CFTC CHAIRMAN GENSLER'S TESTIMONY BEFORE U.S. HOUSE APPROPRIATIONS SUBCOMMITTEE

FROM: U.S. COMMODITY FUTURES TRADING COMMISSION
Testimony of Chairman Gary Gensler before the U.S. House Appropriations Subcommittee, Washington, DC
April 12, 2013

Good morning Chairman Aderholt, Ranking Member Farr and members of the Subcommittee. Thank you for inviting me to today’s hearing on the President’s request for the Commodity Futures Trading Commission’s (CFTC) fiscal year (FY) 2014 budget. I’m pleased to testify along with my fellow Commissioner Scott O’Malia.

This hearing is occurring at an historic time in the markets because under Congress’ direction, the CFTC now oversees the derivatives marketplace: not only futures that we have overseen for decades, but also the swaps market. The agency has completed 80 percent of the swap market reform rules required under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The public is benefiting from seeing the price and volume of each swap transaction. This information is available free of charge on a website, like a modern-day tickertape. For the first time, the public will benefit from the risk reduction and greater access to the market that comes from centralized clearing. And for the first time, the public is benefiting from the oversight of swap dealers. So far, 75 have registered and must adhere to sales practice and business conduct standards to help lower risk to the overall economy.

The marketplace is increasingly shifting to implementation of these common-sense rules of the road. Now it is all the more clear: the CFTC is not the right size for its new and expanded mission Congress has directed it to perform.

The CFTC’s current funding is $207 million prior to sequestration. We recognize that the federal government is operating under a sequester and that budgets for agencies across government require additional scrutiny. Our mission, however, has expanded dramatically. We have a duty to help protect the economy and taxpayers from risks in the financial system. Thus, the President’ FY 2014 budget requests an appropriation of $315 million and 1,015 FTEs. The overall funding levels requested approximate the plan set forth in the President’s 2013 Budget ($308 million and 1,015 FTE), but also take into account industry progress in implementing financial reform. Although 1,015 FTE resources requested in this budget are at the same level as for FY 2013, adjustments were made across our mission activities to reflect the transition from Dodd-Frank rulemaking to swaps market oversight in 2014. Primarily, the Commission shifted its requested resource allocation to support and maintain direct examinations – a critical component of customer protection. Market events have highlighted that the Commission must do everything within our authorities and resources to strengthen oversight programs and the protection of customers and their funds.

The President’s budget request for the Commission strikes a balance between important investments in technology and human capital, both of which are essential to carrying out the agency’s mandate. This approximately 52 percent increase in funding includes a 62 percent increase in IT services, but only a 44 percent increase in staff.

The CFTC is dedicated to using taxpayer dollars efficiently – nearly a fourth of the overall budget request, $73 million, is for outside IT services. When the CFTC’s dedicated IT staff is included, the request is $94.8 million for IT, or nearly a third of the overall budget. But it still takes human beings to watch for market manipulation and abuses that affect hedgers, farmers, ranchers, producers and commercial companies, as well as the public buying gas at the pump.

The CFTC is operating under a strategic plan for FY 2011-2015. This plan raises the bar on the agency’s performance measures to more accurately evaluate our progress. But the agency’s performance is affected by the challenges of limited resources. For the second year in a row, there are many goals that were not met, as are detailed in the agency’s Annual Performance Report (APR). The CFTC is reviewing the results of the APR and will include the findings in this year’s revision of the strategic plan and consider the results as the agency reevaluates the allocation of resources.

In my remaining testimony, I will review the five areas that make up over 90 percent of our requested budgeted staff increase: registrations, examinations, surveillance and data, enforcement, and economics and legal analysis.

Registration and Product Reviews

A significant task before us in FY 2014 will be the continuation of registration of effected entities, as well as reviews of new products for both the clearing mandate and the trading mandate.

We want to consider registration applications in a thoughtful and timely manner, be efficient in reviewing submissions, and be responsive to market participant inquiries –but this will require sufficient funding. For FY 2014, the President’s request supports $38.9 million and 147 FTEs for these two mission areas, an increase of $22.6 million and 92 FTEs.

The estimated 200 clearinghouses, trading platforms, swap data repositories, swap dealers and major swap participants that are recently registered or may seek CFTC registration within the next year is a dramatic increase over any registration effort the agency has overseen in the past. The Commission needs staff to facilitate the registration of the following:

• Clearinghouses – Entities that lower risk to the public by guaranteeing the obligations of both parties in a transaction. We are working with five entities seeking to register as DCOs and have inquiries from others. These entities would join the 14 we currently oversee.

• Designated contract markets (DCMs) – U.S. trading platforms that list futures and options and likely will start listing swaps. The CFTC currently oversees 16 DCMs, and by 2014, staff expects another two to three to seek registration.

• Foreign boards of trade (FBOTs) – Regulated trading platforms in other countries that are generally equivalent to DCMs. Since the FBOT rule became effective, 19 FBOTs have filed applications with the CFTC. By 2014, staff expects an additional couple of FBOTs to seek registration with the CFTC.

• Swap data repositories (SDRs) – Recordkeeping facilities created by Dodd-Frank to bring transparency to the swaps market. Three are provisionally registered with the CFTC, and by 2014, an additional SDR may seek registration.

• Swap dealers and major swap participants – Under the Dodd-Frank Act, the CFTC is working to comprehensively regulate swap dealers and major swap participants to lower their risk to the economy. As the result of completed CFTC rules, 75 swap dealers and two major swap participants are now provisionally registered. This initial group includes the largest domestic and international financial institutions dealing in swaps with U.S. persons. Commission staff currently estimates that over time, 25-50 additional swap dealers may request registration with the National Futures Association (NFA). We’ll be overseeing their registration and related questions.

• Swap execution facilities (SEFs) – The new trading platform for swaps. Commission staff estimates that 15 entities may request to become SEFs.

While we will have a system for provisional registration in place, market participants will want the certainty of final registration.

The Commission approved the first clearing requirement last November. A key milestone was reached last week with the requirement that swap dealers and the largest hedge funds clear as of March 11. The vast majority of interest rate and credit default index swaps are being brought into central clearing. Compliance will continue to be phased in throughout this year. Other financial entities begin clearing June 10. Accounts managed by third party investment managers and ERISA pension plans have until September 9. The Commission continues in the resource intensive review for determinations of other swaps that will be subject to the clearing mandate.

Full funding for the agency means that we will be best prepared to review the dramatic increase in requested registrations and to review swaps for the clearing mandate. A partial increase in funding means market participants will see a backlog in registrations, responses to their inquiries, and product review because we won’t have personnel sufficient to review their submissions in a timely and complete manner. Flat funding will mean market participants will wait even longer. There will be significant backlogs for participants seeking to register with the CFTC, as well as for review of swaps for mandatory clearing.

Examinations

Another critical mission for FY 2014 will be more regular and more in-depth examinations of the major market participants the CFTC oversees. Examinations are the CFTC’s tool to check for compliance with laws that protect the public and to ensure the protection of customer funds. The President’s request would provide $44.3 million and 185 FTEs for examinations, an increase of $25.6 million and 104 FTEs. The CFTC would more than double our current allocation for this mission because the number of entities we examine is expected to more than double.

This is an area where the agency has fallen short of our goals in performance reviews. The CFTC directly reviews clearinghouses and trading platforms and will review SDRs. But while the agency reviews them directly, we don’t have the resources to have full-time staff on site, unlike other regulatory agencies that do have on-the-ground staff at the significant firms they oversee. The CFTC also doesn’t do annual reviews. Clearinghouses, for instance, currently are examined on a three-year cycle. For intermediaries such as futures commission merchants (FCMs) and swap dealers, the CFTC relies on what are known as self-regulatory organizations (SROs) to be the primary examiners. Given our lack of resources, we’re only able to double check the SROs’ work on a limited number of FCMs each year, and the agency can spend little time onsite at the firms.

On top of the current lack of staff for examinations, our responsibilities in 2014 will expand to include reviews of many new market participants. For instance, there are currently 117 FCMs, 75 swap dealers and two major swap participants have provisionally registered, and more are expected to do so as the year progresses. More frequent and in-depth examinations are necessary to assure the public that firms have adequate capital, as well as systems and procedures in place to protect customer money. Reviews are critical to ensuring the financial soundness of clearinghouses, and ensuring transparency and competition in the trading markets.

Fully funding the increase for examinations means the Commission can move toward annual reviews of all significant clearinghouses and trading platforms and adequate reviews of other market participants. A partial increase for examinations means cutting back our monitoring plans for new market participants and more in-depth risk reviews. Flat funding means we will continue lacking the ability to assure the public that the CFTC’s registrants are financially sound and in compliance with regulatory protections.

Surveillance and Data

Effective market surveillance is dependent on the CFTC’s ability to acquire and analyze extremely large volumes of data to identify trends and events that warrant further investigation. For FY 2014, the President’s request would support $61.7 million and 174 FTEs for surveillance, data acquisition, and analytics, an increase of $18.3 million and 53 FTEs. Of the $61.7 million request, 55 percent would be directed toward IT.

The Dodd-Frank swaps market transparency rules mean a major increase in the amount of incoming data for the CFTC to aggregate and analyze. The agency is taking on the challenge of establishing connections with SDRs and aggregating the newly available swaps data with futures market data. This requires high performance hardware and software and the development of analytical alerts. But it also requires the corresponding personnel to manage this technology effectively for surveillance and enforcement.

As the CFTC also receives ownership and control information for trading accounts, it will have data to better detect intraday position limit violations and analyze high frequency trading.

A full increase for surveillance means the CFTC will have the ability to analyze futures and swaps data to protect market participants and the public. A partial increase would limit the agency’s investments in analysis-based surveillance tools. And flat funding will limit our capacity to effectively utilize and aggregate the new data we now are receiving.

Enforcement

The CFTC’s enforcement arm protects market participants and other members of the public from fraud, manipulation and other abusive practices in the futures and swaps markets. Our efforts range from pursuing Ponzi schemers who defraud individuals across the country out of life savings; to abuses that threaten customer funds; to false reporting of prices; to schemes to manipulate prices, including of goods, such as oil, gas and agricultural products. The Commission has opened more than 800 investigations in the past two fiscal years. The President’s FY 2014 request would provide $57.7 million and 213 FTEs for enforcement, an increase of $18.1 million and 51 FTEs.

