Key Topics & Takeaways
- Derivatives Reforms: Giancarlo expressed his support for the “core tenets” of Title VII of the Dodd-Frank Act, but said that if excessive regulation “stymies the legitimate use of derivatives, the overall economy will suffer.”
- Cross-Border: Giancarlo said the CFTC’s cross-border staff advisory “poses a serious threat” to jobs in the U.S. and is causing trading firms to consider “cutting off all activity with U.S.-based trade support personnel.” He added that there is “certainly appetite on my part” to turn the guidance into a formal rulemaking.
- Fragmentation: Giancarlo does not agree that market fragmentation is temporary because Europe will learn from the CFTC’s mistakes and not create bad rules.
- Position Limits: Giancarlo said the CFTC needs to “re-look” at the position limits rule and approach it in a “targeted fashion.”
Christopher Giancarlo, Commissioner of the Commodity Futures Trading Commission (CFTC), in his prepared remarks, stated that “what really matters to American voters” is their jobs and that free enterprise “remains the best path to job creation.”
Giancarlo expressed his support for the “core tenets” of Title VII of the Dodd-Frank Act, including central clearing, reporting, and sensible regulation of swaps intermediaries, but said that if “excessive regulation artificially increases the cost of risk management and stymies the legitimate use of derivatives, the overall economy will suffer – and American jobs will be lost.”
He continued that a more “thoughtful, steady, and less hectic” approach to regulation must be taken and outlined six principles for better financial market regulation.
Principle One: Regulation Must Not Restrain the U.S. Economy
Giancarlo stated that federal regulations have “become a major drag on the U.S. economy,” citing that regulations cost the U.S. more than 12 percent of gross domestic product (GDP) or $2 trillion annually. He said this level of regulation acts as a barrier to capital investment that would otherwise lead to job creation and wage growth.
He noted that the health and efficiency of the futures and derivatives markets has a direct impact on things like the price and availability of food and fuel because producers use these markets to access risk hedging instruments.
Giancarlo highlighted that, in the spirit of not restraining the economy, he voted against a CFTC rule proposal that was “well intentioned” but provided “insufficient relief” from data record keeping requirements that would impose “senseless costs” on small futures commission merchants (FCMs).
Principle Two: Regulation Must Not Threaten American Jobs
Giancarlo said that the opportunity to work in a full time job has been diminished in the U.S. over the past few years and that that “federal regulators are not helping matters.”
He highlighted that the CFTC’s staff advisory in November 2013 “poses a serious threat” to jobs in the U.S. financial services industry and is causing “many trading firms to consider cutting off all activity with U.S.-based trade support personnel.” He explained that this advisory was “hurriedly issued” without a vote by the full Commission and noted that fellow Commissioner Mark Wetjen said the issuance was not the “right decision.” He continued that this advisory “jeopardizes the role of bank sales personnel in U.S. financial centers” and “will likely have a ripple effect” on “thousands of jobs tied to” the U.S. financial services industry.
He noted that last week the CFTC delayed this advisory for the fourth time, adding that “when a regulatory action needs four delays, I think we all can admit that it is not workable and needs to be scrapped.”
Principle Three: Regulation Must Be Impartial and Balanced
Giancarlo said that a “crisis exploitation methodology” was used as a “catalyst” for new legislation across the government, including the CFTC. He stated that the CFTC “took advantage” of the crisis to assert jurisdiction over previous excluded registered investment companies regulated by the Securities and Exchange Commission (SEC).
Giancarlo said this action required these entities to register with the CFTC as commodity pool operators and triggered burdensome disclosure requirements, which resulted in higher costs being passed on to the retirements savings and 401(k) plans of millions of ordinary Americans.
Principle Four: Regulation Must Be Competent
Next, Giancarlo noted that public trust in the federal government is at an all-time low and said he believes there is a “direct link between a government trying to do too much and a government doing things incompetently.”
He pointed to the CFTC’s “misnamed” customer protection rule as an example of flawed regulation. He said that while some aspects of the rule were needed, the CFTC did not conduct enough analysis on the rule to figure out that it could cause FCM customers to lose more of their money in a potential failure.
