House Ag on CFTC Reauthorization with Commissioners Bowen , Giancarlo and Wetjen
House Agriculture Commodity Exchanges, Energy, & Credit Subcommittee
“Reauthorizing the CFTC: Commissioners’ Perspectives”
Tuesday, April 14, 2015
Key Topics & Takeaways
- Cross-Border Risk: When asked whether the cross-border approach taken by the Commodity Futures Trading Commission (CFTC) was appropriate, Commissioner Bowen suggested that the CFTC should look to follow “where the risk actually lies” for cross-border swaps transactions, and said that where a person is located “may not be indicative as to where the real risk is.” She added that in global markets “the concept of U.S. person, frankly, may be irrelevant because transactions will be taking place in cyberspace.”
- International Competitiveness: Commissioner Wetjen said it is important to make sure U.S. institutions are competitive and noted the CFTC can compare regimes and decide if additional policy is needed once other the nations’ rules are complete.
- Initial Margin for Inter-Affiliate Transactions: Commissioner Giancarlo said that the rule of charging initial margin for internal risk transfer activities could cause risk to be retained in the U.S. and harm the ability of end-users to hedge risk outside the U.S.
- User-Fee: Commissioner Bowen requested that the CFTC be able to impose fees on registrants or a de minimis fee on trades as a way to fund the agency.
Witnesses
- Mark Wetjen, CFTC Commissioner
- Sharon Bowen, CFTC Commissioner
- Christopher Giancarlo, CFTC Commissioner
Opening Statements
Subcommittee Chairman Austin Scott (R-Ga.) stated in his opening remarks that regulatory requirements should be “minimized and justified” while providing “clarity and certainty.” He said one of the Committee’s goals is to “ensure that each Commissioner at the CFTC is adequately empowered within his or her role.” He added that the derivatives markets are essential to the farmers, ranchers, and end-users as well as to the broader economy and said the Committee “will continue to look for a healthy balance between market access and market integrity, so that the markets meet the needs of those who use them to hedge risk.”
Ranking Member David Scott (D-Ga.) said he was happy to be able to hear from the Commissioners who ensure that there is a “level playing field” in the market and who have an understanding of the “deep complexity” of derivatives issues. He stressed that he would like to hear the Commissioners’ views on U.S. and European clearing house recognition, the definition of U.S. person, and the CFTC’s cross-border regime, but stressed that “all of it means virtually nothing” if the agency is not provided with adequate funding to carry out its mission.
Witness Testimony
Commissioner Bowen
Commissioner Sharon Bowen, in her testimony, stated that the CFTC needs additional funding and suggested imposing fees on registrants, or a de minimis fee on “some trades” as a way to raise this money. She also suggested that the CFTC: 1) reevaluate its system of self-regulation and potentially establish a separate self-regulatory organization (SRO) for swaps activity that could establish minimum standards of accountability; 2) impose stricter regulations on the retail foreign exchange market; 3) create new regulations to address cybersecurity concerns; and 5) increase enforcement penalties so fines are not “just a cost of doing business.”
Commissioner Giancarlo
Commissioner Christopher Giancarlo, in his testimony, stated he has been a “consistent advocate for practical and effective implementation of the three key pillars” of Dodd-Frank: 1) enhanced swaps transparency through data reporting; 2) regulated swaps execution; and 3) increased central counterparty (CCP) clearing. He added that “balanced and well-crafted regulatory oversight goes hand-in-hand with vibrant, transparent and competitive markets.”
Giancarlo noted that the CFTC is working on making changes to Rule 1.35 and said rules on position limits are a “work in progress.” He expressed concern with the position limits rulemaking, calling it “the most complex and restrictive rule you can imagine,” and said the CFTC must make sure the bona fide hedge exemption is sufficient to not place burdens on hedgers and end-users.
Giancarlo noted that the G20 called for coordinated global reform of the derivatives market but said that current conflicts threaten a “modern day trade war” resulting in market fragmentation along national boundaries that will increase systemic risk.
Commissioner Wetjen
Commissioner Mark Wetjen, in his testimony, stated that the markets look significantly different today than they did in 2011, when he became a Commissioner, noting that new requirements, including clearing and trading mandates and reporting obligations, have led to a safer and more transparent market structure.
