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

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION 

September 30, 2015

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

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

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

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

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

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

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

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

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

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

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

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

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

SEC PROPOSES RULES ON EXECUTIVE COMPENSATION CLAWBACKS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

SEC Proposes Rules Requiring Companies to Adopt Clawback Policies on Executive Compensation

07/01/2015 12:45 PM EDT

The Securities and Exchange Commission today proposed rules directing national securities exchanges and associations to establish listing standards requiring companies to adopt policies that require executive officers to pay back incentive-based compensation that they were awarded erroneously.  With this proposal, the Commission has completed proposals on all executive compensation rules required by the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Under the proposed new Rule 10D-1, listed companies would be required to develop and enforce recovery policies that  in the event of an accounting restatement, “claw back” from current and former executive officers incentive-based compensation they would not have received based on the restatement.  Recovery would be required without regard to fault.  The proposed rules would also require disclosure of listed companies’ recovery policies, and their actions under those policies.

“These listing standards will require executive officers to return incentive-based compensation that was not earned,” said SEC Chair Mary Jo White.  “The proposed rules would result in increased accountability and greater focus on the quality of financial reporting, which will benefit investors and the markets.”

Under the proposed rules, the listing standards would apply to incentive-based compensation that is tied to accounting-related metrics, stock price or total shareholder return.  Recovery would apply to excess incentive-based compensation received by executive officers in the three fiscal years preceding the date a listed company is required to prepare an accounting restatement.

Each listed company would be required to file its recovery policy as an exhibit to its annual report under the Securities Exchange Act.  In addition, a listed company would be required to disclose its actions to recover in its annual reports and any proxy statement that requires executive compensation disclosure if, during its last fiscal year, a restatement requiring recovery of excess incentive-based compensation was completed, or there was an outstanding balance of excess incentive-based compensation from a prior restatement.

The comment period for the proposed rules will be 60 days after publication in the Federal Register.

#  #  #

FACT SHEET

Listing Standards for Clawing Back Erroneously Awarded Executive Compensation

SEC Open Meeting

July 1, 2015

Action

The Commission will consider whether to propose rules directing national securities exchanges and associations to establish listing standards requiring companies to develop and implement policies to claw back incentive-based executive compensation that later is shown to have been awarded in error.  The proposed rules are designed to improve the quality of financial reporting and benefit investors by providing enhanced accountability.  The proposed new rules required by Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act would be the last of the executive compensation rules to be proposed.

Highlights of the Proposed Rules

Listing Standards – Proposed Rule 10D-1 under the Securities Exchange Act

The proposed rules would require national securities exchanges and associations to establish listing standards that would require listed companies to adopt and comply with a compensation recovery policy in which:

Recovery would be required from current and former executive officers who received incentive-based compensation during the three fiscal years preceding the date on which the company is required to prepare an accounting restatement to correct a material error.  The recovery would be required on a “no fault” basis, without regard to whether any misconduct occurred or an executive officer’s responsibility for the erroneous financial statements.

Companies would be required to recover the amount of incentive-based compensation received by an executive officer that exceeds the amount the executive officer would have received had the incentive-based compensation been determined based on the accounting restatement.  For incentive-based compensation based on stock price or total shareholder return, companies could use a reasonable estimate of the effect of the restatement on the applicable measure to determine the amount to be recovered.

Companies would have discretion not to recover the excess incentive-based compensation received by executive officers if the direct expense of enforcing recovery would exceed the amount to be recovered or, for foreign private issuers, in specified circumstances where recovery would violate home country law.
Under the proposed rules, a company would be subject to delisting if it does not adopt a compensation recovery policy that complies with the applicable listing standard, disclose the policy in accordance with Commission rules or comply with the policy’s recovery provisions.
Definition of Executive Officers

The proposed rules would include a definition of an “executive officer” that is modeled on the definition of “officer” under Section 16 under the Exchange Act.  The definition includes the company’s president, principal financial officer, principal accounting officer, any vice-president in charge of a principal business unit, division or function, and any other person who performs policy-making functions for the company.  

Incentive-Based Compensation Subject to Recovery

Under the proposal, incentive-based compensation that is granted, earned or vested based wholly or in part on the attainment of any financial reporting measure would be subject to recovery.  Financial reporting measures are those based on the accounting principles used in preparing the company’s financial statements, any measures derived wholly or in part from such financial information, and stock price and total shareholder return.

