CFTC ANNOUNCES DEUTSCHE BANK AG ORDERED TO PAY $2.5 MILLION PENALTY IN CASE INVOLVING SWAPS REPORTING VIOLATIONS AND SUPERVISION FAILURES

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION 

September 30, 2015

CFTC Orders Deutsche Bank AG to Pay a $2.5 Million Civil Monetary Penalty for Swaps Reporting Violations and Related Supervision Failures

CFTC Finds that Deutsche Bank Did Not Diligently Address and Correct Errors until after Bank Was Notified of CFTC Investigation

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today issued an Order filing and simultaneously settling charges against Deutsche Bank AG, a global banking and financial services company and provisionally registered Swap Dealer, for failing to properly report its swaps transactions from in or about January 2013 until July 2015 (the Relevant Period). The CFTC Order also finds that Deutsche Bank did not diligently address and correct the reporting errors until the Bank was notified of the CFTC’s investigation, and failed to have an adequate swaps supervisory system governing its swaps reporting requirements.

This is the CFTC's first action enforcing the new Dodd-Frank requirements that provide for the real-time public reporting of swap transactions and the reporting of swap data to swap data repositories.

The Order requires Deutsche Bank to pay a $2.5 million civil monetary penalty and comply with undertakings to improve its internal controls to ensure the accuracy and integrity of its swaps reporting.

CFTC Director of Enforcement Aitan Goelman commented: “This is another in a series of cases the CFTC has brought this year highlighting the importance of complete and accurate reporting – here involving reporting of swap transactions. When reporting parties fail to meet their reporting obligations, the CFTC cannot carry out its vital mission of protecting market participants and promoting market integrity.”

As a provisionally registered Swap Dealer, Deutsche Bank is required to comply with certain disclosure, recordkeeping, and reporting requirements related to its swap transactions. Specifically, Parts 43 and 45 of the CFTC’s Regulations specify requirements for real-time public reporting, public availability of swap transaction and pricing data, and reporting of creation and continuation data. These Regulations also include requirements for a reporting counterparty to report and correct errors and omissions in its swaps reporting, including cancellations, to the registered Swap Data Repository (SDR) to which the reporting counterparty originally reported the swap.

The reporting requirements are designed to enhance transparency, promote standardization, and reduce systemic risk in swaps trading. Accurate swap data is essential to effective fulfillment of the regulatory functions of the CFTC, including meaningful surveillance and enforcement programs. Moreover, real-time public dissemination of swap transaction and pricing data supports the fairness and efficiency of markets and increases transparency, which in turn improves price discovery and decreases risk.

According to the CFTC Order, during the Relevant Period, Deutsche Bank failed to properly report cancellations of swap transactions in all asset classes, which in the aggregate included between tens of thousands and hundreds of thousands of reporting violations and errors and omissions in its swap reporting. Deutsche Bank was aware of problems relating to its cancellation messages since its reporting obligations began on December 31, 2012, but failed to provide timely notice to its SDR and did not diligently investigate, address and remediate the problems until it was notified of the Division of Enforcement’s investigation in June 2014. Because of Deutsche Bank’s reporting failures, misinformation was disseminated to the market through the real time public tape and to the CFTC.

The Order further finds that Deutsche Bank’s reporting failures resulted in part due to deficiencies with its swaps supervisory system. Deutsche Bank did not have an adequate system to supervise all activities related to compliance with the swaps reporting requirements until at least sometime between April and July of 2014 – well after its reporting obligations went into effect, according to the Order.

The Order recognizes Deutsche Bank’s significant cooperation with the CFTC during the investigation of this matter.

The CFTC’s Data and Reporting Branch in the Division of Market Oversight (DMO) is responsible for the supervision of swaps data collection and reporting obligations of registered entities. This matter originated from referrals by DMO, and the Data and Reporting Branch provided substantial assistance to the Division of Enforcement during the investigation.

The CFTC Division of Enforcement staff members responsible for this matter are Allison Passman, Joseph Patrick, Robert Howell, Scott Williamson, and Rosemary Hollinger, with assistance from DMO staff Lawrence Grannan, Athanasia Papadopoulos, Kristin Liegel, Benjamin DeMaria, and Daniel Bucsa.

MORGAN STANLEY TO PAY $300,000 FINE FOR VIOLATING CUSTOMER PROTECTION RULE AND RELATED SUPERVISION FAILURES

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

August 6, 2015

CFTC Orders Morgan Stanley & Co. LLC to Pay a $300,000 Civil Monetary Penalty for Violations of Customer Protection Rule for Cleared Swaps and Related Supervision Failures

Order Finds that the Firm Failed to Maintain Sufficient U.S. Dollars in Segregated Accounts in the United States, Holding Required Funds Instead in Other Currencies

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today issued an Order requiring Morgan Stanley & Co. LLC (Morgan Stanley), a registered Futures Commission Merchant and provisionally registered swap dealer, to pay a $300,000 civil monetary penalty for failing to hold sufficient U.S. Dollars in segregated accounts in the United States to meet all of its U.S. Dollar obligations to cleared swaps customers. The Order also finds that the firm failed to implement adequate procedures and requires Morgan Stanley to cease and desist from violating CFTC Regulations, as charged.

Aitan Goelman, the CFTC’s Director of Enforcement, commented: “Since passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the CFTC has implemented rules to protect swaps customers and market participants, including rules for protection of cleared swaps customer collateral. This action demonstrates that the Division of Enforcement will investigate and pursue violations of these important rules of the road in the swaps market.”

As set forth in the Order, on numerous days from March 12, 2013 to March 7, 2014, Morgan Stanley failed to hold sufficient U.S. Dollars in segregated accounts in the United States to meet all U.S. Dollar obligations to the firm’s cleared swaps customers, in violation of CFTC Regulation 22.9. On those days, Morgan Stanley held the amount of the U.S. Dollar deficits in Euros and other currencies, rather than in U.S. Dollars, according to the Order. Because Morgan Stanley held the amount of the U.S. Dollar deficits in other currencies, it did not have a shortfall in overall cleared swaps customer collateral. As the Order finds, however, the size of Morgan Stanley’s U.S. Dollar deficits ranged from approximately $5 million to approximately $265 million, at times representing more than 10 percent of the amount that the firm was obligated to maintain in U.S. Dollars for cleared swaps customers.

Additionally, the Order finds that from November 8, 2012 to on or about April 8, 2014, Morgan Stanley did not have in place adequate procedures to comply with the currency denomination requirements for cleared swaps customer collateral and did not train and supervise its personnel to ensure compliance with CFTC Regulation 22.9. Morgan Stanley thereby failed to supervise diligently its officers, employees, and agents and did not have sufficient procedures in place to detect and deter the violations found herein, in violation of Regulation 166.3, the Order finds.

The Order recognizes that Morgan Stanley promptly reported the deficiencies to the CFTC, implemented corrective procedures, and cooperated with the CFTC’s Division of Enforcement in its investigation.

The CFTC appreciates the assistance of the Division of Swap Dealer and Intermediary Oversight.

The CFTC Division of Enforcement staff members responsible for this case are Elizabeth C. Brennan, Douglas K. Yatter, Lenel Hickson, Jr., and Manal M. Sultan.

CFTC CHAIRMAN MASSAD'S ADDRESS TO FUTURES INDUSTRY ASSOCIATION BOCA CONFERENCE

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION
Keynote Address of Chairman Timothy G. Massad before the Futures Industry Association Boca Conference
March 11 2015
As Prepared For Delivery

Thank you for inviting me today, and I thank Walt for that kind introduction. It is a pleasure to be here. This is my first time to the International FIA Conference here, an event that I have heard a lot about. And, of course, with the winter we have been having in Washington, being here is a real treat.

Let me begin by acknowledging the work that the Futures Industry Association and its members do. Your commitment to improving the industry, and your participation in the work of the Commission, is very important.

I want to also acknowledge and thank the CFTC staff. What this agency has accomplished, not only since my arrival, but well before that, is a credit to their hard work. We have an incredibly dedicated and talented team. I also thank my fellow commissioners for their efforts, particularly their willingness to work constructively together. We may not always agree, but I believe all of us are working in good faith to carry out the CFTC’s responsibilities.

Everyone here appreciates the importance of the derivatives markets. They enable businesses of all types to manage risk, and in so doing, are engines of economic growth. The success of these markets depends on many factors, and a key one is having a strong and sensible regulatory framework.

We knew that before the global financial crisis, but the crisis certainly drove that lesson home. The absence of regulation allowed the build-up of excessive risk in the over-the-counter swaps market. That risk intensified the crisis and the damage it caused. We must never forget the true costs of the crisis: millions of jobs lost, homes foreclosed and dreams shattered.

As a result of the financial crisis our country took action to address those risks. We are implementing a new regulatory framework for swaps, one that mandates central clearing and brings greater transparency, reporting and oversight. The CFTC’s responsibility today is to regulate the derivatives markets in a manner that not only prevents the build-up of excessive risk, but also creates a foundation on which the derivatives markets can continue to thrive and work for the many businesses that rely on them.

