CFTC GARY GENSLER'S REMARKS AT 2013 ANNUAL GLAUBER LECTURE AT HARVARD UNIVERSITY

FROM:  COMMODITY FUTURES TRADING COMMISSION 
Remarks of Chairman Gary Gensler at the 2013 Annual Glauber Lecture at Harvard University
October 29, 2013

Thank you, Bob, for that kind introduction. I also would like to thank you and Harvard University for the invitation to speak today. I’m particularly pleased to be here as Bob and I are both examples that there is life after serving as an undersecretary of the Treasury.

Five years ago, the U.S. economy was in a free fall.

Five years ago, the swaps market was at the center of the crisis. It cost middle-class Americans – and hardworking people around the globe – their jobs, their pensions and their homes.

Five years ago, the swaps market contributed to the financial system failing corporate America and the economy as a whole. Thousands of businesses closed their doors.

President Obama met in 2009 with the G-20 leaders in Pittsburgh. They committed to bringing the swaps market into the light through transparency and oversight.

The President and Congress in 2010 gave the task of implementing swaps market reform to the Commodity Futures Trading Commission (CFTC) and security-based swaps market reform to the Securities and Exchange Commission.

With the CFTC’s near completion of these reforms, the shift to a transparent, regulated marketplace benefitting investors, consumers and businesses is fully in motion.

The CFTC’s 62 final rules, orders and guidance have brought traffic lights, stop signs, and speed limits to the once dark and unregulated swaps roads.

There are bright lights and robust safety measures in place that didn’t exist in 2008.

With these reforms, farmers, ranchers, producers and commercial companies can continue to rely on transparent, competitive markets to lock in a price or a rate and focus on what they do best – innovating, producing goods and services for the economy, and creating jobs.

These reforms are not based on new ideas. Economists have written about them for centuries. Just start with Adam Smith in the Wealth of Nations where he wrote about the benefits of lowering the price of information and the price of access. In essence, if you make information free, the economy benefits. Similarly, if access to the market is free, everybody gets to compete.

Transparency

Thus, in line with Adam Smith, the first critical component of swaps market reform is transparency.

Today, the public can see the price and volume of each swap transaction as it occurs on a website, like a modern-day tickertape.

This transparency lowers costs for investors, consumers and businesses. It increases liquidity, efficiency and competition.

Regulators have benefited as well. Nearly $400 trillion in market facing swaps are being reported into data repositories.

This transparency spans the entire marketplace – cleared as well as bilateral or customized swaps. Every product, without exception, now must be reported.

Further, starting this month, the public is benefitting as swap trading platforms come under new common-sense rules of the road.

Over time, market participants will benefit from the enhanced pre-trade transparency and competition of these new trading platforms, called swap execution facilities (SEFs).

SEFs are required to provide all market participants – dealers and non-dealers alike – with impartial access, once again following Adam Smith’s observations on how to benefit the economy.

Further, SEFS provide the ability to compete by leaving live, executable bids or offers in an order book.

Requiring trading platforms to be registered and overseen by regulators was central to the swaps market reform President Obama and Congress included in the Dodd-Frank Wall Street Reform and Consumer Protection Act. They expressly repealed exemptions, such as the so-called “Enron Loophole,” for unregistered, multilateral swap trading platforms.

Seventeen SEFs are temporarily registered. This is truly a paradigm shift – a transition from a dark to a lit market. It’s a transition from a mostly dealer-dominated market to one where others have a greater chance to compete.

Clearing

Another key component of completed swaps reforms is bringing transactions among financial institutions into central clearing.

This month, mandatory clearing of interest rate and credit index swaps is a reality for swap dealers, hedge funds and other financial institutions.

Clearinghouses lower risk and promote access for market participants.

As of October 25, 80 percent of new interest rate swaps were cleared. In total, over $190 trillion of the approximately $340 trillion market facing interest rate swaps market, or 57 percent, was cleared. This compares to only 21 percent of the market in 2008.

Earlier this month, the guaranteed affiliates and branches of U.S. persons were required to come into central clearing. Further, hedge funds and other funds whose principal place of business is in the United States or that are majority owned by U.S. persons are required to clear as well. No longer will a hedge fund with a P.O. Box in the Cayman Islands for its legal address be able to skirt the important reforms Congress put in place.

Swap Dealer Oversight

The third key component of swaps market reform is bringing oversight to swap dealers.

