CFTC CHAIRMAN MASSAD MAKES REMARKS TO ASIAN FINANCIAL FORUM, HONG KONG

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION 

Remarks of Chairman Timothy G. Massad before the Asian Financial Forum, Hong Kong

January 19, 2015

As Prepared For Delivery

Introduction

Good morning. I want to thank the Asian Financial Forum for inviting me. It is a pleasure to be here. I am especially pleased to be here on a panel with Chairman Xiao, Chairman Maijoor, and Secretary Purisima. Since I took office in June of last year, working with my international counterparts has been a priority. I look forward to our discussion shortly with Professor Chan.

It is great to be back in Hong Kong. I spent five years living here when I was a lawyer in private practice – some of the best years in my life. I made many good friends, and met my wife here – though she happens to be from St. Paul, Minnesota.

It was a pleasure to begin my trip in Beijing last week, where I met with Chairman Xiao and others. And I will be going on from here to Tokyo and Singapore.

You have asked us to discuss the prospects for sustainable growth in Asia in a world of change, particularly a world of changing financial sector regulations. I am very involved in changing financial sector regulations. I chair the Commodity Futures Trading Commission, which is the United States agency responsible for overseeing the futures, options, and swaps markets. And in that capacity, it is my responsibility to lead the U.S. effort to implement the commitments of the G-20 nations to reform the over-the-counter swaps market.

Let me first say a word about the relationship of the derivatives markets to growth. Many people probably hadn’t heard the word derivatives until the financial crisis, and today they may associate that word with bad behavior by big banks. But these markets, when working properly, are very beneficial to the real economy. When designed to help commercial users, they create substantial, if largely unseen, benefits for all of us. They enable utility companies or airlines to hedge the costs of fuel. They help manufacturers control the costs of industrial metals like copper. They enable farmers to lock in a price for their crops. They enable exporters to manage fluctuations in foreign currencies. And businesses of all types can lock in their borrowing costs. In the simplest terms, derivatives enable businesses to manage risk.

The Asian economies have grown to the point where well-developed derivatives markets can provide great value. To achieve that, there must be a regulatory foundation that enables markets to thrive and that attracts participants. That is, a framework that provides transparency and sensible oversight while also promoting competition and innovation. And because the economies of Asia, the United States, and Europe are increasingly interconnected, we must work together to build a global regulatory framework that achieves those ends.

Our lives shape our views, so let me tell you a little about how mine has.

I agreed to move to Hong Kong in 1997 right before the handover. Things were booming here and throughout Asia at the time. But by the time I arrived in January 1998, the Thai baht had collapsed, and the financial crisis had spread throughout Southeast Asia. I spent much of the first year or so I was in Asia on transactions involving sales of distressed debt by Thailand and Korea.

Now, at that time, I never would have guessed that many years later I would work on distressed debt sales, or troubled assets as we called them, for my own country. But a decade later, I joined the U.S. Treasury Department to help the United States recover from the worst financial crisis we have experienced since the Great Depression. I oversaw the Troubled Asset Relief Program, the key U.S. response to the 2008 global financial crisis.

Today, I look back on both the Asian financial crisis and the 2008 global financial crisis as I think about the challenges we face and the relationship of sustainable growth to regulatory change.

Looking back teaches us more than a little humility. When the Asian financial crisis occurred, many in the West were quick to point out why the West would not catch what was sometimes referred to as the “Asian flu.” Some people said our markets and financial regulatory system were more mature, more transparent, and better supervised. They said that all of those things made us more resilient to shocks. Well, not resilient enough. Those things didn’t mean we wouldn’t have our own crisis. They didn’t inoculate us from the dangers that can occur when risks are not properly understood, or when authorities believe markets are fully self-policing

By the same token, after Asia had rebounded from its crisis, some began to suggest that the Asian economies had “decoupled” from the economies of the West. No longer were they dependent on what happened in the West. Slow growth or even more serious problems in the West would not affect the dynamic growth in Asia.

Well, that didn’t prove true either. The Asian economies did not escape the collateral damage of the 2008 financial crisis. And that should not surprise us, given the severity of the shocks. In the United States, we lost eight million jobs, and millions lost their homes in foreclosure. With markets so interconnected, the shock waves reverberated worldwide.

