CFTC MRAC Meeting
Commodity Futures Trading Commission
Market Risk Advisory Committee Meeting
Wednesday, June 12, 2019
Opening Statements
Rostin Behnam, MRAC Sponsor and Commissioner, CFTC
In his opening remarks, Benham described climate-related financial market risks as “critically important.” He stated that as most of the world’s markets and market regulators are taking steps towards assessing mitigating the current and potential threats of climate change, “we in the U.S. must also demand action from all segments of the public and private sectors, including this agency.” He acknowledged the efforts of the Network for Greening the Financial System (NGFS), a group of more than 30 central banks and supervisors from around the world, to better understand and manage the financial risks of climate change and noted that man of these supervise the same market participants as the CFTC. He also pointed to the work of the Financial Stability Board’s (FSB) Task Force on Climate-Related Financial Disclosures (TCFD), stressing its value in enhancing how risks are assessed, priced, disclosed and managed.
Benham argued that assessing climate-related risk must be a priority and expressed his hope that this MRAC meeting would be a first step towards a comprehensive review of what the CFTC can do to prepare for and mitigate against these risks.
Benham also welcomed Steven Maijoor, the chair of the European Securities and Markets Authority (ESMA), who would join the meeting to discuss the European Markets Infrastructure Regulation (EMIR) 2.2, central counterparty clearing house (CCP) stress testing and Brexit. In line with Chairman Giancarlo’s stance on deference, Behnam emphasized the importance of working with international counterparts to ensure a stable transition that is aligned with the global regulatory infrastructure.
Christopher Giancarlo, Chairman, CFTC
Giancarlo emphasized the importance of today’s subject matter and acknowledged the diverse audience members present at this meeting. Giancarlo explained that the advisory committees of the CFTC are composed of key market stakeholders who set their own agendas and choose their research topics in order to foster a well-informed, bipartisan spirit on topics that can often divide the masses based on political views. He noted that the purpose of advisory committees is to support the CFTC and foster open, competitive, and financially-sound markets for trading derivative products.
Brian D. Quintenz, Commissioner, CFTC
Commissioner Quintenz explained that the MRAC meeting is important because it highlights the ability of the derivatives markets to address climate change, adding that this was exemplified by the energy revolution that saw an increase in electricity production from natural gas, which in turn has reduced carbon emissions. He continued that these examples show the vibrancy and liquidity of the American futures and swaps markets in reducing carbon emissions related to electricity generation by serving as effective hedging venues to support private sector innovation in this sector. Quintenz stated that he embraces the characterization of the derivatives market as a tool to address climate risk, as he was recently reminded by the CFTC’s approval to trade agricultural contracts on EUREX. Furthermore, Quintenz voiced his support of the EPA’s proposed rule on Renewable Identification Numbers that will strengthen the RIN market.
Dawn DeBerry Stump, Commissioner, CFTC
Commissioner Stump briefly emphasized the importance of these timely dialogues which are extremely useful and central to accomplishing the task of allowing market participants to hedge and mitigate these risks.
Dan M. Berkovitz, Commissioner, CFTC
Commissioner Berkovitz welcomed the participants and explained his interest in this topic specifically because political systems may not be immediately responsive to emerging trends, but markets represent the collective wisdom. Berkovitz also explained that he has read several reports and news about potential threats to the financial markets from climate change so he is particularly interested in learning what those impacts might be.
Panel 1: Domestic and International Policy Initiatives regarding Climate-Related Market Risks to the Financial System
Sarah Breeden, Executive Director of International Banks Division, Prudential Regulation Authority, Bank of England, discussed the physical and transition risks climate change brings. She explained that the physical risks come from weather-related event damage which causes financial losses and increased insurance claims, while transition risks refer to the challenges of adjusting business models and strategies in line with a lower-carbon economy. Breeden stated that sizing risks is “highly complex” and that translating the many possible climate pathways into economic outcomes and financial risks is needed, adding that many of the modeled estimates “aren’t very good” and are “heavily dependent on assumptions” and “significant” data gaps. She explained that the Prudential Regulatory Authority and Financial Conduct Authority established a Climate Financial Risk Forum that brings together regulators and the industry for workstreams on governance, risk management, scenario analysis and disclosure, with the aim of publishing “practical” guidance. Breeden added that they may include climate change in future stress tests and that UK insurers have been asked to examine how their businesses will be impacted in different physical and transition risk scenarios.
