At a House Agriculture Committee Hearing on February 29, members discussed the Commodity Futures Trading Commission (CFTC) 2012 agenda with CFTC Chairman Gary Gensler, who was accompanied by CFTC Commissioner Jill Sommers.
A number of questions concerned rising oil prices, the impact speculation has on the energy markets, and how the CFTC is tackling this issue. Committee members also sought to clarify which entities would be considered swap dealers, adding that this could negatively affect agricultural cooperatives, energy utilities, and small, community banks. Gensler reassured the committee that the CFTC has received a number of comments on end-user concerns. Gensler added the CFTC “will sufficiently address hedging in the context of a producer or merchant.”
In his opening testimony, Gensler said the CFTC “has made significant progress in completing the reforms that will bring transparency to the swaps market and lower its risk to the rest of the economy.” Gensler added, though, that “there is much work yet to be done.”
Gensler said the Commission “substantially finished” the proposed rulemaking phase last spring, and “largely reopened” the bulk of those proposed rules for additional public comments. To date, the CFTC has completed 28 rules and has roughly 20 more to write.
For a complete list of rules the CFTC has finalized, including a list of proposed rules, see the attachment at the end of the testimony.
Gensler said “it is my anticipation that we will finish most of the rule-writing work by this summer,” but said it was possible that “a handful” of rules will not be finished until late this year. “We hope to complete rules with regard to designated contract markets (DCMs), followed later this spring by rules for swap execution facilities (SEFs),” adding that the rules “will be critical” to bring transparency and competition to the swaps market.
With regard to bringing swaps into central clearing, the Commission is looking to complete, in the near term, final rules on client clearing documentation, risk management, and straight-through processing, in addition to the end-user exemption.
“To address commenters’ questions about a possible clearing requirement between affiliates of financial entities, I expect the Commission to consider a proposal and take public comments later this year,” Gensler said.
On regulation of swap dealers, Gensler said the CFTC will consider final rules on capital and margin rules “later this year” and anticipates the CFTC will seek public input on the extraterritorial application of Title VII of Dodd-Frank.
Regarding rules relating to defining the meaning of swap and swap dealer, Gensler said the Commission is taking into account all public comments and the product definitions rule will follow in the spring. The CFTC is also actively working with electricity markets “on possible exemptive orders for rural electric cooperatives, municipal power providers and regional transmission organizations.”
On Volcker, Gensler said “one of the challenges” in finalizing the rule is how to achieve prohibiting banking entities from proprietary trading, while permitting them to engage in market making, among other activities.
On the CFTC’s role in determining which swaps must be mandatorily cleared, Gensler said the CFTC asked registered clearinghouses to submit for review all swaps cleared as of February 1, 2012, including pre-enactment swaps. He added that CFTC staff are reviewing the submissions and preparing recommendations for which swaps should be cleared. Gensler expects the comment period to begin later this spring.
Gensler said the CFTC is actively engaged with foreign authorities to promote “robust and consistent standards and avoid conflicting requirements in the global marketplace.” Next week, Gensler will travel to Basel to meet with the Financial Stability Board (FSB) and then onto Brussels to meet with European officials to discuss the implementation of swaps reforms in various market jurisdictions.
On compliance issues, the CFTC “will continue looking at appropriate timing for compliance,” balancing “the desire to protect the public while providing adequate time for industry to comply with reforms,” Gensler said. To ensure a smooth transition, the CFTC has given market participants exemptive relief from effective dates of certain rules until July 16, 2012. In the Commission’s efforts to “be as responsive as possible,” Gensler noted the agency has delayed certain requirements, and the CFTC will continue to actively engage with market participants.
On the registration of new market participants, the Commission’s staff estimates 20 to 30 entities will seek to become swap execution facilities (SEFs) and registration will likely begin by the end of this year. He noted that the registration process has already begun for swap data repositories (SDRs) and foreign boards of trade (FBOTs), adding that three FBOTs have requested to be registered so far. In addition, two new entities are seeking to resister with the CFTC as designated clearing organizations. Gensler also said the CFTC will be working actively with the National Futures Association on registration matters concerning swap dealers and major swap participants, after the CFTC finalized the registration rule in January.
On segregation of customer funds, Gensler said the completed amendments to rule 1.25 regarding the investment of funds “bring customers back to protections they had prior to exemptions the Commission granted between 2000 and 2005.” Gensler added further that the CFTC will continue to look at options to protect customers and referenced this week’s two-day roundtable to examine additional enhancements.
On position limits, Gensler said the limits “will come into effect once the joint rule further defining the term ‘swap’ is completed and the Commission has received a year’s worth of data on the relevant swap markets.” Gensler’s comments did not include any mention of the SIFMA/ISDA lawsuit on position limits.