In 2008, swaps activity was basically not regulated in the United States, Europe or Asia. Among the reasons for this, it was claimed that financial institutions did not need to be specifically regulated for their swaps activity, as they or their affiliates already were generally regulated as banks, investment banks or insurance companies.

AIG’s downfall was a clear example of what happens with such limited oversight.

Today, we have 88 swap dealers and two major swap participants registered. This group includes the world’s 16 largest financial institutions in the global swaps market, commonly referred to as the G16 dealers. It also includes a number of energy swap dealers.

Swap dealer oversight helps protect the public. It lowers risk and increases market integrity. Swap dealers throughout this year have had to report their transactions and comply with sales practice and other business conduct standards.

International Coordination on Swap Market Reform

Since the 2009 meeting in Pittsburgh, the CFTC has been consistently coordinating with our international counterparts on swaps market reform. The United States, Europe, Japan and the largest provinces in Canada all have made substantial progress.

As the CFTC and the international regulatory community move forward with reform, we all recognize that risk knows no geographic border. AIG nearly brought down the U.S. economy through the operations of its offshore guaranteed affiliate.

It wasn’t the only U.S. financial institution that brought risk back home from its far-flung operations during the 2008 crisis.

It was also true at Lehman Brothers, Citigroup, and Bear Stearns. Ten years earlier, it was true at Long-Term Capital Management.

The nature of modern finance is that financial institutions commonly set up hundreds, or even thousands, of legal entities around the globe. When a run starts on any part of an overseas affiliate or branch of a modern financial institution, risk crosses international borders.

The U.S. Congress was clear in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) that the far-flung operations of U.S. enterprises are to be covered by reform.

The CFTC, coordinating closely with global regulators, completed guidance on the cross-border application of the Dodd-Frank Act in July. Swaps market reform covers transactions between non-U.S. swap dealers and guaranteed affiliates of U.S. persons, as well as swaps between two guaranteed affiliates.

The guidance embraces the concept of substituted compliances, or relying on another country’s rules when they are comparable and comprehensive.

This guidance is critical to protecting the public from the risk of foreign-affiliate failures in the future.

Benchmark Interest Rates

Today, the CFTC announced its fifth settlement against a bank for pervasively rigging key interest rate benchmarks, LIBOR and Euribor.

LIBOR and Euribor are critical reference rates for global futures and swaps markets. In the U.S., LIBOR is the reference rate for 70 percent of the futures market and more than half of the swaps market. It is the reference rate for more than $10 trillion in loans.

Unfortunately, we once again see how the public trust can be violated through bad actors readily manipulating benchmark interest rates.

Through hundreds of manipulative acts spanning six years, in six offices, and on three continents, more than two dozen Rabobank employees, including a senior manager, manipulated, attempted to manipulate and falsely reported crucial reference rates in global financial markets. Rabobank employees also aided and abetted other banks to manipulate benchmark interest rates.

I wish I could say that this won’t happen again, but I can’t.

LIBOR and Euribor are not sufficiently anchored in observable transactions. Thus, they are basically more akin to fiction than fact. That’s the fundamental challenge so sharply revealed by Rabobank and our prior cases.

This fifth instance of benchmark manipulative conduct highlights the critical need to find replacements for LIBOR and Euribor – replacements truly anchored in observable transactions.

Though addressing governance and conflicts of interest regarding benchmarks is critical, that will not solve the lack of transactions in the market underlying these benchmarks.

That is why the work of the Financial Stability Board to find alternatives and consider potential transitions to these alternatives is so important. The CFTC looks forward to continuing to work with the international community on much-needed reforms.

Resources

I’d like to close on one of the greatest challenges to well-functioning swaps and futures markets. That challenge is that the agency tasked with overseeing these markets is not sized to the task at hand.

At 675 people, we are only slightly larger than we were 20 years ago. Since then though, Congress gave us the job of overseeing the $400 trillion swaps market, which is more than 10 times the market we oversaw just four years ago. Further, the futures market itself has grown fivefold since the 1990s.

You might not have liked the umpire’s call in the game this week on obstruction, but would you want Major League Baseball to expand tenfold and not add to its corps of umpires?

We’ve basically completed the task of writing all the reforms and are past the initial market implementation dates. We’ve brought the largest and most significant enforcement cases in the Commission’s history.

These successes, however, should not be confused with the agency having sufficient people and technology to oversee these markets.