Both crises illustrate the speed with which capital can move, and markets can fall, when problems hit. And these crises remind us that the economies of the United States and Asia are strongly and increasingly intertwined. What we do affects you. What happens here affects us. We are all in this together.

And that is why I am in Asia this week. I believe that we must continue to work together to build a global regulatory framework that helps our financial markets thrive. And that is especially true when it comes to the derivatives markets.

The Asian derivatives markets are growing. They represent nearly a third of global futures and options volume.

There are exciting developments taking place that may portend further growth and, in particular, greater sophistication and innovation in your markets. One is the launch of a crude oil contract on the Shanghai Exchange that is open to foreign participation. Another is what is happening in the equities market with Stock Connect.

I know many here are focused on making sure the derivatives markets serve the real economy. I share that objective, and I had a good discussion about this with Chairman Xiao last week. And I believe a good regulatory foundation is critical for that.

One way a good regulatory foundation can do so is by creating transparency. This can encourage innovation, which can lead to the development of a wide range of contracts that enable businesses to hedge different types of risk. For example, in the U.S., there are futures contracts traded on over 40 physical commodities, but there are more than 2000 different listed futures and options contracts on those commodities, though not all are actively traded. These contracts reflect differences in grade or quality of the product, length of term, delivery location, or other factors. This variety is a response to the diverse hedging needs of market participants. And in the over-the-counter market, parties can design contracts that allow for further customization.

But a good regulatory framework is needed so that this innovation does not create excessive risk or other problems. In the U.S., we have had a strong framework for futures for many years. We learned in the 2008 financial crisis that we needed regulation for over-the-counter swaps. We saw how over-the-counter swaps accelerated and intensified the crisis. The swaps market had grown to be a massive, global market that was unregulated. Participants had taken on risk that they didn’t always fully understand, and that was opaque to regulators. The interconnectedness of large institutions meant that trouble at one firm could easily cascade through the system. And we learned how a country’s financial stability could be threatened by excessive risk that starts outside its borders.

In response, the leaders of the G-20 nations agreed to bring the swaps market out of the shadows and achieve greater transparency. They agreed to implement some fundamental reforms such as requiring central clearing of standardized swaps.

The fact that the nations comprising the G-20 agreed on how to reform the swap market is, in and of itself, an achievement.

A G-20 communique only goes so far, however. The task of actually implementing those reforms remains with individual nation states, each with its own markets, legal traditions, regulatory philosophies and political processes. That can lead to differences.

Now, the fact is that, in most areas of financial regulation, national laws differ. Consider how securities are sold, for example. When I was working here, and we received approval for listings and initial public offerings on the Hong Kong Stock Exchange, that did not mean we could sell the same stock in a public offering in the United States.

But because the swap market was already global, many participants expect harmonization in regulation from the start. That is a good goal, though it may take time. To me, however, the glass is half full, not half empty. We are making good progress.

I can assure you that we in the United States want to continue to work with Asia to build that framework. We are aware that there are limits to the reach of any one country’s laws. We recognize the importance of harmonizing our rules with those of other nations where possible.

I believe Asia has much to gain from building this new global regulatory framework. It can create strong and innovative derivatives markets that can help propel growth in the real economy. And that can contribute to sustainable growth.I look forward to working with you to build that framework, and to enhancing sustainable growth for all of us.