So today I would like first to review briefly some of the things we have done recently, and some of the things we will be doing in the months ahead. And then I want to discuss a key aspect of that new framework, which is the role of clearinghouses. In particular, I want to discuss the issue of clearinghouse resiliency, because this is an issue that has been a priority for us and has received increased public attention lately.

Current Priorities

We have been very busy since two of my fellow commissioners and I took office last summer. Our agenda today reflects several priorities.

First, the agency has largely finished an intensive rule-writing phase to create the new regulatory framework for swaps. We are now focused on implementation of that framework. One of our priorities has therefore been to focus on fine-tuning our rules, in particular to make sure that the commercial businesses, consistent with the Congressional mandate, that depend on these markets to hedge risk can continue to use the markets effectively. We have made a number of changes to address concerns of commercial end-users. This has included amending our rules to enable publicly-owned utilities to continue to be able to hedge their risks effectively in the energy swaps market. We have proposed revisions regarding the posting of residual interest which is related to the posting of collateral with clearing members. We have proposed exemptions for commercial end-users from certain recordkeeping requirements and clarifications to give the market greater certainty with regard to the treatment of contracts with embedded volumetric optionality.

In addition, the Commission staff has taken action to make sure that end-users can use the Congressional exemption regarding clearing and swap trading, including when they enter into swaps through a treasury affiliate. The staff also recently granted relief from the real-time reporting requirements for certain less liquid, long-dated swap contracts, recognizing that immediate reporting can sometimes undermine a company’s ability to hedge.

We have also extended relief with respect to the treatment of package trades on swap execution facilities to avoid unnecessary disruptions in the marketplace. There may be additional measures, such as today we are looking at trade option reporting rules and the rules on trading of swaps on swap execution facilities.

Finishing the Dodd Frank Rules. We are also working to finish the few remaining rules mandated by Congress, including our proposed rule on margin for uncleared swaps. This rule plays a key role in the new regulatory framework, because uncleared transactions will always be an important part of the market. Certain products will not be suitable for central clearing because of their lack of sufficient liquidity or other risk characteristics. In these cases, margin will continue to be a significant tool to mitigate the risk of default from those transactions and, therefore, the potential risk to the financial system as a whole.

We are currently working with the bank regulators to finalize these proposed rules. These rules exempt commercial end-users from the margin requirements, consistent with Congressional intent. I am hopeful that we can finalize these rules by the summer.

We are also working on the rules on position limits and capital for swap dealers.

Cross-Border Harmonization. We are also focused on addressing cross border issues related to the new framework. We have had productive discussions with the Europeans to facilitate their recognition of U.S. based clearinghouses, and I would hope that we could reach agreement soon. Another important area for cross-border harmonization is the proposed rule I just mentioned, concerning margin for uncleared swaps. We have been working with our counterparts in Europe and Japan, and I am hopeful that our respective final rules will be substantially similar, even though they are not likely to be identical.

Data. We have also made enhancing our ability to use market data effectively a key priority. We continue to focus on data harmonization, including by helping to lead the international work in this area. We are also looking at clarifications to our own rules to improve data collection and usage. We have a lot of work to do in the area of data generally, but we have come a long way since 2008, when we knew very little about the swaps market. Today, there is real time price and volume information and we have much better insight into participant activity.

New Challenges and Risks. We are also looking at new challenges and risks in our markets. We have been very focused on the increased use of automated trading strategies, for example, and their impact on the derivatives markets. We issued a concept release last year and we received a lot of very useful input. We are also keenly focused on cybersecurity, which is perhaps the single most important new risk to market integrity and financial stability. We have incorporated cyber concerns into our core principles and made it a priority in our examinations. Our challenge is to leverage our limited resources as effectively as possible. Many major financial institutions are spending far more on cybersecurity than our entire budget. We do not have, for example, the resources to do independent testing. So one of the things we are looking at is whether the private companies that run the core infrastructure under our jurisdiction – the major exchanges and clearinghouses for example – are doing adequate testing themselves of their cyber protections. We are holding a public staff roundtable to discuss this issue next week.

Enforcement and Compliance. We also remain committed to a robust surveillance and enforcement program to prevent fraud and manipulation. We have held some of the world’s largest banks accountable for attempting to manipulate key benchmarks. We have brought successful cases against those who would attempt to manipulate our markets through sophisticated spoofing strategies. And we have also stopped crooks trying to defraud seniors through precious metal scams and Ponzi schemes. In all these efforts, our goal is to make sure that the markets we oversee operate with fairness for all participants regardless of their size or sophistication.

Ensuring the Strength and Stability of Clearinghouses in the New Regulatory Framework

Let me turn now to discuss clearinghouses. In just about every speech I have given since taking office, I have talked about our progress in implementing the mandate to clear standardized swaps. In our markets, the percentage of swaps cleared has increased from 15% in December 2007 to about 75% today. At the same time, I have talked about the importance of clearinghouse stability and oversight. As we make clearinghouses even more important in the global financial system, we must pay attention to the risks that they can pose.

Lately, there has been increased discussion of this, with many views put forward in papers and speeches, on issues like clearinghouse resiliency, recovery, and resolution. Questions are being asked in particular about the adequacy of recovery plans, about whether clearinghouses have enough capital or “skin in the game,” and whether the potential liability of clearing members is properly sized or capped. This is a good and healthy debate. Today, I would like to discuss how we at the CFTC think about some of these issues. Let me do so by first talking about the work that has taken place in this area, both by us and internationally, then discuss the need to look at issues in context, and then discuss the work that lies ahead.

First, a great deal of work has already taken place to consider these issues, here and internationally. The CFTC has had a regulatory framework in place to oversee clearinghouses since well before the passage of Dodd-Frank. Dodd-Frank amended the agency’s core principles for clearinghouses, with the goal of reducing risk, increasing transparency, and promoting market integrity within the financial system. In 2011, the agency adopted detailed regulations to implement the revised core principles. These regulations provide a regulatory framework designed to strengthen the risk management practices of DCOs, promote financial integrity for swaps and futures markets, and enhance legal certainty for DCOs, clearing members, and market participants.

In 2013, we also supplemented these regulations by adopting additional requirements for systemically important clearinghouses. Thus, our clearinghouse regulations are now consistent with the Principles for Financial Market Infrastructures, or PFMIs, published in 2012 by CPMI-IOSCO.

The work of CPMI-IOSCO with respect to clearinghouses has been an important international effort, and the CFTC has played an active role. The PFMIs set comprehensive principles and key considerations for the design and operation of financial market infrastructures, including clearinghouses, to enhance their safety and efficiency, to limit systemic risk, and to foster transparency and financial stability. This same group also published a Disclosure Framework and Assessment Methodology and last month published quantitative disclosure standards, to further increase transparency of clearinghouses.

The Basel Committee on Banking Supervision has provided strong incentives for clearinghouses to meet these standards, because bank exposures to such “qualifying CCPs” are subject to capital treatment that is significantly more favorable than that afforded to exposures to clearinghouses that do not meet these standards. CPMI-IOSCO has also undertaken a rigorous process to assess the completeness of the regulatory framework in several jurisdictions. The Financial Stability Board has also contributed through the publication of the Key Attributes of Effective Resolution Regimes, which includes an annex on financial market infrastructures.

Writing standards that clearinghouses must follow, however, is of course not enough. That is why the CFTC also engages in extensive oversight activities. Our program includes daily risk surveillance, analysis of margin models, stress testing, back testing, and in-depth compliance examinations. We engage in ongoing review of clearinghouse rules and practices, and we review what products should be mandated for clearing. We require a variety of periodic reporting including some on a daily basis as well as event-specific reporting.

In addition to supervision of clearinghouses, we look at risk at the clearing member and large trader levels. We conduct daily stress tests to identify traders who pose risks to clearing members and clearing members who pose risks to clearinghouses. We require clearinghouses to oversee the risk management policies and practices of their members. We require FCMs, whether clearing members or not, to meet risk management and minimum capital standards. And we have a rigorous compliance examination process.

There is also public transparency on these matters. You can go to our website and see each FCM’s net capital requirement and the amounts of adjusted capital and customer segregated assets they hold.

This oversight and reporting framework is intended to enable us to take proactive measures to promote the financial integrity of the clearing process.

So as we engage in this public discussion about clearinghouse risk, we should always remember to look at the full picture – that is, to look at all the regulatory policies, the clearinghouse practices, the oversight, and the sum of activities that contribute to rigorous risk mitigation. We should not focus on one particular issue without considering how it connects to other issues.

An example of the importance of looking at the full picture is when we consider issues pertaining to risk mitigation through the collection of initial margin. Although there are many aspects to consider, there has been some focus on one issue in particular, which is the liquidation period – that is, whether a clearinghouse should assume a 1 day, 2 day, 5 day, or other minimum time horizon for its ability to liquidate a particular product. This is an important issue. Indeed, our regulations require that the time period must be appropriate based on the characteristics of a particular product or portfolio. But the minimum liquidation period is only one of the many issues that affect how much initial margin is posted with the clearinghouse.

