FED BANKING AGENCIES REPORT "SERIOUS DEFICIENCIES IN UNDERWRITING STANDARDS AND RISK MANAGEMENT OF LEVERAGED LOANS"

FROM:  FEDERAL DEPOSIT INSURANCE CORPORATION 

For Immediate Release November 7, 2014 

Credit Risk in the Shared National Credit Portfolio is High; Leveraged Lending Remains a Concern

The credit quality of large loan commitments owned by U.S. banking organizations, foreign banking organizations (FBOs), and nonbanks is generally unchanged in 2014 from the prior year, federal banking agencies said Friday. In a supplemental report, the agencies highlighted findings specific to leveraged lending, including serious deficiencies in underwriting standards and risk management of leveraged loans.

The annual Shared National Credits (SNC) review found that the volume of criticized assets remained elevated at $340.8 billion, or 10.1 percent of total commitments, which approximately is double pre-crisis levels. The stagnation in credit quality follows three consecutive years of improvements. A criticized asset is rated special mention, substandard, doubtful, or loss as defined by the agencies' uniform loan classification standards. The SNC review was completed by the Federal Reserve Board, Federal Deposit Insurance Corporation (FDIC), and Office of the Comptroller of the Currency.

Leveraged loans as reported by agent banks totaled $767 billion, or 22.6 percent of the 2014 SNC portfolio and accounted for $254.7 billion, or 74.7 percent, of criticized SNC assets. Material weaknesses in the underwriting and risk management of leveraged loans were observed, and 33.2 percent of leveraged loans were criticized by the agencies.

The leveraged loan supplement also identifies several areas where institutions need to strengthen compliance with the March 2013 guidance, including provisions addressing borrower repayment capacity, leverage, underwriting, and enterprise valuation. In addition, examiners noted risk-management weaknesses at several institutions engaged in leveraged lending including lack of adequate support for enterprise valuations and reliance on dated valuations, weaknesses in credit analysis, and overreliance on sponsor's projections.

Federal banking regulations require institutions to employ safe and sound practices when engaging in commercial lending activities, including leveraged lending. As a result of the SNC exam, the agencies will increase the frequency of leveraged lending reviews to ensure the level of risk is identified and managed.

In response to questions, the agencies also are releasing answers to FAQs on the guidance. The questions cover expectations when defining leveraged loans, supervisory expectations on the origination of non-pass leveraged loans, and other topics. The FAQ document is intended to advance industry and examiner understanding of the guidance, and promote consistent application in policy formulation, implementation, and regulatory supervisory assessments.

Other highlights of the 2014 SNC review:

Total SNC commitments increased by $379 billion to $3.39 trillion, or 12.6 percent from the 2013 review. Total SNC outstanding increased $206 billion to $1.57trillion, an increase of 15.2 percent.

Criticized assets increased from $302 billion to $341 billion, representing 10.1 percent of the SNC portfolio, compared with 10.0 percent in 2013. Criticized dollar volume increased 12.9 percent from the 2013 level.

Leveraged loans comprised 72.9 percent of SNC loans rated special mention, 75.3 percent of all substandard loans, 81.6 percent of all doubtful loans, and 83.9 percent of all nonaccrual loans.

Classified assets increased from $187 billion to $191 billion, representing 5.6 percent of the portfolio, compared with 6.2 percent in 2013. Classified dollar volume increased 2.1 percent from 2013.

Credits rated special mention, which exhibit potential weakness and could result in further deterioration if uncorrected, increased from $115 billion to $149 billion, representing 4.4 percent of the portfolio, compared with 3.8 percent in 2013. Special mention dollar volume increased 29.6 percent from the 2013 level.
The overall severity of classifications declined, with credits rated as doubtful decreasing from $14.5 billion to $11.8 billion and assets rated as loss decreasing slightly from $8 billion to $7.8 billion. Loans that were rated either doubtful or loss account for 0.6 percent of the portfolio, compared with 0.7 percent in the prior review. Adjusted for losses, nonaccrual loans declined from $61 billion to $43billion, a 27.8percent reduction.