In 2002, we had 154 people devoted to enforcement, and that number is nearly flat with our current staff of 158. This staff has been called upon to enforce laws and rules that are new to our arsenal. The Dodd-Frank mandate closed a significant gap in the agency’s enforcement authorities by extending the enforcement reach to swaps and prohibiting the reckless use of manipulative or deceptive schemes. In addition, the CFTC will be overseeing a host of new market participants.

A full increase for enforcement means more investigations and cases that the agency can pursue to protect the public. A less than full increase means that the CFTC will be faced with difficult choices. We could maintain the current volume and types of cases, but we would have to shift resources from futures cases to swaps cases or not cover all of the swaps market. Flat funding means not only that the Commission’s enforcement volume likely would shrink, but parts of the markets would be left with little enforcement oversight.

The Commission’s engagement in targeted enforcement efforts in the public interest include its historic actions regarding the rigging of benchmark rates, such as the London Interbank Offered Rate (LIBOR), a reference rate for much of the U.S. futures and swaps markets. Barclays, UBS and RBS were fined approximately $2.5 billion for manipulative conduct by the CFTC, the UK Financial Services Authority (FSA) and the Justice Department. At each bank, the misconduct spanned many years, took place in offices in several cities around the globe, included numerous people, and involved multiple benchmark rates and currencies. In each case, there was evidence of collusion. In the UBS and RBS cases, one or more inter-dealer brokers painted false pictures to influence submissions of other banks, i.e., to spread the falsehoods more widely. Barclays and UBS also were reporting falsely low borrowing rates in an effort to protect their reputation. While the cases led to $2 billion in fines flowing to the U.S. Treasury, what this is about is ensuring for financial market integrity.

Economics and Legal Analysis

For FY 2014, the President’s budget would support $24.6 million and 97 FTEs to invest in robust economic analysis teams and Commission-wide legal analysis, a decrease of $3.6 million and 20 FTEs from our estimate under the pre-sequester continuing resolution. The CFTC’s economists support all of the Commission’s divisions, including surveillance and complex enforcement cases. They have served on Dodd-Frank rule teams to carefully consider the costs and benefits of each rule.

The decision to make downward adjustments in the resources requested for this critical mission activity was not an easy one. However, given the increasing number of intermediaries the CFTC now oversees, examination teams needed to be bolstered.

In 2014, the CFTC’s economists will be integral in developing tools to analyze automated surveillance data and continue to evaluate new products for clearing.

Flat funding means a strained ability to analyze the market and detect problems that could be negative for the economy. Flat funding also means the Commission’s legal analysis team will be cut back even further to support front-line examinations, adding to the delays in responding to market participants and processing applications and straining the team’s ability to support of enforcement efforts.

Conclusion

The CFTC’s hardworking team is just 8 percent more in numbers than at our peak in the 1990s. Yet since that time, the futures market has grown five-fold, driven by rapid advances in technology. The swaps market is eight times larger than the futures market. Effective market implementation of swaps reforms by the CFTC requires additional resources. We are not asking for eight times the funding or staff. Investments in both technology and people, however, are needed for effective oversight of these markets by regulators.

Though data has started to be reported to the public and to regulators, we need the staff and technology to access, review and analyze the data. With 77 entities having registered as new swap dealers and major swap participants, we need people to answer their questions and work with the NFA on the necessary oversight to ensure market integrity. Furthermore, as market participants expand their technological sophistication, CFTC technology upgrades are critical for market surveillance and to enhance customer fund protection programs.

This is an incredibly strained budget environment. But without sufficient funding for the CFTC, the nation cannot be assured this agency can closely monitor for the protection of customer funds and utilize our enforcement arm to its fullest potential to go after bad actors in the futures and swaps markets. Without sufficient funding for the CFTC, the nation cannot be assured that this agency can effectively enforce essential rules that promote transparency and lower risk to the economy.

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

CFTC COMMISSIONER CHILTON SETS OUT TEN PRINCIPLES FOR A MORE "TRANSPARENT DODD-FRANK REGULATORY REGIME"

FROM: U.S. COMMODITY FUTURES TRADING COMMISSION
"The End-User Bill of Rights"

Statement of Commissioner Bart Chilton
April 3, 2013

We are one week away from an important date in Dodd-Frank implementation: the April 10 compliance date for Dodd-Frank swap reporting rules for end-users. This date represents the first major compliance date for the end-user community, a class of market participants that includes many who have not been regulated by the CFTC until now.

As we move one step closer to the full implementation of Dodd-Frank, I’m reminded of another important transition, one from over 220 years ago, the transition of this great nation from a colonial monarchy to a national democracy. At the dawn of the United States of America, the founding fathers set out ten principles, the "Bill of Rights" that would bind the new national democratic government. Similarly, today I am setting out ten principles to guide the Commission as we move into a new, more transparent Dodd-Frank regulatory regime. I believe these principles best protect our consumers and end-users who help move our economy forward—and let's keep in mind that these end-users were not the cause of the financial crisis that lead to financial reform. In fact, end-users were among the many victims of the crisis and much of Dodd-Frank was drafted with their interests in mind.

The futures and swaps markets wouldn't exist without end-users. The primary public benefit of derivatives markets is that they provide end-users risk management opportunities that, in turn, allow them to more easily fund operations and investments and thereby generate economic growth. The ability of end-users to fund their operations is directly related to the prices paid by consumers and the overall well-being of our economy; so protecting the end-users is akin to protecting the every-day consumer. The End-User Bill of Rights therefore focuses on what I believe should be the inalienable rights of end-users:

1. Right to reasonable Dodd-Frank implementation. Dodd-Frank needs to be implemented and needs to be implemented quickly, but that does not mean it should be done so harshly. Back in December 2012, I supported the Commission providing good faith forbearance relief for swap dealers (SDs) and major swap participants (MSPs) until July 31, 2013 (under certain circumstances) when trying in earnest to come into compliance with new CFTC Dodd-Frank rules. Consistent with that six month forbearance relief, I will not approve an action against end-users seeking to comply with CFTC Dodd-Frank rules in good faith, provided they act in ways consistent with a good faith intention to comply, until after October 31, 2013.

2. Right to legal certainty. The Commission and the Commission staff need to provide the market as much legal certainty as possible as we move through a challenging implementation period. End-users and other market participants should have little doubt as to the status of their activities and the Commission and staff should respond thoughtfully and diligently to requests for legal certainty. When an answer isn’t easy to provide, then the Commission or staff should be as transparent as possible with the public. The Commission or staff should strive to provide the market relief or clarity well in advance of a compliance date—last minute relief and clarification should be avoided. Finally, during this implementation of Dodd-Frank, I will not support an action against an end-user, exchange, or anyone else on an issue deserving clarity that is the subject of an outstanding request for interpretive guidance.

To provide a specific example of where the Commission could assist the end-user community with additional legal clarity, take the legal status of trade options. The Commission should tighten our guidance on commodity contracts with volumetric optionality, consistent with Commission precedent. At the same time, the Commission should focus on implementing Dodd-Frank for non-trade option swaps and broaden the trade option exemption in order to minimize any market disruptions in the trade options market. We should give end-users the opportunity to meet their statutory obligation to report trade options through an annual Form TO so that the Commission can monitor these markets for problems or evasion.

3. Right to compete in the markets. End-users should be able to hedge without getting mauled by cheetahs or crushed by Massive Passives. To protect end-users' right to compete in the markets, the Commission should start with two common sense rulemakings: First, we need high-frequency trader registration and conduct rules to prevent cheetahs from going feral. We should also provide the public market quality metrics designed to help end-users and other non-cheetahs from distinguishing between false cheetah liquidity and true liquidity. Second, we need caps on speculation so that the commodity markets return to their principal role as risk management markets for end-users. The commodity markets worked best when end-users were the predominant players. The Commission should move quickly on a new proposal on speculation limits by May 1.

4. Right to safe accounts. We need strong rules and rigorous auditing to ensure that futures commission merchants (FCMs) don't abuse their role as intermediaries while not imposing undue burdens on FCMs that provide end-users access to critical risk management markets (including a sensible compromise on residual interest). End-users should also have the right to choose between full segregation or to have their money at an FCM. If we require the availability of this option, the market will provide end-users better and more competitively-priced access to full segregation. Congress should also act to give end-users backstop protection through federally-mandated insurance.

5. Right to have confidence in the commodity markets. End-users should be confident that their intermediaries, FCMs and SDs in particular, are appropriately regulated and supervised. The Commission needs to establish rules that do this and ensure they are being enforced. The Commission needs bigger penalties to deter the abuses that threaten the health and stability of the markets. I have called for raising civil monetary penalty maximums to $10 million for entities and $1 million for individuals. The current $140,000 maximum civil monetary penalty is simply an inadequate deterrence for an agency tasked with, among other things, deterring manipulation and preventing systemic risk. Today’s regulatory infractions can spawn tomorrow’s financial meltdown and the Commission should be able to seek penalties to deter the malfeasance and negligence that can contribute to systemic problems.

6. Right to clear (or not to clear). The right to clear or not to clear should be protected for end-users. Central hedging units for non-financial end-users should be free to clear or not to clear on transactions that mitigate commercial risks for their corporate group. End-users that use inter-affiliate swaps to centralize and manage risk across a corporate group through a central hedging unit should be given the flexibility to clear or not to clear. End-users’ inter-affiliate swaps should also be exempt from transaction-by-transaction reporting. The Commission should move quickly to provide relief from reporting requirements for inter-affiliate transactions for end-users.

7. Right to margin flexibility and reasonable capital rules. Under-collateralization has not been an end-user problem. Accordingly, I support the latest February 2013 IOSCO/Basel consultation that would exempt non-financial entities that are not systemically important from prescriptive margin requirements. The Commission also needs to come up with a sensible compromise on capital requirements for non-financial SDs. The Commission should encourage non-financial SDs to register. Non-financial SDs provide competition to financial SDs and their presence lets end-users hedge their risks on more competitive terms. On the one hand, Commission capital rules should ensure non-financial SDs have adequate capital to fall back on in the event of market or portfolio stresses. On the other hand, these rules should not put non-financial SDs at a competitive disadvantage.

8. Right to hedge. Speculative position limits should encourage and not unduly complicate prudent commercial risk management practices. Public power end-users using swaps to hedge commercial risk should have the same access to risk management markets as privately-owned utilities. This should be done preferably through regulatory relief.

9. Right to smart regulation. As we move through implementation, we are going to find smarter ways to accomplish regulatory policy goals. The Commission owes the end-user community a commitment that it will amend its rules when these smarter ways become apparent. For example, there may be more prudent ways to implement Part 46 historical swaps reporting for end-users that the Commission should consider. In the interim, the Commission should give end-users a six month reprieve, through October 2013, for historical swaps reporting requirements.