The amount of margin a clearinghouse holds will also depend on whether clearing members post margin on a gross or net basis. “Net” means a clearing member can net customers’ positions to the extent they offset one another, which reduces the amount of margin that must be sent to the clearinghouse for the overall portfolio. By contrast, “gross” posting means the clearing member must post for each customer, without any offsets across customers, which means the clearinghouse receives more – in many cases, much more – collateral than under net posting.

A further difference in regulatory regimes is whether the clearing member is even obligated to collect a minimum amount of margin from each customer, sufficient to cover that customer’s position, or whether the clearing member can negotiate different deals with different customers. Our rules, for example, require that the clearinghouse must require each clearing member to collect from each customer, more than 100% of the clearinghouse’s initial margin requirements with respect to each product and swap portfolio.

Another example of the importance of context is with regard to the issue of whether clearinghouses have enough capital or “skin in the game.” There has obviously been a lot of public and regulatory attention in the last few years on how much capital banks should hold. When it comes to clearinghouses, it’s important to remember that there are significant differences between the business models of clearinghouses and banks, and therefore, in the role that capital plays. A banking institution needs capital to offset losses that may arise frequently. Those losses can be as varied as the many lines of businesses in which a bank engages.

By contrast, when people talk about a clearinghouse drawing on its capital, they are usually talking about a very unusual event: there has been a default of a clearing member, and the resources of the defaulter held by the clearinghouse – both initial margin and default fund contribution – are not enough to cover the loss. The clearinghouse has sought to transfer the defaulting member’s positions to one or more other clearing members, and the success of that auction has affected the size of the loss. The clearinghouse is now looking at covering that loss through the waterfall of resources available to it for recovery – that is, the clearinghouse’s capital, the other clearing members’ prefunded contributions to the default fund, and potential assessments on clearing members.

This would be a very serious event. Historically, however, the use of other clearing members’ resources to meet a default is exceedingly rare worldwide. To my knowledge, it has never happened here in the United States.

That does not mean we should not think about it or plan for it. Post financial crisis, we are and should be doing many things to increase the resiliency of our financial system in the event of unusual situations. The issue of capital needs to be considered in the context of a clearinghouse’s overall financial resources. That is, what are the resources to deal with a loss if initial margin is not adequate? Under CFTC requirements, each of our systemically important clearinghouses must maintain sufficient financial resources to meets its financial obligations to its clearing members notwithstanding the default by the two clearing members creating the largest combined loss to the clearinghouse in extreme but plausible market conditions – the standard known as “Cover 2.” These requirements are consistent with the PFMIs.

To meet these requirements, a clearinghouse may use initial margin payments, its own capital dedicated to this purpose, and default fund contributions. The allocation or the balance between these financial resources may vary, such that the more margin paid up front, the less default fund contributions the clearinghouse will collect and vice versa.

I should note that a clearinghouse faces risks outside of a default by a member, and we are looking at those as well. These can include operational or technological issues, such as the cybersecurity concerns I noted earlier. And we separately require clearinghouses to have capital, or other resources acceptable to us, to cover operating costs for one year. This capital is not fungible with the Cover 2 resources.

We are currently considering the issues pertaining to the resources available to deal with a default in the context of reviewing clearinghouse recovery plans. We are trying to make sure that these plans are “viable” – that is, that they are designed to maximize the probability of a successful clearinghouse recovery, while mitigating the risk that recovery actions could result in contagion to other parts of the financial system. And we will be holding a public staff roundtable on these issues next week – unless Washington gets another snowstorm. The agenda will include discussion of what tools a clearinghouse may use in these situations.

Let me suggest a few questions that may be useful to think about in considering clearinghouse capital in this context: first, is capital primarily about alignment of incentives – that is, alignment of incentives between the clearinghouse and its clearing members – rather than the quantitative increase to the waterfall? In an era when the equity of clearinghouses is held by persons other than the clearing members, this may be particularly important. As the CPMI-IOSCO Recovery Report notes, “[e]xposing owners to losses … provides appropriate incentives for them to ensure that the [clearinghouse] is properly risk-managed.”

Second, when we think about capital in the context of recovery plans, should we also think about issues of governance and process? That is, whose interests should be taken into account when a clearinghouse designs its recovery plan and when a clearinghouse faces a default? If the waterfall of resources is not sufficient to cover a default, then how does the clearinghouse decide what happens next, and who should participate in or have input into that decision? How do we ensure there is adequate time for that decision-making process to take place?

In outlining the things the CFTC has done and is doing, as well as the international work that has taken place, let me note a couple of caveats. While I believe the agency has developed very good policies and practices, there is more we should be doing, particularly with respect to the frequency of examinations. Unfortunately, we are limited by our resources. In addition, to state the obvious, no matter how good the regulatory framework, no regulator can ever guarantee that there won’t be problems.

Finally, I want to underscore that this work is ongoing, and there are many aspects of these issues that I have not touched on today given time limitations. We will be continuing to look at the full range of issues pertaining to clearinghouse risk, resiliency, recovery, and resolution. We will also be participating in further international work on these issues. I note that CPMI-IOSCO will be continuing to look at stress testing – are clearinghouse stress testing programs adequate and should we develop standards, for example – and they will also be looking at recovery issues, and we will be helping to lead that process. I also expect the FSB’s Resolution Steering Group to look further at the resolution issues, and we will work with our colleagues on that as well. While no one wants to get to resolution, it is important that we explore how this would be done as well, without a government bailout and without creating contagion. This is very useful, and it reflects the very good international dialogue that has taken place already in this area. In addition, this work can help us balance the multiple regulatory objectives that come into play in considering these issues, so that regulators with different responsibilities do not work at cross purposes.

As we engage in this work, and as the public discussion about clearinghouse resilience continues, I would just encourage all of us to keep in mind the full picture. We should always take a comprehensive approach to these issues, one that is based on a clear understanding of risk, that enhances transparency and market integrity, and that is backed up by rigorous, ongoing oversight. Effective risk mitigation and resiliency require a broad range of policies and procedures.

Central clearing is fundamental to the health and vibrancy of our markets. We must make sure that clearing firms, as well as clearinghouses, can continue to operate successfully. It is only in this way that the businesses which depend on these markets can continue to use them effectively.

Conclusion

That brings me back to where I started, which is the importance of these markets to the many businesses that rely on them, and to our economy generally. All of you who participate in these markets understand that. And that is what guides us at the Commission. I know I speak for all the Commissioners in saying it is a privilege for us to work on these issues of importance to these markets and our economy. I look forward to working with you to make sure these markets continue to thrive in the years ahead.

Thank you for inviting me.

Last Updated: March 11, 2015

CFTC CHAIRMAN MASSAD'S TESITMONY BEFORE U.S. SENATE COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

FROM:  COMMODITY FUTURES TRADING COMMISSION

Testimony of Chairman Timothy Massad before the U.S. Senate Committee on Banking, Housing, and Urban Affairs, Washington, DC

September 9, 2014

Thank you Chairman Johnson, Ranking Member Crapo and members of the Committee. I am pleased to testify before you today on behalf of the Commission. This is my first official hearing as Chairman of the CFTC. It is truly an honor to serve as Chairman at this important time.

I met and spoke with several members of this Committee during the confirmation process, and I appreciated hearing your thoughts and suggestions during that time. I look forward to this Committee’s input going forward.

During the last five years, we have made substantial progress in recovering from the worst financial crisis since the Great Depression. The Dodd-Frank Act was a comprehensive response, and much has been accomplished in implementing it. The CFTC has largely completed the rulemaking stage of Dodd-Frank implementation. However, much work remains to finish the job Congress has given us.

I look forward to working together with you, as well as my colleagues at the CFTC and others around the globe to ensure that our futures, swaps and options markets remain the most efficient and competitive in the world, and to protect the integrity of the markets.

The Significance of Derivatives Market Oversight

Very few Americans participate directly in the derivatives markets. Yet these markets profoundly affect the prices we all pay for food, energy, and most other goods and services we buy each day. They enable farmers to lock in a price for their crops, utility companies or airlines to hedge the costs of fuel, and auto companies or soda bottlers to know what aluminum will cost. They enable exporters to manage fluctuations in foreign currencies, and businesses of all types to lock in their borrowing costs. In the simplest terms, derivatives enable market participants to manage risk.

In normal times, these markets create substantial, but largely unseen, benefits for American families. During the financial crisis, however, they created just the opposite. It was during the financial crisis that many Americans first heard the word derivatives. That was because over-the-counter swaps – a large, unregulated part of these otherwise strong markets – accelerated and intensified the crisis like gasoline poured on a fire. The government was then required to take actions that today still stagger the imagination: for example, largely because of excessive swap risk, the government committed $182 billion to prevent the collapse of a single company – AIG – because its failure at that time, in those circumstances, could have caused our economy to fall into another Great Depression.

It is hard for most Americans to fathom how this could have happened. While derivatives were just one of many things that caused or contributed to the crisis, the structure of some of these products created significant risk in an economic downturn. In addition, the extensive, bilateral transactions between our largest banks and other institutions meant that trouble at one institution could cascade quickly through the financial system like a waterfall. And, the opaque nature of this market meant that regulators did not know what was going on or who was at risk.

