CFTC CHAIRMAN MASSAD'S REMARKS BEFORE GLOBAL EXCHANGE AND BROKERAGE CONFERENCE

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION 

Remarks of Chairman Timothy Massad before the Global Exchange and Brokerage Conference (New York)

June 3, 2015

As Prepared For Delivery

Thank you for inviting me today, and I thank Rich for that kind introduction. It’s a pleasure to be here.

Next month, we will observe the fifth anniversary of the passage of the Dodd-Frank Act. As you know, this law made dramatic changes to our regulatory system in response to the worst financial crisis since the Great Depression. In particular, it aimed to bring transparency and oversight to the over-the-counter swaps market, and gave the CFTC primary responsibility to accomplish that task.

The timing of this speech is significant to me in another way, as it was exactly one year ago today that I was confirmed by the Senate as chairman of the CFTC. So in light of those two anniversaries, it seems like a good time to take stock. Where are we in implementing these reforms? Is the new regulatory framework achieving the goals envisioned in Dodd-Frank? And what have we done over the last year in particular to advance those objectives? What are our priorities going forward?

All of you appreciate the important role that the derivatives markets play in our economy. In 2008, however, we saw how the build-up of excessive risk in the over-the-counter swaps market made a very bad crisis even worse. There were many causes of the crisis, but particularly because of that excessive swap risk, our government was required to commit $182 billion just 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. Our country lost eight million jobs as a result of the crisis. I spent five years at Treasury helping our nation recover from that crisis – including getting all that money back from AIG. I also had a long career working as a corporate lawyer, which included helping to draft the original ISDA master agreements and advising businesses on all sorts of transactions, including derivatives. So I appreciate both the need for reform and the importance of implementing these reforms in a way that ensures that these markets can continue to thrive and contribute to our economy.

The Dodd-Frank Act enacted the four basic reforms agreed to by the leaders of the G-20 nations to bring transparency and oversight to this market: central clearing of standardized swaps, oversight of the largest market participants, regular reporting, and transparent trading on regulated platforms.

Today that framework is largely in place. The vast majority of transactions are centrally cleared. Trading on regulated platforms is a reality. Transaction data is being reported and publicly available. And we have developed a program for the oversight of major market participants.

There is more work to do in all these areas, as I will discuss in a moment. But as I see it, there are a lot of parallels between where we are today with swaps market reform and what happened with securities market reform in the 1930s and 40s. Coming out of the Great Depression, we created a framework for securities regulation and trading which proved tremendously successful. Many of its mandates were revolutionary at the time and therefore quite controversial. When the Securities Exchange Act was passed and required periodic reporting by public companies, the President of the New York Stock Exchange said it was “a menace to national recovery.” History has proved otherwise. Today, the concept of periodic reporting by public companies is about as controversial as seat belts. Indeed, the basic framework created in the 1930s of disclosure, transparency, periodic reporting and trading on regulated exchanges has been the foundation for the growth of our securities markets.

I believe the swaps market reforms we have put in place are similar. I believe the basic framework is one that will benefit our markets and the economy as a whole for decades to come. Is that framework perfect? No. Is there more to do? Yes. So let’s look at where we are.

Congress required that the rules be written within a year of passage of Dodd-Frank, and the agency worked incredibly hard to meet that goal. Now we are in a phase of making necessary minor adjustments to the rules, which is to be expected with any change as significant as this. And so a priority of mine over the last year has been to do just that: to look at how well the new rules are working and to make adjustments where necessary.

So let me give you a quick big picture view of where we are on each of the four key reforms of the OTC swaps market, as well as what I see as the next steps in each of those areas, and then discuss in more detail a couple of key priorities for the months ahead.

Clearing

First is the goal of requiring central clearing of transactions. This is a critical means to monitor and mitigate risk. Here we have accomplished a great deal. Our rules require clearing through central counterparties for most interest rate and credit default swaps, and the percentage of transactions that are centrally cleared in the swaps markets we oversee has gone from about 15 percent in December 2007 to about 75 percent today. That’s a dramatic change.

Importantly, our rules do not impose this requirement on commercial end-users. Nor do we impose the trading mandate on commercial end-users. And an important priority for me over the last year has been to make sure this new framework as a whole does not impose unintended burdens on commercial end-users. They were not the cause of the crisis or the focus of the reforms. And we want to make sure that they can still use these markets to hedge commercial risk effectively.

What are the next steps when it comes to clearing? First, we must recognize that for all its merits, central clearing does not eliminate risk, and therefore we must make sure clearinghouses are strong and resilient. The CFTC has already done a lot of work in this area. Over the last few years, we overhauled our supervisory framework and we increased our oversight. But there is more to do, and there will be significant efforts taking place, including through international organizations.