The distribution of credits across entity types—U.S. bank organizations, FBOs, and nonbanks—remained relatively unchanged. U.S. bank organizations owned 44.1 percent of total SNC loan commitments, FBOs owned 33.5 percent, and nonbanks owned 22.4 percent. Nonbanks continued to own a larger share of classified (73.6 percent) and nonaccrual (76.7 percent) assets than their total share of the SNC portfolio (22.4 percent). Institutions insured by the FDIC owned 10.1percent of classified assets and 6.7 percent of nonaccrual loans.
The SNC program was established in 1977 to provide an efficient and consistent review and analysis of SNCs. A SNC is any loan or formal loan commitment, and asset such as real estate, stocks, notes, bonds, and debentures taken as debts previously contracted, extended to borrowers by a federally supervised institution, its subsidiaries, and affiliates that aggregates $20 million or more and is shared by three or more unaffiliated supervised institutions. Many of these loan commitments also are participated with FBOs and nonbanks, including securitization pools, hedge funds, insurance companies, and pension funds.

In conducting the 2014 SNC Review, the agencies reviewed $975 billion of the $3.39 trillion credit commitments in the portfolio. The sample was weighted toward noninvestment grade and criticized credits. In preparing the leveraged loan supplement, the agencies reviewed $623 billion in commitments or 63.9 percent of leveraged borrowers, representing 81 percent of all leveraged loans by dollar commitments. The results of the review and supplement are based on analyses prepared in the second quarter of 2014 using credit-related data provided by federally supervised institutions as of December 31, 2013, and March 31, 2014.

REMARKS BY CFTC COMMISSIONER O'MALIA AT CFTC COMPLIANCE FORUM

FROM:  COMMODITY FUTURES TRADING COMMISSION 
Keynote Address by Commissioner Scott D. O'Malia, Edison Electric Institute CFTC Compliance Forum, Washington, DC
October 17, 2013

The topic of today's conference is "Compliance and Implementation Issues." I must say such a topic gives us plenty of room to have a wide-ranging discussion, as there are so many questions and concerns regarding industry compliance and on-going implementation.

As we all know, the Dodd-Frank Act was enacted following the G-20 agreement in Pittsburgh in September 2009 to undertake comprehensive financial reform. The G-20 agreement proposed four main objectives of derivatives reform. First, report all data to a data repository. Second, require that all standardized derivatives contracts be exchange traded "as appropriate." Third, require clearing to be done through central counter parties. Fourth, impose higher collateral charges for all uncleared over-the-counter (OTC) products.

Since the passage of Dodd-Frank, the CFTC has been busy with an aggressive schedule of rule promulgation. Today we have finalized just over 60 rules including Dodd-Frank and non-Dodd Frank rule.

This new regulatory regime has had a profound impact on market structure as it has imposed new obligations, higher levels of transparency, and higher standards for risk management. Many of these new rules will have a positive impact on financial markets.

However, I have serious concerns about the Commission’s rule making process and schedule, as well as the statutory foundation of many rules and their overall impact on end-users.

Today, I would like to discuss three topics. First, I would like to address the implementation of the rules, both in terms of compliance already under way and what we need to think about going forward. Second, I would like to discuss the regulatory impact on end-users. Finally, I would like to discuss my concerns about the Commission’s preparedness to oversee the implementation of the Dodd-Frank regulatory regime.

The Process: Sacrificing Transparency and Certainty for Speed

From the beginning of my time at the Commission, I have been very concerned with the Commission's rulemaking process. As you may know, I have been disappointed with the Commission’s failure to develop a transparent rulemaking schedule that would enable market participants to plan for compliance with the massive new obligations imposed by these rules. In addition, I believe the Commission has rushed the rulemaking process, prioritizing getting rules done fast over getting them done right. This approach has compromised the legal soundness and consistency of our rules.

Stark evidence of the Commission’s flawed rules, and their unachievable compliance deadlines, can be seen in the massive number of exemptions and staff no-action letters issued to provide relief from them. To date, we have issued over 130 exemptions and staff no-action letters. That amounts to more than two exemptions for every rule passed. In nearly two dozen cases, the relief provided is for an indefinite period of time – thus making them de facto rulemakings, which didn't go through the Administrative Procedure Act or proper cost-benefit analysis. It is clear that the Commission has abused the no-action relief process.

Market participants are confused regarding the application of our rules, and how or when they must be applied. Further, since the Commission doesn't vote on staff no-action letters, they don't appear in the Federal Register. And you won't find the exemptive letters in our rulebook either. This lack of transparency and consistency will drive a compliance officer crazy.