10. Right to be heard. SDs and MSPs are, by definition, big boys and girls who’ve seen the writing on the wall for years. As Commission registrants and as large financial conglomerates, they can go to the NFA or industry organizations like ISDA for guidance on how to comply with our rules. NFA and ISDA and similar organizations have experience orchestrating change on an industry-wide basis. Many end-users, on the other hand, are not used to having their swaps activity subject to CFTC regulation. During and after Dodd-Frank implementation we need a venue for end-users to air their concerns. I call for an End-User Advisory Committee (EUAC) with regularized meetings. End-users face an array of unique compliance challenges and legitimate business and regulatory concerns that warrant the Commission’s focused attention.

Just like the Constitution is subject to amendment (some of the best amendments came almost eighty years after the first ratified draft), so is this document. I look forward to working with end-users, consumers, SDs, MSPs, FCMs, and others as we move through an exciting and challenging implementation period and invite their comments on this End-User Bill of Rights. If we do our jobs as regulators and implement Dodd-Frank quickly and reasonably, the markets will improve for the benefit of end-users and the American public. That was the goal of Congress and that continues to be my goal.

CFTC CHAIRMAN GARY GENSLER'S REMARKS AT CFTC ROUNDTABLE

FROM: U.S. COMMODITY FUTURES TRADING COMMISSION
Chairman Gary Gensler’s Opening Remarks at CFTC Roundtable
January 31, 2013
Welcome to the Commodity Futures Trading Commission (CFTC). Thank you, Rick, and thanks to the team for putting together this roundtable. This is the CFTC’s 21st public roundtable since the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Next week, we'll be holding the 22nd roundtable, the third focused on customer protection.

Today’s roundtable is occurring at an historic time in the markets. The marketplace is increasingly shifting to implementation of common-sense rules of the road for the swaps market.

For the first time, the public will benefit from the greater access to the markets and the risk reduction that comes with central clearing. Required clearing of interest rate and credit index swaps between financial entities begins in March.

For the first time, the public is benefiting from seeing the price and volume of each swap transaction. This post-trade transparency builds upon what has worked for decades in the futures and securities markets. The new swaps market information is available free of charge on a website, like a modern-day ticker tape.

For the first time, the public will benefit from specific oversight of registered swap dealers. As of the end of this week, there will be 71 provisionally registered swap dealers. They are subject to standards for sales practices, recordkeeping and business conduct to help lower risk to the economy and protect the public from fraud and manipulation.

An earlier crisis led to similar common-sense rules of the road for the futures and securities markets. I believe these critical reforms of the 1930s have been at the foundation of our strong capital markets and many decades of economic growth.

In the 1980s, the swaps market emerged. Until now, though, it lacked the benefit of such rules to promote transparency, lower risk and protect investors. What followed was the 2008 financial crisis. Eight million American jobs were lost. In contrast, the futures market, supported by earlier reforms, weathered the financial crisis.

President Obama and Congress responded and crafted the swaps provisions of Dodd-Frank by borrowing from what has worked best in the futures market for decades: clearing, transparency and oversight of intermediaries.

Given that we have largely completed swaps market rulewriting, with 80 percent behind us, today is a good opportunity to hear from market participants on where we are and where we ought to go from here. As we have asked throughout this process, we'd like to hear from market participants today on what provisions for swaps should mirror those for futures and when is it appropriate for there to be differences. I would note that Congress included a number of provisions in Dodd-Frank recognizing appropriate differences. For instance, it is critical that farmers, ranchers, merchants and other end users continue to benefit from using customized swaps that are not cleared.

Now that the entire derivatives marketplace -- both futures and swaps – has comprehensive oversight, it's the natural order of things for some realignment to take place.

The notional open interest of the futures market ranges around $30 trillion. There are various estimates for the notional size of the U.S. swaps market, but it ranges around $250 trillion. Though the futures market trades more actively, just one-ninth or so of the combined open interest in the derivatives marketplace is futures. Approximately eight-ninths of the combined derivatives marketplace is swaps, which until recently were unregulated.

This roundtable also provides an opportunity to hear from market participants on the recent actions of the two largest exchanges. Last fall, IntercontinentalExchange converted power and natural gas-related swaps into futures contracts. In addition, the CME Group's ClearPort products, which were cleared as futures, including those that were executed bilaterally as swaps, are now being offered for trading on Globex or on the trading floor. CME also adopted new block trading rules for its ClearPort energy contracts, as well as began trading a futures contract where the underlying product is an interest rate swaps contract.

It’s important to note that whether one calls a product a standardized swap or a future, both markets now benefit from central clearing. Since the late 19th century, central clearing in the futures market has lowered risk for the public. It also has fostered access for farmers, ranchers, merchants, and other participants and allowed them to benefit from greater competition in the markets. In March, swap dealers and the largest hedge funds will be required, for the first time, to clear certain interest rate swaps and credit index swaps. Compliance will be phased in for other market participants throughout this year.

In addition, transparency has been a longstanding hallmark of the futures market –both pre-trade and post-trade. Now, for the first time, the swaps market is benefitting from post-trade transparency. On December 31, registered swap dealers began real-time reporting for interest rate and credit index swap transactions. Building on this, swap dealers will begin reporting swap transactions in equity, foreign exchange and other commodity asset classes on February 28. Other market participants will begin reporting April 10. The time delays for reporting currently range from 30 minutes to longer, but will generally be reduced to 15 minutes this October for interest rate and credit index swaps. For other asset classes, the time delay will be reduced next January. After the CFTC completes the block rule for swaps, trades smaller than a block will be reported as soon as technologically practicable.

Oversight of intermediaries and the protection of customer funds have long been integral parts of futures market regulation. Futures commission merchants, introducing brokers and commodity pool operators have been CFTC-registered intermediaries. Dodd-Frank extended oversight of these intermediaries to include their swaps activity, and to promote market integrity and lower risk to taxpayers, brought oversight to another category of intermediaries called swap dealers. The initial group of provisionally registered swap dealers includes the largest domestic and international financial institutions dealing in swaps with U.S. persons. It includes the 16 institutions commonly referred to as the G16 dealers. Reforms the CFTC has finalized to enhance the protection of customer funds, as well as proposed enhancements, consistently cover both futures and swaps.

Looking ahead, to further enhance liquidity and price competition, the CFTC must finish the pre-trade transparency rules for swap execution facilities, as well as the block rules for swaps. It is also critical that we preserve the pre-trade transparency that has been at the core of the futures market. In that context, I am looking forward to hearing from panelists today about recent actions by exchanges to lower their minimum block sizes for certain energy futures.

Thank you again for coming, and we look forward to your input.

CFTC COMMISSIONER O'MALIA SPEAKS ON TECHNOLOGY

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION
“I Have One Word for You: Technology”
Remarks by Commissioner Scott D. O’Malia at SIFMA Tech Leaders Forum 2012, New York City, New York
June 19, 2012
Introduction
In the 1967 film The Graduate, Mr. McGuire, a family friend of recent college grad Benjamin Braddock, played by Dustin Hoffman, gives the young, aimless and slightly disillusioned gentleman the sagest wisdom he can, "I want to say one word to you. Just one word.... Plastics.” Mr. McGuire had a vision that there would be a great future in plastics. Benjamin was worried about his future. He wanted it to be “different.” And this guy was telling him in one word that it could be. Today, that one word is "Technology."
I suppose that doesn’t come as a surprise to anyone in this room full of visionaries. Technology is a tremendous asset; it provides leverage and is a force multiplier. My two eldest daughters, Kelsey and Claire, both have quite an aptitude for math and science. Looking towards their future, I hope that they will hear me when I tell them in their own times of uncertainty, “Technology.”

As a regulator, it is an honor to be invited to speak at an event like this since most folks don’t think of the Commodity Futures Trading Commission (“CFTC”) when it comes to technology. And frankly, that makes sense since we have largely remained in the world of “plastics” when it comes to deploying and utilizing technology to support our oversight responsibilities.

Today, in addition to addressing technology in the markets and in the hands of regulators, I would also like to discuss a few other topics including the Commission's rulemaking progress and budget issues as they relate to implementation of the Dodd-Frank Act and the choices we are making. I’m also happy to answer any questions you may have at the end.

I am grateful for the kind introduction by SIFMA President and CEO Tim Ryan. I would like to give you a few more details about my background and explain why I am so focused on technology.

Prior to my nomination to the Commission, I served as the Clerk of the Senate Committee on Appropriations, Subcommittee on Energy and Water where I had responsibility for funding the Department of Energy (“DoE”). That position’s mission was focused on deploying improved energy technologies. But, what few people realize is that the DoE also funds research on everything from nuclear physics to the nuclear weapons program. Simulating, solving and understanding the most challenging physics questions require massive computer hardware and software operating at speeds that previously didn’t exist. And it was my job to fund this cutting edge technology.

After the ban on underground nuclear testing, the weapons program relied heavily on computer simulation that required bigger and faster computers than what currently existed. So, we invested millions of research dollars into advanced computing and simulation. I am especially proud of the Roadrunner supercomputer, a joint effort with Los Alamos National Laboratory and IBM to create what was then the world’s fastest computer. On May 25, 2008, Roadrunner became the first computer to break and sustain the petaFLOP barrier by processing more than 1.026 quadrillion calculations per second. As you all can imagine it is hard to just walk away from one million, billion calculations per second. And, so I didn’t.

Technology Advisory Committee 2.0
I have continued to fly the technology flag, and I have focused a great deal of my term thus far on advancing the use of technology to more effectively meet the CFTC’s surveillance, oversight and regulatory responsibilities largely through reestablishing and chairing the Technology Advisory Committee (TAC).

We are re-chartering for a second two-year term, and, like every technology upgrade, I have branded it TAC 2.0.

I have been fortunate enough to bring together a diverse membership with industry-wide expertise and shared goals of establishing technological “best practices” for oversight and surveillance while informing the Commission of the technological issues related to ongoing rulemakings under the Dodd-Frank Act. We have covered such issues as pre-trade functionality and pre-trade credit checks, data collection standards, technological surveillance and compliance, the deployment of technology solutions in the swaps market, and most recently, algorithmic and high frequency trading. To put a finer point on what we have accomplished since bringing back the TAC in June 2010 with its 24 charter members, we have:

Held seven public meetings;
Established the 19-member Subcommittee on Data Standardization charged with providing recommendations based on public/private solutions for creating well-accepted standards for describing, communicating, and storing data on complex financial products;
Established the 23-member Subcommittee on Automated and High Frequency Trading charged with advising the Commission as to a working definition of high frequency trading (“HFT”) in the context of automated trading strategies;
Issued Recommendations on Pre-Trade Practices for Trading Firms, Clearing Firms and Exchanges involved in Direct Market Access; and
Issued recommendations on data standardization through the use of legal entity and product identifiers.