Last Updated: January 18, 2015

THE ROLE OF COMPLIANCE AND ETHICS IN RISK MANAGEMENT

The following excerpt is from the SEC website: "Speech by SEC Staff: by Carlo V. di Florio Director, Office of Compliance Inspections and Examinations1 NSCP National Meeting October 17, 2011 Thank you for inviting me to speak at this event. The work you all do is incredibly important, and we appreciate and respect your critical contributions to investor protection and market integrity. Today I would like to address two related topics that are growing in importance: the heightened role of ethics in an effective regulatory compliance program, and the role of both ethics and compliance in enterprise risk management. The views that I express here today are of course my own and do not necessarily reflect the views of the Commission or of my colleagues on the staff of the Commission. In the course of discussing these two topics, I would like to explore with you the following propositions: Ethics is fundamental to the securities laws, and I believe ethical culture objectives should be central to an effective regulatory compliance program. Leading standards have recognized the centrality of ethics and have explicitly integrated ethics into the elements of effective compliance and enterprise risk management. Organizations are making meaningful changes to embraced this trend and implement leading practices to make their regulatory compliance and risk management programs more effective. Ethics and the Federal Securities Laws The debate about how law and ethics relate to each other traces all the way back to Plato and Aristotle. I am not the Director of the Office of Legal Philosophy, so I won’t try to contribute to the received wisdom of the ages on this enormous topic,2 except to say that for my purposes today, the question really boils down to staying true both the spirit and the letter of the law. Framed this way, ethics is a topic of enormous significance to anyone whose job it is to seek to promote compliance with the federal securities laws. At their core, the federal securities laws were intended by Congress to be an exercise in applied ethics. As the Supreme Court stated almost five decades ago, [a] fundamental purpose, common to [the federal securities]… statutes, was to substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry…. “It requires but little appreciation . . . of what happened in this country during the 1920's and 1930's to realize how essential it is that the highest ethical standards prevail” in every facet of the securities industry.3 Of course, what has happened through the financial crisis I believe is yet another reminder of the fundamental need for stronger ethics, risk management and regulatory compliance practices to prevail. Congress has responded once again, as it did after the Great Depression, with landmark legislation to raise the standards of business ethics in the banking and securities industries. The manner in which the federal securities laws are illuminated by ethical principles was well illustrated by the Study on Investment Advisers and Broker-Dealers that the Commission staff submitted to Congress earlier this year pursuant to Section 913 of the Dodd-Frank Act (“913 Study”).4 As described in the 913 study, in some circumstances the relationship is explicit, such as the requirement that each investment adviser that is registered with the Commission or required to be registered with the Commission must also adopt a written code of ethics. These ethical codes must at a minimum address, among other things, a minimum standard of conduct for all supervised persons reflective of the adviser’s and its supervised persons’ fiduciary obligations.5 In other circumstances, an entire body of rules is based implicitly on ethical precepts. This is the case with the rules adopted and enforced by FINRA and other self-regulatory organizations, which “are grounded in concepts of ethics, professionalism, fair dealing, and just and equitable principles of trade,” giving the SROs authority to reach conduct that may not rise to the level of fraud.6 This has empowered FINRA and other SROs to, for example, not require proof of scienter to establish a suitability obligation, ,7 to develop rules and guidance on fair prices, commissions and mark-ups that takes into account that what may be “fair” (or reasonable) in one transaction could be “unfair” (or unreasonable) in another,8 and to require broker-dealers to engage in fair and balanced communications with the public, disclose conflicts of interest, and to undertake a number of other duties.9 In addition to approving rules grounded on these ethical precepts, the Commission has also sustained various FINRA disciplinary actions utilizing FINRA’s authority to enforce “just and equitable principles of trade,” even where the underlying activity did not involve securities, such as actions involving insurance , tax shelters, signature forgery, credit card fraud, fraudulent expense account reimbursement, etc.10 Other ethical precepts are derived from the antifraud provisions of the federal securities laws. The “shingle” theory, for example, holds that by virtue of engaging in the brokerage business a broker-dealer implicitly represents to those with whom it transacts business that it will deal fairly with them. When a broker-dealer takes actions that are not fair to its customer, these must be disclosed to avoid making the implied representation of fairness not misleading. A number of duties and conduct regulations have been articulated by the Commission or by courts based on the shingle theory.11 Another source by which ethical concepts are transposed onto the federal securities laws