Proposed Disclosure

Each listed company would be required to file its compensation recovery policy as an exhibit to its Exchange Act annual report.

In addition, if during its last completed fiscal year the company either prepared a restatement that required recovery of excess incentive-based compensation, or there was an outstanding balance of excess incentive-based compensation relating to a prior restatement, a listed company would be required to disclose:

The date on which it was required to prepare each accounting restatement, the aggregate dollar amount of excess incentive-based compensation attributable to the restatement and the aggregate dollar amount that remained outstanding at the end of its last completed fiscal year.
The name of each person subject to recovery from whom the company decided not to pursue recovery, the amounts due from each such person, and a brief description of the reason the company decided not to pursue recovery.
If amounts of excess incentive-based compensation are outstanding for more than 180 days, the name of, and amount due from, each person at the end of the company’s last completed fiscal year.
The proposed disclosure would be included along with the listed company’s other executive compensation disclosure in annual reports and any proxy or information statements in which executive compensation disclosure is required.

Listed companies would also be required to block tag the disclosure in an interactive data format using eXtensible Business Reporting Language (XBRL).

Covered Companies

The proposed rules would apply to all listed companies except for certain registered investment companies to the extent they do not provide incentive-based compensation to their employees.

Transition Period

The proposal requires the exchanges to file their proposed listing rules no later than 90 days following the publication of the adopted version of Rule 10D-1 in the Federal Register.  The proposal also requires the listing rules to become effective no later than one year following the publication date.

Each listed company would be required to adopt its recovery policy no later than 60 days following the date on which the listing exchange’s listing rule becomes effective.  Each listed company would be required to recover all excess incentive-based compensation received by current and former executive officers on or after the effective date of Rule 10D-1 that results from attaining a financial reporting measure based on financial information for any fiscal period ending on or after the effective date of Rule 10D-1.

Listed companies would be required to comply with the new disclosures in proxy or information statements and Exchange Act annual reports filed on or after the effective date of the listing exchange’s rule.

What’s Next?

If approved for publication by the Commission, the proposed rules will be published on the Commission’s website and in the Federal Register.  The comment period for the proposed rules would be 60 days after publication in the Federal Register.

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 BOWEN'S SPEECH BEFORE 2015 COMPLIANCE CONFERENCE

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION 

Commissioner Bowen Speech before the Managed Funds Association, 2015 Compliance Conference

May 5, 2015

Thank you John for the introduction and good morning everyone. It’s a pleasure to be here today at the Managed Funds Association’s 2015 Compliance Conference. I would like to give a few very brief remarks before we move into my fireside chat with Adam Cooper. I have known Adam through our membership on the Northwestern Law School Board, which I chaired several years ago. I look forward to our conversation at the end of my brief remarks this morning. Of course, my remarks today are my own and do not reflect the views of my fellow Commissioners or the CFTC staff.

In my eleven months as a Commissioner, I’ve spoken about a few topics that are at the top of my agenda and which I hope the Commission will address early during my term. One of those is the need for increased regulation of retail foreign exchange transactions, which I believe is necessary to protect the retail investors who trade in that market. Another is the need for full funding of the Commodity Futures Trading Commission (CFTC) so that we will have strong, comprehensive oversight of the swaps and futures markets. Still another is the need to finalize the remaining regulations required by the Dodd-Frank Wall Street Reform and Consumer Protection Act, aka Dodd-Frank.

Finally, I have also spoken about my belief that we need to ensure that our system of regulation, including our universe of self-regulatory organizations, works efficiently and effectively. In fact, I would like to talk to you today about a subject that confirms my belief that we need to finish our Dodd-Frank rules, while enhancing our overall comprehensive regulations. Specifically, I want to talk to you about the topic of governance.

As compliance professionals, I know that you all understand how good governance protocols and rules are at the heart of how any fund or corporation operates. What some of you may not know is that the CFTC was tasked to issue regulations on this subject under Dodd-Frank. Per Section 726 of Dodd-Frank, “In order to mitigate conflicts of interest,” the CFTC was supposed to issues rules within six months of the law’s passage that could potentially “include numerical limits on the control of, or the voting rights with respect to, any derivatives clearing organization that clears swaps, swap execution facility, or board of trade” that is sufficiently involved in the swaps market.1 Additionally, we were mandated to adopt those rules if we determined that “such rules are necessary or appropriate to improve the governance of” a derivatives clearing organization (DCO), a contract market, or certain swap execution facilities (SEFs).2

This rulemaking requirement was one of the first things we acted on. Back in October 2010, almost three months after Dodd-Frank became law, we issued a proposed rule on this subject. It provided guidelines on conflicts of interest over these entities and also crafted a system to improve the governance of DCOs and SEFs.3 Ironically, however, we have not finalized that governance proposal in the intervening five years nor have we issued a new proposal.