To be sure, our open forums and the contributions of both members and guest presenters have informed and influenced critical policy and regulatory decisions inextricably linked to technological issues, and I believe that many of our rulemakings are better for it.
CFTC is the LEI Leader

In reviewing today’s agenda, I noticed that the Legal Entity Identifier (“LEI”) is a panel topic. Let me take a moment to update you on where the Commission currently is in its LEI implementation strategy. There is good news and not so good news depending on your time horizon. In terms of progress at the CFTC, I’ve got some good news. As to the Global LEI, the news is not as good.

By way of brief background, the CFTC’s swap reporting rules require that counterparties report their trades to a swap data repository (SDR) and be identified by a legal entity identifier. LEIs will be a crucial data aggregation tool that enables the CFTC to utilize the data in SDRs to perform the fundamental mission of monitoring both the swaps and futures markets. It will also give us insight into systemic risk exposure, one of the main goals of the Dodd-Frank Act.

CFTC Leads in Establishing the Legal Entity Identifiers
As was made abundantly clear by the TAC Subcommittee on Data Standards in its final recommendations at our March meeting, a LEI is feasible and the sooner we apply it, the better. As I noted, there is good news and not so good news. The good news is that the Commission is moving to bring LEI’s online for U.S. firms (or anybody transacting in the U.S.) to have an LEI by the time mandatory reporting is required for credit swaps and interest rate swaps, which will be 60 calendar days after the publication in the Federal Register of the Commission’s final rule providing further definition of “swap” (a/k/a “Compliance Date 1”).1

As part of its cooperation with international process, and because the use of identifiers will begin in reporting under CFTC jurisdiction before the global system is established, CFTC is referring to the identifier to be used in reporting under its rules as the CFTC Interim Compliant Identifier or the “CICI”. The Commission anticipates that when the global LEI system is established, the CICI will transition into the global system.
On March 9, 2012 the Commission requested submissions from industry participants wishing to be considered to provide the CICI. The Commission received submissions from several industry participants, and all candidates have provided written demonstrations and live, on-site demonstrations. As I mentioned earlier, the Commission anticipates determining whether a CICI meeting its requirements is available, and designating that provider as the source for CICIs to be used in swap data reporting under Commission jurisdiction, in the very near future.

Status of International LEI Process Coordinated by FSB
While, I was assured that the initial issuance of LEIs by an international body would occur by spring 2012, the international effort has been delayed until March of 2013. The delays are related to governance issues and the insistence upon greater public sector involvement, albeit they still require a private sector solution to implement the systems.

At its May 2012 meeting in Hong Kong, the Financial Standard Boards (“FSB”) approved recommendations for a global LEI system to the G-20 Leaders for consideration (this week) at their summit in Los Cabos, Mexico.2

The recommendations set out a three-tiered governance framework that includes:
A Regulatory Oversight Committee (ROC) committed to support governance in the public interest;
A Central Operating Unit (COU) for ensuring application of uniform global operational standards, and having a Board of Directors that may include both industry representatives and independent participants; and
Local Operating Units (LOUs) that provide the primary interface for entities wishing to register for an LEI, and provide local implementations of the global system.

Further delaying implementation, the recommendations provide for establishment of an LEI Implementation Group (LEI IG), comprised of LEI experts from the global regulatory community charged with launching the global LEI system by March 2013. The LEI IG will be led by representatives from different geographical regions, and will undertake legal and policy work to develop the charter for the ROC and the governing documents for the system, and technology work with the private sector to establish the COU. CFTC will be a member of the LEI IG.

Let me remind you of the good news. In the meantime, the Commission will be adopting its interim LEI, and this should cover roughly half of the overall swaps market. I hope the timely application of an LEI by the Commission will reduce the costs of applying an LEI system retroactively.

HFT Technology in the Market
I would like to spend a few minutes to share with you my thinking on high frequency trading. This topic has generated passionate views, both pro and con, and spawned headlines, economic studies and even books on the subject.

HFT currently accounts for a majority (56% in 2011) of the U.S. equity volume3 and is approaching 50% of our futures market transactions. The influx of high frequency traders are behind the massive trading volume increases. Supporters argue that HFTs are the modern pit trader market makers that narrow bids and provide essential liquidity. Detractors complain that HFT have changed the market dynamics by playing games with trade strategies that bait hedgers and have reduced trade size. The bottom line is there is no definition for, or, rather, there is a struggle to find an appropriate characterization of this practice in our markets.

In a forthcoming study to appear in The Journal of Portfolio Management, Easley, Lopez de Prado, & O'Hara4point out that automated trading systems have created two markets. One market populated by low frequency traders that focus on “macro factors” like available supply, monetary policy and financial statements, while the HFT market focuses “market microstructural factors such as “rigidities in price adjustments across markets” and “variations in matching engines.” The authors accurately point out that the “the goal [of HFT] is to exploit inefficiencies derived for the markets microstructure, such as rigidities in price adjustment within and across markets [agents], idiosyncratic behavior and asymmetric information." What we have here is a tale of two markets operating in one venue.

This is a topic I am very interested in, especially in terms of its relative impact on the markets. What I find most intriguing about the debate itself is that it is not always clear that folks on the pro side and folks on the con side are even talking about the same thing. One person’s HFT may not be another’s. In an effort to take the first step and define the practice, last November, I sent a letter to the Technology Advisory Committee members asking them for their opinion on a definition of HFT. After hearing back from them, I took the next step and formed through a public nomination process the Subcommittee on Automated and High Frequency Trading to develop an appropriate definition of HFT within the universe of automated trading. My goal is to have a working description of the attributes of HFT activities in order to better understand the impact they have on our markets. Developing a nomenclature is important if only as a means to study this trading activity on a consistent basis. Before we implement a new regulatory regime on any continent or in cyberspace, I believe we need to agree on what and who comprises this growing segment of our markets.

Within the ATS/HFT Subcommittee, we have established four working groups, each tasked with identifying specific issues associated with automated trading. The first working group is tasked with defining high frequency trading within the context of automated trading systems. The second group is examining whether or not there should be multiple categories of HFT. Specifically, this working group is examining distinctions in trading activity and how such distinctions should be identified or tagged by the exchanges in which they operate. The third working group is focusing on oversight, surveillance and economic analysis, to understand how HFTs behave as compared to other automated systems. The fourth working group is addressing market micro structure issues to identify possible disruptions that might be provoked by automated trading systems and potential solutions to mitigate such events. Under the leadership of CFTC Chief Economist Andrei Kirilenko and fellow CFTC staff these working groups have been conducting weekly conference calls and will be presenting their preliminary views at the public meeting of the TAC I am holding tomorrow at our CFTC headquarters in Washington.

My goal is to collect the facts, develop the data about the impact of HFT (and all automated trading for that matter) and establish a consistent, universally acceptable view on our new market participants. I never intended to assemble this group to develop rulemakings. This expert group was organized to define and discuss the current and potential impacts of HFT in the futures and swaps markets. It is up to the Commission to develop the policy solutions, and I hope that the Commission will benefit from the extensive debate and hard work of the Subcommittee as well as empirical market data before it considers taking action.

Technology in the Hands of Regulators
Technology in the hands of regulators is a good thing, and I will always support it in any role I have. We are now at the CFTC only beginning to leave “plastics,” but our new Office of Data and Technology headed by Chief Information Officer John Rogers is making progress. Trust me, it is all relative. What my colleagues are seeing now is that technology offers us the opportunity to see across our jurisdictional markets (futures and swaps) and the only way we can develop the appropriate level of surveillance is through the deployment of algorithms and automation. Expanding our surveillance to include order data will require additional hardware to store and sort a massive amount of data. The CFTC has a long way to go, especially when it comes to automating some of our more mission-critical goals such as monitoring systemic risk, but we have learned a thing or two during our first attempts to automate large trader reporting for swaps and I have some ideas as to how we can leverage our expertise.

High-Frequency Regulation
One thing I have been critical of is our speed of regulation—which has nothing to do with technology. In fact, it is speed that I think has caused us to err in some of our rules such as the large trader swaps reporting rules and in our cost-benefit analyses. I do have good news on both fronts though, and things are looking bright and shiny, but not like plastic.

For those of you who are unfamiliar with the typical Washington rulemaking process, it is generally long and all-consuming. Before the Dodd-Frank Act, the Commission issued three or four rules a year at best. My friend and former Commissioner Mike Dunn would always say that most of the Commission’s rules normally take anywhere from 15 to 18 months to finalize. So, trying to complete more than 50 rules in that amount of time guarantees mistakes and errors.

Remember the bumper sticker during Bill Clinton’s 1992 campaign, "It’s the economy, Stupid”. Well, that is still true today. However, in the Dodd-Frank microcosm “It’s the implementation, Stupid.” Let me give you an example of how important it is for the Commission to develop well thought out rules, informed by actual and realistic cost benefit analysis. We can’t guess or make assumptions about the swaps market and hope or expect market participants will be able to comply.

The Commission passed its final large trader reporting rule for physical commodity swaps under Part 20 in July 2011.5 There were a number of problems including:
The futures and options position reporting format under Parts 16 and 17 of the Commission regulations simply could not accommodate the new data needs for Part 20 swap reporting, and Industry standards for large trader swaps reporting (via XML) did not exist.


The Industry couldn’t comply within the two-month implementation deadline, and an extension had to be grated 6. On December 7, 2011, the Commission issued a 172-page guidebook7, which was longer than the rule itself.

The Commission’s Office of Data and Technology (ODT) has now developed rules to ensure that data is submitted accurately and has provided data submitters with an automated way to test their data at any time. As well, ODT now provides an automated feedback mechanism to submitters so they will know about data reporting issues (e.g., files not received, missing data) in real-time. And, just to be sure, DMO and ODT revised the Part 20 guidebook, and released the new 226-page version about three weeks ago.8
On November 20, 2011, the Commission started to receive records on a limited basis. Today, our CIO informs me that we are now receiving approximately 500,000 records per day from clearing members and an additional 200,000 records from clearing organizations. The no-action relief issued to reporting industry participants by the Division of Market Oversight9 will end in less than two weeks on July 2nd, so I am eager to hear the numbers.