On market structure, Gensler said he expects the Commission “will consider putting out for comment a concept release concerning the testing and supervision of automated market participants.” The concepts will address potential market disruptions that high-frequency traders can cause. The Technology Advisory Committee recently established a subcommittee to specifically examine automated and high-frequency trading.
The CFTC is also working closely with the SEC on recommendations from the Joint-SEC-CFTC Advisory Committee on Emerging Regulatory Issues “with regard to cross-market circuit breakers, pre-trade risk safeguards, effective testing of risk-management controls and supervisory requirements regarding algorithmic trading.” The CFTC is also developing proposed rules on the reporting of ownership and control information for trading accounts which will enhance the Commission’s oversight and increase market transparency.
On internal organization, the CFTC’s new responsibilities “necessitated an agency restructuring to ensure the Commission uses its resources as efficiently as possible.” The new Office of Data and Technology is “taking on the challenge of how we aggregate data across SDRs, as well as how we aggregate it with futures market data.” In addition, the office will be working closely with the Treasury Department and international regulators on legal entity identifiers (LEIs). Gensler said the Commission also expects to begin publishing aggregate swaps trader data from the newly available data passed onto the Commission.
In his opening statement, Chairman Frank Lucas (R-Okla.) said he is concerned about the breadth of the CFTC’s proposals as it nears the halfway mark for rulemaking. He added that the scope of CFTC regulations “cast a wide net that could unnecessarily catch end-users.” Adding further, “Congress never intended hedging to be considered swap dealing,” said Lucas.
On extraterritoriality issues, Lucas said the lack of clarification “has made it incredibly difficult for market participants to prepare for compliance.”
In his opening statement, Ranking Member Collin Peterson (D-Minn.) said it is “safe to say that, so far, the CFTC has done a pretty good job,” and the Commission is on the “right track going forward.” He said he expects the CFTC “will continue to get it right” as it finalizes further rules. Peterson said he thought the Commission’s budget is “grossly underfunded.”
Question and Answer
Swap Dealer Definition
Lucas said the end-user community was working “frantically” to have an explicit exemption for hedging included in the rule. Lucas stated that it was never Congress’ intent to consider hedging activity as swap dealing. He asked Gensler why end-users “were forced to make last-minute appeals” to the CFTC on this issue.
Gensler said in the last two to three weeks before the agency votes on something, “we hear from people reminding us of their comment letters.” With regard to the actual rule, “one of the key things in the rule is market making,” adding that the CFTC “got a lot of comments to narrow that and I think we will address that, particularly with regard to the word ‘hedging.’”
Peterson asked whether end-users that are hedging for commercial purposes will be considered swap dealers. Gensler said end-users that hedge for commercial purposes will not be considered swap dealers, adding that “we can modify the final rule to clearly address” the issue. Gensler noted that some entities have chosen to actively deal and that the International Swaps and Derivatives Association (ISDA) has “very real” by-laws that says “you can only be a primary member if you make markets” and not for hedging.
Rep. Marcia Fudge (D-Ohio) referred to H.R. 2779, to exempt inter-affiliate swaps from certain regulatory requirements put in place by the Dodd-Frank Wall Street Reform and Consumer Protection Act. She said “if these contracts are classified as separate transactions there is a concern that it will increase the costs for customers of the products and it will impede the ability of businesses to manage their risk.” Fudge asked what the timetable is for the final rules containing exemptions for inter-affiliate swaps.
Gensler said some of the rules have already been completed, pointing to the real-time reporting rule finalized in December and the external business conduct rule completed in January.
Gensler added, “in most affiliate transactions, if one party is an end-user there will not be any clearing requirement. But what we think we need to do is publish for notice and comment, and we believe we have the authority to do it, between a financial company and its financial affiliate. Where both are financial companies, that’s the one area. For the end-user community, I truly don’t believe this is an issue.”
Asked about the timeframe for this, Gensler said it will likely be in the spring when the CFTC publishes a notice and asks for comments. Referring to the 20 or so rules that remain Gensler said “we’ll be working through the summer and possibly fall on some of these.”
Fudge also told Gensler that the SEC may treat these transactions differently than the CFTC. She asked Gensler to comment on how the CFTC will address the concerns of market participants as they may have to comply with two different sets of rules on the same product.
Gensler said the CFTC “spent a lot of time with the SEC” trying to harmonize trades between affiliates. He added that the issue “has not been brought to my attention,” and asked Fudge to let him know what the SEC is not doing “that I should know about.”
De minimis Exception
Rep. Randy Hultgren (R-Ill.) asked Gensler whether the $100 million level “was realistic to start with.” He added that it is “such a low number and opens it up to so many questions out there.” He asked whether there is a realization that it is an unrealistic number. Gensler said he has received many comment letters on this issue from community banks, end-users, “and we’re taking them very seriously.”
