Testimony of Gary Gensler, Chairman, Commodity Futures Trading Commission Before the U.S. Senate Banking, Housing and Urban Affairs Committee,…
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Testimony of
Good morning Chairman Johnson, Ranking Member Crapo and members of the Committee. I thank you for inviting me to today's hearing on implementation of Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) swaps market reforms. I am pleased to testify along with my fellow regulators. I also want to thank the CFTC Commissioners and staff for their hard work and dedication.
The New Era of Swaps Market Reform
This hearing is occurring at an historic time in the markets. The CFTC now oversees the derivatives marketplace - across both futures and swaps. The marketplace is increasingly shifting to implementation of the common-sense rules of the road for the swaps market that
For the first time, the public is benefiting from seeing the price and volume of each swap transaction. This post-trade transparency builds upon what has worked for decades in the futures and securities markets. The new swaps market information is available free of charge on a website, like a modern-day ticker tape.
For the first time, the public will benefit from the greater access to the markets and the risk reduction that comes with central clearing. Required clearing of interest rate and credit index swaps between financial entities begins next month.
For the first time, the public will benefit from specific oversight of swap dealers. As of today, 71 swap dealers are provisionally registered. They are subject to standards for sales practices, recordkeeping and business conduct to help lower risk to the economy and protect the public from fraud and manipulation. The full list of registered swap dealers is on the CFTC's website, and we will update it as more entities register.
An earlier economic crisis led
In the 1980s, the swaps market emerged. Until now, though, it had lacked the benefit of rules to promote transparency, lower risk and protect the public, rules that we have come to depend upon in the securities and futures markets. What followed was the 2008 financial crisis. Eight million American jobs were lost. In contrast, the futures market, supported by earlier reforms, weathered the financial crisis.
The CFTC has largely completed swaps market rulewriting, with 80 percent behind us. On
The CFTC is seeking to consider and finalize the remaining Dodd-Frank swaps reforms this year. In addition, as
The agency has completed each of our reforms with an eye toward ensuring that the swaps market works for end-users, America's primary job providers. It's the end-users in the non-financial side of our economy that provide 94 percent of private sector jobs.
The CFTC's swaps market reforms benefit end-users by lowering costs and increasing access to the markets. They benefit end-users through greater transparency - shifting information from
The CFTC has worked to complete the Dodd-Frank reforms in a deliberative way - not against a clock. We have been careful to consider significant public input, as well as the costs and benefits of each rule. CFTC Commissioners and staff have met more than 2,000 times with members of the public, and we have held 22 public roundtables. The agency has received more than 39,000 comment letters on matters related to reform. Our rules also have benefited from close consultation with domestic and international regulators and policymakers.
Throughout this process, the Commission has sought input from market participants on appropriate schedules to phase in compliance with swaps reforms. Now, over two-and-a-half years since Dodd-Frank passed and with 80 percent of our rules finalized, the market is moving to implementation. Thus, it's the natural order of things that market participants have questions and have come to us for further guidance. The CFTC welcomes inquiries from market participants, as some fine-tuning is expected. As it is sometimes the case with human nature, the agency receives many inquiries as compliance deadlines approach.
My fellow commissioners and I, along with CFTC staff, have listened to market participants and thoughtfully sorted through issues as they were brought to our attention, as we will continue to do.
I now will go into further detail on the Commission's swaps market reform efforts.
Transparency - Lowering Cost and Increasing Liquidity, Efficiency, Competition
Transparency - a longstanding hallmark of the futures market - both pre- and post-trade - lowers costs for investors, consumers and businesses. It increases liquidity, efficiency and competition. A key benefit of swaps reform is providing this critical pricing information to businesses and other end-users across this land that use the swaps market to lock in a price or hedge a risk.
As of
With these transparency reforms, the public and regulators now have their first full window into the swaps marketplace.
Time delays for reporting currently range from 30 minutes to longer, but will generally be reduced to 15 minutes this October for interest rate and credit index swaps. For other asset classes, the time delay will be reduced next January. After the CFTC completes the block rule for swaps, trades smaller than a block will be reported as soon as technologically practicable.
