CFTC Global Markets Advisory Committee Meeting

Commodities Futures Trading Comission (CFTC)

Global Markets Advisory Committee (GMAC)

Monday, April 15, 2019

Key Topics & Takeaways

  • Shunsuke Shirakawa (Japan Financial Services Agency) identified three priorities of Japan’s G20 presidency: (1) market fragmentation, (2) technological innovation, and (3) societal aging.
  • Steven Kennedy (ISDA) discussed potential actions that policymakers can take to reduce regulatory-driven market fragmentation.  These include recognizing the importance of global markets in developing cross-border regulations, reducing the gap between global standards and domestic regulations, and implementing global standards where appropriate (such as for smaller jurisdictions).
  • Nicolette Cone (ISDA) laid out three outstanding issues relating to centralized cross-border trading; (1) Fragmented liquidity; (2) the “Footnote 88” issue related to non-US trading platforms denial of access to US persons; and (3) Overlapping mandatory trading obligations.
  • Colin Lloyd (Cleary) explained the current framework for U.S. customer access to non-U.S. CCPs, and noted three key issues, including: (1) to provide access for non-U.S. CCPs, a clearing firm typically must have both a U.S. FCM affiliate that clears U.S. customer business and a non-U.S. affiliate that clears non-U.S. customer business; (2) the structure directly exposes the U.S. FCM to the non-U.S. CCP’s risk mutualization framework and can increase the overall firm’s liquidity/funding risk and CCP exposure; and (3) the non-U.S. CCP must directly satisfy U.S. customer protection requirements, which may not in all cases be consistent with local equivalents and has in some cases necessitated relief from the CFTC. Lloyd then laid out the FIA/SIFMA proposal that the CFTC adopt an approach to foreign cleared swaps modeled on Part 30’s approach to foreign futures.
  • On Phase-in, Rafael Martinez (CFTC) candidly admitted that the WGMR got the implementation schedule “pretty wrong,” noting that Phase 5 would bring into scope 1,110 entities, versus only 34 entities in Phases 1-3. He elaborated that there was a question regarding possible “congestion” as the new swap relationships will require IM documentation, and custodial arrangements in place by September 2020.
  • David Aron (CFTC) discussed the trade reporting global harmonization work in three specific areas: (1) Legal Entity Identifiers (LEIs); (2) Unique Transaction Identifiers (UTIs); and (3) Unique Product Identifiers (UPIs). He noted that there will be a report on LEI technical guidance later this year.

Opening Statements & Introduction

Speakers

  • Commissioner Dawn D. Stump (GMAC Sponsor)
  • Chairman J. Christopher Giancarlo

In her opening statement, CFTC Commissioner Stump outlined the objectives of the GMAC, saying the objectives are to help the Commission determine how it can avoid unnecessary regulatory or operational impediments to global business while still preserving core protections for customers and other market participants. Additionally, Stump stated another objective of the GMAC is to assist the Commission in assessing the impact on U.S. markets and firms of the Commission’s international efforts and the initiatives of foreign regulators and market authorities. Commissioner Stump then turned to the agenda, noting that the focus of the meeting was on an examination of the status of the key pillars of the Group of 20 (G20) directive regarding the OTC derivatives market.

In his opening statement, CFTC Chairman Giancarlo stated that today’s GMAC will consider how the OTC derivatives market reforms are being implemented at the G20 nation state level in a fashion that is “consistent,” though not identical. He referenced the concern about whether disparate implementation of the reforms is causing undue fragmentation in global markets, challenges in swaps trading, and reducing market fragility. Further, he noted that fragmentation leads to smaller, disconnected liquidity pools and less efficient and more variable pricing. Giancarlo outlined the issue as that of how to conduct reform implementation in ways that are well calibrated to systemic risk mitigation while balancing undue market fragmentation. He then mentioned the Cross-Border Task Force, set up by IOSCO in 2013, that examines ways to assist member authorities with the challenges of cross-border regulation and to promote sound and effective domestic regulation without unduly constraining cross-border trade, investment, and risk mitigation. The Task Force published a report in 2015 that identified three basic tools used by regulators to regulate cross-border securities market activities: (1) national treatment; (2) recognition; and (3) passporting. Additionally, he mentioned the tasks the group has been assigned and mentioned that they are in the process of writing up observations and considerations following outreach to IOSCO members, the industry, and other stakeholders.