We need people to examine the clearinghouses, trading platforms and dealers. We need surveillance staff to actually swim in the new data pouring into the data repositories. We need lawyers and analysts to answer the many hundreds of questions that are coming in from market participants about implementation. We need sufficient funding to ensure this agency can closely monitor for the protection of customer funds. And we need more enforcement staff to ensure this vast market actually comes into compliance and go after bad actors in the futures and swaps markets.

The President has asked for $315 million for the CFTC. This year we’ve been operating with only $195 million.

Worse yet, as a result of continued funding challenges, sequestration and a required minimum level Congress set for the CFTC’s outside technology spending, the CFTC already has shrunk 5 percent, and just last week, was forced to notify employees that they would be put on administrative furlough for up to 14 days this year.

I recognize that Congress and the President have real challenges with regard to our federal budget. I believe, though, that the CFTC is a good investment for the American public. It’s a good investment to ensure the country has transparent and well-functioning markets.

Thank you, and I look forward to your questions.

CFTC CHAIRMAN GENSLER TESTIFIES BEFORE U.S. CONGRRESS REGARDING SWAPS MARKET REFORMS

FROM: U.S. COMMODITY FUTURES TRADING COMMISSION

Testimony Before the U.S. House Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises, Washington, DC
Chairman Gary Gensler
December 12, 2012

Good morning Chairman Garrett, Ranking Member Waters and members of the Subcommittee. I thank you for inviting me to today’s hearing on implementation of Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) swaps market reforms. I would like to thank Robert Cook from the Securities and Exchange Commission (SEC). I’d also like to thank my friend, Chairman Mary Schapiro, who has been a terrific partner. Our agencies have consistently coordinated on this reform effort. I also want to thank my fellow Commissioners and the CFTC staff for their hard work and dedication.

The New Era of Swaps Market Reform

Swaps market reform is now becoming a reality. The marketplace is increasingly shifting to implementation of the common-sense rules of the road that Congress included in the Dodd-Frank Act.

The financial crisis cost eight million American jobs, millions of people lost their homes, and thousands of businesses closed their doors – in part because of the unregulated swaps market. In the aftermath of the crisis, President Obama convened the G-20 leaders in Pittsburgh in 2009. They came to an international consensus that the opaque swaps market should be brought into the light through transparency and oversight, and that standardized swaps between financial entities should be centrally cleared by the end of 2012.

In 2010, Congress and President Obama came together to pass the historic Dodd-Frank Act. The key objectives of the law’s swaps provisions are:
Lowering the risk of the interconnected financial system by bringing standardized swaps into centralized clearing;
Bringing public transparency to the marketplace; and
Ensuring that swap dealers and major swap participants are specifically regulated for their swaps activity.
The CFTC has made significant progress in each of these areas. October 12, given the completed foundational definition rules, marked the new era of swaps market reform.

As a result of completed reforms:
Standardized swaps between financial entities will be cleared starting in March, fulfilling the U.S. commitment at the G-20 meeting in Pittsburgh;
Initial data reporting to regulators has begun and will be expanded as swap dealers report their transactions. The public will benefit from real-time reporting early next year; and
Swap dealers have begun the process of registering, and we anticipate many dealers will do so later this month.
With 42 finalized swaps market reforms, the CFTC has completed about 80 percent of the Dodd-Frank swaps rules. We are seeking to consider and finalize the remaining rules in the first half of 2013. I believe it’s also critical that we continue our efforts to put in place aggregate speculative position limits across futures and swaps on physical commodities, as Congress directed the CFTC to do.

Throughout this process, the CFTC has worked toward a smooth transition to a transparent, regulated swaps marketplace and has phased in the timing for compliance to give market participants appropriate time to adjust.

I will now go into further detail on the Commission’s swaps market reform efforts.

Lowering Risk and Democratizing the Market through Clearing

Central clearing, the first building block of Dodd-Frank reform, lowers the risk of the highly interconnected financial system. It also broadens access to many more market participants, as they no longer will have to individually determine counterparty credit risk. Now clearinghouses will stand between buyers and sellers. This broadened access through central clearing will help promote greater competition and lower costs to users of swaps.

Clearinghouses have lowered risk for the public and fostered competition in the futures markets since the late 19th century. Now central clearing will do the same for the swaps market.