We will be looking at stress testing of clearinghouses, and whether there should be international standards for stress testing that give us some basis to compare the resiliency of different clearinghouses. And while we hope never to have to use these tools, we will be looking further at recovery and resolution planning.

You may also know that we are engaged in discussions with Europe on cross-border recognition of clearinghouses. While this issue is taking longer to resolve than I expected, I believe we have narrowed the issues and are making good progress. For those interested, I recently gave a speech to a committee of the European Parliament that describes the issues we are discussing in more detail. I believe my counterpart in these discussions, Lord Jonathan Hill of the European Commission, wants to resolve this soon, as I do, and we are working in good faith toward that end. I also believe we can resolve this without disruptions to the market, and I am pleased that the EC has again postponed capital charges toward that end.

Oversight of Swap Dealers

Let me turn to the second reform area, general oversight of major market players. We have made great progress here as well, as we have in place a regulatory framework for supervision of swap dealers. They are now required to observe strong risk management practices, and they will be subject to regular examinations to assess risk and compliance with rules designed to mitigate excessive risk.

Next steps in this area include looking at the swap dealer de minimis threshold. Under the swap dealer rules adopted in 2012, the threshold for determining who is a swap dealer will decline from $8 billion to $3 billion in December of 2017 unless the Commission takes action. I believe it is vital that our actions be data-driven, and so we have started work on a comprehensive report to analyze this issue. We will make a preliminary version available for public comment, and seek comment not only on the methodology and data, but also on the policy questions as to what the threshold should be, and why. I want us to complete this process well in advance of the December 2017 date so that the Commission has some data, analysis, and public input with which to decide what to do.

Another priority for us over the next few months in the area of general oversight is to finalize our proposal on margin requirements for uncleared swaps. This is one of the most important Dodd-Frank requirements that remains to be finalized, and one of the most important overall. There will always be a large part of the swaps market that is not and should not be centrally cleared, and therefore margin is key to minimizing the risk to our system that can come from uncleared bilateral trades. The proposal applies to swap dealers, in their transactions with one another and their transactions with financial institutions that exceed certain thresholds. As with the clearing and trading mandates, commercial firms are exempted.

We are working closely with the bank regulators on this rule. They have the responsibility to issue rules that apply to swap dealers that are banking entities under their respective jurisdictions, and our rule will apply to other swap dealers. It is vitally important that these rules be as consistent as possible, and we are making good progress in this regard. We are also working to have our U.S. rules be similar to rules being considered by Europe and Japan. I expect that they will be consistent on many major issues.

Reporting

With regard to reporting, the public and regulators are benefiting from a new level of market transparency – transparency that did not exist before. All swap transactions, whether cleared or uncleared, must be reported to registered swap data repositories (SDRs), a new type of entity responsible for collecting and maintaining this information. You can now go to public websites and see the price and volume for individual swap transactions. And the CFTC publishes the Weekly Swaps Report that gives the public a snapshot of the swaps market. This means more efficient price discovery for all market participants. Equally important, this reporting enables regulatory authorities to engage in meaningful oversight, and when necessary, enforcement actions.

While we have much better data today than in 2008, we have a lot more work to do to get to where we want to be. One step is revising our rules to bring further clarity to reporting obligations. Later this summer I expect that we will propose some initial changes to the swap reporting rules for cleared swaps designed to clarify reporting obligations and, at the same time, improve the quality and usability of the data in the SDRs. And we are looking at other possible changes as well to improve the data reporting process and usefulness of the information.

This is also an international effort. There are around two dozen data repositories globally. And there are participants around the world who must report. We and the European Central Bank currently co-chair a global task force that is seeking to standardize data standards internationally. While much of this work is highly technical, it is vitally important to international cooperation and transparency.

We will also make sure participants are taking their obligations seriously to provide us good data in the first place. We have taken, and will continue to take, enforcement action against those who do not.

Transparent Trading

Let me turn to the last reform area, which is trading. Today, trading swaps on regulated platforms is a reality. We have nearly two dozen SEFs registered. Each registered exchange is required to operate in accordance with certain statutory 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 necessary to discharge their responsibilities.

So we are making progress, but here too, there is more work to do. We have been looking at ways to improve the framework, focusing on some operational issues where we believe adjustments can improve trading. We have taken action in a number of areas, including steps to make it easier to execute package trades and correct error trades, and steps to simplify trade confirmations and reporting obligations. We are looking at additional issues pertaining to SEF trading as well. For example, we are planning to hold a public roundtable later this year on the made-available-for-trade determination process, where many industry participants have suggested that the agency play a greater role in determining which products should be mandated for trading and when.

We have also been working to harmonize our trading rules with the rules of other jurisdictions where possible. CFTC staff worked with Australian swap platforms to clarify how they can permit U.S. participation under our trading rules. One platform, Yieldbroker, confirmed that it intends to apply for relief and achieve compliance by this fall. This is an important step and we are open to working with other jurisdictions and platforms.