To further enhance liquidity and price competition, the CFTC is working to finish the pre-trade transparency rules for swap execution facilities (SEFs), as well as the block rule for swaps. SEFs would allow market participants to view the prices of available bids and offers prior to making their decision on a transaction. These rules will build on the democratization of the swaps market that comes with the clearing of standardized swaps.
Clearing - Lowering Risk and Democratizing the Market
Since the late 19th century, clearinghouses have lowered risk for the public and fostered competition in the futures market. Clearing also has democratized the market by fostering access for farmers, ranchers, merchants, and other participants.
A key milestone was reached in
Consistent with the direction of Dodd-Frank, the Commission in the fall of 2011 adopted a comprehensive set of rules for the risk management of clearinghouses. These final rules were consistent with international standards, as evidenced by the Principles for Financial Market Infrastructures (PFMIs) consultative document that had been published by the
In April of 2012, CPSS-IOSCO issued the final PFMIs. The Commission's clearinghouse risk management rules cover the vast majority of the standards set forth in the final PFMIs. There are a small number of areas where it may be appropriate to augment our rules to meet those standards, particularly as it relates to systemically important clearinghouses. I have directed staff to work expeditiously to recommend the necessary steps so that the Commission may implement any remaining items from the PFMIs not yet incorporated in our clearinghouse rules. I look forward to the Commission considering action on this in 2013.
I expect that soon we will complete a rule to exempt swaps between certain affiliated entities within a corporate group from the clearing requirement. This year, the CFTC also will be considering possible clearing determinations for other commodity swaps, including energy swaps.
Swap Dealer Oversight - Promoting Market Integrity and Lowering Risk
Comprehensive oversight of swap dealers, a foundational piece of Dodd-Frank, will promote market integrity and lower risk to taxpayers and the rest of the economy.
As the result of CFTC rules completed in the first half of last year, 71 swap dealers are now provisionally registered. This initial group of dealers includes the largest domestic and international financial institutions dealing in swaps with U.S. persons. It includes the 16 institutions commonly referred to as the G16 dealers. Other entities are expected to register over the course of this year once they exceed the de minimis threshold for swap dealing activity.
In addition to reporting trades to both regulators and the public, swap dealers will implement crucial back office standards that lower risk and increase market integrity. These include promoting the timely confirmation of trades and documentation of the trading relationship. Swap dealers also will be required to implement sales practice standards that prohibit fraud, treat customers fairly and improve transparency. These reforms are being phased in over the course of this year.
The CFTC is collaborating closely domestically and internationally on a global approach to margin requirements for uncleared swaps. We are working along with the Federal Reserve, the other U.S. banking regulators, the
Following
International Coordination on Swaps Market Reform
In enacting financial reform,
This phenomenon was true with the overseas affiliates and operations of AIG,
Last year's events of
Failing to incorporate these basic lessons of modern finance into the CFTC's oversight of the swaps market would fall short of the goals of Dodd-Frank reform. It would leave the public at risk.
More specifically, I believe that Dodd-Frank reform applies to transactions entered into by overseas branches of U.S. entities with non-U.S. persons, as well as between overseas affiliates guaranteed by U.S. entities. Failing to do so would mean American jobs and markets may move offshore, but, particularly in times of crisis, risk would come crashing back to our economy.
Similar lessons of modern finance were evident, as well, with the collapse of the hedge fund
The same was true when
We must thus ensure that collective investment vehicles, including hedge funds, that either have their principal place of business in
We are hearing, though, that some swap dealers may be promoting to hedge funds an idea to avoid required clearing, at least during an interim period from March until July. I would be concerned if, in an effort to avoid clearing, swap dealers route to their foreign affiliates trades with hedge funds organized offshore, even though such hedge funds' principle place of business was in
To give financial institutions and market participants guidance on 722(d), the CFTC last June sought public consultation on its interpretation of this provision. The proposed guidance is a balanced, measured approach, consistent with the cross-border provisions in Dodd-Frank and
Pursuant to Commission guidance, foreign firms that do more than a de minimis amount of swap-dealing activity with U.S. persons would be required to register with the CFTC within about two months after crossing the de minimis threshold. A number of international financial institutions are among the 71 swap dealers that are provisionally registered with the CFTC.