So, to some extent, one of the first regulations out of the gate has become one of the last ones to be completed. In fact, the governance rulemaking is one of three major rules we have to complete, along with such well-known regulations as position limits and capital for swap dealers and margin for uncleared swaps. And honestly, I believe that it is as important for us to complete and promulgate a rule on governance, as it is for us to complete those two rules.

The reason I believe completing the rule on governance is critical is two-fold. First, the governance of designated contract markets (DCMs) and SEFs is critical to how the overall markets we regulate function. As a reminder, the governance proposal covered a number of major topics - from compensation policies for public boards of directors4 to an expertise standard for other members of public boards.5 The proposal even required that boards of directors of registered entities engage in an annual performance review.6 Some of those concepts might seem self-evident, but it’s critical that all such entities have such policies in place.

Second, I believe this rule can and should be part of a broader effort to address another key issue at present: improving culture. As I have mentioned previously and as seems self-evident, we have a culture problem in finance at present.7 As a Commissioner at the CFTC, I’ve seen a significant number of settlements and alleged violations of our laws in the last eleven months. Sometimes those violations are from individuals deliberately seeking to defraud investors. Other times, however, the violations come from large organizations that have previously violated the rules. And that is something that should trouble us.

I believe the governance rule is a major tool to deter rule-breaking. Culture comes from the top – when you have a strong, independent, and involved board of directors, it’s more likely that issues will be fixed before they become problems or cause a regulation or law to be broken.

I think completing this governance rule is important because it is a critical step in the process of addressing our mandate. We need to be able to release a strong rule on governance practices for SEFs and DCMs if we’re going to fix the broader culture problem on Wall Street. We all expect that the governance of our DCMs and SEFs will be superior – after all, these markets revolve around trust. If market participants don’t trust that decisions are made fairly on an exchange, they are less likely to trade on that exchange.

It is because of that key fact that I believe there is support for strong governance rules on these entities because they’re the intermediaries between industry players. They’re a big part of the marketplace. And if we want to fix a big problem like culture, this is a good place to start. If we can establish strong, robust governance practices on DCMs and SEFs, that may not be a panacea to our cultural ills, but it could be a small dose of medicine.

To return to the particular rule at hand, the 2010 governance proposal was filled with a number of good, worthy ideas. I want to offer my thoughts on how to enhance this governance rulemaking. My hope is that with these and possibly other enhancements, we can at least be closer to introducing model rules and best practices that serve as a template to improve the culture in the financial industry.

First, we need to have some qualitative standard for board membership. The previous proposal required that 35% of the members of boards of directors of our registrants be public directors and that those boards have a minimum of two public directors.8 I see why that was done that way – specific numerical standards are easy to implement. But I think we can do better. After all, a person being a public director doesn’t immediately make them a good director. We want people who are fully invested in their firms and who will diligently oversee management accountability.

To put a finer point on it, I do think you need a sufficient number of public directors to achieve meaningful independence. We could approach an independence standard through a holistic review of the board’s independence or we may require certifications by the public directors each year to the stockholders that they are truly independent. Alternatively, we could ask that the board certify that it is providing adequate resources to improve culture and the tone at the top or that it craft plans for improving the overall culture of a company. Clearly the standard needs to be more dynamic than just a number. It also has to be one that can clearly be consistently met by a registrant.

Second, I think we should use this rule to ensure that issues of culture will merit the active attention of the board. The previous proposal had provisions that mandated the board of directors to do certain things. For instance, it mandated an annual self-review and required that a registered entity establish procedures to remove a member of the board. I think this rule can be enhanced with a requirement that issues of culture be considered by the board.

There are several ways this could work. As I mentioned in my OpRisk speech, “If there isn’t a dedicated person in the company trying to improve the culture – both through communication and making it clear that the rules need to be constantly followed – the culture won’t broadly improve.”9

Third, we need to try and standardize governance across entities as much as possible. Good governance principles should apply across entities, financial or non-financial, because they provide simple incentives designed to protect the company and its shareholders from issues; inadvertent errors as well as deliberate ones. Entities should strive to ensure that a board is independent and that it is really taking a separate hard-look at the company’s actions, just as entities should strive to prevent conflicts of interest from arising.

