Friday, October 14, 2011

CFTC Chair Gensler Emphasizes Importance of Cross-Border Consistency in Derivatives Regulation

It is critically important that derivatives regulatory efforts be coordinated and consistent cross-border, emphasized CFTC Chair Gary Gensler. In remarks at the London School Economics, he particularly noted that like the European Market Infrastructure Regulation (EMIR), the Dodd-Frank Act covers the entire swaps marketplace, both bilateral and cleared, and the entire product suite, including interest rate swaps, currency swaps, commodity swaps, equity swaps and credit default swaps. More broadly, Chairman Gensler said that the CFTC is consulting and coordinating with international regulators to promote consistent standards in swaps oversight, and is sharing many of its memos and draft work product with them. The Chair also said that he has met with EU Commissioner for the Internal Market Michel Barnier numerous times and has set up a process with weekly staff calls coordinated between the CFTC, SEC, European Commission, and the European Securities and Market Authority.

Dodd-Frank requires that all swaps transactions, both cleared and bilateral, be publicly reported as soon as technologically practicable after the swap has been executed. Further, the Act requires all swaps that can be cleared and are made available for trading to be traded on a transparent trading platform. The Chair noted that the European Commission will address public transparency requirements in the Markets in Financial Instruments Directive (MiFID) reform proposal later this year. He said that it is critical that reform includes a strong requirement that standardized swaps be traded on exchanges or similar swap execution facilities that provide true pre-trade transparency.

The CFTC Chair went on to note that the G-20 concurs that all standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest. Earlier this year, the International Organization of Securities Commissions (IOSCO) issued a report on trading that further clarifies the G-20 mandate to trade standardized swaps on electronic trading platforms, including eight characteristics of such platforms. Many of the IOSCO members participating indicated a belief that added benefits are achieved through multi-dealer trading platforms. The IOSCO report concluded that, beyond the added benefits of pre-trade transparency, trading helps mitigate systemic risk and protect against market abuse.

Chairman Gensler also observed that the Dodd-Frank Act requires the clearing of standardized swaps, those that Americans call “clearable” and that Europeans often call “eligible.” Under the Dodd-Frank Act, all clearable swaps, regardless of whether they are done on an exchange or off an exchange, are subject to the clearing requirement. The Chairman is pleased to see that the latest European Council version of EMIR will require clearing of most clearable swaps, including those traded over-the-counter or on electronic trading platforms.

It is critical, though, he continued, that those swaps traded on regulated exchanges also be subject to the clearing requirement to bring the benefits of clearing to swaps, regardless of whether they are traded on exchange or off exchange. In his view, creating an environment where all standardized swaps are cleared, whether off-exchange or exchange-traded, will ensure a level playing field and promote consistent and comparable requirements internationally within derivatives regulations.

The Dodd-Frank Act includes comprehensive regulation of swap dealers. Though EMIR is organized differently, noted Chairman Gensler, it is important that it include many of the same critical components for the regulation of dealers, including capital and margin, risk mitigation techniques, better communication and sales practices with counterparties and regulatory reporting.

He explained that one of the lessons from the financial crisis was that dealers were insufficiently prepared for the losses they could take if their swaps counterparty were to fail. Capital requirements help protect the public by lowering the risk of a dealer’s failure. On the other hand, margin requirements help protect dealers and their customers in volatile markets or if either of them defaults. Both are important tools to lower risk in the swaps markets.

The CFTC Chair noted that a group of international standard-setting bodies, led by IOSCO and the Basel Committee recognizes that international consistency on margin for uncleared trades is essential to protect against regulatory arbitrage. The group is developing standards for margin on uncleared trades for consultation by June 2012.

The Dodd-Frank Act also explicitly authorizes regulators to write business conduct standards to lower risk and promote market integrity, including documentation, confirmation and portfolio reconciliation requirements. Further, noted the Chair, the Act provides regulators with authority to write business conduct rules to provide material information to customers and to protect against fraud, manipulation and other abuses. Chairman Gensler emphasized how important it is that similar authorities also are written into European swaps reform.

As part implementing the Dodd-Frank derivatives oversight regime, the CFTC will work with its international colleagues on memoranda of understanding for access to information and cooperative oversight. Dodd-Frank gives the CFTC the flexibility to recognize foreign regulatory frameworks that are comprehensive and comparable to U.S. oversight of the swaps markets in certain areas. The CFTC will also seek public input on the application of Section 722(d) of the Dodd-Frank Act, which says that the law doesn’t apply to activities outside the United States unless those activities have a direct and significant connection with activities in, or effect on, U.S. commerce.

Finally, he said that the CFTC is seeking inclusion as an Ordinary member of IOSCO. For IOSCO to be the premier standard-setter for both securities and derivatives, he reasoned, it is critical that the CFTC have membership status commensurate with its regulatory responsibilities, which he said would be the regulation of both the $300 trillion U.S. swaps market as well as the $40 trillion U.S. futures market, in aggregate the largest derivatives markets in the world.