Responding to Changes in the Market

I began by saying that the approaching five year anniversary of Dodd-Frank was a good time to take stock of what has been accomplished in terms of implementing the reforms required by the law. Equally important to consider is: How have the markets changed over the last five years? How does that impact what we are doing? After all, there is always the danger that as regulators, we focus on fighting the last war.

It is beyond the scope of my speech today to discuss all the significant changes to markets over the last few years, or how regulatory actions may be affecting market dynamics and costs. These are important, complex subjects, but they are well beyond the time I have today to explore. Today, however, I’d like to take a few minutes more to just note one major way in which our markets are changing, and how that is affecting our work.

That change has to do with the increased use of electronic and automated trading. Some speak of “high frequency trading” or HFT, a classification that is hard to define precisely. I will focus on automated or algorithmic trading. Over the last decade, automated trading has increased from about 25 percent to well over 50 percent of trading in U.S. financial markets. Looking specifically at the futures markets, almost all trading is electronic in some form, and automated trading accounts for more than 70 percent of trading over the last few years.

I commend to you a recent paper by our Chief Economist office which gives some interesting data on our markets. This looked at over 1.5 billion transactions across over 800 products on CME over a two year period. It found that the percentage of automated trading in financial futures – such as those based on interest rates, currencies or equity indices – was 60 to 80 percent. But even among many physical commodities, there was a high degree of automated trading, such as 40 to 50 percent for many energy and metals products. The paper also provides a lot of rich detail on what types of trades are more likely to be automated.

The increase in electronic, and particularly automated, trading has changed what we do, and how we do it. Let me say at the outset that the increased use of electronic trading has brought many benefits, such as more efficient execution and lower spreads. But it also raises issues. These are somewhat different in the futures markets than in the cash equity markets where they have received the most attention, in part because typically in the futures market, trading of a given product occurs on only one exchange. Nevertheless, the increased use of automated, algorithmic trading poses challenges for how we execute our responsibilities, and it raises important policy questions. For example, it creates profound changes in how we conduct surveillance. The days when market surveillance could be conducted by observing traders in floor pits are long gone. Today, successful market surveillance activities require us to have the ability to continually receive, load, and analyze large volumes of data. We already receive a complete transactions tape, but effective surveillance requires looking at the much larger sets of message data—the bids, offers, cancelations which far outnumber consummated transactions.

And consider that we oversee the markets in a wide range of financial futures products based on interest rates, currencies and equities, as well as over 40 physical commodity categories, each of which has very different characteristics.

Surveillance today requires a massive information technology investment and sophisticated analytical tools that we must develop for these unique environments. And we must have experienced personnel who understand the markets we oversee, who can discern anomalies and patterns and who have the experience, judgment, and skills to know when to investigate further.

The increased use of high speed and electronic trading has impacted our enforcement activity as well. We have recently brought several spoofing cases, where market participants used complex algorithmic strategies to generate and then cancel massive numbers of bids or offers without the intention of actually consummating those transactions in order to affect price. Some have asked, does that mean I cannot cancel a trade without fear of enforcement coming after me? Hardly. Intent is a key element that we must prove. There is a difference between changing your mind in response to changed market conditions and canceling an order you previously entered, and entering an order that you know, at the time, you have no intention of consummating.

The Commission is also looking at automated trading and specifically the use of algorithmic trading strategies from a policy perspective. We have adopted rules requiring certain registrants to automatically screen orders for compliance with risk limits if they are automatically executed. The Commission has also adopted rules to ensure that trading programs, such as algorithms, are regularly tested. In addition, the Commission issued a Concept Release on Risk Controls and System Safeguards for Automated Trading Environments. We received substantial public comment, and we are currently considering what further actions may be appropriate.

Although we have not made any decisions yet, let me note a few areas we are thinking about. Traditionally, our regulatory framework has required registration by intermediaries handling customer orders and customer funds. In addition, proprietary traders who were physically present on the floor of the exchange and active in the pits had to register as floor traders. Today, the pits are gone, and physical presence on the floor of an exchange is no longer a relevant concept. We are considering whether the successors to those floor traders – proprietary traders with direct electronic access to a trading venue – should be subject to a registration requirement if they engage in algorithmic trading.

We are considering the adequacy of risk controls, and in particular pre-trade controls, with respect to algorithmic trading. The exchanges, and many participants themselves, have put controls in place. The question is whether our rule framework should set some general principles to require measures such as message and execution throttles, kill switches, and controls designed to prevent erroneous orders. We also may consider standards on the development and monitoring of algorithmic trading systems.

We are also considering who should have the responsibility to implement controls. This may include persons using algorithmic trading strategies as well as the exchanges. But what about the role of clearing members who do not see the orders of customers using direct electronic access? Today, our rules require exchanges that permit direct electronic access to have systems to facilitate the clearing member’s management of the financial risk of their direct access customers. Should there be a similar requirement for the exchanges to facilitate the management by clearing members of risks related to those customers’ use of algorithmic trading?