Yet, we should not be micro-managing the process. If we’re crafting rules that are too entrenched in the particulars of how a DCM operates, we’re making two mistakes. First, having standards that aren’t largely uniform will lead to additional legal and compliance expenses for those entities. Differing standards could lead to confusion and result in entities making mistakes. Second, we’re missing the chance to actually establish standards that could be a model for others to use, and that would be a clear missed opportunity to improve the culture in finance and increase board independence.

If we can seek standardization and harmonization on the particulars of data standards or determine which country has the jurisdiction over a particular trade, we shouldn’t shy away from the chance to seek standardization on this subject. And I hope and believe that if we can establish strong rules on these entities -- rules that work -- there will be other private sector entities that will voluntarily adopt these rules as well.

I would hope that many entities which are not SEFs or DCMs would view a new governance rule as a model and adopt it voluntarily. But even if they do not, I believe we have the ability to set governance rules on a number of swap dealers and major swap participants, and that we should consider whether it makes sense to apply this rule to those entities.

If you’re going to have an optimally effective organization, you’ve got to have good governance. It’s a condition that is absolutely necessary for success. I believe the time has come for the CFTC to finish this rule, ideally before the end of this calendar year. Thank you and I look forward to my fireside chat with Adam and questions from the audience. Obviously, time is a constraint, so feel free to reach out to me or my staff if you do not have the opportunity to ask a question or raise issues this morning.

1 Dodd-Frank Wall Street Reform and Consumer Protection Act, § 726(a), available at http://www.cftc.gov/ucm/groups/public/@swaps/documents/file/hr4173_enrolledbill.pdf at page 320.

2 Dodd-Frank Wall Street Reform and Consumer Protection Act, § 726(b), available at http://www.cftc.gov/ucm/groups/public/@swaps/documents/file/hr4173_enrolledbill.pdf at page 320.

3 Commodity Futures Trading Commission, “Requirements for Derivatives Clearing Organizations, Designated Contract Markets, and Swap Execution Facilities Regarding the Mitigation of Conflicts of Interest, 17 CFR Parts 1, 37, 38, 39 & 40, October 18, 2010, 75 Fed. Reg. 63732, [hereinafter “Proposed CFTC Governance Rule”], available at http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2010-26220a.pdf.

4 Proposed CFTC Governance Rule, 17 C.F.R. Part 40.9(b)(4), at 75 Fed. Reg. 63752, available at http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2010-26220a.pdf.

5 Proposed CFTC Governance Rule, 17 C.F.R. Part 40.9(b)(3), at 75 Fed. Reg. 63751, available at http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2010-26220a.pdf.

6 Proposed CFTC Governance Rule, 17 C.F.R. Part 40.9(b)(5), at 75 Fed. Reg. 63752, available at http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2010-26220a.pdf.

7 Commissioner Sharon Y. Bowen, Commodity Futures Trading Commission, “Remarks of CFTC Commissioner Sharon Y. Bowen Before the 17th Annual OpRisk North America,” March 25, 2015, available at http://www.cftc.gov/PressRoom/SpeechesTestimony/opabowen-2.

8 Proposed Governance Rule, 17 C.F.R. Part 40.9(b)(1)(i), at 75 Fed. Reg. 63751, available at http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2010-26220a.pdf.

9 Commissioner Sharon Y. Bowen, Commodity Futures Trading Commission, “Remarks of CFTC Commissioner Sharon Y. Bowen Before the 17th Annual OpRisk North America,” March 25, 2015, available at http://www.cftc.gov/PressRoom/SpeechesTestimony/opabowen-2.

Last Updated: May 5, 2015

FDIC CHAIRMAN GRUENBERG'S STATEMENT BEFORE COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS

FROM:  FEDERAL DEPOSIT INSURANCE CORPORATION 

Speeches & Testimony

Statement of Martin J. Gruenberg, Chairman, Federal Deposit Insurance Corporation: Examining the Regulatory Regime for Regional Banks before the Committee on Banking, Housing, and Urban Affairs; 538 Dirksen Senate Office Building; Washington, DC

March 19, 2015

Chairman Shelby, Ranking Member Brown, and members of the Committee, I appreciate the opportunity to testify on the regulatory regime for regional banks. My testimony will begin with a profile of the large companies subject to the enhanced prudential standards requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). I then will describe how regulators have implemented the enhanced standards requirements. Finally, I will review various considerations important to any discussion of proposals to change these requirements.