Responding to the Crisis – Enactment and Implementation of the Dodd-Frank Act

The lessons of this tragedy were not lost on the leaders of the United States and the G-20 nations. They committed to bring the over-the-counter swaps market out of the shadows. They agreed to do four basic things: require regulatory oversight of the major market players; require clearing of standardized transactions through regulated clearinghouses known as central counterparties or CCPs; require more transparent trading of standardized transactions; and require regular reporting so that we have an accurate picture of what is going on in this market.

In the United States, these commitments were set forth in Title VII of the Dodd-Frank Act. Responsibility for implementing these commitments was given primarily to the CFTC. I would like to review where we stand in implementing the regulatory framework passed by Congress to bring the over-the-counter swaps market out of the shadows.

Oversight

The first of the major directives Congress gave to the CFTC was to create a framework for the registration and regulation of swap dealers and major swap participants. The agency has done so. As of August 2014, there are 104 swap dealers and two major swap participants provisionally registered with the CFTC.

We have adopted rules requiring strong risk management. We will also be making periodic examinations to assess risk and compliance. The new framework requires registered swap dealers and major swap participants to comply with various business conduct requirements. These include strong standards for documentation and confirmation of transactions, as well as dispute resolution processes. They include requirements to reduce risk of multiple transactions through what is known as portfolio reconciliation and portfolio compression. In addition, swap dealers are required to make sure their counterparties are eligible to enter into swaps, and to make appropriate disclosures to those counterparties of risks and conflicts of interest.

As directed by Congress, we have worked with the SEC, other US regulators, and our international counterparts to establish this framework. We will continue to work with them to achieve as much consistency as possible. We will also look to make sure these rules work to achieve their objectives, and fine-tune them as needed where they do not.

Clearing

A second commitment of Dodd-Frank was to require clearing of standardized transactions at central counterparties. The use of CCPs in financial markets is commonplace and has been around for over one hundred years. The idea is simple: if many participants are trading standardized products on a regular basis, the tangled, hidden web created by thousands of private two-way trades can be replaced with a more transparent and orderly structure, like the spokes of a wheel, with the CCP at the center interacting with other market participants. The CCP monitors the overall risk and positions of each participant.

Clearing does not eliminate the risk that a counterparty to a trade will default, but it provides us various means to mitigate that risk. As the value of positions change, margin can be collected efficiently to ensure counterparties are able to fulfill their obligations to each other. And if a counterparty does default, there are tools available to transfer or unwind positions and protect other market participants. To work well, active, ongoing oversight is critical. We must be vigilant to ensure that CCPs are operated safely and deliver the benefits they are designed to provide.

The CFTC was the first of the G-20 nations’ regulators to implement clearing mandates. We have required clearing for interest rate swaps (IRS) denominated in US dollars, Euros, Pounds and Yen, as well as credit default swaps (CDS) on certain North American and European indices. Based on CFTC analysis of data reported to swap data repositories, as of August 2014, measured by notional value, 60% of all outstanding transactions were cleared. This is compared to estimates by the International Swaps and Derivatives Association (ISDA) of only 16% in December 2007. With regard to index CDS, most new transactions are being cleared – 85% of notional value during the month of August.

Our rules for clearing swaps were patterned after the successful regulatory framework we have had in place for many years in the futures market. We do not require that clearing take place in the United States, even if the swap is in U.S. dollars and between U.S. persons. But we do require that clearing occurs through registered CCPs that meet certain standards – a comprehensive set of core principles that ensures each clearinghouse is appropriately managing the risk of its members, and monitoring its members for compliance with important rules.

Fourteen CCPs are registered with the CFTC as derivatives clearing organizations (DCOs) either for swaps, futures, or both. Five of those are organized outside of the United States, including three in Europe which have been registered since 2001 (LCH.Clearnet Ltd.); 2010 (ICE Clear Europe Ltd); and 2013 (LCH.Clearnet SA). In some cases, a majority of the trades cleared on these European-based DCOs are for U.S. persons.

At the same time, the CFTC has specifically exempted most commercial end-users from the clearing mandate. We have been sensitive to Congress’s directive that these entities, which were not responsible for the crisis and rely on derivatives primarily to hedge commercial risks, should not bear undue burdens in accessing these markets to hedge their risk.

Of course, central clearing by itself is not a panacea. CCPs do not eliminate the risks inherent in the swaps market. We must therefore be vigilant. We must do all we can to ensure that CCPs have financial resources, risk management systems, settlement procedures, and all the necessary standards and safeguards consistent with the core principles to operate in a fair, transparent and efficient manner. We must also make sure that CCP contingency planning is sufficient.

Trading

The third area for reform under Dodd-Frank was to require more transparent trading of standardized products. In the Dodd-Frank Act, Congress provided that certain swaps must be traded on a swap execution facility (SEF) or other regulated exchange. The Dodd Frank Act defined a SEF as “a trading system or platform in which multiple participants have the ability to execute or trade swaps by accepting bids and offers made by multiple participants.” The trading requirement was designed to facilitate a more open, transparent and competitive marketplace, benefiting commercial end-users seeking to lock in a price or hedge risk.

The CFTC finalized its rules for SEFs in June 2013. Twenty-two SEFs have temporarily registered with the CFTC, and two applications are pending. These SEFs are diverse, but each will be required to operate in accordance with the same core principles. These core principles provide a framework that includes obligations to establish and enforce rules, as well as policies and procedures that enable transparent and efficient trading. SEFs must make trading information publicly available, put into place system safeguards, and maintain financial, operational and managerial resources to discharge their responsibilities.

Trading on SEFs began in October of last year. Beginning February 2014, specified interest rate swaps and credit default swaps must be traded on a SEF or other regulated exchange. Notional value executed on SEFs has generally been in excess of $1.5 trillion weekly.

It is important to remember that trading of swaps on SEFs is still in its infancy. SEFs are still developing best practices under the new regulatory regime. The new technologies that SEF trading requires are likewise being refined. Additionally, other jurisdictions have not yet implemented trading mandates, which has slowed the development of cross-border platforms. There will be issues as SEF trading continues to mature. We will need to work through these to achieve fully the goals of efficiency and transparency SEFs are meant to provide.

Data Reporting

The fourth Dodd-Frank reform commitment was to require ongoing reporting of swap activity. Having rules that require oversight, clearing, and transparent trading is not enough. We must have an accurate, ongoing picture of what is going on in the marketplace to achieve greater transparency and to address potential systemic risk.

Title VII of the Dodd-Frank Act assigns the responsibility for collecting and maintaining swap data to swap data repositories (SDRs), a new type of entity necessitated by these reforms. All swaps, whether cleared or uncleared, must be reported to SDRs. There are currently four SDRs that are provisionally registered with the CFTC.

The collection and public dissemination of swap data by SDRs helps regulators and the public. It provides regulators with information that can facilitate informed oversight and surveillance of the market and implementation of our statutory responsibilities. Dissemination, especially in real-time, also provides the public with information that can contribute to price discovery and market efficiency.

While we have accomplished a lot, much work remains. The task of collecting and analyzing data concerning this marketplace requires intensely collaborative and technical work by industry and the agency’s staff. Going forward, it must continue to be one of our chief priorities.

There are three general areas of activity. We must have data reporting rules and standards that are specific and clear, and that are harmonized as much as possible across jurisdictions. The CFTC is leading the international effort in this area. It is an enormous task that will take time. We must also make sure the SDRs collect, maintain, and publicly disseminate data in the manner that supports effective market oversight and transparency. Finally, market participants must live up to their reporting obligations. Ultimately, they bear the responsibility to make sure that the data is accurate and reported promptly.

Our Agenda Going Forward

The progress I have outlined reflects the fact that the CFTC has finished almost all of the rules required by Congress in the Dodd-Frank Act to regulate the over-the-counter swaps market. This was a difficult task, and required tremendous effort and commitment. My predecessor, Gary Gensler, deserves substantial credit for leading the agency in implementing these reforms so quickly. All of the Commissioners contributed valuable insight and deserve our thanks. But no group deserves more credit than the hardworking professional staff of the agency. It was an extraordinary effort. I want to publicly acknowledge and thank them for their contributions.

The next phase requires no less effort. I want to highlight several areas going forward that are critical to realizing the benefits Congress had in mind when it adopted this new framework and to minimizing any unintended consequences.

Finishing and Fine-tuning Dodd-Frank Regulations

First, as markets develop and we gain experience with the new Dodd-Frank regulations, I anticipate we will, from time to time, make some adjustments and changes. This is to be expected in the case of a reform effort as significant as this one. These are markets that grew to be global in nature without any regulation, and the effort to bring them out of the shadows is a substantial change. It is particularly difficult to anticipate with certainty how market participants will respond and how markets will evolve. At this juncture, I do not believe wholesale changes are needed, but some clarifications and improvements are likely to be considered.