Where appropriate, we are committed to permitting, foreign firms and, in certain circumstances, overseas branches and guaranteed affiliates of U.S. swap dealers, to comply with Dodd-Frank through complying with comparable and comprehensive foreign regulatory requirements. We call this substituted compliance.
For foreign swap dealers, we would allow such substituted compliance for requirements that apply across a swap dealer's entity, as well as for certain transaction-level requirements when facing overseas branches of U.S. entities and overseas affiliates guaranteed by U.S. entities. Entity-level requirements include capital, chief compliance officer and swap data recordkeeping. Transaction-level requirements include clearing, margin, real-time public reporting, trade execution, trading documentation and sales practices.
When foreign swaps dealers transact with a U.S. person, though, compliance with Dodd-Frank is required.
To assist foreign swap dealers with Dodd-Frank compliance, the CFTC recently finalized an exemptive order that applies until
Under this Final Order, foreign swap dealers may phase in compliance with certain entity-level requirements. In addition, the Order provides time-limited relief for foreign dealers from specified transaction-level requirements when they transact with overseas affiliates guaranteed by U.S. entities, as well as with foreign branches of U.S. swap dealers.
The Final Order provides time for the Commission to continue working with foreign regulators as they implement comparable swaps reforms and as the Commission considers substituted compliance determinations for the various foreign jurisdictions with entities that have registered as swap dealers under Dodd-Frank.
The CFTC will continue engaging with our international counterparts through bilateral and multilateral discussions on reform and cross-border swaps activity. Just last week,
Given our different cultures, political systems and legislative mandates some differences are unavoidable, but we've made great progress internationally on an aligned approach to reform. The CFTC is committed to working through any instances where we are made aware of a conflict between U.S. law and that of another jurisdiction.
Customer Protection
Dodd-Frank included provisions directing the CFTC to enhance the protection of swaps customer funds. While it was not a requirement of Dodd-Frank, in 2009 the CFTC also reviewed our existing customer protection rules for futures market customers. As a result, a number of our customer protection enhancements affect both futures and swaps market customers. I would like to review our finalized enhancements, as well as an important customer protection proposal.
The CFTC's completed amendments to rule 1.25 regarding the investment of customer funds benefit both futures and swaps customers. The amendments include preventing in-house lending of customer money through repurchase agreements. The CFTC's gross margining rules for futures and swaps customers require clearinghouses to collect margin on a gross basis. Futures commission merchants (FCMs) are no longer able to offset one customer's collateral against another or to send only the net to the clearinghouse.
Swaps customers further benefit from the new so-called LSOC (legal segregation with operational comingling) rules, which ensure their money is protected individually all the way to the clearinghouse.
The Commission also worked closely with market participants on new rules for customer protection adopted by the self-regulatory organization (SRO), the
These steps were significant, but market events have further highlighted that the Commission must do everything within our authorities and resources to strengthen oversight programs and the protection of customers and their funds.
In the fall of 2012, the Commission sought public comment on a proposal to further enhance the protection of customer funds.
The proposal, which the CFTC looks forward to finalizing this year, would strengthen the controls around customer funds at FCMs. It would set new regulatory accounting requirements and would raise minimum standards for independent public accountants who audit FCMs. And it would provide regulators with daily direct electronic access to the FCMs' bank and custodial accounts for customer funds. Last week, the CFTC held a public roundtable on this proposal, the third roundtable focused on customer protection.
Further, the CFTC intends to finalize a rule this year on segregation for uncleared swaps.