Wetjen said that the CFTC should “take action to clarify the matters discussed” in the CFTC’s staff advisory on cross-border application of swap regulations, particularly how the CFTC views U.S. personnel. He stressed that many of the issues arising in CFTC’s cross-border regime are due to the Commission’s “first mover impact.”
To promote trading of swaps on swap execution facilities (SEFs) using the CFTC’s existing authority, Wetjen said the Commission will be looking into issues regarding: 1) eligibility under the floor trader exemption; 2) name give-up; 3) the embargo rule and work-ups; 4) made available to trade (MAT) determinations; 5) package transactions; 6) block trades; and 7) error trades.
He said Congress could help the CFTC by making amendments to the bankruptcy code for segregated customer accounts and addressing problems with indemnification rules that impede information sharing efforts.
Wetjen then highlighted the following trends that the Committee and the CFTC should be monitoring: 1) liquidity fragmentation in the global swaps market; 2) disruptive technologies; 3) futures commission merchant (FCM) concentration; 4) CCP risk; 5) cybersecurity; and 6) automated trading.
Question and Answer
Swap Dealer De Minimis
Chairman Scott explained that the CFTC’s swap dealer de minimis level will automatically move from $8 billion to $3 billion in 2017, regardless of what a mandated CFTC study shows. He noted that the CFTC changed the automatic trigger in its residual interest rule, and asked if the same should be done for the de minimis threshold.
Bowen replied that it is important to base rules on good data but that there is “no basis at this stage” to change this level.
Giancarlo said that the CFTC should approach the de minimis level in the same way they approached the residual interest rule, requiring affirmative Commission action based on the data provided in staff studies – not automatically as currently written.
Wetjen said that whatever decision that is made should be data driven and while he thinks that the rule now reflects this approach, he would be willing to change it and would be “comfortable” with the Commission being required to take a vote.
Special Calls
Chairman Scott asked what the CFTC’s process for “special calls” is in the context of the trade reporting rule and how this process is overseen.
Giancarlo said that the special call process is part of the CFTC’s oversight authority and that they have a “legitimate role.” However, he noted that the issuance of special calls has increased dramatically over the past several years and that several hundred have recently been issued in error. He stressed that the Commission should ensure that proper procedures are in place.
CFTC Funding
Ranking Member Scott asked if the CFTC is currently being appropriated sufficient funds to do its job.
Bowen said that it is “critically important” for the CFTC to receive additional funds, noting that the agency has fewer employees than it did before the financial crisis and that it needs to hire new staff and invest in new technology.
Giancarlo said that the CFTC must have resources to do its job, but that he supports current funding levels. He said the question is whether the agency is doing the job it needs to, or if it is wasting resources on other jobs.
Wetjen said the CFTC could use additional resources to meet the increased size and risk of the market that the agency has to regulate, but said there is not a “specific number” that would be appropriate. He added that the CFTC is not doing a good enough job examining clearing houses.
Enforcement
Ranking Member Scott asked how the CFTC can strengthen its enforcement.
Bowen said that the CFTC should have “much higher penalties” because current levels are not doing enough to deter bad behavior. She added that the agency needs more enforcement staff and said she has been surprised at the number of Ponzi schemes and attempts to take advantage of retirement funds she has seen since joining the Commission.
Regulatory Harmonization/Market Fragmentation
Rep. Michael Conway Lucas (R-Texas) noted that European Commissioner Patrick Pearson appeared before the Committee and warned that if there is not regulatory harmonization, markets would become walled off. He asked if this prediction was coming true.
Wetjen said he has seen “some regulatory fragmentation” as a result of the CFTC moving first with its rules. He noted that the cross-border guidance from the CFTC was a risk-based policy making that looked at how risk comes back into the U.S., and that it relies heavily on substituted compliance. Thus, “every jurisdiction needs to embrace substituted compliance.”
Giancarlo said that the prediction has “absolutely come true” and said that conduct and clearing has “silo-ed” regionally, making products “flee U.S. shores.”
Bowen said it is important to harmonize rules “as best we can” while protecting investors and making sure risk across borders does not come back to the U.S.
SEFs
Rep. Pete Aguilar (D-Calif.) asked what can be done to promote increased trading volume on SEFs.
Wetjen said that Congressional intent was to make SEFs flexible and that increased volume could be promoted by bringing additional liquidity providers onto these platforms. He noted that some of these entities are not willing to join the platforms currently but said entities that do not have customers would not be held to the same requirements as those for swap dealers. He explained that post-trade name give-up has discouraged some traders from joining SEFs and that an adjustment should be made to address this problem.