Profile of Large Companies Subject to Section 165

Section 165 of the Dodd-Frank Act requires the Board of Governors of the Federal Reserve System (Federal Reserve) to establish enhanced prudential standards for certain groups of institutions. The Act defines these institutions to include bank holding companies with total consolidated assets equal to or greater than $50 billion and nonbank financial companies that the Financial Stability Oversight Council (Council) has designated for Federal Reserve supervision.
The companies that meet the $50 billion threshold for enhanced prudential standards represent a significant portion of the U.S. banking industry. As of December 31, 2014, 37 companies with combined assets of $15.7 trillion reported total assets greater than $50 billion. They owned a total of 72 FDIC-insured subsidiary banks and savings institutions, with combined assets of $11.3 trillion, or 73 percent of total FDIC-insured institution assets.

The 37 companies represent a diverse set of business models. The four largest companies, holding combined assets of $8.2 trillion, are universal banks that engage in commercial banking, investment banking, and other financial services. Another twenty companies holding $3.3 trillion in assets are diversified commercial banks that essentially take deposits and make loans. The remaining 13 companies, with a combined total of $4.2 trillion in assets, do not engage predominantly in traditional commercial banking activities. These companies include two investment banks, four custodial banks, two credit-card banks, one online bank, and four specialty institutions. The 37 institutions include eight U.S.-owned institutions that are designated as global systemically important banks by the Financial Stability Board. They include the four universal banks, two investment banks, and two custodial banks.

By way of contrast, the FDIC's Community Banking Study of December 2012 profiled institutions that provide traditional, relationship-based banking services. The FDIC developed criteria for the Study to identify community banks that included more than a strict asset size threshold. These criteria included a ratio of loans-to-assets of at least 33 percent, a ratio of core deposits-to-assets of at least 50 percent, and a maximum of 75 offices operating in no more than two large metropolitan statistical areas and in no more than three states. Based on criteria developed in the Study, 93 percent of all FDIC-insured institutions with 13 percent of FDIC-insured institution assets currently meet the criteria of a community bank. This represents 6,037 institutions, 5,676 of which have assets under $1 billion. The average community bank holds $342 million in assets, has a total of six offices, and operates in one state and one large metropolitan area.

The FDIC does not have a similar set of criteria to identify regional banks. Regional banks may be thought of as institutions that are much larger in asset size than a typical community bank and that tend to focus on more traditional activities and lending products. These institutions typically have expanded branch operations and lending products that may serve several metropolitan areas and they may do business across several states. Regional banks are less complex than the very largest banks, which may have operations and revenue sources beyond traditional lending products.

The 20 holding companies identified as diversified commercial banks -- the subset of the 37 institutions with total assets over $50 billion noted earlier -- have a traditional banking business model that involves taking deposits and making loans, and they derive the majority of their income from their lending activities. Operationally, however, the 20 diversified commercial banks are much more complex than traditional community banks. They operate in a much larger geographic region, and have a much larger footprint within their geographic region.

Of the 20 holding companies:

Seven have total assets from $50 billion to $100 billion. They have an average of nearly 700 offices, and operate in 12 states and 22 large metropolitan areas.
Nine have assets from $100 billion to $250 billion. They have an average of nearly 1,200 offices, and operate in 12 states and 24 large metropolitan areas.
Four have total assets from $250 billion to $500 billion. They have an average of nearly 1,800 offices, and operate in 18 states and 24 large metropolitan areas.
The operational complexity of these 20 diversified commercial bank holding companies presents challenges that community banks do not. Supervisory tools and regulations need to match the complexity of these large $50 billion plus organizations. Any particular institution at the lower to middle part of the grouping may be a dominant player within a particular geographic or market segment and as such may require greater regulatory attention. If there would be a failure, the resolution of any one of these organizations may present challenges. In addition, the failure of more than one of these institutions during a period of severe financial stress could present challenges to financial stability.
Implementation of Enhanced Prudential Standards

Section 165 provides the FDIC with explicit responsibilities in two substantive areas related to prudential supervision: resolution plans and stress testing. In both areas, the FDIC has tailored requirements to fit the complexity of the affected institutions.

Resolution planning

Resolution plans, or living wills, are an important tool for protecting the economy and preventing future taxpayer bailouts. Requiring these plans ensures that firms establish, in advance, how they could be resolved in an orderly way under the Bankruptcy Code in the event of material financial distress or failure. The plans also provide important information to regulators, so they can better prepare for failure to protect markets and taxpayers.