We are looking self-trading – that is, when orders from distinct trading desks or algos from the same firm transact – and its potential implications and effects on the markets. In addition, we are looking at the adequacy of disclosure by exchanges of market maker and incentive programs.

Conclusion

I said at the outset that where we are today in the implementation of reforms of the swaps market has many parallels to the reforms of the securities market after the Great Depression. The framework created then – including public disclosure and regular reporting, and trading on regulated platforms – was controversial at the time. But it has proven to not only be effective, it has provided a vital foundation on which our securities markets grew to become the most dynamic in the world. I believe we can achieve the same result with the derivatives market. We must always be attentive to how the market is changing, and adapt core principles to those changes. I look forward to working with you to achieve that goal.

Last Updated: June 3, 2015

CFTC COMMISSIONER MASSAD'S REMARKS TO COALITION FOR DERIVATIVES END-USERS

FROM:  COMMODITY FUTURES TRADING COMMISSION

Remarks of Timothy G. Massad before the Coalition for Derivatives End-Users

February 26, 2015

Thank you for inviting me today, and I thank Governor Engler for that kind introduction. I am very pleased to be here today.

I am also pleased to have had the opportunity to meet with many of you individually and to hear your concerns. And since June, when two other commissioners and I took office, we have all been doing a lot of listening. Through individual meetings. Through our Commission open meetings. And through our advisory committee meetings. Today in fact, we have the first meeting of our Energy and Environmental Market Advisory Committee since we took office.

Those meetings, like the name of your organization, remind us of why we have derivatives markets in the first place. They enable end-users – businesses of all types – to hedge risk. In the six years since the financial crisis began, there’s been a lot of talk about derivatives. For most Americans, the word is probably associated with a vague notion of bad behavior by big banks that got us into trouble. They may not immediately associate the word with a utility company hedging the cost of fuel. Or a manufacturer locking in prices for metal supplies. Or an exporter managing foreign currency risk. But as you well know, the core function of the derivatives markets is to enable businesses to hedge price, production and other types of risk they routinely face. And therefore anyone in my position has to ask himself, well, are we making the markets better for the businesses that need them? Are we making sure they operate with integrity and without fraud? Can businesses use them effectively and efficiently?

The global financial crisis, however, taught us that this is not the only thing we must think about. The crisis showed us how excessive risk in the over-the-counter derivatives market could contribute to systemic risk. The damage to our financial system and our economy from the global financial crisis is well known: eight million jobs lost, millions of homes foreclosed, many businesses shuttered, many retirements and college educations deferred. I spent five years working to help our nation recover from that crisis. And so as we seek to make sure these markets function well for the businesses that need them, we must at the same time make sure they do not create excessive risk to our financial system or our economy generally.

If you look at what we have been doing since June, you will see that we are addressing both those goals. It has been a busy and productive time. We have been active in a number of areas. We have been addressing the specific concerns of end-users in a number of areas. We have been continuing the work to bring the over-the-counter swaps market out of the shadows and implement the needed regulatory reforms mandated by Congress. We have also continued to carry out our traditional responsibilities of surveillance, compliance, and enforcement. And we have been addressing new developments and challenges in our markets, particularly those created by technological development.

The agency is fortunate to have a talented staff. The progress we have made is a credit to their hard work and dedication. My fellow commissioners each bring valuable experience and judgment. I commend my fellow commissioners in particular for their efforts to reach out and make sure we are all well informed by a diversity of views, and for their willingness to collaborate and work constructively together. I believe all of us are working in good faith to carry out the CFTC’s responsibilities.

Today I want to review some of the things we have done over the last eight months, and discuss some of the things we will be doing in the upcoming months.

Making Sure the Markets Work for Commercial End-Users

Over the last 8 months, we have made it a priority to address concerns of commercial end-users. An important part of this effort has been fine-tuning our rules. This is, of course, a natural process for any regulatory agency, but it is particularly appropriate in our case. That is because the CFTC’s responsibilities were increased dramatically as a result of the worst financial crisis this country has faced since the Great Depression. As you know, the agency was given the responsibility to implement a new regulatory framework for the over-the-counter swaps market, a $400 trillion market in the U.S., measured by notional amount.

To fulfill that responsibility, the CFTC developed and published many new rules. With reforms as significant as these, it is inevitable that there will be a need for some adjustments. And that is what we have been doing.

Last September, for example, the Commission amended its rules so that local, publicly-owned utility companies could continue to effectively hedge their risks in the energy swaps market. These companies, which keep the lights on in many homes across the country, must access these markets efficiently in order to provide reliable, cost-effective service to their customers. The Commission unanimously approved a change to the swap dealer registration threshold for transactions with special entities which will make that possible.