Panel 1 – Overview of Financial System Issues for the 2019 G20 Japan Presidency

Presenter

  • Shunsuke Shirakawa, Vice Commissioner for International Affairs, Japan Financial Services Agency

After giving a brief history of the G20’s activity, Shirakawa noted that the G20 focus is now shifting from developing new policies to evaluating past reforms and addressing new vulnerabilities. Shirakawa noted that the goals of Japan’s presidency are to remain committed to consistent implementation of financial reform and the evaluation of its effects, including a consideration of whether the reforms are achieving the intended outcome and to identify material unintended consequences. Shirakawa then identified three priorities of Japan’s presidency in monitoring and addressing emerging risks and vulnerabilities related to: (1) market fragmentation, (2) technological innovation, and (3) societal aging.

Market Fragmentation

Shirakawa discussed how to address market fragmentation generally and stated that the FSB and IOSCO have launched an initiative to identify the sources of market fragmentation. He stated that market fragmentation may be the result of inconsistent, overlapping, or incompatible regulations or supervisory practices. Shirakawa noted that Japan will focus on market fragmentation resulting from inconsistencies among international standards; jurisdiction-specific policies; and incompatibilities between domestic and foreign requirements. Shirakawa stated that all of these factors may affect cross-border trading and clearing of OTC derivatives, cross-border management of capital and liquidity, and the sharing of information across borders.  Shirakawa then proposed four phases of an approach to address market fragmentation: (1) development of international standards; (2) domestic rulemaking in each jurisdiction; (3) deference and recognition of foreign regulations; and (4) cross-border cooperation among supervisory authorities, enhancing trust among authorities.

Technological Innovation

Shirakawa discussed the need to address and improve the treatment of technological innovation in the financial sector. Shirakawa stated that one immediate need is to mitigate risks posed by crypto-assets, due to their borderless nature. He stated that the Financial Action Taskforce is expected to submit an interpretive note in June to the G20. Additionally, Shirakawa highlighted that the FSB published a directory of crypto-regulators to form a basis for cross-border supervisory cooperation and is working to identify potential regulatory gaps. Shirakawa also highlighted that IOSCO is preparing a report for public consultation on regulatory approaches to issues related to crypto-assets.

Shirakawa then discussed the FSB’s focus on the underlying decentralized financial technology its implications for financial stability, regulation, and governance. Shirakawa particularly noted that the technology may reduce or eliminate the need for intermediaries. Shirakawa stated that in Japan’s June meeting there will be a panel discussion on the future of the financial landscape in light of blockchain technology.

Aging

Shirakawa discussed financial inclusion in the context of an aging society, noting that there is an international growth in the population of individuals aged 60 or older. Shirakawa stated that many people around the world, particularly in locations with less-developed economies and limited financial infrastructure, will face difficulty in accessing necessary life-planning financial products, especially as they age and their decrease in acuity impedes their financial decision-making. Shirakawa stated that increased longevity is estimated to significantly increase expenses and need for financial security.  Shirakawa stated that Japan will chair the Global Partnership for Financial Inclusion and work to improve financial inclusion, with the intention of submitting a report on the topic in June, and will host a high-level financial symposium in June featuring regulators and leaders in areas including financial services, geriatrics, and life planning.

Panel 2 – Regulatory-Driven Market Fragmentation

Presenter

  • Steven Kennedy, Global Head of Public Policy, ISDA

Kennedy began by stating that derivatives markets are particularly sensitive to market fragmentation issues because they have historically been the most global. Kennedy cited a paper ISDA published earlier this year giving specific examples of regulatory-driven market fragmentation.  Specifically, Kennedy emphasized that sources of market fragmentation can be divided in almost any aspect of the derivatives markets, and that several market fragmentation issues affect capital and margin rules, which Kennedy stated need to be addressed on a global level and implemented on a local level.