I know ODT is eager about the upcoming final rule that will further define the term “swap”. Swap dealers will be required to submit data under Part 20 just 60 days after that final rule is published. Today, 50% of clearing members are in compliance with the FIXML or FpML reporting, and given what we have put them through, that is good news to me.

The lesson, I think, has been learned: swaps and futures markets are different. The large trader reporting project proves my point that the Commission must spend an appropriate amount of time understanding swaps markets and the ramifications of these rules, including the cost and benefits of each and every rule before they are finalized, not after.

Some of you may know that I have been very critical of the Commission’s cost-benefit analyses. The Commission previously minimized the role of performing complete cost-benefit analyses by turning the process into an administrative, check-the-box exercise. The good news is the Commission has altered course and the Chairman recently signed a Memorandum of Understanding with the Office of Information and Regulatory Affairs (“OIRA”) within the White House to provide technical expertise in order to develop a more thorough process for conducting the Commission’s cost-benefit analyses during the implementation of the Dodd-Frank Act.

In my view, there are three critical areas where the Commission can and must improve its cost-benefit analysis. First, the Commission should develop a realistic and status quo ante baseline. Second, the Commission should develop replicable quantitative analysis, which will allow it to make informed decisions about the market. Finally, the Commission should develop a range of policy alternatives for consideration. All three of these standards are best practices recommended in the Office of Management and Budget Circular A-4, Regulatory Analysis, which was issued in 2003. I can’t help but wonder that if we had committed the time and resources towards engaging in more thorough cost-benefit analyses that considered not only the differences between the futures and swaps markets, but that set appropriate baselines, considered alternatives, and truly attempted to quantify those baselines and alternatives, that we wouldn’t be challenged as an agency to put forth rules that are sure to stand the test of time—or at least a legal challenge. Plastic might last for an awful long time, but our rules need to be even stronger than that. We need to move on from that illusion and be “different.”
Budget

Before I close, I would like to a moment to highlight the budget situation.
This year, we have a unique budget situation. There are two budget deals that the Commission must manage. The first is our annual appropriation. Every year, brings uncertainty when the House and Senate produce two different funding solutions. This year is no different, and it will be resolved. The Senate and House will reconcile their differences and we are likely to have more funding in 2013 than we have in 2012. The only remaining question is, “When?”

The second budget factor is the debt summit that Congress and the Administration agreed to last August. This deal is set to implement on Jan 1, 2013, and it will automatically cut discretionary spending government-wide by 8 percent ($1.2 trillion in 2013). The impact on the Commission’s current year budget would be a $16.4 million reduction, translating to $188 million in total spending.

I am not aware of any plan of action for the Commission to hedge its budget exposure in the likely event that the mandatory cuts occur in January. I want to make sure the Commission avoids layoffs or other morale-busting action. Also, I don’t think anyone can predict what spending baseline the January cuts will be initiated. The prudent action is to avoid over-spending until our budget future is clear.

I have asked our budget officers for some information about the Commission’s spending outlook. Today, we have 692 people on board, less than the 710 FTE’s planned for under our $205.3 M budget. This amounts to $130 million in spending on employees and $45 million on IT, which is $175 million total, $13 million below the level proposed to be cut in January.

Just like the markets, we need to hedge our risk. Clearly our most pressing risk is the impact of morale-busting layoffs. We have worked our staff extraordinarily hard to develop the rules, take the meetings and respond to questions. Now we are moving toward critically important rules (e.g. margin, SEF, mandatory clearing and trading, definitions, extraterritoriality). We are also entering into the implementation phase. We need people to interpret the vague and uncertain rules we have just put into effect.
Now is the time for the Commission to lock in our hedge, freeze our spending so we don’t risk over-spending and forced layoffs. This debt summit deal has been in place for almost one year. To not prepare for the worst would be irresponsible and unfair to our current employees and the Commission as a whole.

Closing
Without a doubt the Commission has a number of very real challenges ahead. First, we are adapting sensible rules that fulfill the statutory mandates of the Dodd-Frank Act. These rules must be developed with careful cost benefit analyses to ensure both the market and the Commission have the capacity to implement the proposals in a cost-effective and timely manner. We must also pay closer attention to the rule implementation. The more we work to understand the impact of our rules, the more likely the implementation process will be successful.

Second, as we approach the end of the fiscal year, we must be very careful about our spending. The budget challenges facing this nation are real and must be addressed. As such, the Commission must pick its path carefully to navigate the fiscal challenges ahead.
Finally, the Commission must make technology a much higher priority. We have taken the right steps to begin to adopt the 21st Century market technology, and put the fax machine era in our rear-view mirror, but we still have a long way to go before we are at an acceptable position. We also need to work hard to continue to understand the role technology plays in both the fundamental trading strategies as well as the microstructure strategies that the HFTs deploy. I will continue to use the Technology Advisory Committee to engage market participants to find solutions to these challenging questions.
Thank you.

1 Swap Data Recordkeeping and Reporting Requirements, 77 Fed. Reg. 2136, 2196 (Jan. 13, 2012) (To be codified at 17 C.F.R. pt. 45).

2 Financial Stability Board (FSB), A Global Legal Entity Identifier for Financial Markets,
June 8, 2012, available atwww.financialstabilityboard.org/publications/r_120608.pdf.

3 U.S. Securities and Exchange Commission, Organizational Study and Reform at 258, Mar. 10, 2011, available at http://www.sec.gov/news/studies/2011/967study.pdf.

4 David Easley, Marcos M. Lopez de Prado & Maureen O’Hara, The Volume Clock: Insights into the High Frequency Trading Paradigm, The Journal of Portfolio Management (forthcoming) (Fall 2012), Electronic copy available at: http://ssrn.com/abstract=2034858.
5 Large Trader Reporting for Physical Commodity Swaps, 76 Fed. Reg. 43,851 (July 22, 2011) (to be codified at 17 C.F.R. pts. 15 and 20).

6 See Temporary and Conditional Relief from the Requirements of §§ 20.3 and 20.4 of the
Commission's Regulations Regarding Large Swaps Trader Reporting for Physical Commodities (Nov. 18, 2011),available at: http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/relief_letter_111811.pdf.

7 Large Trader Reporting for Physical Commodity Swaps: Division of Market Oversight Guidebook for Part 20 Reports, Dec. 1, 2011, available
at:http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/ltrguidebook120711.pdf.

8 Large Trader Reporting for Physical Commodity Swaps: Division of Market Oversight Guidebook for Part 20 Reports, June 1, 2012, available
at:http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/ltrguidebook053112.pdf.

9 Staff No-Action Relief: Temporary and Conditional Relief from the Requirements of §§ 20.3 and 20.4 of the Commission’s Regulations Regarding Large Swaps Trader Reporting for Physical Commodities (Mar. 20, 2012),available at: http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/relief_letter_032012.pdf.

CFTC COMMISSIONER CHILTON AND DOCTORS NO,WHO AND ALL THE REST .

FROM:  COMMODITY FUTURES TRADING COMMISSION
“The Good Doctors”
Keynote Address of Commissioner Bart Chilton to the Mutual Fund Directors Forum, 2012 Policy Conference, Washington, DC
June 19, 2012
 Introduction
Good evening and thanks for that kind introduction.  It’s great to be with you.  I'm always impressed with people like you who take the time and travel away from your businesses and families to visit Washington and make your case on issues. That's an important thing, and it doesn't matter on which side of issues you fall. It’s a privilege to have an opportunity to be with you for some of your time in D.C. Even after 26 years in this town, it is still intriguing to hear that magical word “policy.”  I hope this year’s policy conference goes well for you.

Regulatory Health
Let’s discuss some policy issues, but do it within the construct of financial market regulatory health.

Before I get to it, is there a doctor in the house? The older I get, the nicer it is to know if we are close to a doctor. Any medical doctors, PhDs, doctors of love, as Gene Simmons says, anyone? Okay, great.

The financial health of markets: aren’t these markets astonishing? Aren't you sometimes simply in awe—in awe—of what they do and how they do it. They are pulsing every day and all night around the world to the beat of 160 million transactions a day.  It’s incredible they work as well as they do.  At the same time, though, we all know that once-in-a-while, they need a doctor. There is often a shock associated with that awe. Maybe that’s because of a Flash Crash, a major bankruptcy, a massive trading loss or any number of other problems. And yes, when there’s talk about needing a doctor—or, in this context—needing a little regulatory check-up, some people’s blood pressure starts to rise.  Chill pills are for that stuff, dude. Let’s just review how not taking very good care of our financial markets got us to where we are today.

 Dr. Drew
We don’t need to guzzle ginkgo biloba beverages to recall 2008 and the collapse of Bear Stearns, Lehman Brothers and AIG; the resulting dreadful bailout and the devastating effect on our own and a large part of the global economy.  Thinking about all of that raises a little financial PTSD for some people.
“Doctor my eyes,
Tell me was I wrong.
Was I unwise to leave them open for so long?”

Well, as hard as it is to think about 2008, there is that whole “learning from our experiences” or rather—mistakes—thing.

Who is familiar with CNN's Dr. Drew Pinsky, Dr. Drew—the former Love Line co-host?  If you’ve ever watched the show, he deals a lot with addictions—drug addictions, alcohol addictions, food addictions, sex addictions—you name it.  He is an impressive guy and he's helped a lot of people. One thing he always says is that the first step to recovery is admitting you have issues.

Well, in 2008 and the years leading up to it, we had issues. We had a problem, and we’re still in recovery today.  The point there is that we are recovering.  We are getting better, thank you very much. Congress recognized that we had a problem and passed the Dodd-Frank Wall Street Reform and Consumer Protection Act about two years ago right now.  That’s good, because we clearly needed something: therapy, recovery, whatever. As they often say in this town, "mistakes were made."

 Dr. Seuss
Once you’ve acknowledged the problem, therapists would suggest dissecting it to understand what went wrong. There were a couple of causes to the financial illness—the economic crisis—“Things,” if you will—that led to the system pretty much failing us.
 Thing One—shout out to good Dr. Seuss—were lax or non-existent laws and regulations that allowed the free markets to rock ‘n’ roll so much that they rolled right over our economies—and our citizens.