A key milestone was reached last month with the adoption of the first clearing requirement determinations. This follows through on the U.S. commitment at the G-20 meeting that standardized swaps between financial entities should be brought into central clearing by the end of 2012. The vast majority of interest rate swaps and credit default index swaps will be brought into central clearing. Swap dealers and the largest hedge funds will be required to clear in March, and compliance will be phased in for other market participants through the summer of 2013. Consistent with congressional intent, the CFTC finalized rules to ensure that end-users using swaps to hedge or mitigate commercial risk will not be required to bring swaps into central clearing. The CFTC will continue working with market participants on implementation.

Promoting Transparency

Transparency, the second building block of reform, lowers costs for investors, consumers and businesses. It increases liquidity, efficiency and competition. It provides critical pricing information to businesses across the country that use swaps markets to lock in a price or hedge a risk.

Bright lights have begun to shine on the swaps market. As a result, swaps transactions are being reported to regulators through swap data repositories. The public also will benefit from real-time reporting of the price and volume of transactions beginning in early 2013, based on rules the CFTC completed in 2011. In addition, the daily valuation over the life of uncleared swaps will be provided to each counterparty. For cleared swaps, it will be provided to the public as well. With these transparency reforms, the public and regulators will have their first full window into the swaps marketplace, a fundamental shift that Congress included in the Dodd-Frank Act.

Looking ahead, Commissioners are now reviewing final rules that would allow market participants to view the prices of available bids and offers. These reforms on trading platforms called swap execution facilities (SEFs) and minimum block sizes will bring pre-trade transparency to the swaps market, further enhancing liquidity and price competition. These rules will build on the democratization of the swaps market that comes with the clearing of standardized swaps.

Promoting Market Integrity and Lowering Risk through Swap Dealer Oversight

Comprehensive oversight of swap dealers, the third building block of reform, will promote market integrity and lower their risk to taxpayers and the rest of the economy.

As the result of CFTC rules completed in the first half of this year, swap dealers have begun the process of registering and, for the first time, will come under comprehensive oversight. We anticipate many dealers will register by the end of this month.

Once swaps dealers register, they will report their trades with U.S. persons to both regulators and the public. In addition, they will implement crucial back office standards that lower risk and increase integrity. These include promoting the timely confirmation of trades and documentation of the trading relationship. Swap dealers also will be required to implement sales practice standards that prohibit fraud, treat customers fairly and improve transparency. These reforms will be phased in next year.

We are collaborating closely internationally on a global approach to margin requirements for uncleared swaps through the Basel Committee on Banking Supervision and the International Organization of Securities Commissions (IOSCO). I would anticipate that the CFTC, in consultation with European regulators, would take up the margin rules, as well as related rules on capital, next year with the benefit of this international work.

International Coordination on Swaps Market Reform

In enacting financial reform, Congress recognized the basic lessons of modern finance and the 2008 crisis. During a default or crisis, risk knows no geographic border. If a run starts on one part of a modern financial institution, almost regardless of where it is around the globe, it invariably means a funding and liquidity crisis rapidly spreads to the entire consolidated entity. Then finance, rather than serving the rest of the economy, can threaten the rest of the economy.

To give financial institutions and market participants operating outside the U.S. guidance on the cross-border application of Dodd-Frank, the CFTC in June sought public consultation on its interpretation of the Dodd-Frank cross-border provisions. The guidance is a balanced, measured approach, consistent with the cross-border provisions in Dodd-Frank and Congress’ recognition that risk easily crosses borders.

Under the guidance, foreign firms that do more than a de minimis amount of swap-dealing activity with U.S. persons will register with the CFTC two months after crossing the de minimis threshold. Many will do so shortly, with others following later.

For firms that do register with the CFTC, we are very committed to allowing for substituted compliance, or permitting market participants to comply with Dodd-Frank through complying with comparable and comprehensive foreign regulatory requirements.

The guidance includes a tiered approach for foreign swap dealer requirements, which was developed in consultation with foreign regulators and market participants. Some requirements would be considered entity-level, such as for capital, chief compliance officer and swap data recordkeeping. Some requirements would be considered transaction-level, such as clearing, margin, real-time public reporting, trade execution, trading documentation and sales practices.

Entity-level requirements would apply to all registered swap dealers, but in certain circumstances, foreign swap dealers could meet these requirements through substituted compliance. In a separate release, the Commission proposed phased compliance regarding entity-level requirements until July 2013. Such phased compliance will allow time for the CFTC, other regulators and market participants to continue coordinating on regulation of cross-border swaps activity.