One area where the Commission has made one of its biggest process fouls is the lack of robust cost-benefit analysis. Without a doubt, the comprehensive nature of the Dodd-Frank regulatory regime will have a significant cost impact on all market participants, and yet the Commission has failed to conduct appropriate and rigorous quantitative and qualitative analysis of our proposed rules. Understanding whether the benefits of the rules outweigh the costs is a common sense tool to determine the least burdensome solution to the problem.

The Commission has so far been able to get away with such inadequate cost-benefit analysis because the current governing statute sets a low bar. I support Congressional efforts to revise our statutory cost-benefit obligations in order to require the Commission to undertake a more rigorous quantitative and qualitative analysis, putting us on par with other federal agencies. I support Chairman Conaway's efforts (H.R. 1003) and hope the House and Senate will pass this legislation.

Implementation: What's Coming

While I have a longer list of process fouls committed by the Commission, I would like to turn to upcoming rules that will have a significant impact on end-users in particular.

The Commission is currently considering the position limit rule do-over. When I say the Commission, I mean that literally. During the shutdown there is no staff available to discuss this rule proposal. We can't make revisions. We can't ask questions about the rationale or justification. We can't even discuss with staff whether or not the proposed limits would have an appropriate impact to curb "excessive speculation."

The Commission is pursuing a dual track on position limits. Later this year, an appeals court will hear our argument urging it to overturn a federal district court’s ruling to vacate the original position limit rule. The district court found that the Commission failed to provide a finding of necessity as directed by the statute. Simultaneously, we are drafting a nearly identical rule arguing more strenuously that Congress made us do it, and that Congress really didn't want to know whether these rules are "necessary" or "appropriate."

Frankly, I find it interesting that the proposed rule will argue on one hand that Congress wanted position limits and that we aren't bound to apply an appropriateness standard – and then, on the other hand, argue in the cost-benefit analysis that these rules are well considered and will have the intended impact based on our analysis.

Another important rulemaking that will be before the Commission shortly is the application of capital and margin for all OTC trades. While I am pleased that the international community has worked together to make the standards consistent, make no mistake: these rules will increase the cost of hedging. End-users will be spared from mandatory margin exchange. However, nobody will receive a break from the new capital charges. These are new costs imposed on banks to offset the risk posed by OTC trades. Needless to say, these costs will be passed on to end-users.

I agree with Sean Owens, an economist with Woodbine Associates, who stated that under Dodd-Frank, "end users face a tradeoff between efficient, cost-effective risk transfer and the need for hedge customization. The cost implicit in this trade off include: regulatory capital, funding initial margin, market liquidity and structural factors."1

There is no doubt that these new requirements will have serious economic consequences for financial markets. And regulators should not take this lightly. In an effort to coordinate with international regulators, the Commission will re-propose its capital and margin rules. But even under the more accommodating margin requirements, the Commission must evaluate additional costs to end-users by conducting an in-depth cost-benefit analysis.

Happy Anniversary: 1st Anniversary of Futurization

It was one year ago, almost to the day, that the energy markets switched from trading swaps to futures. This huge shift was triggered by the then-impending effective date of the swap and swap dealer definitions. To avoid trading swaps and being caught in the unnecessary, costly and highly complex de minimis calculation imposed on swap dealers, energy firms shifted their trading from swaps to futures, literally overnight.

Based on the complexity of our swaps rules and the cost-efficiency of trading futures, it makes sense that participants would make this change. I'm interested to hear more from end-users like you how this shift has impacted your hedging strategies.

I must warn you that there are several more changes coming up that will continue to impact energy markets. First, the Commission is considering a draft futures block rule that will be proposed to limit the availability of block trades.

Second, as I noted before, OTC margin and capital rules will increase the cost of OTC bilateral deals. This draft rule should be published by the end of the year.

Third, the European Union (EU) is considering whether it will find acceptable the U.S. rules allowing a minimum one-day margin liquidation requirement for futures and swaps on energy products. Europe might not recognize U.S. centralized counterparties as qualified and, as a result, ban EU persons from accessing these markets. The EU is insisting on a two-day margin liquidation minimum. I am told that this would have the practical effect of increasing margin requirements for energy trades by 40 percent. I’m not sure how this will be resolved, but I suspect it will be closely tied to U.S. recognition of the European regulatory regime.

