FROM: U.S. COMMODITY FUTURES TRADING COMMISSION
Commissioner Bowen Speech before the Managed Funds Association, 2015 Compliance Conference
May 5, 2015
In my eleven months as a Commissioner, I’ve spoken about a few topics that are at the top of my agenda and which I hope the Commission will address early during my term. One of those is the need for increased regulation of retail foreign exchange transactions, which I believe is necessary to protect the retail investors who trade in that market. Another is the need for full funding of the Commodity Futures Trading Commission (CFTC) so that we will have strong, comprehensive oversight of the swaps and futures markets. Still another is the need to finalize the remaining regulations required by the Dodd-Frank Wall Street Reform and Consumer Protection Act, aka Dodd-Frank.
Finally, I have also spoken about my belief that we need to ensure that our system of regulation, including our universe of self-regulatory organizations, works efficiently and effectively. In fact, I would like to talk to you today about a subject that confirms my belief that we need to finish our Dodd-Frank rules, while enhancing our overall comprehensive regulations. Specifically, I want to talk to you about the topic of governance.
As compliance professionals, I know that you all understand how good governance protocols and rules are at the heart of how any fund or corporation operates. What some of you may not know is that the CFTC was tasked to issue regulations on this subject under Dodd-Frank. Per Section 726 of Dodd-Frank, “In order to mitigate conflicts of interest,” the CFTC was supposed to issues rules within six months of the law’s passage that could potentially “include numerical limits on the control of, or the voting rights with respect to, any derivatives clearing organization that clears swaps, swap execution facility, or board of trade” that is sufficiently involved in the swaps market.1 Additionally, we were mandated to adopt those rules if we determined that “such rules are necessary or appropriate to improve the governance of” a derivatives clearing organization (DCO), a contract market, or certain swap execution facilities (SEFs).2
This rulemaking requirement was one of the first things we acted on. Back in October 2010, almost three months after Dodd-Frank became law, we issued a proposed rule on this subject. It provided guidelines on conflicts of interest over these entities and also crafted a system to improve the governance of DCOs and SEFs.3 Ironically, however, we have not finalized that governance proposal in the intervening five years nor have we issued a new proposal.
So, to some extent, one of the first regulations out of the gate has become one of the last ones to be completed. In fact, the governance rulemaking is one of three major rules we have to complete, along with such well-known regulations as position limits and capital for swap dealers and margin for uncleared swaps. And honestly, I believe that it is as important for us to complete and promulgate a rule on governance, as it is for us to complete those two rules.
The reason I believe completing the rule on governance is critical is two-fold. First, the governance of designated contract markets (DCMs) and SEFs is critical to how the overall markets we regulate function. As a reminder, the governance proposal covered a number of major topics - from compensation policies for public boards of directors4 to an expertise standard for other members of public boards.5 The proposal even required that boards of directors of registered entities engage in an annual performance review.6 Some of those concepts might seem self-evident, but it’s critical that all such entities have such policies in place.
Second, I believe this rule can and should be part of a broader effort to address another key issue at present: improving culture. As I have mentioned previously and as seems self-evident, we have a culture problem in finance at present.7 As a Commissioner at the CFTC, I’ve seen a significant number of settlements and alleged violations of our laws in the last eleven months. Sometimes those violations are from individuals deliberately seeking to defraud investors. Other times, however, the violations come from large organizations that have previously violated the rules. And that is something that should trouble us.
I believe the governance rule is a major tool to deter rule-breaking. Culture comes from the top – when you have a strong, independent, and involved board of directors, it’s more likely that issues will be fixed before they become problems or cause a regulation or law to be broken.
I think completing this governance rule is important because it is a critical step in the process of addressing our mandate. We need to be able to release a strong rule on governance practices for SEFs and DCMs if we’re going to fix the broader culture problem on Wall Street. We all expect that the governance of our DCMs and SEFs will be superior – after all, these markets revolve around trust. If market participants don’t trust that decisions are made fairly on an exchange, they are less likely to trade on that exchange.
It is because of that key fact that I believe there is support for strong governance rules on these entities because they’re the intermediaries between industry players. They’re a big part of the marketplace. And if we want to fix a big problem like culture, this is a good place to start. If we can establish strong, robust governance practices on DCMs and SEFs, that may not be a panacea to our cultural ills, but it could be a small dose of medicine.
To return to the particular rule at hand, the 2010 governance proposal was filled with a number of good, worthy ideas. I want to offer my thoughts on how to enhance this governance rulemaking. My hope is that with these and possibly other enhancements, we can at least be closer to introducing model rules and best practices that serve as a template to improve the culture in the financial industry.
First, we need to have some qualitative standard for board membership. The previous proposal required that 35% of the members of boards of directors of our registrants be public directors and that those boards have a minimum of two public directors.8 I see why that was done that way – specific numerical standards are easy to implement. But I think we can do better. After all, a person being a public director doesn’t immediately make them a good director. We want people who are fully invested in their firms and who will diligently oversee management accountability.