There is an old saying about how the best things in life are free. Well, the worst things in life are also sometimes free, like disease and famine and, yes, unbridled free markets with zero, zip, zilch oversight.  Of course, it wasn’t just the lax laws, rules and regulations.  Nope, Thing One just allowed for unprotected and risky behavior...and risky business.
CHFT
Thing Two were the active agents:  the captains of Wall Street—that’s how the FCIC, the Financial Crisis Inquiry Commission, described them. They wholly developed these very pioneering products, these innovative investments to be traded and re-traded.

Light markets, dark markets, big markets, small,
Green, red and black markets, they traded them all,
Burning up the fiber and fires on the phones,
And then what they did, was trade bundles of loans,
The markets were rising with new dough, don't you know,
And cheetah technology, that just never went slow,
The risk was so portable, so easy to move,
That sometimes they wondered, just whose risk they might lose Trading and trading is what kept them alive
And they did so, this trading, 24-7...365.
Thing One and Thing Two:  those harmless numskulls, what could go possibly go wrong?

 Dr. No
 Well, go wrong it did. We admitted and acknowledged we had a problem and received some treatment.  The problem, the condition if you will, today is: the recovery—the work—is not complete and there is temptation to do away with the very laws—the recovery program—we were admitted to in reaction to the 2008 financial crisis and the all-to-close-to collapse of national economies.  Let’s call that a near relapse.
There have been moves afoot in Congress to repeal some or all of Dodd-Frank, primarily by some of those who voted against it in the first place.  That's okay; they do and vote the best they see fit. Nobody is suggesting we all have to go about things the same way. Remember the James Bond antagonist, Dr. Julius No? Let’s call these folks Dr. Nos.  Many of this group voted no, or nay—on Dodd-Frank and on full funding for regulators.  The Dr. Nos would defund the precise market health professionals who were given the rather tough task of keeping an eye on Wall Street.  And, still others, including regulated entities themselves, like your group, are choosing to fight the new regulations in court. That’s fine. We are a litigious society. I'm not going to touch that one now. I'll leave that not to the doctors, but the lawyers.

The President requested, and the Senate Appropriations Committee passed, a CFTC funding level of $308 million. In the House, the Dr. Nos are proposing only $180 million. In Europe, they’d call that an “austerity measure.” But let’s call it what it is: a seriously substantial and severe budget reduction. Cutting our Agency’s oxygen off so that our nation can’t have market health professionals on the case or the technology we require to monitor those that we are supposed to be overseeing is not putting the financial health of the American people first.

Think about MF Global.  Think about JPMorgan.  Are these markets really any safer and healthier than they were when they did a code blue in 2008?  A little, I’d say.  However, we’re still in recovery mode for sure.  We still require a doctor.  And, it is still essential to pay for it.  There are some folks in this town and on Wall Street who wish Dr. Kevorkian was still around for us regulators. They are doing their best without him to administer a little euthanasia. The financial sector still has 10 lobbyists for every single member of Congress—more than any other sector. They are pretty effective at getting their way.

As regulators, we don't make the laws. If Dodd-Frank went away, I'd think it was a mammoth mistake, but the law is the law and we Commissioners swore an oath to uphold it. That is, however, what we are doing right now—upholding the law—the law. We owe it to taxpayers and consumers to insist that these markets remain healthy.

Dr. Phil
Most folks know TV's Dr. Phil.  He’s forever talking about setting limits, especially in relationships.  If somebody pushes your buttons: be it a parent, child, spouse, co-worker or friend, Dr. Phil will suggest setting some limits.  Don’t get sucked into their world or their drama.  Well, if limits are good enough for Dr. Phil, they’re good enough for me—especially when it seems like an appropriate prescription for a policy I have supported for many years.

 A fundamental part of Dodd-Frank, which only seems to gain public attention when gas prices are high, is speculative position limits.  (And yes, this is another one that’s being challenged in court).

As we all know, oil and gasoline prices were very high earlier this year. The highest prices were actually in the summer of 2008. The average national price of gasoline in July of that year was $4.10 a gallon. There was a lot of attention to the subject then, and there was earlier this year. Today, not so much, although limits are still an essential medication to reduce market manipulation.

Here’s why: numerous studies show a link between speculation and prices. Studies from the International Monetary Fund, the Federal Reserve, and numerous universities all show it.  There was a senior exchange official who a little more than a year ago said there wasn't any evidence that linked speculation to prices. There was even a former colleague of mine who kept saying there was no evidence. Wha wha what? It was amazing. Last year, I put 50 studies, papers and notable quotations from respected individuals on the CFTC web site. They are still there. I talk about them all the time, including right now. I can continue to explain this to people, but I can't comprehend it for them.
Why does a trader need so much concentration that they can push prices around?  I just don’t get it.

 Large concentrations in silver, gold, natural gas, crude oil and orange juice have existed in recent years. I've witnessed it, and at times, I've seen prices react.
In addition to the bankers' lawsuit which seeks to stop our position limits rule from being implemented, regulators have been derelict in not getting them in place sooner.  We keep hearing that imposition of limits is being held up because it's contingent upon our issuance of a swaps definition, and Dodd-Frank requires that we do that as a joint rulemaking with the SEC.  That's correct. Dr. Phil might ask, “How’s that workin’ out for ya?”  Well, I'd say, "Notsamuch, Doc."

I have respect for my regulatory colleagues, but I've gotta say, they’ve moved so slow that I think we need to check their pulse on this one.  Call me an impatient patient, but we have a responsibility to act here, and it's high time we do so to protect markets and consumers.
A man runs into the doctor’s office and says, “Doctor, you need to see me immediately, I think I’m shrinking!” The doctor says, “Calm down and take a seat. You will have to wait your turn and be a ‘little’ patient.” Well, we’ve been a little patient. We’ve been a lot patient.

Earlier this year, in March, I suggested we "consider" using a provision of Dodd-Frank that shifts unresolved jurisdictional disputes to the Financial Stability Oversight Council (FSOC) if an agreement can’t be found. We have been continually reassured we are going to consider this joint rule with the SEC "next month." We've been told that each month since my Agency approved limits. We were told it could happen last December and subsequently almost every month. I see no promise of movement from the SEC on this. We are two years into this new law, and position limits were supposed to be implemented after six months. The FSOC should resolve this.

Dr. Dolittle
Another policy issue I want to spend some time on is the issue of technology in trading.   I was going to call this section “Dr. Strangelove” since he was always fiddling around with technology—in his case nuclear weapons—or maybe “Dr. Leonard McCoy” from Star Trek. “Dammit Jim, I’m a doctor…” not a regulator.

There are a lot of people fiddling around with technology in financial markets today. But instead, I decided on Dr. Dolittle because I call these high frequency computer traders "cheetahs" due to their incredible speed as they travel through the market jungle.  They are out there all the time trying to scoop up micro-dollars in milliseconds. They are wicked smart and clever. I talked to the animals last week. By the way, they really are very agreeable and shrewd folks. I’m just jesting, of course. Nevertheless, I told them very clearly that they need to be regulated.

Here are the problematic symptoms that led to my, umm, diagnosis. The largest futures exchange in the World is in Chicago.  Their third largest trader by volume there has been a cheetah based in Prague.  Bully for the exchange, which has touted this firm in their magazine.

As an aside, I’ll note the curious case of the vanishing articles. The story about this Prague cheetah was in the fall of 2010 and it appeared in the exchange magazine. While you can find the issue on their web site, that article about the cheetah disappeared. I was alerted to this by two reporters who were fact-checking my stuff about the cheetah. When they asked the exchange about it, they were told that the story didn't exist. So, I looked into it. After some digging, I found it again. But, what the exchange did was took it off their web site. As it turns out, there is another story missing from that same edition: one about Jon Corzine, in which he talks about taking more risks as the, then, new head of MF Global. I have both stories. Folks have a right to keep whatever they want on their websites. I just think it is curiously peculiar that they'd pull those two stories—strange, but true.

So, bully for the exchange. Bully for the cheetah.  Bully for Prague. Hooray for Prague!
However, if we, the U.S. regulators, simply want to look at books and records, perhaps because we are concerned about trading activities on a U.S. exchange—it could happen—that cheetah in Prague is not required to provide us with anything. Nada.  Furthermore, we don’t even have the ability to command books and records information from domestic cheetahs.  Nada. These cats are not required to provide a thing to U.S. regulators, under the current set of circumstances, unless we get a judge to issue a subpoena.  It is simply loco.  Nada? informaciónnes de los catos es un problemo.

At the very least, the cheetahs need to be registered.  Yet, no place in the Dodd-Frank law are these traders even mentioned.  That is how quickly the markets are metastasizing.

I believe there is some value to the cheetahs. However, their awesomeness isn't too difficult to contemplate. I wrote about these traders in a Financial Times op-ed a long time ago (September of 2010).  In it, I suggested, “There is a good argument to be made that ‘parasitical trading’ does not truly contribute to fundamental market functions.”  I’m not trying to get rid of them—make the cheetahs an endangered species.  There's no opposition to new technology here.  The cheetahs do provide liquidity—albeit what I’ve dubbed as "fleeting liquidity."  If you want someone to hedge your commercial risk for 3-5 seconds, I know just the cats for the job.

I also believe that these cheetahs have a disproportionate influence on markets simply because of their speed.  Their trading volume isn’t traditionally large—although in overnight illiquid trading even smaller size trades can move markets. We’ve seen that many times—but their swiftness as traders can send signals to the market when they’re in pursuit of their prey.  That, in and of itself, is fairly new and presents troublesome issues.
Consequently, I’m suggesting that in addition to the cheetah registration requirement, we require testing of their programs before they are engaged in the market production environment. The programs should have kill switches in case they go feral. We need to require quarterly reports on their wash sales (and that they undertake efforts to stop those from occurring). And finally, cheetah executives, the head of their pride, must be accountable for such reports.

I expect the Agency to issue a concept release related to technology very soon. My colleague, Commissioner O'Malia, has done a lot of good work on these issues as the Chair of our Technology Advisory Committee. I’m hopeful, and expect (certainly if I am to support it), that as part of this concept release, these ideas will be included and we will receive some public comments to facilitate us moving forward.

Dr. Jekyll
A doctor says to her patient, “You have a split personality, a mental disorder—you’re crazy.” To which the patient says, “I want a second opinion.” The doctor says, “Okay, you’re ugly, too.”
Remember Dr. Jekyll from The Strange Case of Dr. Jekyll and Mr. Hyde? It had to do with split personalities, within the same body.

Just like Dr. Jekyll, who had two personalities, we see that the banks themselves have a troublesome duplexity. This split personality was created when the Glass-Steagall Act was repealed in 1999. Currently, banks have two voices in their heads. They have an interest in their proprietary bottom line, and in their customers. When the two distinct personalities are opposed, just like Dr. Jekyll and Mr. Hyde, it can get unpleasant. And, it has. Here's what we know: with the banks, we understand which personality supersedes. They do—the banks. The customers’ interests can become secondary.