Foreign swap dealers would comply with Dodd-Frank for transaction-level requirements facing U.S. persons. The timing of transaction-level compliance with U.S. persons will be determined according to the generally applicable schedule of each of the CFTC’s rules. The timing of compliance would be phased, however, for transactions facing guaranteed affiliates of U.S. persons, as well as foreign branches of U.S. persons, until next summer.

Pending further action on the cross-border guidance, the CFTC issued time-limited relief to certain foreign legal entities regarding the counting of swaps toward the de minimis swap-dealing threshold.

The CFTC also will continue to engage with our international counterparts through bilateral and multilateral discussions on reform and cross-border swaps activity. We are bound to have some differences, given our different cultures and political systems, but we’ve made great progress internationally on an aligned approach to reform. We are committed to working through any instances where the CFTC is made aware of a conflict between U.S. law and that of another jurisdiction.

International regulators met in New York in late November and had a very productive meeting regarding the CFTC’s guidance and how other jurisdictions are handling cross-border application of swaps market reform.

The regulators and policymakers at the meeting agreed to a joint statement regarding our progress so far. In short, the statement said:
Authorities should consult with each other prior to making final determinations regarding which derivatives products will be subject to required clearing;
Robust supervisory cooperation arrangements should be established;
Authorities should have appropriate access to data held in trade repositories;
The application of reforms to market participants should be clear, and jurisdictions should consider reasonable, time-limited transition periods so that market participants have adequate time to comply; and
The authorities agreed to continue working together, including on substituted compliance, and to meet regularly, starting in early 2013.
Market Implementation of Swaps Market Reform

As we near the end of 2012, market participants are moving to implementation of swaps market reform.

Given the magnitude of the crisis, Congress gave the CFTC but one year to complete implementing rules.

The CFTC, however, has been working to complete these rules in a deliberative way - not against a clock. We have been careful to consider significant public input, as well as the costs and benefits of each rule. CFTC Commissioners and staff have met nearly 2,000 times with members of the public, and we have held 19 public roundtables on important issues related to Dodd-Frank reform. The agency has received nearly 37,000 comment letters on matters related to reform. Our rules also have benefited from close consultation with domestic and international regulators and policy makers.

The CFTC has been working on smoothing the transition from a marketplace that lacked regulation to a new era of transparency and common-sense oversight. We have consulted broadly on appropriately phasing in reforms over time. In the spring of last year, we put out a concepts document for public comment and held a roundtable with the SEC on phased implementation. Subsequently, we proposed and finalized rules on implementation phasing. For instance, the clearing determinations will be phased in depending on the type market participant in March, then June, then September of 2013. Other reforms include built-in phasing. For instance, data reporting requirements are phased in depending on asset classes and market participants. Clearinghouses began reporting for interest rate and credit derivatives on October 12. Swap dealers will follow when they register. Reporting for foreign exchange, equity swaps and physical commodity swaps (including agricultural and energy swaps) begins in February 2013 for swap dealers and major swap participants. Reporting for all other market participants begins in April 2013. Extensive information on the compliance schedules for each of the CFTC’s reforms is available on our website.

arket Participant Inquiries

Now that the market is moving to implementation, it’s the natural order of things that market participants have questions and have come to us for further guidance. As it is sometimes the case with human nature, the agency receives many inquiries as compliance deadlines approach.

The Commission has sought to ensure that market participants have time to prepare. It has now been two and a half years since the Dodd-Frank Act passed. It has been a year or more since many CFTC rules have been finalized. In particular, the data rules that will largely go into effect in January were adopted by the Commission in 2011. The swap dealer definition and registration rules were completed in the first half of this year.

The CFTC, however, still welcomes inquiries from market participants, as some fine-tuning is expected. Prior to the milestone of October 12 when the foundational definition rules became effective, my fellow commissioners and I, along with CFTC staff, listened to market participants and thoughtfully sorted through issues as they were brought to our attention. We will continue to do so as we approach other important milestones in the future.

For example, CFTC staff issued a number of time-limited no-action letters while the Commission considers related exemptive petitions. These include exemptive petitions for electricity-related transactions on markets administered by Regional Transmission Organizations and Independent System Operators, as well as transactions among rural electric cooperatives and municipal-owned utilities.

Similarly, yesterday, CFTC staff issued a time-limited no-action letter to allow certain swap trading facilities and trading platforms to continue operating while the Commission completes its final rules for SEFs.