Giancarlo said that the objective for U.S. swap platforms should be to create the best rules in the world, much like the U.S. stock market, to encourage participants to use the U.S markets. He suggested making changes to the “core principles” for swaps trading provided by Congress.
Bowen noted that the CFTC’s Market Risk Advisory Committee has been looking into these issues and has discussed addressing name give up and removing the SRO function from SEFs as possible paths to improve functioning.
Rep. Rodney Davis (R-Ill.) asked Wetjen for his thoughts on Giancarlo’s White Paper on SEF reform.
Wetjen said the paper was “very thoughtful” but explained that SEFs have “tremendous flexibility.” He explained that there is not no mandate for trades to be done on an order book, and that if there is limited order book activity the Commission will consider other methods of execution.
Position Limits
Rep. Doug LaMalfa (R-Calif.) said that former CFTC Commissioner Michael Dunn described position limits as a “side show” that distracted from efforts to ensure a stable market system. He asked how the effectiveness of position limits could be evaluated.
Wetjen said that the position limits rule is a law that the CFTC must impose and noted that studies looking at the effects of speculation in the marketplace are “inconclusive at the moment.”
LaMalfa said he was concerned that certain bona fide hedges and historical practices to manage risk would be taken away from farmers under the CFTC’s proposal.
Bowen replied the CFTC is continuing to look at this space and the agency does not intend to take away legitimate hedging activity.
Data
LaMalfa asked how current the CFTC’s data is and if having input from the industry would be helpful.
Bowen said that staff has been working to ensure that data received is accurate and useful and noted that the agency receives data on a daily basis.
Giancarlo noted, however, that the data being used in the position limits rulemaking is 20 years old.
Rep. Tom Emmer (R-Minn.) asked about difficulties in consolidating trade data and when the CFTC will implement a plan to address this issue. He also asked if the CFTC is able monitor all the data it collects.
Wetjen noted that the CFTC will be taking action to address issues around trades that start out being bi-lateral but then became cleared, because confusion in the rules has lead to inaccuracies in the CFTC’s data set. He said the Commission has not yet seen a written recommendation but has been briefed by staff.
Giancarlo said that the agency is facing a “big data problem” and that having the right tools should be a “broadly supported mission.”
Rule 1.35
Rep. Ann Kirkpatrick (D-Ariz.) asked if having record keeping requirements under Rule 1.35 will be important for enforcement, noting that there have been allegations of manipulation in the wheat market. She noted that a section of the Commodity Exchange Act (CEA) reauthorization bill from last Congress sought to change this rule.
Wetjen said that the CFTC is deliberating internally on how to finalize this rule and said it is “meaningful” if entities choose to not engage in certain activity to avoid registration and this requirement. He added that the Commission should not finalize a rule that would impede access of end-users to the marketplace and stressed that this rule is just one of the many record keeping requirements from the CFTC, saying that there has “more attention paid to 1.35 than is merited, in a lot respects.”
Giancarlo agreed with Wetjen saying that the CFTC should not discourage membership on SEFs. Bowen added that rules should not be “so onerous” that “people flee.”
Swaps vs. Futures Market
Davis asked how the swaps market is different from the futures market.
Giancarlo explained that the differences between the swaps and futures markets can be compared to the differences between the bond and stock market, because swap and bond trading is more episodic, while futures and stock trading is more continuous. He added that the CFTC is writing rules to address problems seen in the last crisis but worried that the next crisis would result from a lack of liquidity. Giancarlo said that rules such as the supplemental leverage ratio, the Volcker Rule, Basel III, and position limits will negatively impact liquidity and make it more difficult for clearing houses to sell in times of stress.
Cross-Border
Emmer said he is concerned about the impact of the CFTC’s staff advisory 13-69 that deals with cross-border regulation of swaps activity and applies CFTC rules to transactions between two non-U.S. entities if U.S. personnel “arrange, negotiate, or execute” the transaction. He asked for clarification on what these terms mean and how these activities can import risk back into the U.S.