Benchmark Interest Rates
I'd like to now turn to the three cases the CFTC brought against
The three cases shared a number of common traits. Foremost, at each institution the misconduct spanned multiple years, involved offices in multiple cities around the globe, included numerous people, and affected multiple benchmark rates and currencies. In each case, there was evidence of collusion among banks. In both the UBS and RBS cases, one or more inter-dealer brokers were asked to paint false pictures to influence submissions of other banks, i.e., to spread the falsehoods more widely. At
Why does this matter?
The derivatives marketplace that the CFTC oversees started about 150 years ago. Futures contracts initially were linked to physical commodities, like corn and wheat. Such clear linkage ultimately comes from the ability of farmers, ranchers and other market participants to physically deliver the commodity at the expiration of the contract. As the markets evolved, cash-settled contracts emerged, often linked to markets for financial commodities, like the stock market or interest rates. These cash-settled derivatives generally reference indices or benchmarks.
Whether linked to physical commodities or indices, derivatives - both futures and swaps - should ultimately be anchored to observable prices established in real underlying cash markets. And it's only when there are real transactions entered into at arm's length between buyers and sellers that we can be confident that prices are discovered and set accurately.
When market participants submit for a benchmark rate that lacks observable underlying transactions, even if operating in good faith, they may stray from what real transactions would reflect. When a benchmark is separated from real transactions, it is more vulnerable to misconduct.
Today, LIBOR is the reference rate for 70 percent of the U.S. futures market, most of the swaps market and nearly half of U.S. adjustable rate mortgages. It's embedded in the wiring of our financial system.
The challenge we face is that the market for interbank, unsecured borrowing has largely diminished over the last five years. Some say that it is essentially nonexistent. In 2008,
The number of banks willing to lend to one another on such terms has been sharply reduced because of economic turmoil, including the 2008 global financial crisis, the European debt crisis that began in 2010, and the downgrading of large banks' credit ratings. In addition, there have been other factors that have led to unsecured, interbank lending drying up, including changes to
Fortunately, much work is occurring internationally to address these issues. I want to commend the work of
The consultation report said: "The Task Force is of the view that a benchmark should as a matter of priority be anchored by observable transactions entered into at arm's length between buyers and sellers in order for it to function as a credible indicator of prices, rates or index values." It went on to say: "However, at some point, an insufficient level of actual transaction data raises concerns as to whether the benchmark continues to reflect prices or rates that have been formed by the competitive forces of supply and demand."
Among the questions for the public in the report are the following:
- What are the best practices to ensure that benchmark rates honestly reflect market prices?
- What are best practices for benchmark administrators and submitters?
- What factors should be considered in determining whether a current benchmark's underlying market is sufficiently robust? For instance, what is an insufficient level of actual transaction activity?
- And what are the best mechanisms or protocols to transition from an unreliable or obsolete benchmark?
On
Resources
The CFTC's hardworking team of 690 is less than 10 percent more in numbers than at our peak in the 1990s. Yet since that time, the futures market has grown five-fold, and the swaps market is eight times larger than the futures market.
Market implementation of swaps reforms means additional resources for the CFTC are all the more essential. Investments in both technology and people are needed for effective oversight of these markets by regulators - like having more cops on the beat.
Though data has started to be reported to the public and to regulators, we need the staff and technology to access, review and analyze the data. Though 71 entities have registered as new swap dealers, we need people to answer their questions and work with the NFA on the necessary oversight to ensure market integrity. Furthermore, as market participants expand their technological sophistication, CFTC technology upgrades are critical for market surveillance and to enhance customer fund protection programs
Without sufficient funding for the CFTC, the nation cannot be assured this agency can closely monitor for the protection of customer funds and utilize our enforcement arm to its fullest potential to go after bad actors in the futures and swaps markets. Without sufficient funding for the CFTC, the nation cannot be assured that this agency can effectively enforce essential rules that promote transparency and lower risk to the economy.
The CFTC is currently funded at
Thank you again for inviting me today, and I look forward to your questions.
TNS-LE 130215-4205753 StaffFurigay
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