To put a finer point on it, I do think you need a sufficient number of public directors to achieve meaningful independence. We could approach an independence standard through a holistic review of the board’s independence or we may require certifications by the public directors each year to the stockholders that they are truly independent. Alternatively, we could ask that the board certify that it is providing adequate resources to improve culture and the tone at the top or that it craft plans for improving the overall culture of a company. Clearly the standard needs to be more dynamic than just a number. It also has to be one that can clearly be consistently met by a registrant.
Second, I think we should use this rule to ensure that issues of culture will merit the active attention of the board. The previous proposal had provisions that mandated the board of directors to do certain things. For instance, it mandated an annual self-review and required that a registered entity establish procedures to remove a member of the board. I think this rule can be enhanced with a requirement that issues of culture be considered by the board.
There are several ways this could work. As I mentioned in my OpRisk speech, “If there isn’t a dedicated person in the company trying to improve the culture – both through communication and making it clear that the rules need to be constantly followed – the culture won’t broadly improve.”9
Third, we need to try and standardize governance across entities as much as possible. Good governance principles should apply across entities, financial or non-financial, because they provide simple incentives designed to protect the company and its shareholders from issues; inadvertent errors as well as deliberate ones. Entities should strive to ensure that a board is independent and that it is really taking a separate hard-look at the company’s actions, just as entities should strive to prevent conflicts of interest from arising.
Yet, we should not be micro-managing the process. If we’re crafting rules that are too entrenched in the particulars of how a DCM operates, we’re making two mistakes. First, having standards that aren’t largely uniform will lead to additional legal and compliance expenses for those entities. Differing standards could lead to confusion and result in entities making mistakes. Second, we’re missing the chance to actually establish standards that could be a model for others to use, and that would be a clear missed opportunity to improve the culture in finance and increase board independence.
If we can seek standardization and harmonization on the particulars of data standards or determine which country has the jurisdiction over a particular trade, we shouldn’t shy away from the chance to seek standardization on this subject. And I hope and believe that if we can establish strong rules on these entities -- rules that work -- there will be other private sector entities that will voluntarily adopt these rules as well.
I would hope that many entities which are not SEFs or DCMs would view a new governance rule as a model and adopt it voluntarily. But even if they do not, I believe we have the ability to set governance rules on a number of swap dealers and major swap participants, and that we should consider whether it makes sense to apply this rule to those entities.
If you’re going to have an optimally effective organization, you’ve got to have good governance. It’s a condition that is absolutely necessary for success. I believe the time has come for the CFTC to finish this rule, ideally before the end of this calendar year. Thank you and I look forward to my fireside chat with Adam and questions from the audience. Obviously, time is a constraint, so feel free to reach out to me or my staff if you do not have the opportunity to ask a question or raise issues this morning.
1 Dodd-Frank Wall Street Reform and Consumer Protection Act, § 726(a), available at http://www.cftc.gov/ucm/groups/public/@swaps/documents/file/hr4173_enrolledbill.pdf at page 320.
2 Dodd-Frank Wall Street Reform and Consumer Protection Act, § 726(b), available at http://www.cftc.gov/ucm/groups/public/@swaps/documents/file/hr4173_enrolledbill.pdf at page 320.
3 Commodity Futures Trading Commission, “Requirements for Derivatives Clearing Organizations, Designated Contract Markets, and Swap Execution Facilities Regarding the Mitigation of Conflicts of Interest, 17 CFR Parts 1, 37, 38, 39 & 40, October 18, 2010, 75 Fed. Reg. 63732, [hereinafter “Proposed CFTC Governance Rule”], available at http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2010-26220a.pdf.
4 Proposed CFTC Governance Rule, 17 C.F.R. Part 40.9(b)(4), at 75 Fed. Reg. 63752, available at http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2010-26220a.pdf.
5 Proposed CFTC Governance Rule, 17 C.F.R. Part 40.9(b)(3), at 75 Fed. Reg. 63751, available at http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2010-26220a.pdf.
6 Proposed CFTC Governance Rule, 17 C.F.R. Part 40.9(b)(5), at 75 Fed. Reg. 63752, available at http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2010-26220a.pdf.
7 Commissioner Sharon Y. Bowen, Commodity Futures Trading Commission, “Remarks of CFTC Commissioner Sharon Y. Bowen Before the 17th Annual OpRisk North America,” March 25, 2015, available at http://www.cftc.gov/PressRoom/SpeechesTestimony/opabowen-2.
8 Proposed Governance Rule, 17 C.F.R. Part 40.9(b)(1)(i), at 75 Fed. Reg. 63751, available at http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2010-26220a.pdf.
9 Commissioner Sharon Y. Bowen, Commodity Futures Trading Commission, “Remarks of CFTC Commissioner Sharon Y. Bowen Before the 17th Annual OpRisk North America,” March 25, 2015, available at http://www.cftc.gov/PressRoom/SpeechesTestimony/opabowen-2.
Last Updated: May 5, 2015