In fine-tuning existing rules, and in finishing the remaining rules that Congress has required us to implement, we must make sure that commercial businesses like farmers, ranchers, manufacturers, and other companies can continue to use these markets effectively. Congress rightly recognized that these entities stand in a different position compared to financial firms. We must make sure the new rules do not cause inappropriate burdens or unintended consequences for them. We hope to act on a new proposed rule for margin for uncleared swaps in the near future. On position limits, we have asked for and received substantial public comment, including through roundtables and face-to-face meetings. This input has been very helpful enabling us to calibrate the rules to achieve the goals of reducing risk and improving the market without imposing unnecessary burdens or causing unintended consequences.

Cross-Border Regulation of the Swaps Market

A second key area is working with our international counterparts to build a strong global regulatory framework. To succeed in accomplishing the goals set out in the G-20 commitments and embodied in the Dodd-Frank Act, global regulators must work together to harmonize their rules and supervision to the greatest extent possible. Fundamentally, this is because the markets that the CFTC is charged to regulate are truly global. What happens in New York, Chicago, or Kansas City is inextricably interconnected with events in London, Hong Kong and Tokyo. The lessons of the financial crisis remind us how easy it is for risks embedded in overseas derivatives transactions to flow back into the United States. And Congress directed us to address the fact that activities abroad can result in importation of risk into the United States.

This is a challenging task. Although the G-20 nations have agreed on basic principles for regulating over-the-counter derivatives, there can be many differences in the details. While many sectors of the financial industry are global in nature, applicable laws and rules typically are not. For example, no one would expect that the laws which govern the selling of securities, or the securing of bank loans, should be exactly the same in all the G-20 nations. While our goal should be harmonization, we must remember that regulation occurs through individual jurisdictions, each informed by its own legal traditions and regulatory philosophies.

Our challenge is to achieve as consistent a framework as possible while not lowering our standards simply to reach agreement, thus triggering a “race to the bottom.” We must also minimize opportunities for regulatory arbitrage, where business moves to locales where the rules are weaker or not yet in place.

The CFTC’s adoption of regulations for systemically important CCPs is a useful model for success. Our rules were designed to meet the international standards for the risk management of systemically important CCPs, as evidenced by the Principles for Financial Market Infrastructures (PFMIs) published by the Bank of International Settlement’s Committee on Payment and Settlement Systems and the Technical Committee of the International Organization of Securities Commissions, to which the Commission was a key contributor.

Since the day I joined the CFTC, I have been focused on cross-border issues. In my first month in office I went to Europe twice to meet with my fellow regulators, and I have been engaged in ongoing dialogue with them.

Robust Compliance and Enforcement

A third major area is having robust compliance and enforcement activities. It is not enough to have rules on the books. We must be sure that market participants comply with the rules and fulfill their obligations. That is why, for example, several weeks ago we fined a large swap dealer for failing to abide by our data reporting rules.

A strong compliance and enforcement function is vital to maintaining public confidence in our markets. This is critical to the participation of the many Americans who depend on the futures and swaps markets – whether they are farmers, oil producers or exporters. And even though most Americans do not participate directly in the futures and swaps markets, our enforcement efforts can help rebuild and maintain public confidence and trust in our financial markets.

We must aggressively pursue wrongdoers, big or small, and vigorously fulfill our responsibility to enforce the regulations governing these markets. Our pursuit of those who have manipulated benchmarks like LIBOR, a key global benchmark underlying a wide variety of financial products and transactions, is a prime example of this principle in practice. So is our successful litigation against Parnon Energy and Arcadia, two energy companies that systematically manipulated crude oil markets to realize illicit profits.

Dodd-Frank provided the Commission with a number of new statutory tools to ensure the integrity of our markets, and we have moved aggressively to incorporate these tools into our enforcement efforts. Our new anti-manipulation authority gives us enhanced ability to go after fraud-based manipulation of our markets. We have put that authority to good use in a host of cases and investigations, including actions against Hunter Wise and a number of smaller firms for perpetrating precious metals scams. Congress also gave us new authority to attack specific practices that unscrupulous market participants use to distort the markets, such as "spoofing," where a party enters a bid or offer with the intent to move the market price, but not to consummate a transaction. We used this new anti-spoofing provision to successfully prosecute Panther Energy for its spoofing practices in our energy markets.

Going forward, protecting market integrity will continue to be one of our key priorities. Market participants should understand that we will use all the tools at our disposal to do so.

Information Technology and Data Management

It is also vital that the CFTC have up to date information technology systems. Handling massive amounts of swaps data and effective market oversight both depend on the agency having up-to-date technology resources, and the staff – including analysts and economists, as well as IT and data management professionals – to make use of them. The financial markets today are driven by sophisticated use of technology, and the CFTC cannot effectively oversee these markets unless it can keep up.

Cyber-security is a related area where we must remain vigilant. As required by Congress, we have implemented new requirements related to exchanges’ cyber-security and system safeguard programs. The CFTC conducts periodic examinations that include review of cyber-security programs put in place by key market participants, and there is much more we would like to do in this area. Going forward, the Commission’s examination expertise will need to be expanded to keep up with emerging risks in information security, especially in the area of cyber-security.

Resources and Budget

All of these tasks represent the significant increases in responsibility that came with Dodd Frank. They require resources. But the CFTC does not have the resources to fulfill these tasks as well as all the responsibilities it had – and still has – prior to the passage of Dodd Frank. The CFTC is lucky to have a dedicated and resourceful professional staff. Although I have been at the agency a relatively short time, I am already impressed by how much this small group is able to accomplish. Still, as good as they are, the reality of our current budget is evident.

I recognize that there are many important priorities that Congress must consider in the budgeting process. I appreciate the importance of being as efficient as possible. I have also encouraged our staff to be creative in thinking about how we can best use our limited resources to accomplish our responsibilities. We will keep the Teddy Roosevelt adage in mind, that we will do what we can, with what we have, where we are.

But I hope to work with members of Congress to address our budget constraints. Our current financial resources limit our ability to fulfill our responsibilities in a way that most Americans would expect. The simple fact is that Congress’s mandate to oversee the swaps market in addition to the futures and options markets requires significant resources beyond those the agency has previously been allocated. Without additional resources, our markets cannot be as well supervised; participants cannot be as well protected; market transparency and efficiency cannot be as fully achieved.

Specifically, in the absence of additional resources, the CFTC will be limited in its ability to:

Perform adequate examinations of market intermediaries, including systemically important DCOs and the approximately 100 swap dealers that have registered with the Commission under the new regulatory framework required by Dodd-Frank.

Use swaps data to address risk in a marketplace that that has become largely automated, and to develop a meaningful regulatory program that is required to promote price transparency and market integrity.

Conduct effective daily surveillance to identify the buildup of risks in the financial system, including for example, review of CFTC registrant activity reports submitted by Commodity Pool Operators and banking entities, as well as to monitor compliance with rules regarding prohibitions and restrictions on proprietary trading.

Investigate and prosecute major cases involving threats to market integrity and customer harm and strengthen enforcement activities targeted at disruptive trading practices and other misconduct of registered entities such as precious metals schemes and other forms of market manipulation.
Conclusion

A few core principles must motivate our work in implementing Dodd-Frank. The first is that we must never forget the cost to American families of the financial crisis, and we must do all we can to address the causes of that crisis in a responsible way. The second is that the United States has the best financial markets in the world. They are the strongest, most dynamic, most innovative, most competitive and transparent. They have been a significant engine of our economic growth and prosperity. Our work should strengthen our markets and enhance those qualities. We must be careful not to create unnecessary burdens on the dynamic and innovative capacity of our markets. I believe the CFTC's work can accomplish these objectives. We have made important progress but there is still much to do. I look forward to working with the members of this Committee and my fellow regulators on these challenges.

Thank you again for inviting me today. I look forward to your questions.

Last Updated: September 9, 2014

CFTC ACTING CHAIRMAN'S TESTIMONY BEFORE SENATE SUBCOMMITTEE

FROM:  COMMODITY FUTURES TRADING COMMISSION 

Testimony of Mark P. Wetjen Acting Chairman, Commodity Futures Trading Commission Before the U.S. Senate Appropriations Subcommittee on Financial Services And General Government

May 14, 2014

Good morning, Chairman Udall, Ranking Member Johanns and members of the Subcommittee. Thank you for inviting me to today’s hearing on the President's Fiscal Year 2015 funding request and budget justification for the Commodity Futures Trading Commission (Commission or CFTC).

During the last two years, despite significant budgetary constraints, the CFTC has made important progress in fulfilling its mission. As you know, under the Commodity Exchange Act, the Commission has oversight responsibilities for the derivatives markets, which include futures, options, cash, and swaps. Each of these markets is significant. Collectively, they have taken on particular importance to the U.S. economy in recent decades and, as a consequence, have grown substantially in size, measuring hundreds of trillions of dollars in notional value. Their operation and integrity are critical to the effective functioning of the U.S. and global economies.

At their core, the derivatives markets exist to help farmers, producers, small businesses, manufacturers and lenders focus on what they do best: providing goods and services and allocating capital to reduce risk and meet Main Street demand. Well-regulated derivatives markets facilitate job creation and the growth of the economy by providing a means for managing and assuming prices risks and broadly disseminating, and discovering, pricing information.