In 2011, the FDIC and the Federal Reserve jointly issued a final rule implementing the resolution plan requirements of Section 165(d) of the Dodd-Frank Act (the 165(d) rule) for bank holding companies. The FDIC also issued a separate rule that requires all insured depository institutions (IDIs) with greater than $50 billion in assets to submit resolution plans to the FDIC for their orderly resolution through the FDIC's traditional resolution powers under the Federal Deposit Insurance Act (FDI Act). The 165(d) rule and the IDI resolution plan rule are designed to work in tandem by covering the full range of business lines, legal entities, and capital-structure combinations within a large financial firm.
Bank holding companies with $50 billion or more in total consolidated assets and nonbank financial companies regulated by the Federal Reserve are subject to the requirement to prepare resolution plans. However, the FDIC and the Federal Reserve used our statutory discretion to develop a joint resolution planning rule which recognizes the differences among institutions and scales the regulatory requirements and potential burdens to the size and complexity of the institutions subject to that rule. The joint rule also allows the agencies to modify the frequency and timing of required resolution plans.

Our resolution plan regulations also are structured so that both firms and regulators are focused on the areas of greatest risk. Smaller, simpler, and less complex institutions have much smaller and simpler resolution plans than more systemic institutions, with complex structures, multiple business lines, and large numbers of legal entities.

In implementing the requirement for resolution plans, the FDIC and the Federal Reserve instituted a staggered schedule for plan submissions to reflect differing risk profiles. The first group of companies required to file plans on or before July 1, 2012, included bank holding companies with $250 billion or more in nonbank assets. This group comprised 11 institutions—seven U.S. bank holding companies and four foreign banking organizations. These institutions generally ranked among the largest institutions in the United States, although some equally large institutions with smaller amounts of nonbank assets, did not file in this group.

The second group was comprised of bank holding companies with $100 billion or more, but less than $250 billion, in total non-bank assets. These firms submitted their initial resolution plans on or before July 1, 2013. The remaining companies, those subject to the rule with less than $100 billion in total non-bank assets, submitted their initial plans on or before December 31, 2013.

Grouping the firms by their holdings of nonbank assets provided the agencies with an initial proxy for firm complexity. By delaying the submission of plans for those with fewer nonbank assets, less complex firms were given more time to prepare. The FDIC and the Federal Reserve also were able to focus on those firms that are more likely to pose serious adverse effects to the U.S. financial system should they need to be resolved under the Bankruptcy Code. Based on their groupings and measured by asset size as of December 2011, no U.S. bank holding company (BHC) with less than $200 billion in total consolidated assets was required to file with either the first or second group of filers.

For their initial submissions, bank holding companies with less than $100 billion in total nonbank assets and 85 percent or more of their assets in an insured depository institution also were generally permitted to submit tailored resolution plans. Tailored resolution plans simplify the task of creating a living will by aligning it with the FDIC’s IDI resolution plan requirement and focusing on the firm’s nonbank operations. Since the initial filings, the FDIC and Federal Reserve have further recognized differences among institutions with less than $100 billion in nonbank assets and nearly all U.S. institutions in this category filed tailored plans.

Though smaller firms are less systemic, appropriately tailored resolution plans or other enhanced prudential supervision requirements for these firms provide important benefits. Any particular institution at the lower to middle part of the grouping may be a dominant player within a particular geographic or market segment, and its failure would likely have a sizeable impact for those markets. The Deposit Insurance Fund also would face a substantial loss from the failure of even one of these firms. Finally, the size of these firms presents an obstacle in arranging the sale to another firm as only other larger firms would be likely acquirers. Therefore, the FDIC and Federal Reserve should continue to receive and review resolution plans in order to ensure that a rapid and orderly resolution of these companies through bankruptcy could occur in a way that protects taxpayers and the economy.

Stress testing

Section 165(i)(2) of the Dodd-Frank Act requires the federal banking agencies to issue regulations requiring financial companies with more than $10 billion in total consolidated assets to conduct annual stress tests. The statutory language governing stress testing is more detailed and prescriptive than the language covering other prudential standards, leaving the regulators with less discretion to tailor the stress testing process. The Act requires IDIs and BHCs with assets greater than $10 billion to conduct an annual company-run stress test, while BHCs with assets greater than $50 billion must conduct semiannual, company-run stress tests and also are subject to stress tests conducted by the Federal Reserve. The company-run tests must include three scenarios and the institutions must publish a summary of the results.

