In a blistering dissent, CFTC Commissioner Scott O’Malia criticized a final rule imposing certain reporting and recordkeeping requirements for swap dealers and major swap participants. In the commissioner’s view, the agency committed “regulatory malpractice” by implementing a major rule without adequate discussion of anticipated costs.
“I have reached a tipping point and can no longer tolerate the application of such weak standards to analyzing the costs and benefits of our rulemakings,” said the commissioner in a prepared dissent. “I believe it is time for professional help.”
According to Commissioner O’Malia, the CFTC must go out of its way to undertake thorough cost-benefit analyses, both qualitative and quantitative, to ensure that new rules do not impose unreasonable costs. This is required, he said, by two Executive Orders (13,563 and 13,579) issued by President Obama in 2011 with the aim of improving regulatory review. Taken together, the orders exhort independent regulatory agencies – a category that includes the CFTC – to comply with the same provisions required of executive agencies.
The commissioner noted that the staff’s own guidance on cost-benefit analysis stated that rulemaking teams should incorporate the principles of the executive orders to the extent they are consistent with the cost-benefit provisions of the CFTC’s authorizing statute, and to the extent “reasonably feasible.” By accepting the low bar of “reasonably feasible,” said the commissioner, the rulemaking was “nothing but unreasonably feeble.”
Commissioner O’Malia singled out two provisions of the final rules for criticism. The new rules require swap dealers and major swap participants to maintain certain audio recordings, and to tag each taped conversation and make it searchable by transaction and counterparty. According to the commissioner, the technological challenges posed are “enormous”, and the agency did not determine whether such technology exists or the cost or feasibility of developing it in the required timetable.
Further, the commissioner objected to the agency’s decision not to allow substituted compliance for recordkeeping requirements. Specifically, the Commission declined some commenters’ request that firms be allowed to rely on swap data repositories (SDRs) for recordkeeping requirements. The reason for this, according to the Commission, is that SDRs are new entities under the Dodd-Frank Act with no track record of operations. However, said O’Malia, if the Commission had doubts as to the reliability of SDR data, it ought not to have relied on it in a previous rulemaking requiring real-time public reporting of swap data. Moreover, the commissioner has concerns about the Commission’s ability to monitor and reconcile two sets of records.
The commissioner’s statement comes in the context of the recent approval by the House Financial Services Committee of legislation directing the SEC to conduct thorough cost-benefit analyses of its regulations and proposed regulations. Under the SEC Regulatory Accountability Act, HR 2038, the SEC would have to ensure the benefits of its regulations outweigh the costs. The legislation was introduced by Rep. Scott Garrett (R-NJ), Chair of the Subcommittee on Capital Markets and Government-Sponsored Enterprises, with 15 original cosponsors.
A similar bill was introduced last year in the Senate by Sen. Richard Shelby (R-AL), Ranking Member on the Banking Committee. The Financial Regulatory Responsibility Act (S. 1615) would require the SEC and CFTC to provide clear justification for the regulations and determine the economic impacts of proposed rulemakings, including their effects on growth and net job creation. In addition, the legislation mandates that if a regulation’s costs outweigh its benefits, regulators are barred from promulgating it.
In addition to legislative action, several recent court cases have challenged SEC and CFTC rulemakings on the basis of cost-benefit analysis. Last July, the United States Court of Appeals for the District of Columbia Circuit struck down an SEC rule on proxy access, finding that the regulator had conducted inadequate cost-benefit analysis.
More recently, a CFTC rule on position limits has been challenged in the District Court for the District of Columbia. Two derivatives industry associations asserted that the CFTC failed to give serious consideration to the costs that the position limits rule will impose on commodity markets and the broader economy. In particular, the bona fide hedging exemption is “unnecessarily narrow”, limiting the ability of market participants to hedge their risks, and infrastructure costs will be substantial. In the view of the associations, the CFTC did not make a genuine effort to estimate these costs, instead citing its failure to obtain empirical data that would enable to assess the economic impact of the rule.
Also last year, the CFTC Inspector General found that the CFTC used a perilous cost-benefit methodology for the adoption of regulations implementing the derivatives provisions of Dodd-Frank. The study found that the CFTC General Counsel played a dominant role in the cost-benefit analysis to the derogation of the CFTC Chief Economist, which has been a perilous path for other federal rulemakings. The study recommended an enhanced role in cost benefit analysis for the Chief Economist.
In the rulemaking dissent, Commissioner O’Malia indicated that he would follow up his statement with a letter to the Director of the OMB seeking an independent review of the new rules to determine wither the rulemaking fully complies with the President’s Executive Orders and OMB guidance found in OMB Circular A-4.
This post was contributed by my colleague Lene Powell