Principle Five: Regulation Must Be Accountable
Giancarlo said the CFTC must live up to the same transparency standards that they expect from their market participants. He expressed concern that the CFTC has failed to employ a transparent and deliberative rulemaking process under Dodd-Frank and highlighted that this has resulted in over 110 “No Action” letters being issued in the first eight months of 2014.
He added, “these failures eroded not only the public’s confidence in the CFTC as a regulator, but the CFTC’s ability to establish a compliance culture in the industry it regulates.”
Principle Six: Regulation Must Not Create the Next Crisis
Lastly, Giancarlo said that there has been “little in the way of acknowledgement for the federal government’s role” in the last crisis and that there has been “a shifting in attitude on how U.S. capital and financial markets should function.” This shift in attitude, he said, is marked by efforts to make markets less risky, noting efforts include rules such as the Volcker rule, swaps push out, margin on uncleared swaps, and Basel III capital requirements.
He continued that in this pursuit of limiting risk, banks have “curtailed putting their capital to work on behalf of clients and economic growth.” He cited a report by the International Monetary Fund that discusses the need for banks to engage in more economic risk taking to help the global economic recovery.
Giancarlo said that the CFTC put forth “its share of bad rules” in efforts to reduce market risk, highlighting “transaction level rules” based on the “wrong template of the U.S. futures market.” He noted that he and his staff will soon be releasing a White Paper proposing improvements to these rules.
Giancarlo said the global response to the CFTC regime has been “swift and dramatic” and that global liquidity pools have divided between those with and those without U.S. persons. This fragmentation, he added, leads to smaller liquidity pools and more volatile pricing, which creates greater risk of market failure in an economic crisis.
He concluded that the next crisis “could well be a liquidity crisis – a crisis in which capital-constrained banks and other market makers have little choice in a panic but to limit their exposure to increasingly fragmented markets.”
Question and Answer
Giancarlo was asked if market fragmentation will “heal” over time as Europe finalizes their regulatory regime. Giancarlo noted that the G20 agreement after the crisis stated that international regulators would create and implemented rules in a coordinated fashion, but that the CFTC rushed and “made a hash” of their transaction and swap execution facility (SEF) rules. He then said that the world is assessing the U.S.’s flawed rules and the incomplete European rules, which has resulted the global market being broken in two.
Giancarlo said that he does not agree that this fragmentation is temporary because Europe will learn from the CFTC’s mistakes and not create bad rules. He also noted that “history shows” that once a market “runs away” it does not come back, citing the Eurodollar market as an example.
The next question asked where the rulemaking on position limits is heading.
Giancarlo called this rulemaking area another example of “opportunistic” regulation and noted that the CFTC received “enormous opposition” to their proposal, with commenters saying the rule would “strangle” their operations. He said the CFTC needs to “re-look” at this rule and approach it in a “targeted fashion” by first addressing participants known to be engaging excessively in the markets and then “work from there.”
International Derivatives Markets
An audience member noted that there has been increasing derivatives activity in places like Asia and the Middle East and asked how investors can be protected from banks “playing in that game.”
Giancarlo said this activity “is a real problem” and that it is currently “open season” on U.S. institutions. He said that as U.S. banks exit certain markets, they are being replaced by alternatives, noting that physical commodities operations once held by banks are being bought by international firms from places such as Russia and Brazil. He concluded “be careful what you wish for.”
An audience member said that a recent court ruling on the CFTC’s cross-border guidance did not bring much certainty to the market and asked if there is an appetite at the commission to turn the guidance into a formal rulemaking with a notice and comment period.
Giancarlo said that there is “certainly appetite on my part” and that he thinks there is among the other Commissioners as well. He said that part of the problem with the guidance is the CFTC’s U.S. person definition because it has become a “Scarlet Letter” in the industry. He added that before these rules, counterparties would do business with each other based on relationships, but now they chose based on the “one criteria” of whether or not the firm is a U.S. person. He then stressed the need to address this problem and allow the U.S. to become more competitive internationally.
The last question asked if the suggestions in Giancarlo’s remarks are a call for weaker regulation.
Giancarlo replied by referencing the state of Delaware, where many corporations choose to be headquartered. They do this, he said, because Delaware has some of the best, yet most rigorous rules. He said it is a “misnomer” that business flows to the most “lax regime” and that business flows to areas with the “best blend.”
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