In November, the Commission proposed to modify one of our customer-protection related rules to address a concern of many in the agricultural community and many smaller customers regarding the posting of collateral. These rules had been unanimously adopted in the wake of MF Global’s insolvency and were designed to reduce the risk of similar failures and to protect customers in the event of such a failure. Market participants asked that we modify one aspect of the rules regarding the deadline for futures commission merchants to post “residual interest,” which, in turn, can affect when customers must post collateral. I expect that we will finalize this rule change in the near future.

We have taken a number of other steps as well. We have proposed to clarify when forward contracts with embedded volumetric optionality – a contractual right to receive more or less of a commodity at the negotiated contract price – will be excluded from being considered swaps so that commercial companies can continue to conduct their daily operations efficiently. We have proposed to revise certain recordkeeping requirements to lessen the burden on commercial end-users and commodity trading advisors. The Commission staff has taken action to make sure that end-users can use the Congressional exemption given to them regarding clearing and swap trading if they enter into swaps through a treasury affiliate.

CFTC staff also recently granted relief from the real-time reporting requirements for certain less liquid, long-dated swap contracts, recognizing that immediate reporting can undermine a company’s ability to hedge.

In sum, we have been very focused on fine-tuning the rules to make sure they work for commercial end-users, and we will continue to do so. For example, I know several of your companies are working on submitting Form TO to report trade option positions before the March 1st deadline. I’ve asked the CFTC staff to look at the usefulness of this information and we will consider changes to reduce the reporting currently required for trade options.

Implementing the New Swap Framework

Congress recognized the importance of addressing the needs of commercial end-users in creating a regulatory framework for the over-the-counter swaps market. In the Dodd-Frank Act, Congress specifically exempted commercial end-users from the requirement to trade swaps on regulated exchanges and the requirement to clear swap transactions through central counterparties. Congress recognized that the activities of commercial end-users in the derivatives markets do not create the same types or degree of risk as with large financial institutions, and so Congress provided these exemptions to minimize the potential cost impacts of necessary regulatory reform on commercial end-users. And last December, Congress took further action to make it clear that end-users are to be exempted from the requirement to post margin in connection with swaps that are not cleared.

Now, the actions we are taking with respect to the proposed rule on margin for uncleared swaps reflect this Congressional direction. Indeed, the proposed rule on margin for uncleared swaps reflects three of the most important priorities facing the Commission: first, this rule is one of the most important steps we need to take to finish the work of bringing the swaps market out of the shadows and addressing the potential for excessive risks coming out of that market; second, we are implementing this rule in a way that addresses the needs of end-users to make sure they can continue to use the derivatives markets effectively; and third, we are trying to harmonize our proposed rule as much as possible with the rules on margin for uncleared swaps of other jurisdictions. So let me take a few minutes to discuss where we are with the proposed rule on margin for uncleared swaps.

First, this rule is important because uncleared transactions will continue to be an important part of the swaps market. It was critical that we mandated clearing of standardized swaps at centralized counterparties, and we have made great progress in implementing that mandate. But not all transactions will or should be cleared. Sometimes, commercial risks cannot be hedged sufficiently through swap contracts that are available for clearing. Certain products may lack sufficient liquidity to be centrally risk managed and cleared. This may be true even for products that have been in existence for some time. And there will and always should be innovation in the market, which will lead to new products that lack liquidity.

That is why the rule on margin for uncleared swaps is important. Margin will continue to be a significant tool to mitigate the risk of default and, therefore, the potential risk to the financial system as a whole.

The second issue is the end-user concern. The rule we proposed last September on margin for uncleared swaps exempted commercial end-users from the requirement to post margin. This was also true of the original rule we proposed in 2011. Most recently, we worked with the bank regulators, who must also write margin rules, so as to harmonize our rules with theirs as much as possible, and I am pleased that their latest rules also exempt end-users. And in light of the passage of the margin provisions in the TRIA bill, we are working to implement these statutory end-user margin protections quickly through an interim final rule, as Congress intended.

In addition to harmonizing with the U.S. bank regulators, I also think it is very important that our rules be as similar as possible with the rules that Europe and Japan are looking to adopt. For that reason, we have spent considerable time in discussions with our international counterparts. In this regard, I am willing to consider some changes to our proposed rule in order to ensure greater consistency. For example, the threshold for when margin is required is currently lower in our proposed rule than in the proposals in Europe and Japan, and I believe we should harmonize those even if it means increasing ours. I would expect us to finalize a rule by the summer, and I expect that we will incorporate a slight delay in the implementation timetable for the rule.

With regard to cleared transactions, we have made significant progress and continue to move forward. Today, the percentage of transactions that are centrally cleared in the markets we oversee is about 75 percent, up from about 15 percent at the end of 2007. Clearing through central counterparties is now required for most interest rate and credit default swaps. As directed by Congress, our rules specifically exempt commercial end-users. Clearing mandates are also coming on line in other jurisdictions.