is the concept of fiduciary duty. The Supreme Court has construed Section 206(1) and (2) of the Investment Advisers Act as establishing a federal fiduciary standard governing the conduct of advisers.12 This imposes on investment advisers “the affirmative duty of ‘utmost good faith, and full and fair disclosure of all material facts,’ as well as an affirmative obligation to ‘employ reasonable care to avoid misleading’” clients and prospective clients. As the 913 Study stated, Fundamental to the federal fiduciary standard are the duties of loyalty and care. The duty of loyalty requires an adviser to serve the best interests of its clients, which includes an obligation not to subordinate the clients’ interests to its own. An adviser’s duty of care requires it to “make a reasonable investigation to determine that it is not basing its recommendations on materially inaccurate or incomplete information.”13 While broker-dealers are generally not subject to a fiduciary duty under the federal securities laws, courts have imposed such a duty under certain circumstances, such as where a broker-dealer exercises discretion or control over customer assets, or has a relationship of trust and confidence with its customer.14 The 913 Study, of course, explores the principle of a uniform fiduciary standard. Concepts such as fair dealing, good faith and suitability are dynamic and continue to arise in new contexts. For example, the Business Conduct Standards for Securities-Based Swap Dealers (SBSDs”) and Major Security-Based Swap Participants (“MSBSPs”), required by Title VII of the Dodd-Frank Act and put out for comment last summer, include proposed elements such as a requirement that communications with counterparties are made in a fair and balanced manner based on principles of fair dealing and good faith; an obligation to disclosure to a counterparty material information about the security-based swap, such as material risks, characteristics, incentives and conflicts of interest; and a determination by SBSDs that any recommendations that they make regarding security-based swaps are suitable for their counterparties. Of course the Business Conduct Standards have not been finalized, but the requirements of Title VII requiring promulgation of these rules, as well as the content of the rules as proposed, illustrate that ethical concepts continue to be a touchstone for both Congress and the Commission in developing and interpreting the federal securities laws. The Relationship Between Ethics and Enterprise Management. Ethics is not important merely because the federal securities laws are grounded on ethical principles. Good ethics is also good business. Treating customers fairly and honestly helps build a firm’s reputation and brand, while attracting the best employees and business partners. Conversely, creating the impression that ethical behavior is not important to a firm is incredibly damaging to its reputation and business prospects. This, of course, holds true equally for individuals, and there are plenty of enforcement cases that tell the story of highly talented and successful individuals who were punished because they violated their ethical and compliance responsibilities. Another way of saying this is that a corporate culture that reinforces ethical behavior is a key component of effectively managing risk across the enterprise. As the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) put it, in articulating its well-established standards of Internal Control and Enterprise Risk Management: An entity’s strategy and objectives and the way they are implemented are based on preferences, value judgments, and management styles. Management’s integrity and commitment to ethical values influence these preferences and judgments, which are translated into standards of behavior. Because an entity’s good reputation is so valuable, the standards of behavior must go beyond mere compliance with the law. Managers of well-run enterprises increasingly have accepted the view that ethics pays and ethical behavior is good business.15 In the wake of the financial crisis, enterprise risk management is a rapidly evolving discipline that places ethical values at the heart of good governance, enterprise risk management and compliance. For example, organizations such as COSO, the Ethics Resource Center (ERC), the Open Compliance and Ethics Guidelines (OCEG) and the Ethics & Compliance Officer Association (ECOA) have developed detailed guidance, from the board room to business units and key risk, control and compliance departments, on implementation of effective enterprise risk management systems. Industry and sector specific guidance has flowed from these general standards. As COS notes, integrity and ethical values are the pillars of an effective compliance culture. The effectiveness of enterprise risk management cannot rise above the integrity and ethical values of the people who create, administer, and monitor entity activities. Integrity and ethical values are essential elements of an entity’s internal environment, affecting the design, administration, and monitoring of other enterprise risk management components.16 Nowhere should this be more true than in financial services firms today, which depend for their existence on public trust and confidence to a unique degree. Expectations are rising around the world for a stronger culture of ethical behavior at financial services firms of all types and sizes. As the Basle Committee on Banking Supervision recently stated: A demonstrated corporate culture that supports and provides appropriate norms and incentives for professional and responsible behaviour is an essential foundation of good governance. In