To an early question from Hultgren, Gensler said the CFTC is in collaboration with the SEC on de minimis and that the level “is higher than where we were.”
Peterson said he had concerns that the CFTC has an interest in exempting high-frequency traders from the definition of a swap dealer, and asked Gensler whether this is under consideration. Gensler stated that it “would be unwise to leave them out” of the definition.
International & Extraterritoriality Matters
Lucas asked if the CFTC was coordinating with international counterparts on Section 754 of Dodd-Frank, to which Gensler said “very much so.” He added that the CFTC shares draft documents with global counterparts before proposals or final rules are issued.
In response, Lucas asked how coordination could be going so well when just last week EU Commissioner Michael Barnier stated the opposite. Gensler said both he and Barnier had a “good meeting” last week, which included a “lively discussion” on the Volcker Rule. Gensler said he continues to have an ongoing dialogue with Barnier and is slated to meet with him this coming Tuesday.
Lucas replied that Barnier’s comments were not limited to the Volcker Rule, but were much broader in scope. “Clearly there is a lack of coordination here,” he said. He noted that international coordination is key to ensuring effective global reform occurs and urged Gensler to carefully consider feedback from “our global partners.”
Rep. David Scott (D-Ga.) focused on extraterritoriality and the recent announcement by SEC Chairwoman Mary Schapiro that the SEC will issue a formal rulemaking related to the extraterritorial application of the Dodd-Frank law. He asked whether the Committee can expect the CFTC to do the same.
Gensler said the CFTC “will seek public comment on 722(d) of the Commodity Exchange Act.” That’s the “core to this question.” In addition, “I’m hoping to get public comment through that release on swap dealer … where we defer to foreign regulators. We have a long history of deferring to foreign regulators. I’m hoping we can continue to do that … and hopefully get public comment on it.”
Position Limit Rule
Rep. Joe Courtney (D-Conn.) referred to the legal action taken by SIFMA/ISDA against the CFTC regarding the position limit rule. Courtney said he did not believe the CFTC has exceeded its discretion by imposing the position limits. He said the law “is crystal clear that this is something the Commission was required to do … expeditiously.” Courtney added that it has been five months since the vote occurred and there are still no rules in place. He asked Gensler for an update on the position limit rule.
Gensler said the rule goes into effect after the CFTC and SEC jointly finalize the product definition rule, likely by this Spring, and after the CFTC has collected at least one year’s worth of data, which began last fall.
Regarding the court challenge, Gensler said he agreed that the congressional intent is clear that the CFTC was required to write the rule.
Lucas questioned how Gensler could be involved in the policy response to the collapse of MF Global, but recuse himself from the ongoing case. He questioned how Gensler could be in a position to lead the CFTC in its policy response to the segregated accounts issue, when such a response “should be clearly supported by lessons learned from the investigation that you weren’t part of.”
Gensler said what the CFTC did in December, regarding tightening up of rules related to the investment of customer funds, “was critical.” Gensler said is involved in the two-day meeting this week, and added that as consensus forms, the CFTC will ask the public participation will be significant and critical before the CFTC brings about further rulemaking on issues stemming from the MF Global bankruptcy. Gensler added that the public is not participating either in the investigation.
SIPA Bankruptcy vs. Bankruptcy
Rep. Tim Huelskamp (D-Kan.) asked “given that 99 percent of MF Global accounts were commodity accounts regulated by the Commission, do you think it is appropriate that the bankruptcy was structured as a SIPA bankruptcy, thereby stripping customers of their priority status.”
Gensler said when futures commission merchants (FCMs) are also broker-dealers under the SEC, “there is bankruptcy protection of SIPA … and there’s the bankruptcy protection in the bankruptcy code, and they interact.” He added, “once it’s a joint FCM and B-D, and there are securities customers at risk, the way the law interacts is that the SEC and SIPA can put it into a SIPA Trustee.” The good news, according to Gensler, “everything that’s in the bankruptcy code to protect the futures customers, subpart 4, or our code rules 190 … they have to use those same provisions.”
Huelskamp asked whether customers with segregated funds lost priority status with this approach to bankruptcy. Sommers said “in the SIPC proceeding for MF Global, commodity customers have an exclusive right to the customer property that were in the segregated accounts. They did not lose their priority status in that particular bankruptcy case.”
For more on the hearing, please click here.
,Blog Tags:,Blog Categories:,Blog TrackBack:,Blog Pingback:No,Hearing Summaries Issues:Derivatives,Hearing Summaries Agency:House Agriculture Committee,Publish Year:2012