Of course, clearing does not eliminate the risk that a counterparty to a trade will default. Instead, it provides us with strong tools to manage that risk, and mitigate adverse effects should a default occur. For central clearing to work well, active, ongoing oversight is critical. So we are very focused on ongoing surveillance of clearing member risk. We are focused on examinations of clearinghouses, so that we make sure clearinghouses have the financial, operational and managerial resources, and all the necessary systems and safeguards, to operate in a fair, transparent, and efficient manner. We must also make sure that contingency plans for clearinghouse recovery are sufficient, and we will be holding a roundtable in early March to discuss these issues. I am looking forward to gathering feedback from a variety of market participants, including commercial end-users.

We are also continuing to work with the European Commission on cross-border recognition of clearinghouses.

We are also working on two other rules regarding capital and position limits. Congress mandated that we implement position limits to address the risk of excessive speculation. In doing so, we must make sure that commercial end-users can continue to engage in bona fide hedging. We have received substantial public input on the position limits rule. It is important that we consider these comments carefully. Commission staff is also considering next steps on the rule for capital for swap dealers, which is another rule where we are working together with other regulators. As with the rule on margin for uncleared swaps, we will take the time necessary to get these rules right.

New Challenges and Risks

We are also doing all we can to address new challenges and risks in our markets, which can directly impact participants, including commercial end-users. We have been very focused on the increased use of automated trading strategies, for example, and their impact on the derivatives markets.

Cybersecurity is perhaps the single most important new risk to market integrity and financial stability. The risk is apparent. The examples from within and outside the financial sector are all too frequent and familiar: Anthem, JP Morgan, Sony, Home Depot, and Target among others. Some of our nation’s exchanges have also been targeted or suffered technological problems that caused outages or serious concerns. And because of the interconnectedness of financial institutions and market participants, an attack at one institution can have significant repercussions throughout the system.

Because critical parts of the plumbing of the financial system are under our jurisdiction, there is no question that cybersecurity must be a priority for us. The question is how can we be most effective in this area? After all, many financial institutions are spending more on cybersecurity than our entire budget. One bank recently told me they had a cyber operations budget, and a cyber change budget, and each was a multiple of our budget. There were news reports recently that one financial institution is hiring 1,000 people dedicated to digital security. We have about 2/3 of that number in total. And there are many government agencies who have built up great expertise on cybersecurity.

So we are addressing it in the following ways: first, cyber concerns are now part of the core principles that trading platforms and clearinghouses must meet. Second, we have required these entities to develop and maintain risk management programs and recovery procedures that meet certain standards. Third, we are focusing on these issues in our examinations. We are looking at whether the institution is following best practices. Is the board of directors focused on the issue? Is there a culture in which cybersecurity is given priority? Has the entity not only adopted good policies on cybersecurity, but are those policies being observed and enforced?

Another issue we will focus on 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 do not have the resources to do independent testing, but they do. So are they doing it? And what are the best practices they should follow in doing testing? We intend to hold a roundtable on this issue next month.

Resources

While we have made substantial progress over the last 8 months, there is much more we should be doing. Not only do we now have responsibility for the swaps market, but our traditional markets have grown in size and complexity. To do so we must have resources that are proportionate to our responsibilities, and we must use them wisely.

In my view, the CFTC’s current budget still falls short. We cannot be as responsive to your concerns as we wish to be. We cannot do as much to prevent fraud and manipulation, and to engage in the surveillance that helps insure our markets operate with integrity. Simply stated, without additional resources, our markets cannot be as well supervised; participants and their customers cannot be as well protected; market transparency and efficiency cannot be as fully achieved.

Conclusion

The United States has the best derivatives markets in the world – the most dynamic, innovative, competitive and transparent. They have been an engine of our economic growth and prosperity, in large part because they have attracted participants and served the needs of commercial end-users who depend on them. I look forward to working with all of you to make sure that they continue to do so in the years ahead.

Thank you for inviting me. I would be happy to take some questions.

Last Updated: February 26, 2015

CFTC CHAIRMAN GENSLER'S SPEECH BEFORE THE INTERNATIONAL MONETARY FUND CONFERENCE

FROM: COMMODITY FUTURES TRADING COMMISSION
Remarks of Chairman Gary Gensler Before the International Monetary Fund Conference
March 20, 2013

Good afternoon. Thank you, José, for the kind introduction. I also want to thank the International Monetary Fund and Christine Lagarde for the invitation to speak today at your conference on commodity markets.

Derivatives Markets

Farmers, ranchers, producers, commercial companies and other end-users across the globe depend on well-functioning derivatives markets. These markets are essential so that end-users seeking to hedge a risk can lock in a future price of a commodity and thus focus on what they do best – efficiently producing commodities and other goods and services for the economy.