Giancarlo said that “a lot of the industry” is trying to figure out what the terms “arrange, negotiate, or execute” mean, noting that the advisory has already been delayed four times, which “tells something about the efficacy” if it. He then discussed a scenario which highlighted the detrimental impact of the advisory, where a transaction between a German bank and Swiss pension fund for credit risk protection on a U.S. company would be subject to CFTC transaction level rules if the German bank calls U.S.-located personnel who are expert on the U.S. company. He said this situation would lead to foreign companies not wanting to call the expert in the U.S., which may jeopardize that job.
Emmer then asked if the location of the individual negotiating a trade has a “direct and significant impact on U.S. commerce” in a situation where the trade is done between foreign counterparties in a foreign jurisdiction and if that is a “reasonable approach to cross-border regulation.”
Bowen replied that “it is one approach,” but suggested that the CFTC should follow “where the risk actually lies” and that where the person is located “may not be indicative as to where the real risk is.” She added that in global markets “the concept of U.S. person, frankly, may be irrelevant because transactions will be taking place in cyberspace.” Bowen said that these scenarios are why the agency has opened the guidance to comments and that she thinks “there are other approaches.”
Ranking Member Scott said the CFTC needs to be careful not to put the U.S. financial industry in a “non-competitive position” and said that under the push-out rule, pushing out commodity swaps from the same branch that interest rates swaps are done in would put end-users at a competitive disadvantage. He asked if other jurisdictions are taking these types of actions and how the CFTC determines what constitutes a robust regime.
Wetjen noted that the G20 nations are in different stages of implementation, saying that Europe has “done a great deal” and that Japan is “making significant progress.” However he noted that there are lags in timing and some differences between rules that “have to be managed.” Wetjen said it is important to make sure U.S. institutions are competitive and that the CFTC can compare regimes and decide if additional policy is needed, once other the nations’ rules are complete.
Giancarlo noted that one premise of Dodd-Frank was to ring-fence the U.S. market to prevent importing risk from abroad. However, he said that the rule of charging initial margin for internal risk transfer activities could cause risk to be retained in the U.S. and harm the ability of end-users to hedge risk outside the U.S. He explained that companies transfer risk by engaging in swaps between affiliate entities to hedge risk in certain markets and that if they have to change initial margin on these transactions, then costs will increase for end-users.
No-Action Letters
Rep. Frank Lucas (R-Okla.) asked if the use of no-action letters provides regulatory clarity and noted an example where a letter was issued to explain a footnote in staff guidance that was unclear. He also asked how this process can be improved.
Bowen said that the CFTC uses no-action letters and guidance to be flexible and respond to problems raised by the industry, but noted that her preference would be to have a process of rulemaking with notice and comment.
Giancarlo said that the Commission’s recent use of the no-action process “erodes confidence” and “stymies” the ability of the CFTC to instill a culture of compliance.
Wetjen said that one of the ways to avoid the need for no-action letters is to ensure maximum consensus during the rulemaking process, taking into account all comments on file.
FCM Consolidation
Chairman Scott noted that the number of FCMs has been decreasing over time and expressed concern that a reduction in the number of clearing members could lead in increases in systemic risk.
Bowen said this is an area the CFTC is looking at and explained that the current low interest rate environment has contributed to this reduction.
Wetjen agreed that low interest rates make it difficult for FCMs to get sufficient returns and noted that additional prudential regulations may be causing FCMs to exit the market. He said this reduction will “lead to problems of accessibility.”
Giancarlo said that regulators need to be careful “about piling on regulations” and said that non-traditional liquidity providers could present a “real opportunity.”
Real Time Reporting
Davis asked if the no-action relief from certain real-time reporting requirements provided to Southwest Airlines should be broadened to other market participants.
Giancarlo and Wetjen said that the CFTC should look at broadening this relief to others, while Bowen said that this situation was “quite unique” and that if other participants have the same issue, they should come forward.
Improving H.R. 4413
Ranking Member Scott asked how the CEA reauthorization bill from last Congress (H.R. 4413) could be improved.
Bowen said that legislation in this Congress should preserve the flexibility of the CFTC to address problems in the market, saying that if certain things are codified, it could be harmful. She also asked for the ability for the CFTC to impose a user fee to help fund the agency.
Giancarlo suggested: 1) codifying the treatment of special entity utilities; 2) addressing the “core principles” of SEFs; 3) requiring a decision based on the swap dealer de minimis threshold study before lowing the level; 4) removing indemnification requirements for swap data; and 5) removing initial margin requirements for internal risk transfers.
