The chairman of the CFTC, Christopher Giancarlo, discussed derivatives and swaps reform with the Association of German Banks on May 7, 2018, in Berlin. Giancarlo began by citing the Duff and Phelps 2018 Global Regulatory Outlook Survey to stress the need for continued cross border regulatory cooperation. He exclaimed that 19 percent of the financial executives surveyed indicated greater harmonization among regulations to be the “single most important factor in maintaining an effective regulatory system.” Moreover, he said that 52 percent believe that regulators are improving their ability to collaborate with peers across borders.
But while Giacarlo praised the global harmonization taking place across borders, along with the cooperating countries’ increased respect for the varying legal frameworks and tools that different regulators use to solve problems, he emphasized that regulators’ decisions must be consistent with, and not differ from, already agreed-upon international principles. He specifically referenced a recent European Union (EU) legislative proposal that, if adopted, would require deviation from an already agreed-upon transatlantic approach to regulating and supervising central clearing counterparties (CCPs) in the United States and Europe.
Derivatives and swaps. Building on the evidence that, overall, global cooperation between regulators is achieving success, Giancarlo spent the remainder of his remarks commenting on the improvements made to reforming the derivatives and swaps markets since the 2008 economic crisis, along with mentioning the setbacks that resulted from those reforms and his suggestions for reversing the setbacks. Giancarlo introduced the topic by declaring that while the press describes these investments as risky, derivatives and swaps, when used properly, serve society’s needs by moderating price, supply and other commercial risks to free up capital for economic growth, job creation and prosperity.
Derivatives reform since Dodd-Frank. Giancarlo likened the derivatives and swaps reforms that have occurred in the United States and Europe following passage of the Dodd-Frank Act to a software application. The value of a software application, like a regulatory framework, he said, can be enhanced over time by addressing its flaws, improving its security, tweaking its core to meet additional requirements, making it easier and more efficient to use, accommodating it for new technology, and enlarging its user base. He proclaimed that like software developers, market regulators must anticipate bugs and fixes after the first release of the computer program or derivatives/swaps regulation, and continue to revise it to keep pace with changing market conditions and newer technology.
CFTC swap reform. Giancarlo lastly turned from global derivatives reform to the CFTC’s own swap reforms that he highlighted in a 2018-released white paper, which explores and considers a range of improvements to the swap reforms that the CFTC implemented by the end of 2014. The white paper, Giancarlo stated, specifically assesses the CFTC’s implementation of Dodd-Frank-mandated swaps reforms made to:
- CCP clearing, where he emphasized that the swaps clearing mandate was highly successful but mostly because it significantly increased the volume of swap transactions cleared through CCPs that lead to a number of CFTC considerations for further deliberation;
- Swaps trade reporting, where he acknowledged that a decade after the global financial crises, swap data repositories (SDRs) still cannot provide regulators with swap data, but proclaimed that substantial progress has been made by both U.S. and Europe regulators and market participants having begun to standardize data nomenclature, and abide by reporting elements and protocols;
- Swaps trade execution, where he acknowledged that the CFTC misapplied the Dodd-Frank mandate that swaps transactions be traded on regulated platforms, i.e., swap execution facilities (SEFs), which led to market fragmentation, a systemic risk One effect of this unfortunate misapplication, he said, has been to shift swaps price discovery and liquidity formation away from SEFs to platforms not subject to conduct and compliance requirements appropriate for swaps products;
- Swap dealer capital requirements, where he mentioned that while the emerging consensus endorses risk-based capital requirements, many parts of the current regime are biased against swaps because regulators have not allowed regulator-approved internal models in all instances. Still, Giancarlo suggested that continuing to refine, and by necessity, complicate the standard models imposed on market participants might help undo the regulators’ reluctance to endorse the risk-based capital requirements, and he said that an approach ascertaining how regulators might rely more heavily (but confidently) on the internal risk models used by banks and their swap dealer affiliates might best reverse the regulators’ reluctance; and
- The end user exception, where he cited a Dodd-Frank provision exempting certain commercial end users from a requirement that market participants clear standardized swaps to collect margin on uncleared swaps. The Dodd-Frank legislators had presumed the requirement too costly for those commercial end users (since they were considered not to be sources of systemic risk). Giancarlo thought this mandate too prescriptive, agreeing that smaller financial end users should remain exempt from the requirement but that larger end users who can, in fact, be sources of systemic risk should be subject to the clearing and margin requirements.