CFTC staff has also issued a number of interpretations and no-action letters regarding the definition of U.S. person and what swap dealing activity would be counted toward the de minimis swap-dealing threshold.

In addition, staff has issued interpretations and letters with regard to registration with the CFTC as commodity pool operators. Before October 12, relief was provided for equity real estate investment trusts, which are real estate investment trusts that own and operate real property; and certain securitization vehicles that issue securities backed by financial assets, are regulated by the SEC and do not use swaps to generate investment exposure.

We also sought public comment regarding other entities with inquiries about commodity pool operator registration. After October 12, guidance was provided for additional securitization vehicles. These letters addressed "legacy" securitization vehicles, backed by cash or synthetic assets, that have not and will not issue securities after October 12, 2012; and mortgage real estate investment trusts, which primarily invest in mortgage-backed securities and mortgages on residential and commercial property. In addition, these letters addressed family offices that are exempt from SEC regulation as investment advisers; business development companies that only engage in a minimal amount of commodity interest trading; and funds of funds on a time-limited basis while staff considers additional guidance for those vehicles.

We have also addressed a number of issues related to data. CFTC staff set a common date for compliance with the data reporting requirement so that a swap dealer that registers early will be subject to this requirement on the same day as one that registers later. We further phased compliance for swaps dealers to report data regarding certain swaps due to disruptions caused by Hurricane Sandy. We also provided additional time for foreign market participants on the reporting of identifying counterparty information in jurisdictions where secrecy or blocking laws forbid such reporting.

Staff is still considering a number of other specific requests for phased compliance. For instance, to facilitate compliance with new documentation requirements, the International Swaps and Derivatives Association (ISDA) has sponsored a number of documentation protocols for its members and other market participants. The Commission is considering the ISDA and its member firms’ petition for additional time to complete the protocol process or any bilateral amendments to trading documentation.

The CFTC makes all of these interpretations, guidance and no-action letters public through our website and press releases.

Resources

With the market moving to implementation, additional resources for the CFTC are all the more essential. We need resources for the people and technology necessary for effective market surveillance and to enhance customer protection programs. We need resources to handle the incoming registration requests from many new market participants. We need resources to answer all of the questions from market participants on implementation of reform.

At 703 on-board staff, the CFTC’s hardworking team is just 10 percent more in numbers than at our peak in the 1990s. Yet since that time, the futures market has grown more than five-fold, and the swaps market is eight times larger than the futures market.

Picture the NFL expanding eightfold to play more than 100 football games in a weekend without increasing the number of referees. This would leave just one referee per game, and, in some cases, no referee. Imagine the mayhem on the field, the resulting injuries to players, and the loss of confidence fans would have in the integrity of the game.

Given this reality, the President has requested additional resources for both staff and investments in technology for this agency. People and technological resources are critical for the CFTC to properly oversee the futures and swaps markets.

Conclusion

The common-sense rules of the road for the swaps market that Congress laid out in the Dodd-Frank Act are now the order of the day. Standardized swaps between financial entities will be cleared starting in March. Initial data reporting to regulators has begun, and the public will benefit from real-time reporting next year. We anticipate many swap dealers will register at the end of this month. I thank you and look forward to your questions.

DERIVATIVES AND THE CROSS-BORDER APPLICATION OF DODD-FRANK SWAP MARKET REFORMS

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION
Remarks on Derivatives and the Cross-Border Application of Dodd-Frank Swap Market Reforms at the Institute of International Bankers’ Membership Luncheon
Chairman Gary Gensler
June 14, 2012
Good afternoon, Rich, thank you for that kind introduction and for inviting me to speak about the Commodity Futures Trading Commission’s (CFTC) efforts to bring much-needed reform to the swaps market.

With just the click of a mouse, swap market risk can spread around the globe.
AIG’s subsidiary, AIG Financial Products, brought down the company and nearly toppled the U.S. economy. How was it organized? It was run out of London – actually as a branch of a French-registered bank – though technically organized in the United States.
It was sobering evidence of how overseas risk can come crashing back to our shores to affect middle-class taxpayers, many of whom had never heard of swaps.

Swaps – developed to help manage and lower risk for commercial companies – also concentrate and heighten risk in international financial institutions. When these entities fail, as they have and surely will again, swaps can quickly spread risk across borders.
Following the crisis, when President Obama gathered together the G-20 leaders in Pittsburgh in 2009, a new consensus formed internationally. Swaps, which were basically not regulated in the United States, Japan or Europe, should now be brought into the light of regulation.