this regard, the board should take the lead in establishing the “tone at the top” and in setting professional standards and corporate values that promote integrity for itself, senior management and other employees.17 As the standards for ethical behavior continue to evolve, your firms’ key stakeholders – shareholders, clients and employees will increasingly expect you to meet or exceed those standards. In my first speech here at the SEC outlined ten elements I believe make an effective compliance and ethics program. These elements reflect the compliance, ethics and risk management standards and guidance noted above. They also reflect the U.S. Federal Sentencing Guidelines (FSG), which were revised in 2004 to explicitly integrate ethics into the elements of an effective compliance and ethics program that would be considered as mitigating factors in determining criminal sentences for corporations. These elements include: Governance. This includes the board of directors and senior management setting a tone at the top and providing compliance and ethics programs with the necessary resources, independence, standing, and authority to be effective. NEP staff have begun meeting with directors, CEOs, and senior management teams to better understand risk and assess the tone at the top that is shaping the culture of compliance, ethics and risk management. Culture and values. This includes leadership promoting integrity and ethical values in decision-making across the organization and requiring accountability. Incentives and rewards. This includes incorporating integrity and ethical values into performance management systems and compensation so the right behaviors are encouraged and rewarded, while inappropriate behaviors are firmly addressed. Risk management. This includes ensuring effective processes to identify, assess, mitigate and manage compliance and ethics risk across the organization. Policies and procedures. This includes establishing, maintaining and updating policies and procedures that are tailored to your business, your risks, your regulatory requirements and the conflicts of interest in your business model. Communication and training. This includes training that is tailored to your specific business, risk and regulatory requirements, and which is roles-based so that each critical partner in the compliance process understands their roles and responsibilities. Monitoring and reporting. This includes monitoring, testing and surveillance functions that assess the health of the system and report critical issues to management and the board. Escalation, investigation and discipline. This includes ensuring there are processes where employees can raise concerns confidentially and anonymously, without fear of retaliation, and that matters are effectively investigated and resolved with fair and consistent discipline. Issues management. This includes ensuring that root cause analysis is done with respect to issues that are identified so effective remediation can occur in a timely manner. An on-going improvement process. This includes ensuring the organization is proactively keeping pace with developments and leading practices as part of a commitment to a culture of ongoing improvement. In addition to the effective practices above, the NEP has also seen firms that have focused on enhancing regulatory compliance programs through effective integration of ethics principles and practices. These include renaming the function and titles to incorporate ethics explicitly; elevating the dialogue with senior management and the board; implementing core values and business principles to guide ethical decision-making; integrating ethics into key leadership communications; and introducing surveys and other mechanisms to monitor the health of the culture and identify emerging risks and issues. The Relationship of Compliance and Ethics with Enterprise Risk Management. We can expand the discussion above beyond compliance and ethics to address enterprise risk management and risk governance more broadly. These same program elements, and ethics considerations, are equally critical, but the scope of risks expands beyond regulatory risk to also include market, credit and operational risk, among others. The roles and responsibilities also expand to include risk management, finance, internal audit and other key risk and control functions. Whether we’re talking about compliance and ethics or we’re talking about ERM, it is important to clarify fundamental roles and responsibilities across the organization. . The business is the first line of defense responsible for taking, managing and supervising risk effectively and in accordance with the risk appetite and tolerances set by the board and senior management of the whole organization. Key support functions, such as compliance and ethics or risk management, are the second line of defense. They need to have adequate resources, independence, standing and authority to implement effective programs and objectively monitor and escalate risk issues. Internal Audit is the third line of defense and is responsible for providing independent verification and assurance that controls are in place and operating effectively. Senior management is responsible for reinforcing the tone at the top, driving a culture of compliance and ethics and ensuring effective implementation of enterprise risk management in key business processes, including strategic planning, capital allocation, performance management and compensation incentives. The board of directors (if one exists in the organization) is responsible for setting the tone at the top, overseeing management and ensuring risk management, regulatory, compliance and ethics