Some would argue that the two can exist in the same body, but the evidence doesn't support that—not at all. We saw Goldman Sachs and Citibank both establish what I've termed "fake-out funds," like when a player fakes in a ball game. Only this isn't a game. It involves real money for the bank customers.

The two banks each established these funds, recommended them to their own customers, and then the banks took the opposite position. That's pretty sinister, right? A dreadful mixture of contrasting motives played out in a crooked fashion. The Goldman case was settled with the SEC for $550 million. The Citibank settlement with the SEC, for $285 million, was actually thrown out by U.S. District Judge Jed Rakoff for being too lenient. He called it “a mild and modest cost of doing business.” Soon, he's expected to rule on the matter himself.

“Doctor, doctor, give me the news…” What’s the answer to…these policy blues? No pill is gonna kill this ill, it will take the… Volcker Rule.

Well, the Volker Rule is the law. If regulators are thoughtful and implement it appropriately, it will take the banks’ split personality, their troublesome duplexity, out of the equation. I believe we can, and will. Again, it is our responsibility to do so, under...the law.

Conclusion—Dr. Marcus Welby
Well listen, I should wrap this up.  I know you’ve got another big day tomorrow.  We will leave all of the rest of the doctors alone tonight. Doctor Who? Yeah, him, and the rest: our cowboy Docs Holliday and Scurlock, Docs Severinsen, Hollywood and Watson, Dr. Ruth and Sanjay Gupta, Doctor Frasier Crane and Dr. Laura, Doctors Dre, Evil, Feelgood and Demento. You can play at home. It’s fun for the whole family.
This will really date me, but Dr. Marcus Welby was played by actor Robert Young. He, Young the actor, used to do these television commercials that would start off with him saying something like: “I’m not a doctor, but I play one on TV.” Then, he'd endorse some health-related product, like aspirin. Well, I'm not a doctor. And, I DON'T play one on TV, but I sure have enjoyed speaking about the health of our financial markets and the ongoing need for preventative care by regulators to protect investors, hedgers and yes, most importantly consumers.

I’ve got to run to the ER. Thank you for the opportunity to be with you.  Nurse!

CFTC CHARGES MAN AND COMPANY WITH RUNNING A SILVER BULLION PONZI SCHEME

FROM:  COMMODITY FUTURES TRADING COMMISSION
CFTC Charges Ronnie Gene Wilson of South Carolina and His Company, Atlantic Bullion & Coin, Inc., with Operating a $90 Million Silver Bullion Ponzi Scheme

Defendants are allegedly to have fraudulently sold contracts of sale of silver in a nationwide scheme
Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today announced the filing of a federal civil enforcement action charging defendants Ronnie Gene Wilson (Wilson) and Atlantic Bullion & Coin, Inc. (AB&C), both of Easley, S.C., with fraud in connection with operating a $90 million Ponzi scheme, in violation of the Commodity Exchange Act (CEA) and CFTC regulations.

The CFTC’s complaint charges violations under the agency’s new Dodd-Frank authority prohibiting the use of any manipulative or deceptive device, scheme, or contrivance to defraud in connection with a contract of sale of any commodity in interstate commerce in violation of Section 6(c)(1) of the CEA, as amended, to be codified at 7 U.S.C. §§ 9, 15 and the CFTC’s implementing Regulation 180.1 (a). The complaint was filed on June 6, 2012, in the U.S. District Court for the Southern District of South Carolina, Anderson Division.

According to the complaint, since at least 2001 through February 29, 2012, Wilson and AB&C operated a Ponzi scheme, and, as part of the scheme, fraudulently offered contracts of sale of silver, a commodity in interstate commerce. Through their 11-year long scheme, the defendants allegedly fraudulently obtained at least $90.1 million from at least 945 investors for the purchase of silver.

From August 15, 2011, through February 29, 2012 – the time period during which the CFTC has had jurisdiction over the defendants’ actions under new provisions contained in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 – the defendants allegedly fraudulently obtained at least $11.53 million from at least 237 investors in 16 states for the purchase of contracts of sale of silver. The complaint further alleges that during this period, the defendants failed to purchase any silver whatsoever. Instead, the defendants allegedly misappropriated all of the investors’ funds and to conceal their fraud, issued phony account statements to investors.

In its continuing litigation, the CFTC seeks restitution to defrauded investors, a return of ill-gotten gains, civil monetary penalties, trading and registration bans, and permanent injunctions against further violations of the federal commodities laws.

The CFTC appreciates the cooperation and assistance of the U.S. Attorney’s Office in Greenville, S.C., and the U.S. Secret Service.

CFTC Division of Enforcement staff responsible for this case are A. Daniel Ullman II, George H. Malas, Antoinette Chance, John Einstman, Richard Foelber, Paul G. Hayeck, and Joan M. Manley.

COMMISSIONER DANIEL M. GALLAGHER SPEAKS AT CREDIT SUISSE GLOBAL EQUITY TRADING FORUM

The following excerpt is from the SEC website:

“Remarks at the Credit Suisse Global Equity Trading Forum
Commissioner Daniel M. Gallagher
Miami Beach, FL
February 17, 2012
Thank you, John [Anderson], for that very kind introduction. I am pleased to be here today.
Before I continue, I need to provide the standard disclaimer that my comments today are my own, and do not necessarily represent the positions of the Commission or my fellow Commissioners.

The broad topic of this conference is “Seeing Beyond,” and this theme is particularly relevant given the focus of my discussion this morning--Dodd-Frank, with a special emphasis on the Volcker Rule. Indeed, for the financial services industry, not just in the U.S. but worldwide, it is very difficult to “see beyond” Dodd-Frank. The largest financial reform law in 70 years has and will continue to impose massive costs on market participants, and will reconfigure the financial services industry worldwide, but the amount of these costs and the scope of this reconfiguration are still highly uncertain.

18 months on, regulators are still working to implement Dodd-Frank, and most, if not all, of the new regulatory undertakings are very much works in progress. Regulators are therefore in a difficult position, because the markets and the public need regulatory guidance and certainty, but that certainty can and should not come at the cost of hasty and ill-considered regulatory initiatives that will damage the real economy that Dodd-Frank ostensibly is designed to protect.

At the SEC, we face this tension every day. Dodd-Frank requires more than 100 rulemakings and studies from the agency. Among these rulemakings, Dodd-Frank mandates that the agency build regulatory infrastructures from scratch in several areas, including the OTC derivatives market, in conjunction with the CFTC; the registration and oversight of municipal advisors; and the registration and oversight of hedge funds and private equity funds. The sheer breadth of rulemaking for the agency argues for a general approach that is systematic yet incremental: particularly in areas where we are creating new regulatory paradigms, we should strive to build a solid foundation, and develop the regulatory regime over time as the markets and our expertise in those markets develop.

It is also important to remember, as we implement Dodd-Frank, what the law did and didn’t do, particularly as it relates to the SEC. Critically, it did notchange the fundamental mission of the agency. Our mission was and still is to protect investors, maintain fair and efficient markets, and promote capital formation. Dodd-Frank did not make us a banking or safety and soundness regulator. We still regulate markets that are risky, and where the taking of risk is critical to capital allocation and the healthy functioning of these markets and the broader economy. Moreover, in terms of the additional responsibilities given to the SEC, both in those areas we traditionally oversee and those that we don’t, Dodd-Frank reinforced Congress’s nearly 80-year commitment to a strong, vibrant, expert and independent equity markets regulator.

Which brings me to the Volcker Rule. I can think of no better topic to address today. It is not only timely--the comment period to the proposal closed this week, to great fanfare in the press--but it may, perhaps more than any other rule regulators are promulgating under Dodd-Frank, have a dramatic impact on world markets and U.S. competitiveness. Moreover, the heart of the Volcker Rule deals with a topic about which the SEC traditionally has--among all the regulators writing rules in this space--the most experience and expertise in regulating. For those reasons--because it is potentially so significant and because it implicates areas of the SEC’s core competence, it is a perfect case study for how to think about approaching Dodd-Frank rulemaking and the SEC’s role in that rulemaking. Indeed, Volcker is especially important to the major U.S. investment banks which until the financial crisis were subject primarily to SEC oversight. Now, as a result of the financial crisis, the survivors are all within bank holding companies.

I want to begin by talking a bit about the statute and the proposed rules. Section 619 of the Dodd-Frank Act,1 commonly known as the “Volcker Rule” even though it is a statutory provision, imposes two significant prohibitions on banking entities and their affiliates. First, the Rule generally prohibits banking entities that benefit from federal insurance on customer deposits or access to the discount window, as well as their affiliates, from engaging in proprietary trading. Second, the Rule prohibits those entities from sponsoring or investing in hedge funds or private equity funds. The Rule identifies certain specified “permitted activities,” including underwriting, market making, and trading in certain government obligations, that are excepted from these prohibitions but also establishes limitations on those excepted activities. The Volcker Rule defines--in expansive terms--key terms such as “proprietary trading” and “trading account” and grants the Federal Reserve Board, the FDIC, the OCC, the SEC, and the CFTC the rulemaking authority to further add to those definitions.

The statute also charges the three Federal banking agencies, the SEC, and the CFTC with adopting rules to carry out the provisions of the Volcker Rule. It requires the Federal banking agencies to issue their rules with respect to insured depositary institutions jointly and mandates that all of the affected agencies, including the Commission, “consult and coordinate” with each other in the rulemaking process. In doing so, the agencies are required to ensure that the regulations are “comparable,” that they “provide for consistent application and implementation” in order to avoid providing advantages or imposing disadvantages to affected companies, and that they protect the “safety and soundness” of banking entities and nonbank financial companies supervised by the Fed.

In October of last year, the Commission jointly proposed with the Federal banking agencies a set of implementing regulations for the Volcker Rule,2with the CFTC issuing a substantively identical set of proposals last month. The proposed rules, which were issued prior to the beginning of my tenure as a Commissioner, are designed to clarify the scope of the Volcker Rule’s prohibitions as well as certain exceptions and limitations to those exceptions as provided for in the statutory text. The proposing release includes extensive commentary designed to assist entities in distinguishing permitted trading activities from prohibited proprietary trading activities as well as in identifying permitted activities with respect to hedge funds and private equity funds. In addition, the release includes over 1,300 questions on nearly 400 topics--you can see why I and my colleague Commissioner Troy Paredes thought that commenters needed 30 extra days when the comment period extension was granted in December.