Examples of regulatory-driven market fragmentation:

  • Extraterritoriality: Kennedy discussed extraterritoriality, substituted compliance, and deference, and mentioned that recent positive developments indicate willingness among policy-makers to cooperate.
  • Capital: Kennedy stated that there exist significant uncertainties about the extent and implementation of market risk capital rules, and identified issues including inconsistencies related to Net Stable Funding Ratio, Credit Valuation Adjustment, and Leverage Ratio.
  • Initial Margin for Non-Cleared Swaps: Kennedy highlighted jurisdictional inconsistencies among the timeframes for posting margin, collateral eligibility requirements, the posting of IM for inter-affiliate transactions, and the requirement of SIMM back-testing
  • Clearing: Kennedy noted discrepancies across jurisdictions regarding clearing location policies, client clearing requirements, and requirements for Margin-Period-of-Risk (MPOR).
  • Other Jurisdictional Discrepancies: trading location policies as well as policies for trading personnel location; reporting requirements for trades and different definitions for data required to be reported; eligible counterparties and transactions covered by netting; and benchmarks, noting a new EU benchmark regulation that will come into effect in two years

Potential Solutions

Kennedy then discussed potential actions that policymakers can take to reduce regulatory-driven market fragmentation.  These include recognizing the importance of global markets in developing cross-border regulations, reducing the gap between global standards and domestic regulations, and implementing global standards where appropriate (such as for smaller jurisdictions). Kennedy also stated that policymakers implement a risk-based framework for evaluating and recognizing regulatory regime comparability.

Q&A

GMAC Chair Angie Karna asked why market fragmentation has become a key priority and what the concerns are that impact firms and members. Jim Colby (Coalition of Derivatives End Users (Honeywell)) expressed that many benefits the CFTC has conferred are undermined by lack of global coordination, especially considering how much of their trading is cross-border.

Karna then asked what areas the CFTC should be prioritizing. Paul Hamill (Citadel) emphasized the importance of addressing liquidity fragmentation. Chairman Giancarlo noted that capital rules are largely set by prudential regulators and central banks, and are not led by market regulators. Giancarlo stated that this results in difficulty when seeking to influence the regulations and capital requirements even though such requirements have an essential role in derivatives markets. Giancarlo stated that many capital rules are biased against derivatives and clearing, even though clearing was one of the core mandates of the G20 itself. Darcy Bradbury (D.E. Shaw) emphasized the importance of efficiency and obtaining useful data.

Karna then asked about the potential solutions the panelists presented, specifically asking which is most important and inviting suggestions for other potential solutions. Amy Hong (Goldman Sachs) stated that there ought to be an ongoing regulatory review process globally and across all different types of regulators, including trading and prudential, especially considering the dynamic nature of markets in responding to market conditions and regulations. Ashley Belich (RBC) expressed the difficulty that arises for a Canadian bank in light of discrepant regulations among different jurisdictions. Belich stated that equivalence is a high priority for non-U.S. banks. Robert Klein (Citi) agreed with Colby and stated that multiple solutions need to be implemented to address fragmentation.

Chairman Giancarlo referenced Bradbury’s point on data and trying to move toward more risk-based approaches for data. Giancarlo discussed the work of the Chief Economist’s Office in establishing a new way of establishing size of markets using entity netted notionals (ENNs) and moving away from the gross notional amount. Giancarlo encouraged market participants to start moving toward the ENN approach, which in turn would assist regulators in evaluating risk (for example, when setting thresholds).

Panel 3 – Trading on Exchanges or Electronic Trading Platforms and Clearing Through Central Counterparties

Panelists

  • Nicolette Cone, Counsel and Director, ISDA
  • Colin Llyod, Partner, Cleary Gottlieb Steen & Hamilton LLP

Nicolette Cone (ISDA) began the panel by laying out three outstanding issues relating to centralized cross-border trading, and three recent achievements that have been helpful for market participants. The three outstanding issues were: (1) Fragmented liquidity; (2) the “Footnote 88” issue, which related to non-US trading platforms denial of access to US persons; and (3) Overlapping mandatory trading obligations. She noted the third was a newer problem, and effects firms that operate globally. Cone then introduced ISDA’s White Paper that analyzed the effect of mutual recognition on the order flow of trades executed on these venues, highlighting benefits and pointing to areas where further alignment was welcome.