Derivatives markets have existed in the United States since the time of the Civil War. Initially, there were futures on agricultural commodities, including wheat, corn and cotton.

Futures allowed farmers to get price certainty on their crops. As they were planting their fields, farmers could lock in a price for harvest time. Farmers and producers also benefited from prices established in a central market, rather than just relying on competition for their harvested crops among local merchants.

In these central markets, hedgers seeking to reduce risk may meet other hedgers, but often meet speculators on the other side of the transaction.

In the 1920s, Congress brought the first federal oversight to the futures market. These reforms included bringing transparency to the marketplace by requiring that all grain futures be traded on central exchanges.

A federal regulator was established within the U.S. Department of Agriculture to oversee the grain futures market.

During the 1930s, President Roosevelt and Congress strengthened the common-sense rules of the road for these markets by adopting new prohibitions against manipulation, protections for customer funds and speculative position limits to promote market integrity.

By the 1970s, the futures market had expanded to include contracts on additional agricultural commodities, as well as metals.

Market participants also were considering further innovations to trade contracts on other risks in the economy, such as on energy products and financial instruments.

Congress understood this and broadened oversight of the futures markets to all commodities, including any that might be developed in the future.

The Commodity Futures Trading Commission (CFTC) was established as in independent regulator in 1975, and took on this broader role from our predecessor in the Department of Agriculture.

The word commodity in our oversight regime covers agricultural, metals, energy and financial commodities, as well as any other future to manage risk based on any "services, rights and interests."

Thus, the word "commodity" in our oversight regime is more expansive than you are generally discussing at this conference.

In 1981, a new derivatives product emerged. These derivatives, called swaps, were initially transacted bilaterally, off-exchange. While the futures market has been regulated by the CFTC, the swaps marketplace in the United States, Europe and Asia lacked oversight.

What followed was the 2008 financial crisis. Eight million American jobs were lost. In contrast, the futures market, supported by the 1930s reforms, weathered the financial crisis.

President Obama and Congress responded and crafted the swaps provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).

They borrowed from what has worked best in the futures market for decades – clearing, oversight of intermediaries and transparency. The law gave the CFTC responsibility for swaps and the Securities and Exchange Commission responsibility for security-based swaps.

CFTC Mission

As of last year, the CFTC is charged with overseeing both the commodity futures market and the swaps market.

The CFTC is not a price-setting agency.

The mission of the CFTC is to ensure market transparency – both pre- and post-trade. Transparency lowers costs for investors, consumers and businesses. It increases liquidity, efficiency and competition.

The mission of the CFTC is to promote market integrity – to ensure that that the price discovery process is open, competitive and efficient.

The mission of the CFTC is to police the derivatives markets for fraud, manipulation and other abuses.

The mission of the CFTC is to lower the risks to the economy of clearinghouses and intermediaries, as well as ensuring for the protection of customer funds.

And the mission of the CFTC is to ensure these markets work for the real economy – the non-financial side that employs 94 percent of private sector jobs – so that hedgers and investors may use them with confidence.

Three years after the passage of the Dodd-Frank Act, the CFTC is nearly complete with the law’s swaps market reforms. The swaps marketplace is increasingly shifting to implementation of these common-sense rules of the road. For the first time, the public is benefiting from:
Greater access to the swaps market and the risk reduction that comes from centralized clearing.
Oversight of swap dealers; and
The transparency of seeing the price and volume of each swap transaction, available free of charge on a website like a modern-day tickertape.
Looking forward, it’s a priority that the Commission finishes rules to promote pre-trade transparency, including those for a new swaps trading platform, called swap execution facilities (SEFs), and the block rule for swaps.

Pre-trade transparency will allow buyers and sellers to meet and compete in the marketplace, just as they do in the futures and securities marketplaces. SEFs will allow market participants to view the prices of available bids and offers prior to making their decision on a swap transaction.

It’s also a priority that the Commission ensures the cross-border application of swaps market reform appropriately covers the risk of U.S. affiliates operating offshore.

If a run starts in one part of a modern financial institution, whether it's here or offshore, the risk comes back to our shores. That was true with Bear Stearns, which failed five years ago this month, AIG, Lehman Brothers, Citigroup and Long-Term Capital Management.

Thus, as the CFTC completes guidance regarding the cross-border application of swaps market reform, I believe it’s critical that the Dodd-Frank Act’s swaps reform applies to transactions entered into by branches of U.S. institutions offshore, between guaranteed affiliates offshore, and for hedge funds that are incorporated offshore but operate in the U.S. Where there are comparable and comprehensive home country rules and enforcement of those rules abroad, we can look to substituted compliance, but the transactions would still be covered.

Changing Markets

Since the 1980s, the swaps market has grown in size and complexity. It is now eight times as big as the futures market. From total notional amounts of less than $1 trillion in the 1980s, the notional value now ranges around $250 trillion in the United States.