The proposed implementing rules are designed to clarify the scope of the Volcker Rule’s prohibitions on proprietary trading and hedge fund or private equity fund ownership and identify transactions and activities excepted from those prohibitions, as well as the limitations on those exceptions. For example, the proposed rules would except from the prohibition on proprietary trading transactions in certain instruments--such as U.S. government obligations--as well as certain activities, such as market making, underwriting, risk-mitigating hedging, or acting as an agent, broker, or custodian for an unaffiliated third party. The proposed rules would also establish a three-pronged definition of “trading accounts” which would include exceptions from that definition such as repurchase and reverse repurchase agreements and securities lending transactions, liquidity management positions, and certain positions of derivatives clearing organizations and clearing agencies.

The proposed rules would require a banking entity to establish an internal compliance program designed to ensure and monitor compliance with the prohibitions and restrictions of the Volcker Rule. The rules would require firms with significant trading operations to report certain quantitative measurements designed to aid regulators and the firms themselves in determining whether an activity constitutes prohibited proprietary trading or falls under an exception to that prohibition, such as the exception for market-making transactions. Finally, the proposed rules would set forth activities exempt from the general prohibition on investments in hedge funds and private equity funds: for example, organizing and offering a hedge fund or private equity fund with investments in such funds limited to a de minimis amount, making risk-mitigating hedging investments, and making investments in certain non-U.S. funds.

As I mentioned earlier, the Volcker Rule comment period ended earlier this week.
Although it would of course be premature to share my thoughts on the proposed rules today, based on just a quick review of many substantial comment letters--more than 100 of which were filed just this week--it appears that many of my fears about the effect of the proposed rules on the proper functioning of global markets and the competitiveness of the U.S. financial industry might be well-founded.
Here are a few lines from comment letters:

From a major investment bank: “The list of undesirable consequences is long and troublesome. We share the view, already noted by others, that the Proposal would reduce market liquidity, increase market volatility, impede capital formation, harm U.S. individual investors, pension funds, endowments, asset managers, corporations, governments, and other market participants, impinge on the safety and soundness of the U.S. banking system, and constrain U.S. economic growth and job creation.”3

From a major coalition of financial services trade groups: “Many commenters, including customers, buy-side market participants, industrial and manufacturing businesses, treasurers of public companies and foreign regulators--constituencies with different goals and interests--have agreed that the Proposal would significantly harm financial markets. They point to the negative impacts of decreased liquidity, higher costs for issuers, reduced returns on investments and increased risk to corporations wishing to hedge their commercial activities.”4

From a Fortune 50 corporation: “Although we appreciate the Agencies' efforts to strike the correct balance in the Proposed Rule, we are concerned that the sweeping effects of the Proposed Rule and the narrowness of the exceptions to it would have a substantial and negative impact not only on banks and the broader financial services industry, but also on industrial and other non-financial businesses, and ultimately the real economy.”5

From a large foreign bank: ”We are concerned that certain key aspects of the Proposed Rule are deficient and will lead to a significant negative impact on the efficient functioning of the U.S. and international financial systems, with a particularly disruptive effect on the capital markets.”6

And we have also received very interesting comment from our foreign regulatory counterparts from around the world. In a comment letter filed in December, the Japanese FSA and the Bank of Japan discuss “the importance of taking due account of the cross-border effect of financial regulations and the need to collaborate with the affected countries” and express their concerns over “the potentially serious negative impact on the Japanese markets and associated significant rise in the cost of related transactions for Japanese banks” that they believe would arise from the extraterritorial application of the Volcker Rule. They specifically cite the adverse impact they believe the Rule would have on Japanese Government Bonds, adding, “We could also see the same picture in sovereign bond markets worldwide at this critical juncture.” 7

Last month, British Chancellor of the Exchequer George Osborne wrote to Fed Chairman Bernanke to express his belief that the proposed rules would result in the withdrawal of market making services for non-U.S. debt, making it “more difficult and costlier” for banks to trade non-U.S. sovereign bonds on behalf of clients. Citing the harm that would arise from the potential reduction of liquidity in sovereign markets, he proposed that the U.S. and the U.K. “launch a more active dialogue” on the Rule and its potential impact on markets outside the U.S. 8

Bank of Canada Governor Mark Carney--who was recently named Chairman of the G-20’s Financial Stability Board--has stated that he and other Canadian officials have “obvious concerns” about the proposed rules. He cited the lack of clarity in the proposed rules’ definitions of “market making” versus “proprietary trade,” and the effect the rules would have on non-U.S. government bond markets. In addition, he criticized what he viewed as the Rule’s “presumption” that trades are proprietary, stating that any such presumption “should go in reverse.”9

Lastly, Michel Barnier, the European Commissioner for Internal Markets and Services, has written to Fed Chairman Bernanke and Treasury Secretary Geithner that “[t]here is a real risk that banks impacted by the rule would also significantly reduce their market-making activities, reducing liquidity in many markets both within and outside the United States.”10
To be fair, these are just a few select quotes from commenters who have provided significant and detailed comments on a variety of issues, and there is broad comment generally on the range of issues presented by the rule proposal. However, these comments are very different from the garden variety comments we usually see in our rulemaking. Those usually go something like: “We applaud the Commission’s efforts to do X. . .” I am not hearing any clapping in these quotes. And that’s because the consequences to world markets of getting it wrong are so significant.

This brings me back to thinking about the role of the SEC in this rulemaking, our role generally as a markets regulator, and how, if we at the SEC play our role properly, we can and should ensure that the Volcker Rule meets the aims of Congress without destroying critically important market activity explicitly contemplated by the statute.

In particular, although commenters have raised many concerns about the proposal, including significant issues surrounding extraterritoriality, I want to focus on the skills that the SEC can bring to bear in sorting through the difficult questions posed by distinguishing between permitted trading activities and prohibited proprietary trading activities.

In her Opening Statement introducing the joint rule proposals at an SEC Open Meeting last October, Chairman Schapiro praised the collaborative effort among the five agencies involved in the drafting process, noting that it involved “more than a year of weekly, if not more frequent, interagency staff conference calls, interagency meetings, and shared drafting.”11 It is telling, however, that in his recent testimony before a House Financial Services Subcommittee, CFTC Chairman Gensler, noting his agency’s role as a “supporting member” in the rulemaking process, stated, “The bank regulators have the lead role.”12

I think, however, that both the statute and our expertise compel the SEC to play a strong and vigorous role in the rulemaking. The Volcker Rule applies to “banking entities” and their affiliates, affecting a wide range of financial institutions regulated by the five different agencies. Regardless of the nature of the regulated activities, however, the Rule addresses a set of activities--the trading and investment practices of those entities--that fall within the core competencies of the SEC. Indeed, the Rule expressly envisions that quintessential market-making activity continue within these firms.

By taking a leadership role, the SEC can also ensure that the final rule is consistent with our core mission of protecting investors, maintaining fair and efficient markets and promoting capital formation. These considerations, coupled with the expertise that the SEC brings to the table, should ensure that the bank regulators’ focus on safety and soundness and Dodd-Frank’s overarching focus on managing systemic risk (although many have argued whether the statute will in the end reduce such risk), are balanced by legitimate considerations of investor protection and the maintenance of robust markets.

Senator Jeff Merkley, cosponsor of the Volcker Rule, wrote this week: “Put simply, the Volcker rule takes deposit-taking, loan-making banks out of the business of high-risk, conflict-ridden trading.” 13 In essence, a main goal of the Volcker Rule is a return to the Glass-Steagall division between commercial and investment banking. But, it bears mentioning that the major investment banks that became part of bank holding companies during the 2008 crisis don’t meet this profile: they are not buying lottery tickets with their depositors’ money, because their business models are not premised on taking deposits. They provide services to clients and the objective should be for them to provide the services that they have traditionally provided, that market participants count on, while fulfilling the statutory imperative to ban proprietary trading.

I want to turn to another point I made at the beginning of my remarks, but which I think is an appropriate guiding principle as we undertake not only our consideration of the Volcker Rule but also other significant rulemaking mandated under Dodd-Frank. The aggregate impact of the rulemakings we and our fellow regulators are promulgating is massive, the costs are enormous, and we are doing so at a time when our economy is still hopefully limping towards recovery. These factors all argue for an approach that is careful, systematic, but most importantly regulatorily incremental. It is important to remember that regulators’ authority and oversight responsibilities do not end when final rules are promulgated, and that continued oversight will ensure that regulators can refine and improve the rules as markets organize and develop in response to the rules we write. Importantly, we can and should recalibrate the rules as markets develop and regulators learn more and gather and analyze relevant data. We must avoid regulatory hubris and should not regulate--particularly where the changes are so novel or comprehensive--with the belief that we completely understand the consequences of the regulations we may impose. In many of these areas, including Volcker, missing the mark could have dire and perhaps irreversibly negative consequences.

Before I end, I also wanted to touch on one last regulatory issue, which is surprisingly not a Dodd-Frank rulemaking but which has received quite a bit of attention recently, and that is the possibility of a new proposal to regulate money market funds.

I say “surprisingly not in Dodd-Frank” because, in a 2350-page lawostensibly devoted to solving for systemic risk, Congress did not address money market funds and they are, according to various speeches and news articles, considered a continuing systemic risk notwithstanding significant money market reforms approved by the SEC in 2010.

Any effort to reconsider the SEC’s oversight of money market funds should be guided by the same principles outlined above. First, we should ensure that any prospective reforms in this are consistent with the core missions of the agency to protect investors, maintain fair and efficient markets and promote capital formation. Second, we should consider such proposals carefully, but ultimately we need to let empiricism and not guesswork guide our decision-making.

Last year I posed two questions: “First, for what specific problems or risks are we trying to solve? And second, do we have the necessary data that will allow us to regulate in a meaningful and effective way?” Indeed, I have further refined these simple queries to be even more straightforward: What data do we have that clearly demonstrates the need for reform above and beyond that imposed in 2010? This question has yet to be answered for me, although I understand the Staff is working on it. I anticipate working closely with the economists in the Division of Risk, Strategy and Financial Innovation as they analyze the available data. Only by continuing such a data-driven analysis can we determine if money market fund investors are exposed to unnecessary risk. We also, of course, need to fully understand the impact of any action we could take on the capital formation process and the fair and the efficient functioning of the markets.
Thank you for your patience and for having me here today. I would be happy to answer any questions you may have.”