Stated more simply, through the derivatives marketplace, a farmer can lock in a price for his crop; a small business can lock in an interest rate that would otherwise fluctuate, perhaps raising its costs; a global manufacturer can lock in a currency value, allowing it to better plan and grow its global business; and a lender can manage its assets and balance sheet to ensure it can continue lending, fueling the economy in the process.

Essentially, these complex markets facilitate the assumption and distribution of risk throughout the financial system. Well-working derivatives markets are key to supporting a strong, growing economy by enabling the efficient transfer of risk, and therefore the efficient production of goods and services. Accordingly, it is critical that these markets are subject to appropriate governmental oversight.

Mr. Chairman, Ranking Member, and Committee members, I do not intend the testimony that follows to sound alarmist, or to overstate the case for additional resources, but I do want to be sure that Congress, and this committee in particular, have a clear picture of the potential risks posed by the continued state of funding for the agency. When not overseen properly, the derivatives markets may experience irregularities or failures of firms intermediating in them – events that can severely and negatively impact the economy as a whole and cause dramatic losses for individual participants. The stakes, therefore, are high.

The CFT C’s Responsibilities Have Grown Substantially in Recent Years

The unfortunate reality is that, at current funding levels, the Commission is unable to adequately fulfill the mission given to it by Congress: to prevent disruptions to market integrity, protect customer assets, monitor and reduce the build-up of systemic risk, and ensure to the greatest extent possible that the derivatives markets are free of fraud and manipulation.

Recent increases in the agency’s funding have been essential and appreciated. They have not, however, kept pace with the growth of the Commission’s responsibilities, including those given to it under Dodd-Frank.

Various statistics have been used to measure this increase in responsibilities. One often-cited measure is the increase in the gross notional size of the marketplace now under the Commission’s oversight. Other measures, though, are equally and perhaps more illustrative.

Trading Volume Has Increased

For instance, the trading volume of CFTC-regulated futures and options contracts was 3,060 million contracts in 2010 and rose to 3,477 million in 2013. Similarly, the volume of interest rate swap trading activity by the 15 largest dealers averaged 249,564 swap events each in 2010, and by 2012, averaged 332,484 each (according to the International Swaps and Derivatives Association (“ISDA”) data). Those transactions, moreover, can be executed in significantly more trading venues, and types of trading venues, both here and abroad. In addition, the complexity of the markets – its products and sophistication of the market tools, such as automated-trading techniques – has increased greatly over the years.

Clearing Houses Manage More Risk

The notional value of derivatives centrally cleared by clearing houses was $124 trillion in 2010 (according to ISDA data), and is now approximately $223 trillion (according to CFTC data from swap data repositories (“SDRs”)). That is nearly a 100 percent increase. The expanded use of clearinghouses is significant in this context because, among other things, it means that the Commission must ensure through appropriate oversight that these entities continue to properly manage the various types of risks that are incident to a market structure dependent on central clearing. A clearinghouse’s failure to adhere to rigorous risk management practices established by the Commission’s regulations, now more than ever, could have significant economic consequences. The Commission directly oversees fifteen registered clearinghouses and two of them, Chicago Mercantile Exchange, Inc., and ICE Clear Credit LLC, have been designated as systemically important by the Financial Stability Oversight Council.

Clearing Houses and Intermediaries Manage More Customer Funds

The amount of customer funds held by clearinghouses and futures commission merchants (FCMs) was $177 billion in 2010 and is now over $218 billion, another substantial increase. These are customer funds in the form of cash and securities deposited at firms to be used for margin payments made by the end-users of the markets, like farmers, to support their trading activities. Again, Commission rules are designed to ensure customer funds are safely kept by these market intermediaries, and a failure to provide the proper level of oversight increases the risk of certain practices by firms, including operational risks or fraud. In fact, recent events in the FCM community led to the temporary or permanent loss of more than a billion dollars of customer funds.

Substantially Larger Number of Firms Now Registered with the CFTC

The total number of registrants and registered entities overseen directly or indirectly by the Commission, depending on the measure, has increased by at least 40 percent in the last four years. This includes 102 swap dealers and two major swap participants (MSPs).

In addition, the CFTC oversees more than 4,000 advisers and operators of managed funds, some of which have significant outward exposures in and across multiple markets. It is conceivable that the failure of some of these funds could have spill-over effects on the financial system. In all cases, investors in these funds are entitled to know their money is being appropriately held and invested.

Additionally, the Commission directly or indirectly supervises another approximately 64,000 registrants, mostly associated persons that solicit or accept customer orders or participate in certain managed funds, or that invest customer funds through discretionary accounts. Although it leverages the resources of the self-regulatory organizations (“SROs”), the Commission itself must oversee these registrants in certain areas and provide guidance and interpretations to the SROs. The Commission does so with a total staff of only 648 employees currently onboard – about 1 percent of the number of registrants under its purview. Separately, the Commission must oversee more than three dozen registered entities, including clearinghouses and trading venues, each of which is subject to a complex set of regulatory requirements newly established or modified by the Dodd-Frank Act and designed to mitigate systemic risk.

By almost any measure, in fact, the portfolio of entities that the Commission is charged with overseeing has expanded dramatically in size and risk over the last half decade. The intermediaries in the derivatives markets are by and large well-run firms that perform important services in the markets and for their customers. Nevertheless, collectively, these firms can potentially pose risks – in some cases significant risks – to the financial system and the broader economy. Accordingly, those relying upon these firms and the public deserve assurance that such firms are supervised by an agency capable of meaningful oversight.

The CFTC Has Made Important Progress But Has Been Significantly Constrained

For much of FY 2013, the CFTC operated under continuing resolutions, which extended the FY 2012 appropriation of $205 million. These appropriations, however, were subject to sequestration. Effectively, our operating budget for FY 2013 was $195 million. Thus, the FY 2014 appropriation of $215 million was a modest budgetary increase for the Commission, lifting the agency’s appropriations above the sequestration level of $195 million that has posed significant challenges for the agency’s orderly operation. As directed by Congress, the agency has submitted a FY 2014 Spend Plan outlining its allocation of current resources, which reflects an increased emphasis on examinations and technology-related staff.

Even with these significant budget constraints, the dedicated staff of the Commission were able to complete the majority of new rulemakings required by the Dodd-Frank Act – about 50 rulemakings in all. This was in addition to the Commission’s ongoing work overseeing the futures exchange and options markets. These regulatory efforts resulted in greater transparency, which is critical to reducing systemic risk and lowering costs to end-users, while improving efficiency and supporting competition.

With regard to technology, we made progress in a variety of areas. We improved the quality of data reported to swap data repositories and have laid groundwork to receive, analyze and promulgate new datasets from SROs related to new authorities. We upgraded data analytics platforms to keep up with market growth. Financial risk surveillance tools were enhanced to support monitoring and stress testing related to new authorities. The Commission has prototyped a high-performance computing platform that dramatically reduces data analytics computation times and an on-line portal for regulatory business transactions to improve staff and industry productivity. The Commission has implemented enhanced position limit monitoring and is ready to implement pre-trade and heightened account ownership and control surveillance. Finally, the Commission has ensured that foundational server, storage, networking, and workstation technology are refreshed on a cost-effective cycle and that technology investments have cybersecurity and business continuity built-in.

In its role as a law enforcement agency, the Commission’s enforcement arm protects market participants and other members of the public from fraud, manipulation and other abusive practices in the futures, options, cash, and swaps markets, and prosecutes those who engage in such conduct. As of May 1, 2014, the Commission filed 31 enforcement actions in FY 2014 and also obtained orders imposing more than $2.2 billion in sanctions. By way of comparison, in FY 2013, the Commission filed 82 enforcement actions, and obtained orders imposing more than $1.7 billion in sanctions.

With the bulk of rulemaking behind us, the necessary focus must be examinations, market supervision and enforcement. Simply stated, this requires appropriate staffing and technological resources sufficiently robust to oversee what are highly advanced, complex global markets, and be able to take effective and timely enforcement action.

The FY 2015 Request Prioritizes Examinations, Technology, Market Integrity, and Enforcement

The President’s FY 2015 budget request reflects these priorities and highlights both the importance of the Commission’s mission and the potential effects of continuing to operate under difficult budgetary constraints.

The request is a significant step towards the longer-term funding level that is necessary to fully and responsibly fulfill the agency’s core mission: protecting the safety and integrity of the derivatives markets. It recognizes the immediate need for an appropriation of $280 million and approximately 920 staff years (FTEs) for the agency, an increase of $65 million and 253 FTEs over the FY 2014 levels, heavily weighted towards examinations, surveillance, and technology functions.

In this regard, the request balances the need for more technological tools to monitor the markets, detect fraud and manipulation, and identify risk and compliance issues, with the need for staff with the requisite expertise to analyze the data collected through technology and determine how to use the results of that analysis to fulfill the Commission’s mission as the regulator of the derivatives markets. Both are essential to carrying out the agency’s mandate. Technology, after all, is an important means for the agency to effectively carry out critical oversight work; it is not an end in itself.