In October 2012, the FDIC, OCC, and the Federal Reserve issued substantially similar regulations to implement the company-run stress test requirements. The FDIC’s stress testing rules, like those of the other agencies, are tailored to the size of the institutions consistent with the expectations under section 165 for progressive application of the requirements. Under the agencies' implementing regulations, organizations in the $10 billion to $50 billion asset size range have more time to conduct the tests and are subject to less extensive informational requirements, as compared to larger institutions. Currently, 107 IDIs are subject to the banking agencies’ stress testing rules, with the FDIC serving as primary federal regulator for 28 of these IDIs.

Stress testing requirements are an important risk-assessment supervisory tool. The stress tests conducted under the Dodd-Frank Act provide forward-looking information to supervisors to assist in their overall assessments of a covered bank’s capital adequacy and to aid in identifying downside risks and the potential impact of adverse outcomes on the covered bank. Further, these stress tests are expected to support ongoing improvement in a covered bank’s internal assessments of capital adequacy and overall capital planning.

Other Regulatory Standards Affecting Regional Banks

Many of the standards required under section 165 address issues that are within the longstanding regulatory and supervisory purview of the federal banking agencies. For example, with respect to banking organizations, the agencies have pre-existing authority to establish regulatory capital requirements, liquidity standards, risk-management standards, and concentration limits, to mandate disclosures and regular reports, and to conduct stress tests or require banking organizations to do so. These are important safety and soundness authorities that the agencies have exercised by regulation and supervision in the normal course and outside the context of section 165.

The FDIC's capital rules are issued pursuant to its general safety and soundness authority and the FDI Act. In many cases, FDIC capital regulations and those of other federal banking agencies are consistent with standards developed by the Basel Committee on Banking Supervision. For example, recent comprehensive revisions to the agencies’ capital rules and the liquidity coverage ratio rule incorporated aspects of the Basel III accord, which was developed separate and independent from, and mostly before, the Dodd-Frank Act was finalized.

These capital and liquidity rules play an important role in promoting the safety and soundness of the banking industry, including regional and larger banks. The agencies’ capital rules are entirely consistent with the statutory goal in section 165 of progressively strengthening standards for the largest institutions. As a baseline, a set of generally applicable capital rules apply to all institutions. A defined group1 of large or internationally active banking organizations are subject to more extensive U.S. application of Basel capital and liquidity standards. In addition, eight Global Systemically Important Banks (G-SIBs) are subject to enhanced supplemental leverage capital requirements.
Policy Considerations

Section 165 establishes the principle that regulatory standards should be more stringent for the largest institutions. This idea is rooted in the experience of the financial crisis, where the largest financial institutions proved most vulnerable to sudden market-based stress, with effects that included significant disruption of the real economy. The thresholds in the enhanced prudential standards legislative framework state Congress’s expectation for the asset levels at which enhanced regulatory standards should start to apply, while providing for regulatory flexibility to set the details of how those standards should progress in stringency.
In our judgment, the concept of enhanced regulatory standards for the largest institutions is sound, and is consistent with our longstanding approach to bank supervision. Certainly, degrees of size, risk, and complexity exist among the banking organizations subject to section 165, but all are large institutions. Some of the specializations and more extensive operations of regional banks require elevated risk controls, risk mitigations, corporate governance, and internal expertise than what is expected from community banks. We should be cautious about making changes to the statutory framework of heightened prudential standards that would result in a lowering of expectations for the risk management of large banks.

That being said, it is appropriate to take into account differences in the size and complexity of banking organizations when formulating regulatory standards. The federal banking agencies have taken into account such differences in a number of contexts separate and apart from section 165. Examples include asset thresholds for the interagency capital rules, trading book thresholds for the application of the market risk rule, and proposed notional derivatives thresholds for margin requirements. These examples and other size thresholds illustrate that precedents exist apart from section 165 for the application of different and heightened regulatory standards to larger institutions, and that different size thresholds may be appropriate for different types of requirements. Finally, many of the rules that apply to more complex capital market activities do not apply, as a practical matter, to the types of traditional lending activities that many regional banks conduct.

Conclusion

Section 165 provides for significant flexibility in implementation of its requirements. The agencies have made appropriate use of this flexibility thus far, and where issues have been raised by industry, we believe that we have been responsive. The FDIC remains open to further discussion on how best to tailor various enhanced prudential standards and other regulations and supervisory actions to best address risk profiles presented by large institutions, including regional banks.