Stacy Coleman, Managing Director, Promontory Financial Group, and Secretariat of the FSB’s TCFD, noted that the discussion about climate risk has been “limited” and “quite lacking,” adding that without the right information and understanding of the potential risks, there will be “major implications” for markets. She discussed how the FSB pulled together public and private sector participants and held workshops that showed investors need better information about climate risks to factor into their decision making. Coleman noted that the TCFD had a significant public consultation that resulted in the development of a set of recommendations focused on four areas of common core elements: governance, strategy, risk management, and metrics and targets. She continued that since issuing those recommendations, the TCFD has held workshops around the world and worked with industry associations to implement the recommendations. Coleman added that there will be another report issued in September that will focus on scenario analysis.
Dave Jones, Director, Climate Risk Initiative, Center for Law, Energy & the Environment at the University of California Berkeley School of Law and Former California Insurance Commissioner, discussed the California insurance market and physical, transition and liability climate risks, using the recent California wildfires and mudslides as examples. He discussed the National Association of Insurance Commissioners’ (NAIC’s) climate risk disclosure survey that showed how insurers are addressing climate risk in underwriting, reserving and business operations. Jones continued that the California insurance commissioner launched its Climate Risk Carbon Initiative to better understand the climate change transition risks that could impact investments in oil, gas, coal and utilities. Jones also discussed the Sustainable Insurance Forum (SIF), which was founded in 2017 with 25 insurance regulators from around the world to develop and share best practices on addressing climate risk from a supervisory standpoint, noting that they have endorsed the TCFD recommendations.
Question and Answer
In response to a question on whether mandatory uniform reporting of climate-related risks should be the standard, Coleman replied that the FSB has been pushing for voluntary disclosure, but that over time it may have to move toward mandatory because otherwise it is more difficult to receive such information. Breeden explained that disclosure needs to be comprehensive, comparable, and coherent, adding that standardization would support this. Jones stated that he has supported mandatory disclosure for some time and that “the sooner we get there, the more information we’ll have and the better off markets will be in terms of their ability to assess risks and respond accordingly,” adding that “disclosure alone isn’t enough.”
Regarding future challenges for regulators, Jones noted there is a “fair degree” of communication internationally and that there is a broad consensus among the financial regulators that the TCFD recommendations represent “some of the best work” when it comes to the types of disclosure needed. He continued that while uniformity of disclosures and information across the markets can be useful, there may be different regulatory approaches based on the different risks regulatory markets face. Coleman added that looking across the different sectors has been “incredibly helpful.” Giancarlo stated that much of the discussion on climate risk disclosure has been with the FSB and IOSCO, but that the CFTC has participated in discussions at IOSCO, adding that it is “challenging” as the regulators “all have unique operating regimes.”
Panel 2: Market Participant Approaches to the Management and Mitigation of Climate-Related Financial Market Risks
Nancy Meyer, Director of Corporate Engagement, Center for Climate and Energy Solutions, noted that one of the key takeaways from meetings with companies is that while they are eager to learn from one another, the process is “gradual.” She continued that managing physical risk usually falls under risk managers, and that a key challenge is bridging the gap among business units and scenario analysis, adding that most companies focus on transition risk and strategic planning. She continued that many companies are looking for ways to stress test the outcomes of modeling transition models, noting that “it’s about framing the uncertainty” and that she has seen progress in implementing the TCFD recommendations.
Kristen Walters, Global Chief Operating Officer of Risk and Quantitative Analysis Group, BlackRock, stated that environment, social and governance (ESG) inclusion in client portfolios comes in traditional investing and sustainable financing, adding that BlackRock has integrated issuer-level data allowing investors and risk managers to access risk metrics. Matthias Graulich, Member of the Executive Board and Chief Strategy Officer, Eurex Clearing AG, discussed the public attention on climate change and noted the global target to limit global warming and how Europe has operationalized these targets.
Dr. Stefano Giglio, Professor of Finance, Yale School of Management, discussed the conceptual issues with hedging climate change risks. He explained that it is hard to specify the right target of the hedge, that there are obstacles to market participation and development, and that there are limits to quantitative analysis of risks. Regarding operational issues for hedging climate risks, he raised questions of how to hedge long-term risks, and whether short-term portfolios to hedge long-term climate change can be used. Giglio laid out the design of a global derivative market, explaining that markets need different exposures and views and a multiplicity of products.
Question and Answer
In response to a question on defining ESG, Meyer replied that they are “still trying” to define what ESG means, “especially with the TCFD recommendations,” adding that it is not currently well-defined but there is work being done to improve this. Walters added that while the science is known, the link to financial services is not, so the focus should be on finding data to identify and measure that linkage. She continued that the granularity of risk is also an issue, and that other things to consider are the individual companies their locations, and the commodities involved. Giglio stated that the markets are good at integrating information and should focus on producing information right now and then figure out how to use it.