obligations are met. While compliance and ethics officers play a key role in supporting effective ERM, risk managers in areas such as investment risk, market risk, credit risk, operational risk, funding risk and liquidity risk also play an important role. As noted above, the board, senior management, other risk and control functions, the business units and internal audit also play a critical role in ERM. As ERM matures as a discipline, it is critical that these key functions work together in an integrated coordinated manner that supports more effective ERM. Understanding and managing the inter-relationship between various risks is a central tenet of effective ERM. One needs only reflect on the financial crisis to understand how the aggregation and inter-relationship of risks across various risk categories and market participants created the perfect storm. ERM provides a more systemic risk analysis framework to proactively identify, assess and manage risk in today’s market environment. OCIE Considerations As I discussed earlier, there is an ethical component to many of the federal securities laws. When NEP staff examines, for example, an investment adviser’s adherence to its fiduciary obligations, or a broker-dealer’s effective development, maintenance and testing of its compliance program, our examiners are looking at how well firms are meeting both the letter and spirit of these obligations. In addition, our examiners certainly examine specific requirements for ethical processes, such as business conduct standards. There is another way in which the ethical environment within a firm matters to us. As you know, our examination program has greatly increased its emphasis on risk-based examinations. How we perceive a registrant’s culture of compliance and ethics informs our view of the risks posed by particular entities. In this regard we have begun meeting boards of directors, CEOs and senior management to share perspectives on the key risks facing the firm, how those risks are being managed and the effectiveness of key risk management, compliance, ethics and control functions. It provides us an opportunity to emphasize the critical importance of compliance, ethics, risk management and other key control functions, and our expectation that these functions have sufficient resources, independence, standing and authority to be effective in their roles. These dialogues also provide us an opportunity to assess the tone at the top that is shaping the culture of compliance, ethics and risk management in the firm. If we believe that a firm tolerates a nonchalant attitude toward compliance, ethics and risk management, we will factor that into our analysis of which registrants to examine, what issues to focus on, and how deep to go in executing our examinations. Finally, I would end by sharing with you that we are also embracing these leading practices. We recently created our own program around compliance and ethics. For the first time, we have a dedicated team focused on strengthening and monitoring how effectively we adhere to our own examination standards. We are in the process of finalizing our first Exam Manual, which we set forth all of our key policies and standards in one manual. We have also established a senior management committee with oversight responsibility for compliance, ethics and internal control. On the risk management front, we are also making good progress. We have recruited individuals with expertise and established a senior management oversight committee here as well. In short, we are also committing ourselves to a culture of ongoing improvement and leading practices. Conclusion Thank you for inviting me to speak here today. I hope that my remarks, both about ethics and compliance as well as our priorities for the first months of our new fiscal year, will be helpful to you and help you to perform your critical compliance functions more effectively. I invite your feedback, whether regarding the points that I made, or the points that you think I missed. I now invite your questions. -------------------------------------------------------------------------------- 1 The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private statements by its employees. 2 For a deeper plunge into the relationship between law and ethics, a classic exchange on this subject can be found in Positivism and the Separation of Law and Morals, H.L.A. Hart, 71 Harvard L. Rev. 529 (1958) and Positivism and Fidelity to Law: A Reply to Professor Hart, L.L. Fuller, 71 Harvard L. Rev. 630 (1958). 3 SEC v. Investment Research Bureau, Inc., 375 U.S. 180, 186-87 (1963), quoting Silver v. New York Stock Exchange, 373 U.S. 341,366 (1963). 4 Study on Investment Advisers and Broker-Dealers as Required by Section 913 of the Dodd-Frank Wall Street Reform Act (January 2011) at 62 (available at http://www.sec.gov/news/studies/2011/913studyfinal.pdf) (“913 Study”). 5 Advisers Act Section 204A, and Advisers Act Rule 204A-1. 6 913 Study at 51. 7 Id. 8 Id. at 66. 9 Id. at 52. 10 Id. at 52-53 and cases cited therein. 11 Id. at 51, citing Guide to Broker-Dealer Registration (April 2008), available at http://www.sec.gov/divisions/marketreg/bdguide.htm. 12 SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 194 (1963); 913 Study at 21. 13 Id. at 22 (quoting Concept Release on the U.S. Proxy System, Investment Advisers Act Release No. 3052 (July 14, 2010) at 119. 14 Id. at 54 and cases cited therein. 15 Enterprise Risk Management- Integrated Framework, Committee of Sponsoring Organizations of the Treadway Commission (September 2004) at 29. 16 Id. at 29-30. 17 Basel Committee on Banking Supervision, Principles for Enhancing Corporate Governance (October 2010) at 8.