In light of technological developments in the markets today, the agency has committed to an increased focus on technology. The FY 2015 budget request includes a $15 million increase in technology funding above the FY 2014 appropriation, or about a 42 percent increase, solely for IT investments.

In my remaining testimony, I will review three of the primary mission priorities for FY 2015.

Examinations

The President’s request would provide $38 million and 158 FTEs for examinations, which also covers the compliance activities of the Commission. As compared to FY 2014, this request is an increase of $15 million and 63 FTEs.

I noted earlier that the Commission has seen substantial growth in, among other things, trading volumes, customer funds held by intermediaries in the derivatives markets, and margin and risk held by clearinghouses. Examinations and regulatory compliance oversight are perhaps the best deterrents to fraud and improper or insufficient risk management and, as such, remain essential to compliance with the Commission’s customer protection and risk management rules.

The Commission has a direct examinations program for clearinghouses and designated contract markets, and it will soon directly examine swap execution facilities and SDRs. However, the agency does not at this time have the resources to place full-time staff on site at these registered entities, even systemically-important clearing organizations, unlike a number of other financial regulators that have on-the-ground staff at the significant firms they oversee. The Divisions of Market Oversight and Clearing and Risk collectively have a total of 47 examinations positions in FY 2014 to monitor, review, and report on some of the most complex financial market operations in the world.

The Commission today performs only high-level, limited-scope reviews of the nearly 100 FCMs holding over $218 billion in customer funds and 102 swap dealers. In fact, the Commission currently has a staff of only 38 to examine these firms, and to review and analyze, among other things, over 1,200 financial filings and over 2,400 regulatory notices each year. This staff level is less than the number the Commission had in 2010, yet the number of firms requiring its attention has almost doubled, and there has been a noted increase in the complexity and risk profile of the firms. Additionally, although it has begun legal compliance oversight of swap dealers and MSPs, the Commission has been able to allocate only 13 FTEs for this purpose. This number is insufficient to perform the necessary level of oversight of the newly registered swap dealer entities.

In FY 2014, the Commission overall will have a mere 95 staff positions dedicated to examinations of the thousands of different registrants that should be subject to thorough oversight and examinations. The reality is that the agency has fallen far short of performance goals for its examinations activities, and it will continue to do so in the absence of additional funding from Congress. For example, as detailed in the Annual Performance Review for FY 2013, the Commission failed to meet performance targets for system safeguard examinations and for conducting direct examinations of FCM and non-FCM intermediaries. The President’s budget request appropriately calls on Congress to bolster the examinations function at the agency, and it would protect the public, and money deposited by customers, by enhancing the examinations program staff by more than 66 percent in FY 2015.

Moreover, if Congress fully funds the President’s request, the Commission can move toward annual reviews of all significant clearinghouses and trading platforms and perform more effective monitoring of market participants and intermediaries. Partially funding the request will mean accepting potentially avoidable risk in the derivatives markets as the Commission is forced to forego more in-depth financial, operational and risk reviews of the firms within its jurisdiction. Thus, the Commission would be reactive, rather than proactive in regard to firm or industry risk issues.

Technology and Market Integrity

The FY 2015 request also supports a substantial increase in technology investments relative to FY 2014, roughly a 42 percent increase. The $50 million investment in technology will provide millions of dollars for new and sophisticated analytical systems that will, in part, assist the Commission in its efforts to ensure market integrity. As global markets have moved almost entirely to electronic systems, the Commission must invest in technology required to collect and analyze market data, and to handle the unprecedented volumes of transaction-level data provided by financial markets.

The President’s FY 2015 budget request supports, in addition, 103 data-analytics and surveillance-related positions in the Division of Market Oversight alone, an increase of more than 98 percent over the FY 2014 staffing levels. Market surveillance is a core Commission mission, and it is an area that depends heavily on technology. As trading across the world has moved almost entirely to electronic systems, the Commission must make the technology investments required to collect and make sense of market data and handle the unprecedented volumes of transaction-level data provided by financial markets.

Effective market surveillance, though, equally depends on the Commission’s ability to hire and retain experienced market professionals who can analyze extremely complex and voluminous data from multiple trading markets and develop sophisticated analytics and models to respond to and identify trading activity that warrants investigation. The FY 2015 investment in high-performance hardware and software therefore must be paired with investments in personnel that can employ technology investments effectively.

Accordingly, to make use of existing and new IT investments, the FY 2015 request would provide funding for 193 FTEs, an increase of 74 FTEs over FY 2014. These new staff positions are necessary for the Commission to receive, analyze, and effectively surveil the markets it oversees. These new positions, together with the technology investments included in the FY 2015 request, will enable the Commission to make market surveillance a core component of our mission.

The CFTC has invested appropriated funds in FY 2013 and FY 2014 in technology to make important progress. We have the groundwork in place to receive and effectively analyze swaps transaction data submitted to repositories and SROs related to new authorities. The FY 2015 request would provide funding to continue and increase the pace of progress in the areas noted above and also support the additional examination, enforcement, and economic and legal staff. Effective use of technology is essential to our mission to ensure market integrity, promote transparency, and effectively surveil market participants.

Enforcement

The President’s FY 2015 request would provide $62 million and 200 FTEs for enforcement, an increase of $16 million and 51 FTEs over FY 2014. The simple fact is that, without a robust, effective enforcement program, the Commission cannot fulfill its mandate to ensure a fair playing field. From FY 2011 to date, the Commission has filed 314 enforcement actions and also obtained orders imposing more than $5.4 billion in sanctions.

The cases the agency pursues range from sophisticated manipulative and disruptive trading schemes in markets the Commission regulates, including financial instruments, oil, gas, precious metals and agricultural products, to quick strike actions against Ponzi schemes that victimize investors. The agency also is engaged in complex litigations related to issues of financial market integrity and customer protection. By way of example, in FY 2013, the CFTC filed and settled charges against three financial institutions for engaging in manipulation, attempted manipulation and false reporting of LIBOR and other benchmark interest rates.

Such investigations continue to be a significant and important part of the Division of Enforcement’s docket. Preventing manipulation is critical to the Commission’s mission to help protect taxpayers and the markets, but manipulation investigations, in particular, strain resources and time. And once a case is filed, the priority must shift to the litigation. In addition to requiring significant time and resources at the Commission, litigation requires additional resources, such as the retention of costly expert witnesses.

In 2002, when the Commission was responsible for the futures and options markets alone, the Division of Enforcement had approximately 154 people. Today, the agency’s responsibilities have substantially increased. The CFTC now also has anti-fraud and anti-manipulation authority over the vast swaps market and the host of new market participants the agency now oversees. In addition, the agency is now responsible for pursuing cases under our enhanced Dodd-Frank authority that prohibits the reckless use of manipulative or deceptive schemes. Notwithstanding these additional responsibilities, however, total enforcement staff has shrunk – there are currently only 147 members of the enforcement staff. The President’s budget request would bring this number to 200. More cops on the beat means the public is better assured that the rules of the road are being followed.

In addition to the need for additional enforcement staff and resources, the CFTC also believes technology investments will make our enforcement staff more efficient. For instance, the FY 2015 request would support developing and enhancing forensic analysis and case management capabilities to assist in the development of analytical evidence for enforcement cases. In FY 2013 and FY 2014, appropriated funds invested in information technology have enabled the Commission to continue enhancing enforcement and litigation automation services, including a major upgrade to the document and digital evidence review platform that will enable staff to keep pace with the exploding volume of data required to successfully conduct enforcement actions.

A full increase for enforcement means that the agency can pursue more investigations and better protect the public and the markets. A less than full increase means that the CFTC will continue to face difficult choices about how to use its limited enforcement resources. At this point, it is not clear that the agency could maintain the current volume and types of cases, as well as ensure timely responses to market events.

Other FY 2015 Priorities: International Policy Coordination & Economic and Legal Analysis

The global nature of the derivatives markets makes it imperative that the United States consult and coordinate with international authorities. For example, the Commission recently announced significant progress towards harmonizing a regulatory framework for CFTC-regulated SEFs and EU-regulated multilateral trading facilities (MTFs). The Commission is working internationally to promote robust and consistent standards, to avoid or minimize potentially conflicting or duplicative requirements, and to engage in cooperative supervision, wherever possible.

Over the past two years, the CFTC, SEC, European Commission, European Securities and Markets Authority, and other market regulators from around the globe have been meeting regularly to discuss and resolve issues with the goal of harmonizing financial reform. The Commission also participates in numerous international working groups regarding derivatives. The Commission’s international efforts directly support global consistency in the oversight of the derivatives markets. In addition, the Commission anticipates a significant need for ongoing international policy coordination related to both market participants and infrastructure in the swaps markets. The Commission also anticipates a need for ongoing international work and coordination in the development of data and reporting standards under Dodd-Frank rules. Dodd- Frank further provided a framework for foreign trading platforms to seek registration as foreign boards of trade, and 24 applications have been submitted so far.