Despite different cultures, political systems and financial systems, we've made significant progress on a coordinated and harmonized international approach to reform.
In 2010, the U.S. Congress passed the historic Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). To date, the CFTC has completed 33 swaps market reforms. We are on track to finish the nearly 20 remaining reforms this year.
Japan, Europe and the largest provinces in Canada have also made substantial legislative progress on reform.

I would like to highlight the progress we're making together on transparency, clearing and margin.

Promoting transparency to the public in the swaps market is critical to both lowering the risk of the financial system, as well as to reducing costs to end users.

The CFTC has completed key transparency rules. Starting as early as September, real-time reporting to the public and to regulators will become a reality. We are nearing consideration of the final swap execution facility rule, which will bring pre-trade transparency to the marketplace.

The G-20 leaders recognized reporting to regulators is not enough. Public market transparency is critical to promoting competition and lowering risk. The Japanese and Europeans have public transparency proposals in front of their legislative bodies that would further align international reform efforts.

Clearinghouses also significantly benefit from public market transparency, as they need to mark their positions to market daily, as well as rely on liquid markets when a clearing member defaults.

While our approaches are not identical, there is a great deal of consistency among the major market jurisdictions in lowering risk by bringing standardized swaps into central clearing. We are collaborating internationally on clearinghouse rules, as well as on determinations as to which swaps must be cleared. It is my hope that the CFTC’s first clearing determinations will be put out for public comment this summer and completed this fall.

The CFTC’s determinations are likely to begin with standard interest rate swaps in U.S. dollars, Euros, British pounds and Japanese yen, as well as a number of credit default swap indices.

The CFTC is working with the Federal Reserve, the other U.S. banking regulators, the Securities and Exchange Commission (SEC), and international regulators and policymakers to align margin requirements for uncleared swaps. I think it is essential that we align these requirements globally, particularly between the major market jurisdictions. An international release on margin requirements will be put out for public comment shortly. The approach will be consistent with the approach the CFTC laid out in its margin proposal last year. We anticipate, in addition, formally reopening the comment period on our initial proposal so that we can hear further from market participants in light of the international release.

Cross-border Application of Swaps Market Reforms
Though what I've reviewed so far may have been of interest, I guess that Rich and Sally Miller invited me here today mostly to tell you how reforms will affect those of you in the international banking community.

Section 722(d) of the Dodd-Frank Act, states that swaps reforms shall not apply to activities outside the United States unless those activities have “a direct and significant connection with activities in, or effect on, commerce of the United States.”
The CFTC plans to soon put out to public comment our interpretation and related guidance on this provision to get public feedback, including from your members.
Let me touch upon how it relates to U.S. financial institutions, and then discuss how it relates to international institutions.

Recent events at JPMorgan Chase are a stark reminder of how swaps traded overseas can quickly reverberate with losses coming back into the United States.

We've seen this movie before. Financial institutions set up hundreds, if not thousands of legal entities around the globe. During a default or crisis, risk of overseas' branches and affiliates inevitably flows back into the United States.
We saw this with AIG.

We saw this with Lehman Brothers. Among Lehman Brothers’ complex web of affiliates was Lehman Brothers International (Europe) in London. When Lehman failed, this London affiliate, with more than 130,000 outstanding swaps contracts, failed as well. Who stood behind these swaps contracts? The U.S. mother ship, Lehman Brothers Holdings, had guaranteed many of them.

We saw this with Citigroup. It set up numerous structured investment vehicles (SIVs) to move positions off its balance sheet for accounting purposes, as well as to lower its regulatory capital requirements. Yet, Citigroup had guaranteed the funding of these SIVs through a mechanism called a liquidity put. When the SIVs were about to fail, Citigroup in the United States assumed the huge debt, and taxpayers later bore the brunt with two multi-billion dollar infusions. And where were these SIVs set up? They were launched out of London and incorporated in the Cayman Islands.

We saw this with Bear Stearns. Its two sinking hedge funds it bailed out in 2007 were incorporated in the Cayman Islands. Yet again, the public assumed part of the burden when Bear Stearns itself collapsed nine months later.

And remember Long-Term Capital Management? When this hedge fund failed in 1998, its swaps book totaled in excess of $1.2 trillion notional. The vast majority were booked in its affiliated partnership… in the Cayman Islands.

There are some in the financial community who want us to ignore these hard lessons of past financial institution failures.