Wetjen said that indemnification should be eliminated and that the agency should have sufficient flexibility.
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House Agriculture Commodity Exchanges, Energy, & Credit Subcommittee
“Reauthorizing the CFTC: Commissioners’ Perspectives”
Tuesday, April 14, 2015
Key Topics & Takeaways
- Cross-Border Risk: When asked whether the cross-border approach taken by the Commodity Futures Trading Commission (CFTC) was appropriate, Commissioner Bowen suggested that the CFTC should look to follow “where the risk actually lies” for cross-border swaps transactions, and said that where a person is located “may not be indicative as to where the real risk is.” She added that in global markets “the concept of U.S. person, frankly, may be irrelevant because transactions will be taking place in cyberspace.”
- International Competitiveness: Commissioner Wetjen said it is important to make sure U.S. institutions are competitive and noted the CFTC can compare regimes and decide if additional policy is needed once other the nations’ rules are complete.
- Initial Margin for Inter-Affiliate Transactions: Commissioner Giancarlo said that the rule of charging initial margin for internal risk transfer activities could cause risk to be retained in the U.S. and harm the ability of end-users to hedge risk outside the U.S.
- User-Fee: Commissioner Bowen requested that the CFTC be able to impose fees on registrants or a de minimis fee on trades as a way to fund the agency.
Witnesses
- Mark Wetjen, CFTC Commissioner
- Sharon Bowen, CFTC Commissioner
- Christopher Giancarlo, CFTC Commissioner
Opening Statements
Subcommittee Chairman Austin Scott (R-Ga.) stated in his opening remarks that regulatory requirements should be “minimized and justified” while providing “clarity and certainty.” He said one of the Committee’s goals is to “ensure that each Commissioner at the CFTC is adequately empowered within his or her role.” He added that the derivatives markets are essential to the farmers, ranchers, and end-users as well as to the broader economy and said the Committee “will continue to look for a healthy balance between market access and market integrity, so that the markets meet the needs of those who use them to hedge risk.”
Ranking Member David Scott (D-Ga.) said he was happy to be able to hear from the Commissioners who ensure that there is a “level playing field” in the market and who have an understanding of the “deep complexity” of derivatives issues. He stressed that he would like to hear the Commissioners’ views on U.S. and European clearing house recognition, the definition of U.S. person, and the CFTC’s cross-border regime, but stressed that “all of it means virtually nothing” if the agency is not provided with adequate funding to carry out its mission.
Witness Testimony
Commissioner Bowen
Commissioner Sharon Bowen, in her testimony, stated that the CFTC needs additional funding and suggested imposing fees on registrants, or a de minimis fee on “some trades” as a way to raise this money. She also suggested that the CFTC: 1) reevaluate its system of self-regulation and potentially establish a separate self-regulatory organization (SRO) for swaps activity that could establish minimum standards of accountability; 2) impose stricter regulations on the retail foreign exchange market; 3) create new regulations to address cybersecurity concerns; and 5) increase enforcement penalties so fines are not “just a cost of doing business.”
Commissioner Giancarlo
Commissioner Christopher Giancarlo, in his testimony, stated he has been a “consistent advocate for practical and effective implementation of the three key pillars” of Dodd-Frank: 1) enhanced swaps transparency through data reporting; 2) regulated swaps execution; and 3) increased central counterparty (CCP) clearing. He added that “balanced and well-crafted regulatory oversight goes hand-in-hand with vibrant, transparent and competitive markets.”
Giancarlo noted that the CFTC is working on making changes to Rule 1.35 and said rules on position limits are a “work in progress.” He expressed concern with the position limits rulemaking, calling it “the most complex and restrictive rule you can imagine,” and said the CFTC must make sure the bona fide hedge exemption is sufficient to not place burdens on hedgers and end-users.
Giancarlo noted that the G20 called for coordinated global reform of the derivatives market but said that current conflicts threaten a “modern day trade war” resulting in market fragmentation along national boundaries that will increase systemic risk.
Commissioner Wetjen
Commissioner Mark Wetjen, in his testimony, stated that the markets look significantly different today than they did in 2011, when he became a Commissioner, noting that new requirements, including clearing and trading mandates and reporting obligations, have led to a safer and more transparent market structure.
Wetjen said that the CFTC should “take action to clarify the matters discussed” in the CFTC’s staff advisory on cross-border application of swap regulations, particularly how the CFTC views U.S. personnel. He stressed that many of the issues arising in CFTC’s cross-border regime are due to the Commission’s “first mover impact.”
