Wednesday, May 27, 2015

Chairman Massad Concerned About Proposed EU Legislation on Benchmark Supervision

By Lene Powell, J.D.

In the wake of multiple enforcement actions against major banks for benchmark rate rigging, CFTC Chairman Timothy Massad sounded a warning about legislation being considered in Europe that could stop European banks and asset managers from trading in U.S. markets unless benchmarks are supervised in an “equivalent” manner. In remarks at a natural gas conference, Massad explained that proposed EU legislation could effectively require government oversight of benchmark administrators, which is not an approach contemplated by the U.S.

“The United States does not have a government-sponsored supervisory regime for benchmarks. That’s simply not how our system works,” said Massad.

Benchmarks. Thousands of contracts rely on benchmarks or other indices, such as the S&P 500 and many benchmarks in the energy markets published by third parties such as Platts and Argus. Over the past few years, the CFTC has joined other regulators in enforcement actions against a number of major international banks regarding manipulation of key benchmarks, resulting in billions of dollars in fines. Last week, Barclays agreed to pay $515 million for attempted manipulation and false reporting involving both foreign exchange (FX) and ISDA FIX, a key interest rate benchmark.

U.S. government regulators do not supervise benchmarks. Instead, said Massad, U.S. law gives the CFTC the power to review new proposed contracts and determine whether they are susceptible to fraud and manipulation, and to engage in surveillance and enforcement on an ongoing basis to identify and deter manipulation. In light of the proposed EU legislation, Massad encourages European officials to recognize this alternative approach, and to consider the work of the International Organization of Securities Commissions (IOSCO) in this area, which the CFTC helped lead. Oil price reporting agencies have been voluntarily complying with IOSCO standards, he said.

Massad also suggested that European regulators consider focusing their standards on the most widely used benchmarks, so smaller contracts are not subject to prohibitive compliance costs. Imposing upfront, significant costs for regulatory compliance before a contract has developed significant liquidity could stifle innovation.

Upcoming rulemaking. The CFTC has finished most of its Dodd-Frank rulemaking and taken a number of actions over the past year to address concerns of commercial end-users, including amending rules and providing no-action and exemptive relief. Looking forward, the CFTC has a few rules to finish.

Regarding position limits, Massad observed that commodity futures markets have had federal limits for nine agricultural commodities for decades, and exchange-imposed limits in other commodities. As part of extending the federal scheme to other commodities, the CFTC has received from exchanges estimates of deliverable supply, which are used in calculating limits. The CFTC is also “carefully considering” comments on bona fide hedging exemptions, and is looking at the possibility of relying on exchanges to review applications for “non-enumerated” exemptions.

The CFTC is also working to finish its proposed rule on margin for uncleared swaps, which would require swap dealers to post and collect margin from their counterparties on uncleared swaps, much as is required for cleared swaps. The proposed rule would not, however, require swap dealers to collect margin from commercial end-user counterparties, said Massad.

In addition, the CFTC has started work on a study examining the threshold for determining who is a swap dealer and related policy questions, the chairman reported. Under swap dealer rules finalized in 2012, the threshold for determining who is a swap dealer will decline from $8 billion to $3 billion in December of 2017 unless the CFTC takes action.

Finally, the CFTC is looking at market liquidity issues. The CFTC has been discussing with banking regulators the implications of the supplemental leverage ratio or SLR on the costs of clearing, and Massad is concerned that the way the SLR treats segregated cash margin creates a disincentive to clearing. Also being looked at is changes in market structure due to automated trading. For example, about 80 percent of trades in Henry Hub natural gas futures contracts are now conducted by automated trading on at least one side. Around 40 percent of trades are automated on both sides of the trade, Massad said.