They might tell you that swap trades booked in London branches of U.S. entities shouldn't be brought under Dodd-Frank reform.

They might tell you that affiliates, even when guaranteed by the mother ship back here in the United States, shouldn't come under Dodd-Frank reform.

They might tell you that affiliates acting as conduits for swaps activity back here shouldn't be brought under Dodd-Frank reform.

If we follow their comments, the result would be that American jobs and markets would move offshore, but, particularly in times of crisis, risk would come back to affect our economy.

So what has the CFTC staff recommended to the Commission?
First, when a foreign entity transacts in more than a de minimis level of U.S. swap dealing activity, the entity would register under the CFTC’s swap dealer registration rules.
Second, the staff recommendation includes a tiered approach for overseas swap dealer requirements. This is largely consistent with comments received from major international swap dealers. Some requirements would be considered entity-level, such as for capital, risk management, recordkeeping and reporting to swap data repositories (SDRs). Some requirements would be considered transaction-level, such as clearing, margin, real-time public reporting, trade execution and sales practices.

Third, entity-level requirements would apply to all registered swap dealers, but in certain circumstances, overseas swap dealers could meet these requirements by complying with comparable and comprehensive foreign regulatory requirements, or what we call “substituted compliance.”

Fourth, transaction-level requirements would apply to all U.S. facing transactions. For these requirements, U.S. facing transactions would include not only transactions with persons or entities operating or incorporated in the United States, but also transactions with their overseas branches. Likewise, this would include transactions with overseas affiliates that are guaranteed by a U.S. entity, as well as the overseas affiliates operating as conduits for a U.S. entity’s swap activity.
Fifth, for certain transactions between an overseas swap dealer (including a foreign swap dealer that is an affiliate of a U.S. person) and counterparties not guaranteed by or operating as conduits for U.S. entities, Dodd-Frank transaction-level requirements may not apply. For example, this would be the case for a transaction between a foreign swap dealer and a foreign insurance company not guaranteed by a U.S. person.

What does this mean for your membership?

So it means that if a legal entity has over $8 billion in market making swaps activity with U.S. market participants, it should be preparing to register as a swap dealer. For foreign financial institutions, swaps with U.S. persons or their overseas branches would count toward the de minimis threshold. In the midst of a default or a crisis, there is no satisfactory way to really separate the risk posed to a branch from being transmitted to its parent bank.

Swap dealer registration will be required two months after we finalize with the SEC the joint rule further defining the term "swap." The further definition rule is now before Commissioners at both agencies.

It means the entity would have to comply with the various Dodd-Frank provisions applicable to swap dealers, though in certain cases, this may be done through substituted compliance.

In addition to the interpretive guidance, the CFTC also is considering a release on phased compliance for foreign swap dealers. The separate release addresses comments from international and U.S. market participants. For overseas swap dealers that register with the CFTC, the release provides for phased compliance in the following manner:
Compliance with transaction-level requirements with U.S. persons and branches of U.S. persons would be required;
Entity-level requirements (other than reporting to SDRs) that might come under substituted compliance may be delayed for up to one year. During that time, the CFTC would be moving to complete the cross-border interpretive guidance and would work with market participants and foreign regulators on plans for substituted compliance; and
For overseas swap dealers, swap transactions with U.S. persons and branches of U.S. persons would be required to be reported to a SDR (or the CFTC).
The CFTC has had a long history of recognizing comparable regulations of foreign regimes. We have entered into numerous memoranda of understanding on both information sharing and supervisory coordination with our international counterparts with regard to foreign clearinghouses, exchanges and intermediaries.
Conclusion

The 2008 crisis – caused in part by swaps – was the worst financial and economic crisis Americans have experienced since the Great Depression. Eight million Americans lost their jobs, and millions of families lost their homes.

The crisis was a failure of the financial system and of financial regulation. The high levels of debt and excessive risk that contributed to the crisis continue to reverberate in Europe and the United States.

The CFTC is well over halfway to finishing critical swaps market reforms bringing transparency to this market and lowering its risk to the public. We’ve taken into account more than 30,000 comment letters, held 1,600 meetings with the public and hosted 18 roundtables. But now it's time to finish the job.

Some in the financial community have suggested that we retreat from these critical reforms. But the ever-growing financial storm clouds hanging over Europe and the lessons from the U.S. financial crisis should guide us that now is not the time to retreat from reform. Now is the time to promote transparency and protect the public.