Report from Interest Rate Benchmark Reform Subcommittee
Thomas Wipf, Subcommittee Chairman, Vice Chairman, Institutional Securities, Morgan Stanley, recapped the key developments in the London Inter-bank Offered Rate (LIBOR) transition that has occurred since December 2018, to include the publication of fallback language for those who continue to use LIBOR in cash products. He continued that the International Swaps and Derivatives Association (ISDA) is working on fallback language for derivative contracts that should be done by the end of the year, and will be seeking feedback on the market’s views on the implementation of the eventual fallback spread, adding that he hopes to see final fallback terms for swaps. Wipf stated that Secured Overnight Financing Rate (SOFR) based products continue to grow in the U.S. markets and how the Federal Reserve’s Alternative Reference Rates Committee (ARRC) has published a user’s guide to SOFR showing how market participants can start using SOFR in contracts today. He explained that the FSB had a roundtable with global regulators to discuss views on the transition from LIBOR and how they are “willing to entertain relief within reason.” Wipf noted that the subcommittee has focused on uncleared margin, clearing, and disclosures, as they could all cause potential impediments to adoption of rates and that the subcommittee intends to write a letter to the MRAC with their recommendations in greater detail.
Question and Answer
In response to a comment about an estimate of transaction volumes being helpful, Wipf replied that they tried to ensure any of the recommendations put forward all have some kind of analysis, with a large part of their discussions being focused on whether they can provide data. He continued that the CFTC’s chief economist’s office has done work on the data of legacy swaps existing under various asset classes, which shows how many would roll off based on maturities.
A committee member stated that temporary relief may be needed to encourage activity, and Giancarlo echoed that some sort of short-term relief may be needed, as they want to create a dynamic of people wanting to move away from LIBOR before time runs out, adding that the CFTC is committed to benchmark reform and he is “confident they’ll find the right way to go.”
Remarks by Steven Maijoor, European Securities and Markets Authority (ESMA) Chair
Maijoor explained that the EU regulatory supervisory framework has focused on sustainability for two important reasons. First, sustainability risk can affect the risk’s returns and valuations of issuers. Second, ESMA is aware that the investment community is changing their preferences and wants to take sustainability into account when selecting their issuers. He continued that ESMA is working on the following in the EU action plan that has driven the sustainability: 1) Request to ESMA to provide advice on the integration of sustainability risks and factors into the relevant investment management and firm legislation; 2) Political agreement on a disclosure regulation on the sustainability issues; and 3) Integration of sustainability into the benchmark regulation and making sure for carton benchmarks there are common factors.
Cross-Border Regulation and Supervision
Maijoor explained that cross-border regulation and supervision is a national and regional challenge because market participants want to take away these differences, but regulators are limited by their framework and mandates. He continued that IOSCO recently published a report on “Market Fragmentation & Cross-border Regulation” that discusses the G-20 Japanese presidency and gives an account of how these tools can be used to address these problems and indicate that national treatment, mutual recognition (also known as equivalence), substituted compliance and passporting all affect the functioning of financial markets.
He continued that the EU has been at the forefront of these developments for third-country firms, and that the full reliance on home country regulation has been very important in reducing and avoiding market fragmentation. Maijoor stated that the new amendments to EMIR on CCP supervision will create new rules under the current recognition regime for systemically important foreign CCPs, as assessed from the EU-perspective, that had up until now benefited from full reliance on the foreign home regulator. He continued that ESMA will assess the 34 non-EU CCPs to determine which ones are systemically important, and that these 34 CCPs that are now recognized with ESMA can participate fully in the EU derivatives market. Maijoor noted that the EU approach is changing, and Brexit has accelerated their thinking on this topic. He continued that there might be full reliance on third-country supervision and regulation as a result of Brexit, and that ESMA already pointed out this issue even before Brexit and the improved EU approach is reflected in EMIR 2.2 and EU legislation. Maijoor stated that ESMA will receive several new tools regarding CCPs and analysis will be conducted. He noted that the EU’s approach will become more proportionate to be able to rely fully on EU regulation and supervision and in cases where there may be systemic risk, EU legislation will apply directly.