To promote trading of swaps on swap execution facilities (SEFs) using the CFTC’s existing authority, Wetjen said the Commission will be looking into issues regarding: 1) eligibility under the floor trader exemption; 2) name give-up; 3) the embargo rule and work-ups; 4) made available to trade (MAT) determinations; 5) package transactions; 6) block trades; and 7) error trades.
He said Congress could help the CFTC by making amendments to the bankruptcy code for segregated customer accounts and addressing problems with indemnification rules that impede information sharing efforts.
Wetjen then highlighted the following trends that the Committee and the CFTC should be monitoring: 1) liquidity fragmentation in the global swaps market; 2) disruptive technologies; 3) futures commission merchant (FCM) concentration; 4) CCP risk; 5) cybersecurity; and 6) automated trading.
Question and Answer
Swap Dealer De Minimis
Chairman Scott explained that the CFTC’s swap dealer de minimis level will automatically move from $8 billion to $3 billion in 2017, regardless of what a mandated CFTC study shows. He noted that the CFTC changed the automatic trigger in its residual interest rule, and asked if the same should be done for the de minimis threshold.
Bowen replied that it is important to base rules on good data but that there is “no basis at this stage” to change this level.
Giancarlo said that the CFTC should approach the de minimis level in the same way they approached the residual interest rule, requiring affirmative Commission action based on the data provided in staff studies – not automatically as currently written.
Wetjen said that whatever decision that is made should be data driven and while he thinks that the rule now reflects this approach, he would be willing to change it and would be “comfortable” with the Commission being required to take a vote.
Special Calls
Chairman Scott asked what the CFTC’s process for “special calls” is in the context of the trade reporting rule and how this process is overseen.
Giancarlo said that the special call process is part of the CFTC’s oversight authority and that they have a “legitimate role.” However, he noted that the issuance of special calls has increased dramatically over the past several years and that several hundred have recently been issued in error. He stressed that the Commission should ensure that proper procedures are in place.
CFTC Funding
Ranking Member Scott asked if the CFTC is currently being appropriated sufficient funds to do its job.
Bowen said that it is “critically important” for the CFTC to receive additional funds, noting that the agency has fewer employees than it did before the financial crisis and that it needs to hire new staff and invest in new technology.
Giancarlo said that the CFTC must have resources to do its job, but that he supports current funding levels. He said the question is whether the agency is doing the job it needs to, or if it is wasting resources on other jobs.
Wetjen said the CFTC could use additional resources to meet the increased size and risk of the market that the agency has to regulate, but said there is not a “specific number” that would be appropriate. He added that the CFTC is not doing a good enough job examining clearing houses.
Enforcement
Ranking Member Scott asked how the CFTC can strengthen its enforcement.
Bowen said that the CFTC should have “much higher penalties” because current levels are not doing enough to deter bad behavior. She added that the agency needs more enforcement staff and said she has been surprised at the number of Ponzi schemes and attempts to take advantage of retirement funds she has seen since joining the Commission.
Regulatory Harmonization/Market Fragmentation
Rep. Michael Conway Lucas (R-Texas) noted that European Commissioner Patrick Pearson appeared before the Committee and warned that if there is not regulatory harmonization, markets would become walled off. He asked if this prediction was coming true.
Wetjen said he has seen “some regulatory fragmentation” as a result of the CFTC moving first with its rules. He noted that the cross-border guidance from the CFTC was a risk-based policy making that looked at how risk comes back into the U.S., and that it relies heavily on substituted compliance. Thus, “every jurisdiction needs to embrace substituted compliance.”
Giancarlo said that the prediction has “absolutely come true” and said that conduct and clearing has “silo-ed” regionally, making products “flee U.S. shores.”
Bowen said it is important to harmonize rules “as best we can” while protecting investors and making sure risk across borders does not come back to the U.S.
SEFs
Rep. Pete Aguilar (D-Calif.) asked what can be done to promote increased trading volume on SEFs.
Wetjen said that Congressional intent was to make SEFs flexible and that increased volume could be promoted by bringing additional liquidity providers onto these platforms. He noted that some of these entities are not willing to join the platforms currently but said entities that do not have customers would not be held to the same requirements as those for swap dealers. He explained that post-trade name give-up has discouraged some traders from joining SEFs and that an adjustment should be made to address this problem.
