. Lukken, President & CEO, Futures Industry Association (FIA)

Lukken began his testimony by addressing market trends since the CFTC’s last reauthorization. He noted four key trends in the market since 2008: 1) increased volume in futures and options; 2) markets are safer since the implementation of post-crisis reforms; 3) markets are increasingly global, with foreign participants adding important liquidity to the market that keeps costs affordable for domestic customers hedging risk; and 4) technology has transformed markets and provided greater efficiencies and lower costs. Lukken said the FIA supports the CFTC’s existing principles-based approach to regulation, comment that it allows the CFTC to tailor regulations to an ever-changing market while maintaining access to the global markets.

Lukken also discussed some of the FIA’s concerns, including how recent revisions to the European Market Infrastructure Regulation legislation (EMIR 2.2) may require direct compliance with substantial elements of EU law and supervision by EU regulators for U.S. clearinghouses deemed systemic unless EU regulators find U.S. supervision equivalent. He explained that without proper recognition of home country supervision, this could lead to contradictory requirements, duplicative supervision, and counter-reactions by global regulatory authorities.

Joe Barker, Director of Brokerage Services, CHS Hedging
Barker began his testimony by stating that he was testifying on behalf of the National Council of Farmer Cooperatives (NCFC). Barker said agriculture markets are increasingly volatile due to ongoing international trade negotiations and an extremely wet spring. To manage such large commodity price risks and movements, Barker explained, cooperatives rely on highly functioning derivatives markets. He Barker encouraged Congress to provide sufficient funding through appropriations for the CFTC to perform its important functions. However, he cautioned against imposition of any type of user fee on the industry to fund the CFTC because a further increase in cost structure due to higher transaction costs would discourage prudent hedging practices. Lastly, regarding position limits, Barker urged the CFTC to recognize common commercial hedging practices, such as anticipatory hedging and cross hedging, as bona fide hedges in that rule.

Dennis M. Kelleher, President and CEO, Better Markets

Mr. Kelleher began his testimony by giving a brief summary of the 2008 financial crisis and the regulations promulgated under Dodd-Frank that addressed the derivatives market. He emphasized the key role derivatives played in precipitating and transmitting the financial crisis and explained that derivatives regulation is an essential part of comprehensive financial reform that protects the American taxpayer from again having to bail out the financial industry. However, Kelleher stated that the CFTC has historically been underfunded and proposed the idea of establishing transaction or user fees on trades executed in the futures, options and swaps markets, similar to similar fees imposed on issuers and traders in equity markets that help fund the Securities and Exchange Commission. He argued that that a small user fee could easily raise the level of funding that the CFTC desperately needs, and denied that such a free would harm liquidity or otherwise disrupt or burden the markets or market participants.

Question & Answer

Automated Trading

Sen. Charles Grassley (R-Iowa) asked panelists how the speed and frequency of automatic trading can affect the derivatives markets. Sexton replied that the NFA has tools in place to monitor members and volatility. Lukken responded that the CFTC has the adequate tools to guard against market changes due to manipulation, but that overall automated trading has brought liquidity to the market. Kelleher responded that though automated trading has brought liquidity into the market, the technology is far ahead of regulators and that due to limitations in funding and authority the CFTC may not be able to adequately handle associated issues.

CCP Equivalence in the EU

Roberts questioned Lukken on the issue of CCP equivalence in the EU post-Brexit, specifically asking whether this is in conflict with the 2016 equivalence agreement between the CFTC and the EU, and whether there is there anything within the context of re-authorization that could be done. Lukken replied that the FIA fully supports the EU coming out with a full deference report, noting that CFTC regulation is very strong and equivalent to the EU’s.

Sen. Richard Durbin (D-Ill.) addressed the panel about Brexit, and noted he noted that as EU members look to drive business and clearing away from the UK, U.S. clearing houses could be harmed. Durbin asked what is under consideration to ensure the contours of equivalence are maintained. Lukken replied that the equivalence concept has largely been accepted as an international standard. Further, he opined that the EU should do the right thing and acknowledge the equivalence agreement made in 2016.

CFTC Funding & Resources

Roberts asked Barker whether end-users have efficient, effective and fair access to the futures markets, and whether any fees or position limits may affect access. Barker replied that they do, however, the concern is that eventually these user fees trickle down and could reduce liquidity. Regarding position limits, Barker stated that the agricultural business is largely dependent on the ability to hedge against risk and certain crops, such as durum wheat have no derivatives market.

Sen. Tina Smith (D-Minn.) commented that there has been significant economic growth yet many Minnesotans in the agricultural market are still suffering because there is no regulatory regime in place to oversee the swaps markets. She asked Kelleher if he thinks the CFTC has the resources to effectively oversee this market. Kelleher responded that statutory duties are grossly underfunded, and that the CFTC could not oversee the market it in this current climate.

Consolidation of FCMs

Sen. John Boozman (R-Ark.) asked Mr. Lukken to address a point he raised in his opening testimony about the consolidation FCMs in the U.S. Mr. Lukken replied that FCMs play a critical role as the safety net in the clearing system, given that the first absorption of losses when a clearing member defaults are the FCMs. He continued that part of that safety net is from capital charges banks face that hold capital against clearing.

Cybersecurity

Stabenow expressed her concerns on cybersecurity and asked how we can prepare our markets for cyberattacks. Sexton responded that the NFA views this problem as a high-risk area, and over the past few years it has significantly increased its technology personnel and budget to protect its systems while adopting policies for members to create plans to guard against threat.

Virtual Currencies

Roberts addressed the entire panel, referencing the recent announcement that Facebook has plans to offer its own currency and Bitcoin’s reemergence as a viable commodity. He asked what role regulators should play in virtual currency and blockchain technology.

Sexton responded that the role regulators should play is to cautiously allow for innovation, adding that over the past year the NFA has dealt with virtual currency issues such as disclosure and customer protection. He noted that there have been talks of establishing an SRO overseeing virtual currency and that, if Congress chooses to regulate this area, there need to be mandatory compliance and strong enforcement powers.

Lukken responded that the CFTC has broad anti-manipulation and enforcement authority over these products. He said crypto assets are unique in that, unlike agriculture and energy, they have no regulatory structure at the cash level.

Kelleher responded that both Chairman Giancarlo of the CFTC and Chairman Clayton of the SEC have been proactive on this issue to make sure customers are informed and protected. However, he emphasized that the CFTC will not be able to keep up with advancements in this space with their current level of resources and funding.

For more information on this hearing, please click here.

 

 

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