EMIR 2.2
He explained that EMIR 2.2 enhances the recognition regime for third country CCPs (TC-CCPs), as it introduces a dedicated regime for the TC-CCPs which are determined to be, or likely to become, systemically important for the financial stability of the EU or of one or more of its Member States, named Tier 2 CCPs. He continued that Tier 2 CCPs will need to comply with the requirements under EMIR or ask for comparable compliance, where compliance with the requirements in a third country satisfies compliance with the requirements under EMIR. Maijoor stated that EMIR 2.2 also introduces a fee system for TC-CCPs to fund the relevant activities, and that ESMA recently published technical consultation papers in the context of the technical advice they need to provide to the EU commission. He noted three areas of focus: 1) Tiering and classifying a CCP as tier 1 or 2; 2) comparable compliance; and 3) fees for TC-CCPs. Maijoor stated he expects to deliver advice to the Commission towards the end of this year and for the EU commission to make these into delegated acts. He continued that the Commission needs to decide on this within a year of publication of EMIR 2.2, and that after delegated acts have come into force by the European Commission, then ESMA can start work with Tier 1 and Tier 2 CCPs. Maijoor noted that looking back at the many equivalence decisions taken in financial markets, it is fair to say they have been outcome based, resulting in reliance on home country regulation and supervision, changing from an EU approach to a global approach relying on more granular assessments. He discussed the consultation paper on comparable compliance, noting that there will be opportunity to rely on the home country of a Tier 2 CCP and on a requirements basis because as the term makes clear, comparability of the requirements will be enough, there is no need to be identical. He stressed that good cooperation with foreign regulators is essential to make the system work and they are committed to continuously work with foreign regulators.
Stress Testing CCPs
Maijoor noted that ESMA completed the first stress test of CCPs in 2016, and that in terms of coverage of the exercise, it concerns all cleared products and all authorized 16 EU CCPs, including the UK CCPs. he continued that the institutional arrangement for stress testing in the EU is that they are provided by the systemic risk board in the EU who hands them over to ESMA for stress testing exercises. He noted that the exercise is quite transparent, with the publishing of the shocks being testing for and the information being made public. Maijoor stated that interconnectedness is a very important part of this and ESMA specifically tests for the fact that there are common memberships, ownerships, and liquidity providers, and that ESMA looks at the interactive effect when clearing members have that.
Brexit
Maijoor explained that it is clear Brexit will have a negative impact for the EU and UK, stating that one of the main objectives of the EU securities market is to increase its scope, size and depth, and Brexit will not help that. He continued that preparations are focused on the risks of a no-deal Brexit because in principle, passporting arrangements will not be available anymore, adding that a no-deal Brexit has seen a lot of relocation to EU 27, but for some cases it is not possible for the private sector to risk a no-deal situation. He stressed that ESMA will ensure continued access to UK CCPs in the event of a deal and there will be insurances put in place in the case of a no-deal. Maijoor noted that the three UK CCPs will be able to provide services to EU 27 clients and clearing members.
Question and Answer
In response to a question on comparable compliance, Maijoor responded that the tiering criterion will be based on the relevant legal text and through joint collaboration with local regulators regarding stability risk, adding that the compliance requirements will not need to be identical and ESMA is actively working towards publishing specific advice on this issue because there will be no quantitative threshold.
Asked whether equivalence will be granted in the context of share trading obligations, Maijoor responded that ESMA would prefer equivalence in the case of a withdrawal. He continued that if there is a no-deal Brexit, only when there are stability risks would equivalence be determined, and that is the reason equivalence exists in the CCP clearing so it is not considered for trading, shares or derivatives, even though it negatively impacts those markets.
In response to a question about the issue of determining liquidity in the event that the Markets in Financial Instruments Directive (MiFID) is destroyed because of Brexit, Maijoor responded that UK data will only be used in the event that Brexit succeeds. In that case, the UK data would be phased out generally while avoiding any cliff edges. He continued that ESMA recently decided that a solution is needed to address market abuse calculations because equivalence does not foresee an arrangement for this since this issue goes beyond an MOU or legal obligations for reporting data on shares or derivatives, adding that the main concern is ensuring that this data exchange can continue.
Asked about the preparedness of local authorities to manage financial risks associated with relocation, Maijoor stated that relocation raises issues of supervisory consistency and making sure that these relocations are the proper response. He stressed the importance that these relocations are done in the appropriate way and the risks of trying to become a member in the EU state are clear, including that the UK entity will not be recognized in the case of a no-deal Brexit.
In response to a question regarding phase 5 of the initial margin rules, Maijoor stated that entities who know they will exceed the $8 billion threshold but never the $50 million exchange threshold will not have to comply with the cost of documentation. He continued that ESMA is committed to the current timetable because of the complexity of the different regulatory systems involved, adding that the need for predictability is “paramount.”
MRAC Subcommittee Establishment
The MRAC agreed to establish subcommittees on the following issues: CCP Risk and Governance, Operational Risk, Market Structure, and Climate-Related Financial Risk.
For more information on this event, click here.