Giancarlo said that the objective for U.S. swap platforms should be to create the best rules in the world, much like the U.S. stock market, to encourage participants to use the U.S markets. He suggested making changes to the “core principles” for swaps trading provided by Congress.
Bowen noted that the CFTC’s Market Risk Advisory Committee has been looking into these issues and has discussed addressing name give up and removing the SRO function from SEFs as possible paths to improve functioning.
Rep. Rodney Davis (R-Ill.) asked Wetjen for his thoughts on Giancarlo’s White Paper on SEF reform.
Wetjen said the paper was “very thoughtful” but explained that SEFs have “tremendous flexibility.” He explained that there is not no mandate for trades to be done on an order book, and that if there is limited order book activity the Commission will consider other methods of execution.
Position Limits
Rep. Doug LaMalfa (R-Calif.) said that former CFTC Commissioner Michael Dunn described position limits as a “side show” that distracted from efforts to ensure a stable market system. He asked how the effectiveness of position limits could be evaluated.
Wetjen said that the position limits rule is a law that the CFTC must impose and noted that studies looking at the effects of speculation in the marketplace are “inconclusive at the moment.”
LaMalfa said he was concerned that certain bona fide hedges and historical practices to manage risk would be taken away from farmers under the CFTC’s proposal.
Bowen replied the CFTC is continuing to look at this space and the agency does not intend to take away legitimate hedging activity.
Data
LaMalfa asked how current the CFTC’s data is and if having input from the industry would be helpful.
Bowen said that staff has been working to ensure that data received is accurate and useful and noted that the agency receives data on a daily basis.
Giancarlo noted, however, that the data being used in the position limits rulemaking is 20 years old.
Rep. Tom Emmer (R-Minn.) asked about difficulties in consolidating trade data and when the CFTC will implement a plan to address this issue. He also asked if the CFTC is able monitor all the data it collects.
Wetjen noted that the CFTC will be taking action to address issues around trades that start out being bi-lateral but then became cleared, because confusion in the rules has lead to inaccuracies in the CFTC’s data set. He said the Commission has not yet seen a written recommendation but has been briefed by staff.
Giancarlo said that the agency is facing a “big data problem” and that having the right tools should be a “broadly supported mission.”
Rule 1.35
Rep. Ann Kirkpatrick (D-Ariz.) asked if having record keeping requirements under Rule 1.35 will be important for enforcement, noting that there have been allegations of manipulation in the wheat market. She noted that a section of the Commodity Exchange Act (CEA) reauthorization bill from last Congress sought to change this rule.
Wetjen said that the CFTC is deliberating internally on how to finalize this rule and said it is “meaningful” if entities choose to not engage in certain activity to avoid registration and this requirement. He added that the Commission should not finalize a rule that would impede access of end-users to the marketplace and stressed that this rule is just one of the many record keeping requirements from the CFTC, saying that there has “more attention paid to 1.35 than is merited, in a lot respects.”
Giancarlo agreed with Wetjen saying that the CFTC should not discourage membership on SEFs. Bowen added that rules should not be “so onerous” that “people flee.”
Swaps vs. Futures Market
Davis asked how the swaps market is different from the futures market.
Giancarlo explained that the differences between the swaps and futures markets can be compared to the differences between the bond and stock market, because swap and bond trading is more episodic, while futures and stock trading is more continuous. He added that the CFTC is writing rules to address problems seen in the last crisis but worried that the next crisis would result from a lack of liquidity. Giancarlo said that rules such as the supplemental leverage ratio, the Volcker Rule, Basel III, and position limits will negatively impact liquidity and make it more difficult for clearing houses to sell in times of stress.
Cross-Border
Emmer said he is concerned about the impact of the CFTC’s staff advisory 13-69 that deals with cross-border regulation of swaps activity and applies CFTC rules to transactions between two non-U.S. entities if U.S. personnel “arrange, negotiate, or execute” the transaction. He asked for clarification on what these terms mean and how these activities can import risk back into the U.S.
Giancarlo said that “a lot of the industry” is trying to figure out what the terms “arrange, negotiate, or execute” mean, noting that the advisory has already been delayed four times, which “tells something about the efficacy” if it. He then discussed a scenario which highlighted the detrimental impact of the advisory, where a transaction between a German bank and Swiss pension fund for credit risk protection on a U.S. company would be subject to CFTC transaction level rules if the German bank calls U.S.-located personnel who are expert on the U.S. company. He said this situation would lead to foreign companies not wanting to call the expert in the U.S., which may jeopardize that job.