Full funding for international policy means the Commission will be able to maintain our coordination efforts with financial regulators and market participants from around the globe. If available funding is decreased, we will be less able to engage in cooperative work with our international counterparts, respond to requests, and provide staffing for various standard-setting projects. The President’s FY 2015 request would enable the Commission to sustain its efforts, providing $4.2 million and 15 FTEs that would be dedicated to international policy.

In addition, for FY 2015, the President’s budget would support $24 million and 92 FTEs to invest in robust economic analysis teams and Commission-wide legal analysis. Compared to the FY 2014 Spending Plan, this request is an increase of $4 million and 18 FTEs. Both of these teams support all of the Commission’s divisions.

The CFTC’s economists analyze innovations in trading technology, developments in trading instruments and market structure, and interactions among various market participants in the futures and swaps markets. Economics staff with particular expertise and experience provides leverage to dedicated staff in other divisions to anticipate and address significant regulatory, surveillance, clearing, and enforcement challenges. Economic analysis plays an integral role in the development, implementation, and review of financial regulations to ensure that the regulations are economically sound and subjected to a careful consideration of potential costs and benefits. Economic analysis also is critical to the public transparency initiatives of the Commission, such as the Weekly Swaps Report. Moving into FY 2015, the CFTC’s economists will be working to integrate large quantities of swaps market data with data from designated contract markets and swap execution facilities, and large swaps and futures position data to provide a more comprehensive view of the derivatives markets.

The legal analysis team provides interpretations of Commission statutory and regulatory authority and, where appropriate, provides exemptive, interpretive, and no-action letters to CFTC registrants and market participants. In FY 2013, the Commission experienced a significant increase in the number and complexity of requests from market participants for written interpretations and no-action letters, and this trend is expected to increase into FY 2015.

A full increase for the economics and legal analysis mission means the Commission will be able to support each of the CFTC’s divisions with economic and legal analysis. Funding short of this full increase or flat funding means an increasingly strained ability to integrate and analyze vast amounts of data the Commission is receiving on the derivatives markets, thus impacting our ability to study and detect problems that could be detrimental to the economy. Flat funding also means the Commission’s legal analysis team will continue to be constrained in supporting front- line examinations, adding to the delays in responding to market participants and processing applications, and hampering the team’s ability to support enforcement efforts.

Conclusion

Effective oversight of the futures and swaps markets requires additional resources for the Commission. This means investing in both personnel and information technology. We need staff to analyze the vast amounts of data we are receiving on the swaps and futures markets. We need staff to regularly examine firms, clearinghouses, trade repositories, and trading platforms. We need staff to bring enforcement actions against perpetrators of fraud and manipulation. The agency’s ability to appropriately oversee the marketplace hinges on securing additional resources.

Thank you again for inviting me today, and I look forward to your questions.

CFTC COMMISSIONER O'MALIA'S DISSENTING STATEMENT ON NON-U.S. SWAP DEALERS

FROM:  COMMODITY FUTURES TRADING COMMISSION 
Dissenting Statement by Commissioner Scott D. O’Malia

Request for Comment on Application of Commission Regulations to Swaps Between Non-U.S. Swap Dealers and Non-U.S. Counterparties Involving Personnel or Agents of the Non-U.S. Swap Dealers Located in the United States

January 2, 2014

If you thought that the Commission’s approach last year regarding cross-border issues resulted in an unsound rulemaking process, the start of 2014 is no better.

Today’s announcement of the request for comment on a staff Advisory abrogates the Commission’s fundamental legal obligations under the Administrative Procedure Act (“APA”) and provides another example of the Commission’s unsound rule implementation process.

Making matters worse, today’s request for comment is completely outside the scope of the cross-border Guidance and the Exemptive Order as the Commission did not address the issue relating to swaps negotiated between non-U.S. swap dealers (“SDs”) and non-U.S. counterparties acting through agents of the non-U.S. SDs located in the United States. This is simply a strategic move by the Commission to try to duck blame for consistently circumventing the fundamental tenets of the APA and failing to adhere faithfully to the express congressional directive to limit the extraterritorial application of the Dodd-Frank Act to foreign transactions that “have a direct and significant connection with activities in, or effect on, commerce of the United States.”1

Moreover, I question why the Commission has decided to request comment on a narrow issue of the extraterritorial application of Dodd-Frank, while essentially ignoring the dozens of comments already filed as part of the Commission’s cross-border Exemptive Order.2 Simply requesting comment on a staff Advisory does not endorse the validity of the cross-border Guidance or the staff Advisory issued based on the Guidance.

Additionally, I have serious concerns with the evolving jurisdictional application of the Commission’s authority over cross-border trades. It appears based on the staff Advisory, that the Commission is applying a “territorial” jurisdiction test to elements of a trade between non-U.S. entities. To better understand the legal underpinnings of this position, I have included several additional questions to be considered as part of the overall comment file. It is my hope that public comments will provide greater clarity regarding our cross-border authority and identify areas where we must harmonize global rules with our international regulatory partners in the near future. It makes no sense to apply guidance or staff advisories that do not enjoy the full support and authority provided through rulemakings based on the Commodity Exchange Act (“CEA”).

Looking forward into this year, the CFTC needs to do away with the reflexive rule implementation process via staff no-action and advisories that are not voted on by the Commission. It should be the goal of the Commission to develop rules that adhere to the APA and ensure proper regulatory oversight, transparency and promote competition in the derivatives space.

In this regard, I would like to seek additional comment on the following points:

1. Please provide your views on whether Covered Transactions with non-U.S. persons who are not guaranteed or conduit affiliates of U.S. persons meet the direct and significant test under CEA section 2(i).3  Please provide a detailed analysis of any such view and its effect on other aspects of the Commission’s cross-border policy, if any. Would your view change depending on whether a non-U.S. SD is a guaranteed affiliate or a conduit affiliate of a U.S. person?

2. CEA section 2(a)(1)4 provides for the general jurisidiction of the Commission. Please provide your views on whether Covered Transactions with non-U.S. persons who are not guaranteed or conduit affiliates of U.S. persons fall within the Commission’s jurisdiction under CEA section 2(a)(1) or any other provision of the CEA providing for Commission jurisdiction. Please provide a detailed analysis of any such view and its effect on other aspects of the Commission’s cross-border policy, if any. Would your view change depending on the nature of the non-U.S. SD (i.e., whether it is a guaranteed affiliate or a conduit affiliate of a U.S. person)?

3. To the extent that Covered Transactions fall within the Commission’s jurisdiction, should a non-U.S. SD be required to comply with all, or only certain, Transaction-Level Requirements? Please provide a detailed analysis of any such view and its effect on other aspects of the Commission’s cross-border policy, if any. Would your view change depending on the nature of the non-U.S. SD (i.e., whether it is a guaranteed affiliate or a conduit affiliate of a U.S. person)?

4. In the open meeting to consider the cross-border final guidance and cross-border phase-in exemptive order, I asked about the Commission’s enforcement and legal authority under the cross-border guidance. The Commission’s General Counsel replied, “[T]he guidance itself is not binding strictly. We couldn’t go into court and, in a count of the complaint, list a violation of the guidance as an actionable claim.”5 If the Commission adopts the staff Advisory as Commission policy (and not through the rulemaking process), please provide your views on the Commission’s ability to enforce such policy.

DODD-FRANK SWAPS CLEARING RULES HAVE BEGUN

FROM: COMMODITY FUTURES TRADING COMMISSION
CFTC Announces that Mandatory Clearing Begins

Washington, DC – Today, swap dealers, major swap participants and private funds active in the swaps market are required to begin clearing certain index credit default swaps (CDS) and interest rate swaps that they entered into on or after March 11, 2013. The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) amended the Commodity Exchange Act (CEA) to require clearing of certain swaps. The Dodd-Frank Act also requires the Commission to determine whether a swap is required to be cleared by either a Commission-initiated review or a submission from a DCO for the review of a swap, or group, category, type, or class of swap. The clearing requirement determination does not apply to those who are eligible to elect an exception from clearing because they are non-financial entities hedging commercial risk.

"One of the most significant Dodd-Frank reforms begins implementation today," said CFTC Chairman Gary Gensler. "Central clearing lowers the risk of the highly interconnected financial system. It promotes competition in and broadens access to the market by eliminating the need for market participants to individually determine counterparty credit risk, as now clearinghouses stand between buyers and sellers."

As of today, swap dealers and private funds active in the swaps market began clearing certain CDS and interest rate swaps that they entered into on or after March 11. The clearing requirement applies to newly executed swaps, as well as changes in the ownership of a swap. The five swap classes that are required to be cleared include the swaps can be found here: See Related Link.

Market participants electing an exception from mandatory clearing under section 2(h)(7) of the CEA do not have to comply with the reporting requirements for electing the exception until September 9, 2013.

"This week’s implementation of mandatory clearing continues the process of implementing key goals of the Dodd-Frank Act," Chairman Gensler said. "It is an historic change for the markets that will benefit the public and the economy at large. This achievement is a real testament to the dedication and excellence of the CFTC staff working as a team and with other regulators, both domestic and international. I also would like to thank Commissioners Sommers, Chilton, O’Malia and Wetjen for their significant contributions to making the implementation of these reforms now a reality."