End-Users

Now let me turn to my second topic: how our rules treat end-users.

Congress was very clear about protecting end-users from Dodd-Frank's expansive regulatory reach. As a result, many end-users assumed that they wouldn't be impacted by these rules. Clearly, they are no longer under such misconceptions.

The swap dealer definition is a good example of how the Commission failed to accurately interpret Dodd-Frank and broadly applied the swap dealer definition to all market participants. The Commission ignored the express statutory mandate to exclude end-users from its reach. The swap dealer final rule requires entities to navigate through a complex set of factors on a trade-by-trade basis, rather than provide a bright line test. While I appreciate that the Commission set an $8 billion de minimis level to exclude trades from a dealer designation, it remains challenging to determine what is in and what is out from this safe harbor.

As part of the complexity of the swap dealer definition, the Commission has applied inconsistent and incoherent requirements around bona fide hedging as part of the dealer calculation. The hedge exclusion from the dealer definition applies only to physical, but not financial, transactions. The Commission should apply a consistent definition for hedging.

Another complexity that the Commission has imposed on end-users is the definition of a volumetric option. Specifically, to determine whether a volumetric option is a forward or a swap, the rule applies a seven-part test. But the real kicker is that under the seventh factor, contracts with embedded volumetric optionality may qualify for the forward contract exclusion only if exercise of the optionality is based on physical factors that are outside the control of the parties. This is in contradiction to how volumetric options have been traditionally used by market participants, makes no sense and provides absolutely no certainty for market participants.

The Commission has seemingly gone out of its way to create complex rules that generally result in an outcome of heads we win, tails you lose. We need to clean up the definition and create reliable and well-defined safe harbors. If we don't, I would encourage Congress to revisit the statute.

Commission Readiness: The Consequences of a “Ready, Fire, Aim” Approach

Let me move now to my third main topic: Commission readiness to properly oversee the implementation of its Dodd-Frank regulatory regime. There are two questions I have regarding this issue. The first question is pretty straightforward: is the Commission prepared to effectively oversee the new swaps markets? I believe the answer to this question is "no."

Take the area of registration. The Commission’s new swaps regime has created multiple new categories of Commission registrants, and in each category there has been an inconsistent and uncertain process with the bar constantly moving for applicants. For example, it has been ten months since the first swap dealer application arrived. Today, we have 89 temporarily registered applications totaling over 180,000 pages and we haven’t signed off on single application as complete or final.

With regard to swap data repository (SDR) registration, it has taken the Commission eight to ten months to register just three SDRs under temporary status. We have exceeded our own self-imposed limit of 180 days in some cases and we still haven’t issued a final SDR determination.

As for the registration of swap execution facilities (SEFs), while we have registered 18 entities under a temporary basis, I can only imagine how long it will take for a SEF to secure final approval, especially when we admit that we didn’t read the rulebooks in order to meet the arbitrary October 2 effective date. My guess is that it will be a long and painful process as we insist on evolving revisions to SEF rulebooks while trading is going on.

Another area where the Commission has not been adequately prepared to do its job is in connection with swap data being submitted under new reporting regulations. Despite imposing aggressive compliance requirements on the market, the Commission doesn't have the tools in place to effectively utilize the new data being reported to SDRs, and it doesn't have a surveillance system in either the futures or swaps market that I would regard as adequate or modern.

Today, the data we receive from SDRs requires extensive cleaning and changes to make it useful. As chairman of the Commission’s Technology Advisory Committee (TAC), I have devoted significant TAC attention and resources to aid this effort. Stemming from our TAC meeting in April, a working group including Commission staff and the SDRs has been established and is working to harmonize data fields to aid in our ability to easily aggregate and analyze data across SDR platforms. It will take time before we are able to access, aggregate and analyze data efficiently.

I am also disappointed with our current stance on the oversight of SEFs. Despite the October 2 start-up date for SEFs, the Commission relies on self-regulatory organizations to send data via Excel spreadsheet. There is no aggregation capacity and I am not aware of any plan to automate this process for the less than two thousand swap trades that occur on a daily basis.

My second question: is the Commission sufficiently familiar with the readiness of the market to adapt to our rules? The answer to this question is also "no." As I discussed earlier, evidence of this failure can be found in the Commission’s extensive use of no-action relief tied to arbitrary deadlines. The Commission needs to do a better job of understanding the significant compliance challenges facing market participants as a result of new regulations.