Together, the notional value of the U.S. futures and swaps markets is approximately $300 trillion – or roughly$20 of derivatives for every dollar of goods and services produced in the U.S. economy.

The futures market has changed dramatically as well.

There has been a significant increase in electronic trading. Instead of face-to-face trading on an exchange floor, more than 85 percent of the futures volume in 2012 was traded electronically.

In addition, the makeup of the market has changed. While the futures market has always been where hedgers and speculators meet, today a significant majority of the market is made up of financial actors, such as swap dealers, hedge funds, pension funds and other financial entities.

For example, based upon CFTC data as of last week, only about 14 percent of long positions and about 13 percent of short positions in the crude oil market (NYMEX WTI contracts) were held by producers, merchants, processors and other users of the commodity.

Similarly, only about 18 percent of gross long positions and about 27 percent of gross short positions in the Chicago Board of Trade wheat market were held by producers, merchants, processors and other users of the commodity.

Furthermore, CFTC data published in 2011 shows the vast majority of trading volume in key futures markets – more than 80 percent in many contracts – is day trading or trading in calendar spreads.

Only a modest proportion of average daily trading volume results in reportable traders changing their net long or net short futures positions for the day. This means that about 20 percent or less of the trading is done by traders who bring a longer-term perspective to the market on the price of the commodity.

Modern technology has led to other dramatic changes in the markets. With advancements in cell phone technology, a farmer in Africa or Asia can see the world prices for these markets, whether set in Chicago or elsewhere. This technological advancement greatly increases access to the markets. Farmers around the globe can more fully benefit from the competitive market.

But modern technology also more tightly connects us all and highlights why we have to ensure the markets are transparent and free of fraud, manipulation, and other abuses.

Position Limits and Enforcement Authority

Since the reforms of the 1930s, the CFTC’s predecessor and now the CFTC have promoted market integrity with position limits, as well as the agency’s enforcement authority to police manipulative conduct.

Position Limits

Since the 1930s, Congress has prescribed position limits to protect against the burdens of excessive speculation, including those that may be caused by large concentrated positions.

When the CFTC set position limits in the past, the agency sought to ensure that the markets were made up of a broad group of participants.

At the core of our obligations is promoting market integrity, which the agency has historically interpreted to include ensuring that markets do not become too concentrated.

Position limits are a critical tool to ensure that a single trader does not accumulate an outsize position that could potentially affect integrity or liquidity in the marketplace.

As required by Congress in the Dodd-Frank Act, in October 2011 the CFTC finalized a rule to establish position limits for futures, options and swaps on 28 physical commodities.

A group of financial associations is challenging this rule in court. I believe it’s critical that we continue our efforts to put in place aggregate speculative position limits across futures and swaps on physical commodities.

Enforcement Authority

In the United States, we have strong prohibitions against misconduct that can affect the integrity of our markets, which were further strengthened by Congress in the Dodd-Frank Act.

Our laws prohibit successful manipulations, where the wrongdoer intended to and actually did manipulate a price.

But we also cover a much broader swath of misconduct.

Our laws prohibit all attempts at manipulation, and all manipulative or deceptive schemes, where the wrongdoer acted recklessly. In addition, our laws prohibit the transmission of false information that may tend to affect the price of a commodity.

These laws, aggressively and fairly enforced, are designed to protect market participants and the integrity of our markets. The international community can draw on these provisions to enhance their own regulatory regimes.

International Coordination

Other market jurisdictions have made progress on position limits and attempted manipulation provisions.

In November 2011, the G-20 leaders endorsed an International Organization of Securities Commissions (IOSCO) report noting that market regulators should have and use formal position management authorities, including the power to set position limits, to prevent market abuses.

Most jurisdictions with commodity derivatives markets have subsequently implemented or are moving forward on position management authorities. For instance, the European legislative bodies are considering a position limit regime for the European Union.

In addition, European legislative bodies are considering proposals that would include attempted market manipulation within its regulatory framework.

As the CFTC works with our global counterparts on swaps market reform, we are advocating for a consistent approach with regard to these reforms.

The Importance of an Effective Market Regulator

In conclusion, farmers, ranchers, producers and consumers need to have confidence that derivatives markets are free of fraud, manipulation and other abuses.

The end-users in the non-financial side of the economy benefit from transparency both before and after the trade. End-users benefit from open and competitive markets where no one party has an outsized position.

The CFTC is nearly complete with the swaps market reforms that have brought clearing, oversight of intermediaries and transparency to the once dark swaps market.

But for the CFTC to effectively ensure market integrity, it is critical for the agency to be well-resourced.

At 684 people, we are just 7 percent larger than we were 20 years ago.

Simply put, the CFTC is not the right size for the new and expanded mission Congress has directed it to perform.