Cone continued the presentation by walking through order flows of Multilateral Trading Facilities (MTFs) and Organised Trading Facilities (OTFs), as well as the Swap Execution Facility (SEF) order flow. ISDA concluded that (1) trading venue recognition has had a positive effect on cross-border centralized trading; and (2) granting recognition for certain rulesets, but not others, continues to introduce complexity to cross-border trading. Further, Cone noted that ISDA advocates for a holistic risk-centered, outcomes-based approach in issuing comparability determinations, and recommended regulators allow de minimis trading activity in emerging market jurisdictions.

Colin Lloyd, Cleary Gottlieb Steen & Hamilton LLP, began by stating that he will be discussing the December 2017 Whitepaper published by FIA and SIFMA titled Promoting U.S. Access to Non-U.S. Swaps Markets: A Roadmap to Reverse Fragmentation, and introduced some reactions to Chairman Giancarlo’s Cross-Border Swaps Regulation Version 2.0 Whitepaper  published in October 2018. Lloyd gave background on cross-border trading in both the listed derivatives and cleared swaps markets. He noted that for the swaps regime most cross-border trading in cleared swaps takes place between the U.S. and E.U., but that regulators should not forget other marketplaces as we are starting to see clearing mandates in other jurisdictions. Moreover, he noted that in the future increased demand for U.S. access to additional non-U.S. CCPs, can be expected because of the expansion of initial margin requirements for uncleared swaps.

Lloyd continued by explaining the current framework for U.S. customer access to non-U.S. CCPs, and notes three key issues, including: (1) to provide access for non-U.S. CCPs, a clearing firm typically must have both a U.S. FCM affiliate that clears U.S. customer business and a non-U.S. affiliate that clears non-U.S. customer business; (2) the structure directly exposes the U.S. FCM to the non-U.S. CCP’s risk mutualization framework and can increase the overall firm’s liquidity/funding risk and CCP exposure; and (3) the non-U.S. CCP must directly satisfy U.S. customer protection requirements, which may not in all cases be consistent with local equivalents and has in some cases necessitated relief from the CFTC. Llyod then laid out the FIA and SIFMA proposal that the CFTC adopt an approach to foreign cleared swaps modeled on Part 30’s approach to foreign futures. In addition to laying out the proposal, Lloyd also noted implications for non-U.S. CCPs, and how the FIA/SIFMA proposal could be implemented.

Lloyd then discussed CFTC Chairman Giancarlo’s Cross Border 2.0 white paper. He noted that the white paper addressed certain aspects of FIA/SIFMA’s proposal regarding U.S. customer access to non-U.S. CCPs.

Q&A 

Chair Karna began by asking how the current cross-border guidance is going for firms. Muthukrishnan Ramaswami (Singapore Exchange Limited) responded by stating that his firm hasn’t seen an ability of global clearing members to take up two clearing memberships, and that a form of mutual recognition or third-party recognition is probably the best solution moving forward. Sunil Cutinho (CME) agreed with Ramaswami and noted that the framework for futures could be extended to swaps, and emphasized the importance of reciprocity.

Joseph Ciseweski (Better Markets) stated that he believed the papers presented oversimplified policy, and questioned the source of the materials, given whom they represent. He noted that we should seek to avoid fragmentation, but that is one concern that needs to be balanced with other competing policy objectives. Ciseweski stated that the CFTC has a workable regime for recognizing comparable jurisdictions and does not take an undue deferential approach. He noted that there are good reasons to consider the conflicts of interests that non-U.S. regulators have in not enforcing U.S. laws, and that from a public interest perspective, U.S. law should be applied strictly and not deferentially.

Klein responded by saying that Dodd Frank was not developed in a vacuum, but it was based on core principles laid out by the G20. Klein continued, noting that the public interest is not being sacrificed by pointing out that market fragmentation is a problem, and it is a false dichotomy to say that non-U.S. regulations are less prescriptive than the U.S. regulator regime. Cutinho also responded that there was an assumption in his statement that deference is less comprehensive than US regulations, because the presumption that the U.S. is far stronger than everywhere else isn’t necessarily true. David Goone (Intercontinental Exchange) commented that it is difficult for regulators to coordinate, but market fragmentation is a huge cost to the industry, and it hasn’t necessarily made the industry any safer.

Hamill urged that market participants breakdown what we talk about when we talk about fragmentation of liquidity. He stated that his firm has seen a lot of bank centric concerns presented, with very little mention of protecting key tenants of end users, such as impartial access. Additionally, Hamill emphasized the clear intangible benefits of pre and post-trade transparency.

