Tuesday, July 16, 2019

Former NFA CEO expounds on self-regulation in the futures and derivatives markets and where the pendulum may swing next

By Brad Rosen, J.D.

Former NFA Chief Executive Officer Dan Roth engaged in a lively, insightful, and far-flung armchair discussion focusing on self-regulation with Mayer Brown Partner Matt Kluchenek at the recent National Introducing Broker Association (NIBA)/DePaul University Annual Symposium. Roth, a 34-year veteran of the organization before his retirement in 2017, was candid and conversational as he responded to an array of questions from both Kluchenek and audience members, covering a wide range of topics and issues. Some of these items are noted here.

A circuitous route to the NFA CEO’s office. After graduating as an undergraduate from Notre Dame University, Roth moved to Des Moines, Iowa, where he worked for a few years in the front office for a AAA affiliate of the Chicago White Sox. Seeing little room for advancement, he enrolled at Loyola School of Law. After graduating and before joining the NFA’s legal department, Roth did stints at the Cook County State’s Attorney Office, Public Corruption Unit, as well as at Sidley and Austin.

A view of self-regulation: Bad headlines make bad law. According to Roth, the main purpose of self-regulation is to provide effective and efficient regulation for the public’s benefit. Roth also pointed to a second purpose for self-regulation, which is to keep government off industry’s back. The premise here is that if industry doesn’t police itself, government will, and he added, “Bad headlines make bad law.” Roth agreed with Kluchenek that the lack of self-regulation in the swaps industry, pre-financial crisis, led to the Dodd-Frank market reforms. Roth noted there was no self-regulation going on in that space, and the headlines around the financial crisis were really bad. “Congress does what Congress has to do,” he observed.

The job of government isn’t to be efficient. Roth indicated he is suspicious of those who say they will make government more efficient. “The job of government isn’t to be efficient, but to address abuses of power.” He also observed that the CFTC’s structure of rotating commissioners and bipartisan control is inherently inefficient.

On the NFA-CFTC relationship. Overall, the relationship between the NFA and the CFTC is a good one. However, Roth conceded it can be frustrating and painful at times. Roth pointed to the early days in the relationship when the NFA hired Dan Driscoll away from the CFTC to be its vice president of compliance. Driscoll had served as the CFTC’s chief accountant and was known for his encyclopedic knowledge of the CFTC rule book. After he joined the NFA in the 1980s, Driscoll continued to be the go-to guy for explanations from both NFA and CFTC personnel alike.

Roth noted that the NFA seeks to be a bridge between government and industry. The NFA makes a point of meeting with all commissioners, and with meet Division of Swap and Intermediary Oversight (DSIO) staff on a regular basis, and with DOE quarterly. He noted that the key to a good relationship with the Commission is to avoid surprises.

Some thoughts about the virtual currency industry. Roth has watched developments in the virtual currency space with interest, especially with regard to the role self-regulation might play. He noted that to be an effective self-regulator, you just can’t be a trade association and say what best practices are. He also indicated that two other conditions must be met. First, a self-regulatory organization must have mandatory membership. Second, it must have statutory protection from legal liability. If it doesn’t have the second, the costs of operation will be exorbitant.

This self-regulator is not too cozy with industry. Roth wholly rejected the notion that the self -regulator is too close with the industry it oversees. “I’ve heard it for 40 years—it’s a bunch of crap,” Roth exclaimed. In Roth’s view, government oversight addresses any conflicts of interest between the SRO and the industry. On this point Kluchenek asked for a show of hands from the audience if they thought NFA and industry were too cozy. None went up.

FCM’s blowing up and sleepless nights. When asked what kept him up at night when at the NFA’s helm, Roth pointed to issues involving systematic risk and an FCM blowing up. “Any time an FCM blows up, it’s a bad thing,” he observed. In this regard and in response to an audience question, Roth pointed to the big impact NFA made in implementing procedures to assure the integrity of FCM daily segregation numbers. That occurred in the aftermath of some very bad headlines involving two FCMs, MF Global and PFG, where customer funds were either seriously at risk or were lost.

Regulatory piling on is not good for anyone. In response to a question from this Wolters Kluwer writer, Roth stated that duplication of SRO enforcement actions by the CFTC is a pain in the neck. Roth further observed that such regulatory double teaming is an inefficient use of resources and is one of the reasons that NFA meets with the CFTC DOE on a quarterly basis to review matters.

And then came the swap dealers. After the Dodd-Frank legislation passed in 2010, the CFTC played a major role in the oversight of those markets. Roth recalled thinking at the time that if the CFTC has a major role in swaps regulation, NFA will have a major role as well. He remembers that dealing with swap dealers and all of the attendant issues was fun.

He noted that NFA knew nothing about swaps, but they had time to learn and think about it. They knew how processes worked and knew how to work with industry and boards. He also recalled the challenges of integrating the swaps community and the futures community. “That was interesting—like the first day of school.”

Self-regulation and the future. When asked by Kluchenek where self-regulation may be going in the future, Roth responded that two things will determine the future flow of the regulatory pendulum: the next election and bad headlines.

NIBA, the event sponsor, was established in 1991 as a non-profit association by its founder and chairman, Melinda Schramm. The organization bills itself as the united voice for derivatives professionals, and its goal is to facilitate member education and networking while also providing a voice in regulatory and industry matters.