Pre-Trade Credit Checks: Time for the TAC to Revisit the Issue

Let me give you a brief example of one challenge we are dealing with today. The Commission has been working toward a goal of straight-through processing of trades and clearing to prevent any trade failures due to credit issues. Just recently, the Commission has started insisting that SEFs provide functionality to pre-check all trades for adequate credit at the futures commission merchant (FCM) to guarantee a trade. In general, I support this objective. However, market participants were not prepared to comply with this new requirement by October 2, the date SEFs began operation.

Consistent with the Commission’s practice of issuing last-minute ad-hoc relief, the day before the SEF start-up date, staff issued a delay of the pre-trade credit checks for one month until November 1. We are just two weeks away from this new deadline and it is clear that not all SEFs, FCMs, credit hubs and customers are fully interconnected. Without end-to-end fully tested connectivity, I suspect trades will continue to be done over the phone – stalling limit order book trading.

This is a topic that we discussed at the recent TAC meeting on September 12. It was clear at that meeting that the pieces were not in place and additional time is needed.

With the arbitrary November 1 deadline looming and the Commission yet to provide confused swap market participants with necessary guidance on a host of unresolved issues, often stemming from a lack of clarity in the SEF rules, I believe additional time is required. The Commission has not provided adequate time to complete the on-boarding process and conduct the technology testing and validation that is necessary. We should also consider phasing in participants, similar to our approach with clearing, in order to avoid a big bang integration issue.

Again, I offer to use the TAC to identify a path forward if that will be useful, but the issues identified in September still remain.

Conclusion

In many respects it is quite remarkable the work that has been accomplished – by both the Commission and the market – to put in place trade reporting, mandatory clearing, and now the first stages of swap exchange trading. However, the Commission process by which all of this was accomplished is certainly not to be replicated.

We need to continue to make sure we follow Congressional direction to protect end-users and focus more on outcomes rather than setting arbitrary timetables tied to an individual agenda. Rather than relying on the ad-hoc no-action process, the Commission should take responsibility of fixing the unworkable rules – swap data reporting and the swap dealer definition come to mind.

If we are going to impose rules, let’s make sure they are informed by data and will not interfere with the fundamental function of hedging and price discovery in the markets – I’m thinking about position limits and our proposed futures blocks.

Finally, let's keep an eye on the costs – putting these markets out of reach for commercial hedgers doesn't help anyone. Let's sharpen the pencil and consider all the options. There is no reason why we should not be able to quantify the solution as the most cost-effective rule for the market.

Thank you again for the opportunity to speak with you today.

1 See Sean Owens, Optimizing the Cost of Customization, Review of Futures Market (July 2012).

Last Updated: October 17, 2013

CFTC COMMISSIONER MARK WETJEN GIVES TESTIMONY BEFORE CONGRESS

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION 
Testimony of Commissioner Mark Wetjen Before the U.S. House Committee on Agriculture Subcommittee on General Farm Commodities and Risk Management, Washington, DC

July 23, 2013

Good morning Chairman Conaway, Ranking Member Scott, and members of the subcommittee. Thank you for inviting me to testify this morning and share some of my perspectives on the future of the Commodity Futures Trading Commission. It is a pleasure to be here.

I want to personally thank Chairman Conaway for his open dialogue with me since I joined the commission. I have found our discussions to be useful and hopefully mutually beneficial.

I also want to acknowledge my friend, Commissioner O’Malia, who is beside me today. I have admired his skills in analyzing and bringing attention to important issues raised by our rules or other market developments. I hope he would agree that we have developed a good working partnership at the agency.

For a host of reasons, now is a very good time for not only this subcommittee, but all stakeholders in the CFTC, to reflect on what the future might bring for this agency. Allow me to mention a few.

First, and most obviously, Congress must address the expiring authorization for the agency, which is the primary reason for the hearing today and of course will require a congressional response. I appreciate this subcommittee’s efforts to work toward making that response an informed one that seeks to solve any inadequacies or other problems related to the Commodity Exchange Act or the work of the commission.

It is my hope and belief that many of the issues raised by CFTC rulemakings in the past three years that eventually became the subject of congressional legislation have been resolved or adequately addressed in our final rules or through other relief granted by the agency. With or without additional direction from Congress through CFTC re-authorization, it is important that the agency and its staff continue to find ways to address problems that are still in need of a solution.