Chair Karna then asked what some of the specific trading are and/or clearing challenges that members’ firms/clients have had to deal with, and other areas they’d suggest the Commission change.

Commissioner Berkovitz noted that as he looked at the ISDA presentation and recommendations, it seemed to him they are things the CFTC is already doing. He stated that the 2013 CFTC guidance and approach is very risk based. Further, he stated that he would like to get feedback as to whether what the CFTC has been doing is considered risk-based and outcomes-based. Klein responded that he thinks the answer is yes, the CFTC is acting consistently with the recommendations. However, he noted that there are other areas where more needs to be done, for instance the Footnote 88 issue. Additionally, Klein noted that there continues to be minor technical disconnects, like in trade reporting rules.

Panel 4 – Initial Margin for Non-Centrally Cleared Derivatives Contracts

Panelists

  • Rafael Martinez, Senior Financial Risk Analyst, Division of Swap Dealer and Intermediary Oversight
  • Richard Haynes, Supervisory Research Analyst, Office of the Chief Economist, CFTC

Mr. Martinez (CFTC)began the fourth panel by walking through the framework of the initial margin rules and gave background on BCBS-IOSCO’s working group to develop margin standards for uncleared swaps (“WGMR”). He then explained the qualitative impact statement that took place in 2012. Most notably, he stated that at the time of the report 39 firms that contributed information, and although the WGMR reached out to 9 non-bank firms only one firm responded. Further, he noted that the WGMR determined that the information provided by the sole firm was too specific to be included in the qualitative statement without giving away confidential information.

On phase-in, Mr. Martinez candidly admitted that the WGMR got the implementation schedule “pretty wrong,” noting that Phase 5 would bring 1,110 entities in scope, versus only 34 entities in Phases 1-3. He elaborated that there was a question regarding possible “congestion” as the new swap relationships will require IM documentation, and custodial arrangements in place by September 2020.

Following Mr. Martinez’s presentation, Richard Haynes presented data analysis that was included in the CFTC’s “Initial Margin Phase 5” White Paper, published in October 2018. Specifically, Mr. Hanes noted the white paper anticipates that Phase 5 entities significantly outnumber those of the other four phases, and that Phase 5 entities are concentrated around the low end of the threshold. The white paper also concluded that most (75%) of the Phase 5 entities will have less than $50 billion AANA, while comprising of just 30% of cumulative AANA.

Q&A

Chair Karna asked if members could comment on challenges that smaller entities might face complying with Phase 5. Supurna VedBrat (Blackrock) responded that there are unique challenges faced by the buy-side in relation to the significant amount of relationships that need to be established as a result of including physically-settled FX, and best execution. Specifically, she stated that from an asset manager perspective, to comply with best execution it’s imperative that mangers have relationships with dealers and counterparties, and for FX specifically, it is not uncommon for a single asset manager to have up to 24 relationships. Additionally, VedBrat added that the inability to see any derivatives activity a separately managed account has with another manager will be extremely difficult when trying to monitor whether the client breaches the exchange threshold. Finally, VedBrat recommended the GMAC set up a working group to figure out how the industry can make recommendations to regulators, similar to the way it was done with the minimum transfer amount (MTA).

Alexandra Guest (Cargill Risk Management) noted that even if you exempt physically-settled FX there will still be a significant number of relationships which can add to the “bottleneck” issue. Guest remarked that Phase 5 is largely comprised of smaller institutions, each with unique circumstances, and even with the help of vendor tools it will still be extremely difficult for firms to comply. Bradbury noted that her firm would need to re-negotiate all of their agreements, and that they are daunted about going through this process along with thousands of others. Masahiro Yamada (JP Morgan) commented that re-cutting to a more manageable population that is more systemically important might be the right approach to addressing this issue. Chris Allen (Standard Chartered Bank) added that a cost/benefit analysis should be done on the basis that many clients potentially in scope for Phase 5 would have to go through negotiations and may never have to post IM.

Chairman Giancarlo questioned whether there might be some measures that would be more meaningful in risk weighting than notional. Further he commented that notionals were used because at the time there weren’t better measurements, and that at some point we need to move away from notional amounts. Guest responded that she believes there are and would want to have that discussion with a broader group.