Emmer then asked if the location of the individual negotiating a trade has a “direct and significant impact on U.S. commerce” in a situation where the trade is done between foreign counterparties in a foreign jurisdiction and if that is a “reasonable approach to cross-border regulation.”
Bowen replied that “it is one approach,” but suggested that the CFTC should follow “where the risk actually lies” and that where the person is located “may not be indicative as to where the real risk is.” She added that in global markets “the concept of U.S. person, frankly, may be irrelevant because transactions will be taking place in cyberspace.” Bowen said that these scenarios are why the agency has opened the guidance to comments and that she thinks “there are other approaches.”
Ranking Member Scott said the CFTC needs to be careful not to put the U.S. financial industry in a “non-competitive position” and said that under the push-out rule, pushing out commodity swaps from the same branch that interest rates swaps are done in would put end-users at a competitive disadvantage. He asked if other jurisdictions are taking these types of actions and how the CFTC determines what constitutes a robust regime.
Wetjen noted that the G20 nations are in different stages of implementation, saying that Europe has “done a great deal” and that Japan is “making significant progress.” However he noted that there are lags in timing and some differences between rules that “have to be managed.” Wetjen said it is important to make sure U.S. institutions are competitive and that the CFTC can compare regimes and decide if additional policy is needed, once other the nations’ rules are complete.
Giancarlo noted that one premise of Dodd-Frank was to ring-fence the U.S. market to prevent importing risk from abroad. However, he said that the rule of charging initial margin for internal risk transfer activities could cause risk to be retained in the U.S. and harm the ability of end-users to hedge risk outside the U.S. He explained that companies transfer risk by engaging in swaps between affiliate entities to hedge risk in certain markets and that if they have to change initial margin on these transactions, then costs will increase for end-users.
No-Action Letters
Rep. Frank Lucas (R-Okla.) asked if the use of no-action letters provides regulatory clarity and noted an example where a letter was issued to explain a footnote in staff guidance that was unclear. He also asked how this process can be improved.
Bowen said that the CFTC uses no-action letters and guidance to be flexible and respond to problems raised by the industry, but noted that her preference would be to have a process of rulemaking with notice and comment.
Giancarlo said that the Commission’s recent use of the no-action process “erodes confidence” and “stymies” the ability of the CFTC to instill a culture of compliance.
Wetjen said that one of the ways to avoid the need for no-action letters is to ensure maximum consensus during the rulemaking process, taking into account all comments on file.
FCM Consolidation
Chairman Scott noted that the number of FCMs has been decreasing over time and expressed concern that a reduction in the number of clearing members could lead in increases in systemic risk.
Bowen said this is an area the CFTC is looking at and explained that the current low interest rate environment has contributed to this reduction.
Wetjen agreed that low interest rates make it difficult for FCMs to get sufficient returns and noted that additional prudential regulations may be causing FCMs to exit the market. He said this reduction will “lead to problems of accessibility.”
Giancarlo said that regulators need to be careful “about piling on regulations” and said that non-traditional liquidity providers could present a “real opportunity.”
Real Time Reporting
Davis asked if the no-action relief from certain real-time reporting requirements provided to Southwest Airlines should be broadened to other market participants.
Giancarlo and Wetjen said that the CFTC should look at broadening this relief to others, while Bowen said that this situation was “quite unique” and that if other participants have the same issue, they should come forward.
Improving H.R. 4413
Ranking Member Scott asked how the CEA reauthorization bill from last Congress (H.R. 4413) could be improved.
Bowen said that legislation in this Congress should preserve the flexibility of the CFTC to address problems in the market, saying that if certain things are codified, it could be harmful. She also asked for the ability for the CFTC to impose a user fee to help fund the agency.
Giancarlo suggested: 1) codifying the treatment of special entity utilities; 2) addressing the “core principles” of SEFs; 3) requiring a decision based on the swap dealer de minimis threshold study before lowing the level; 4) removing indemnification requirements for swap data; and 5) removing initial margin requirements for internal risk transfers.
Wetjen said that indemnification should be eliminated and that the agency should have sufficient flexibility.
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