Second, the commission’s implementation of Title VII of Dodd-Frank is for the most part finished. We have almost 80 swap dealers now registered with the CFTC, clearing mandates in place for a broad swath of the swap market, and new reporting obligations for market participants. The commission also just completed its cross-border guidance, informing market participants and other regulators how the commission’s rules will be applied to activities and entities overseas.

Looking ahead through the lens of what already has been done, the commission and all stakeholders will need to closely monitor and, if appropriate, address the inevitable challenges that that will come with implementing the new regulatory framework under Dodd-Frank.

Third, while most of the commission’s work to implement Dodd-Frank is complete, there remain important rulemakings and administrative matters in the months ahead. Perhaps most importantly, the commission, along with the Federal Reserve, the OCC, the FDIC, and the SEC, must finalize its rulemaking on the so-called “Volcker Rule.”

The agency also must undertake “substituted compliance” determinations under the recently finalized cross-border guidance. This will involve a review of swap-regulatory regimes in other nations to determine whether they are “comparable and comprehensive” or “essentially identical” to U.S. law.

The commission also must finalize its rulemaking on capital-and-margin requirements for un-cleared swaps. And there are two very important rulemakings related to the international harmonization of risk-management requirements on clearing houses, which dovetails with the substituted-compliance determinations.

Another critical rulemaking, albeit not directly related to Dodd-Frank, is the commission’s customer-protection rule that seeks to improve risk-management practices at futures commission merchants.

Finally, given that the U.S. has nearly delivered on its G20 commitments to derivatives reform, and the European Union is close behind, all of us can spend more time focusing on the developing market structure for swaps on a more global scale. The commission already has authorized new trading platforms for swaps, and Europe is about to do the same. We anticipate that with these developments many swaps will be executed on regulated and transparent marketplaces located both here and abroad, facilitating global liquidity formation and risk management. Consistent with this result, I believe the commission’s cross-border guidance reversed a developing trend toward market and risk-management fragmentation that would have been counterproductive to the goals of Dodd-Frank as well as the G20 commitments.

But we all must wait and see to a greater degree what developments will take shape outside of the U.S. and Europe. Other jurisdictions that host a substantial market for swap activity are still working on their reforms, and certainly will be informed by our work. All of us will need to monitor those developments closely, with an eye toward how they could separate those jurisdictions from the fabric we – along with our European partners – stitched together in last week’s accord.

In other words, the commission must remain vigilant in monitoring, identifying, and addressing risk, and continually prioritize so we are focused on the greatest threats. Indeed, another threat identified by the Treasury Secretary last week must be part of this global monitoring: the cyber-security threat. As marketplaces and systems continue to rely more and more on technology, the need to better understand and protect against cyber-security threats to the markets the commission regulates increases. There are multiple task forces and coalitions formed of domestic and international partners that the commission will need to work with to ensure success on this front.

Thank you again for inviting me today. I would be happy to answer any questions from the panel.

CFTC COMMISSIONER SOMMER'S REMARKS BEFORE CONGRESS ON FARM COMMODIITES AND RISK MANAGEMENT

FROM: U.S. COMMODITY FUTURES TRADING COMMISSION

Testimony Before the US House of Representatives Committee on Agriculture Subcommittee on General Farm Commodities and Risk Management

Commissioner Jill E. Sommers
December 13, 2012

Good morning Chairman Conaway, Ranking Member Boswell and members of the Committee. Thank you for inviting me to testify on the challenges facing U.S. and international markets resulting from the Dodd-Frank derivatives reforms. I have worked in the derivatives industry for over fifteen years and have been a Commissioner at the Commodity Futures Trading Commission (CFTC or Commission) since August of 2007. During my time at the Commission I have served as the Chairman and sponsor of the CFTC’s Global Markets Advisory Committee (GMAC) and have represented the Commission at meetings of the International Organization of Securities Commissions (IOSCO), one of the principal organizations formed to develop, implement and promote internationally recognized and consistent standards of regulation, oversight and enforcement in the securities and derivatives markets. I am pleased to give you my perspective on the many challenges facing regulators across the globe in their quest to meet the commitments on over-the-counter (OTC) derivatives reform made by the G20 Leaders in 2009 and, in particular, the challenges presented in interpreting the cross-border scope of Dodd-Frank. The views I present today are my own and not those of the Commission.