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

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

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

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

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

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

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

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

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

Current Priorities

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Conclusion

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

Thank you for inviting me.

Last Updated: March 11, 2015

CFTC COMMISSIONER BOWEN ON REGULATION OF FOREIGN EXCHANGE DERIVATIVE REGULATION

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION 

Statement of U.S. Commodity Futures Trading Commissioner Sharon Bowen Regarding Recent Activity in the Retail Foreign Exchange Markets

January 21, 2015

Commissioner Sharon Bowen of the Commodity Futures Trading Commission issued the following statement on the subject of last week’s activity in the retail foreign exchange markets:

It is ironic, that following the enactment of Dodd-Frank, the retail foreign exchange industry is the least regulated part of the derivatives industry. I am concerned that lower standards are putting this industry in a precarious position and placing retail foreign exchange investors unnecessarily at risk. These concerns were underscored by recent unsettling events involving financial difficulties at retail foreign exchange dealers following the Swiss National Bank’s policy change regarding the Swiss Franc.

As I have said before, we have an obligation to prevent the establishment of “gaps” in our regulations. If we find that a part of the swaps or futures industry is so lightly regulated that investors, markets, and the public are being placed in undue risk, we have an obligation to fill that gap and establish a more efficient and effective regulatory regime. Even prior to these events, I raised the issue of whether enhanced regulation of retail foreign exchange would benefit consumers.

Therefore, in the wake of last week’s events, I believe the Commodity Futures Trading Commission has an obligation to seriously consider enhancing our regulations of retail foreign exchange dealers. Specifically, I believe we should consider establishing regulations on the retail foreign exchange industry that are at least as strong as the regulations on the rest of the derivatives industry.

Last Updated: January 21, 2015

SEC ADOPTS NEW RULES REGARDING SWAP DATA REPOSITORIES

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission today adopted two new sets of rules that will require security-based swap data repositories (SDRs) to register with the SEC and prescribe reporting and public dissemination requirements for security-based swap transaction data.  The SEC also proposed certain additional rules, rule amendments and guidance related to the reporting and public dissemination of security-based swap transaction data.  The new rules are designed to increase transparency in the security-based swap market and to ensure that SDRs maintain complete records of security-based swap transactions that can be accessed by regulators.

The rules implement mandates under Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

“These rules go to the core of derivatives reform by establishing a strong foundation for transparency and efficiency in the market,” said SEC Chair Mary Jo White.  “They provide a powerful framework for trade reporting and the public dissemination of information that addresses blind spots exposed by the financial crisis.”

The rules require an SDR to register with the SEC and set forth other requirements with which SDRs must comply.  The rules also provide an exemption from registration for certain non-U.S. SDRs when specific conditions are met.

The rules addressing security-based swap data reporting and public dissemination, known as Regulation SBSR, outline the information that must be reported and publicly disseminated for each security-based swap transaction.  In addition, the rules assign reporting duties for many security-based swap transactions and require SDRs registered with the SEC to establish and maintain policies and procedures for carrying out their duties under Regulation SBSR.  Under the rules, the Commission is recognizing the Global Legal Entity Identifier System as the system from which security-based swap counterparties must obtain codes to identify themselves when reporting security-based swap data.  The rules also address the application of Regulation SBSR to cross-border security-based swap activity and include provisions to permit market participants to satisfy their obligations under Regulation SBSR through compliance with the comparable regulation of a foreign jurisdiction.

The proposed rule amendments would assign reporting duties for certain security-based swaps not addressed by the adopted rules, prohibit registered SDRs from charging fees to or imposing usage restrictions on the users of publicly disseminated security-based swap transaction data, and provide a compliance schedule for certain provisions of Regulation SBSR.

“We carefully considered comments received and the workability of the rules and rule proposal in the context of the existing CFTC regimes for swap data repositories, swap data reporting and public dissemination,” said Steve Luparello, Director of the SEC’s Division of Trading and Markets.  “Today’s measures are robust and appropriately tailored to the security-based swap market.”

The new rules will become effective 60 days after they are published in the Federal Register.  Persons subject to the new rules governing the registration of SDRs must comply with them by 365 days after they are published in the Federal Register.  The compliance date for certain provisions of Regulation SBSR is the effective date, and the Commission is proposing compliance dates for the remaining provisions of Regulation SBSR in the proposed amendments release.