Thomas Sexton (NFA) stated that he has a concern about the smaller dealers that would be in scope for Phase 5. He noted that the NFA performs a unique role in approving IM models for firms, and that in earlier phases it took 8 months to work with the biggest dealers on model implementation, and feels they would need the full 18 months to work with the 20 or so different firms in Phase 5. Further, he questioned whether these firms had the infrastructure, and 3rd party relationships they can rely upon to have their IM models approved.

Mr. Martinez then noted the clarification recently made by BCBS-IOSCO that documentation would not be necessary until you cross the $50 million exchange threshold. However, he noted that regulators needed to clarify expectations on what firms need to do as they approach $50 million, and what needs to done once a firm reaches $50 million. Moreover, he noted that he is aware of the asset manager issues, and specifically the problem surrounding clients with separately managed accounts.

Karna asked whether the BCBS-IOSCO statement went far enough, and Bradbury responded that it was a good first step however, regulators need to tell firms how it actually works in practice. Further, Bradbury stated that ‘the clock is ticking’ and firms need guidance this summer because it will take at least a year to get documentation in place. Chairman Giancarlo noted that the CFTC is very aware of that issue.

Commissioner Stump closed the panel by noting that there are certainly a number of operational challenges and posed the question of whether we are missing the objective. Mr. Martinez responded by stating the challenges of working alongside many different jurisdictions, small and large, in the WGMR which puts pressure on their lookback at the margin rules.

Panel 5 – OTC Derivatives Reporting to Trade Repositories

Panelists

  • David Aron, Special Counsel, Division of Market Oversight, CFTC
  • Kate Delp, Executive Director and General Manager, GTR Americas, DTCC

David Aron, CFTC DMO, began by giving an update on DMO’s Swap Data Roadmap review and global harmonization work. He noted that in 2017 DMO published a roadmap with several priorities including harmonizing data fields across SDRs and streamlining reporting and increasing the utility of swaps data. Moreover, he gave updates on work being done at the CFTC to review reporting rules under Part’s 43, 45, and 49. Further, Aron discussed the trade reporting global harmonization work in three specific areas, (1) Legal Entity Identifiers (LEIs); (2) Unique Transaction Identifiers (UTIs); and (3) Unique Product Identifiers (UPIs). He noted that there will be a report on LEI technical guidance later this year.

Next, Kate Delp began by talking about who DTCC is and did a review of trade reporting. She gave a brief history on the creation of trade repositories and challenges that DTCC faced. Delp laid out the progress that has been made to date on (1) collaboration between regulators, regulated firms, and industry bodies to share experience information and perspective, (2) establishing global standards that harmonize reporting practices across jurisdictions, and (3) parties have worked toward removing barriers to data sharing and third-party access. On shaping the future, Delp noted that there will be increased coordination among jurisdictions, and that the proliferation of technology innovation, including artificial intelligence and distributed ledger technology will improve the reporting process and increase the usefulness of collected data.

Q&A

Karna kicked off with asked how transparency with respect to swaps data has impacted strategies in the institution’s members represent. While not directly answering the Chair’s question, members made comments surrounding transparency, streamlining data, and data privacy. Hong commented that transparency in the markets is helpful in instilling confidence in markets. Ms. Bradbury noted that her firm has experienced inadvertent data breaches by regulators, exposing market participant’s positions, and commented that we need to protect people’s confidential information.

On harmonizing data reporting, Guest commented that anything the commission can do to simplify and streamline is extremely helpful due to the challenging nature of changing products and other reporting challenges. Belich noted that having the same system to handle unharmonized reporting across jurisdictions is a huge challenge, and that the CFTC has been good to date about giving relief to market participants in this area.

On fragmentation, Yamada noted that duplication and fragmentation in the market has led firms to recreate the systems that do the exact same things multiple times, and that this is a challenge for smaller and medium sized banks.

The session ended with remarks from Chairman Giancarlo. The Chairman mentioned the success that the Alternative Reference Rates Committee (ARRC) has had to date, and that as we talk about international data field harmonization, regulators will need to work this out like the ARRC has. He noted one thing that regulators have struggled with in LEIs is regional differences and he has been outspoken about he’s upset about the lack of progress to date.

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