Section 722(d) of the Dodd-Frank Act, which added Section 2(i) to the Commodity Exchange Act, provides that the Act shall not apply to activities outside the United States unless those activities have a direct and significant connection with activities in, or effect on, commerce of the United States, or contravene rules or regulations prescribed by the Commission designed to prevent evasion. In 2011 the Commission acknowledged the growing uncertainty surrounding the extraterritorial reach of Dodd-Frank and in August of that year held a two-day roundtable, followed by a public comment period. In July 2012 the Commission published proposed guidance setting forth an interpretation of how it might construe Section 2(i), followed by another round of public comment. The guidance included a proposed definition of "U.S. person," the types and levels of activities that would require foreign entities to register as U.S. swap dealers or major swap participants (swap entities), and the areas in which such swap entities might be required to comply with U.S. law and those in which the Commission might recognize substituted compliance with the law of an entity’s home jurisdiction.

On November 7, 2012 I convened a meeting of the GMAC to further discuss the Commission’s proposed interpretive guidance and to identify questions and areas of concern in implementing the CFTC’s proposed approach. A number of foreign jurisdictions were represented, including regulators from Australia, the European Commission, the European Securities and Markets Authority, Hong Kong, Japan, Quebec and Singapore. Representatives of the U.S. Securities and Exchange Commission (SEC) also attended to discuss the SEC’s perspective. A common theme that emerged was concern over the breadth of CFTC’s proposed definition of "U.S. person," the implications of having to register in the U.S., the uncertainty of the Commission’s proposal on substituted compliance, and the need to identify areas where complying with a particular U.S. requirement might conflict with the law of a foreign swap entity’s home country regime.

On November 28, 2012 regulatory leaders from Australia, Brazil, the European Union, Hong Kong, Japan, Ontario, Quebec, Singapore, Switzerland and the United States met in New York to continue the dialogue. In a press statement issued after the meeting the leaders supported the adoption and enforcement of robust and consistent standards in and across jurisdictions, and recognized the importance of fostering a level playing field for market participants, intermediaries and infrastructures, while furthering the G20 commitments to mitigating risk and improving transparency. The leaders identified five areas for further exploration, including:
the need to consult with each other prior to making final determinations regarding which products will be subject to a mandatory clearing requirement and to consider whether the same products should be subject to the same requirements in each jurisdiction, taking into consideration the characteristics of each domestic market and legal regime;
the need for robust supervisory and cooperative enforcement arrangements to facilitate effective supervision and oversight of cross-border market participants, using IOSCO standards as a guide;
the need for reasonable, time-limited transition periods for entities in jurisdictions that are implementing comparable regulatory regimes that have not yet been finalized and to establish clear requirements on the cross-border applicability of regulations;
the need to prevent the application of conflicting rules and to minimize the application of inconsistent and duplicative rules by considering, among other things, recognition or substituted compliance with foreign regulatory regimes where appropriate; and
the continued development of international standards by IOSCO and other standard setting bodies.
The authorities agreed to meet again in early 2013 to inform each other on the progress made in finalizing reforms in their respective jurisdictions and to consult on possible transition periods. Future meetings will explore options for addressing identified conflicts, inconsistencies, and duplicative rules and ways in which comparability assessments and appropriate cross-border supervisory and enforcement arrangements may be made.

The Commission has worked for decades to establish relationships with our foreign counterparts, built on respect, trust, and information sharing, which has resulted in a successful history of mutual recognition of foreign regulatory regimes in the futures and options markets spanning 20-plus years. At the Pittsburg summit in 2009 all G20 nations agreed to a comprehensive set of principles for regulating the OTC derivatives markets. We should rely on their regional expertise. While the pace of implementing reforms among the various jurisdictions has been uneven, I have no reason to believe that comparable or equivalent regulation is unachievable. It is obvious that more time is needed to facilitate an orderly transition to a regulated environment. It is important that assessments of comparability be made at a high level, keeping in mind the core policy objectives of the G20 commitments rather than a line-by-line comparison of rulebooks. It is also important to avoid creating an unlevel playing field for U.S. firms just because the U.S. is ahead of the rest of the world in finalizing reforms. U.S. firms should not be disadvantaged by tight compliance deadlines set by the CFTC. Global coordination is key. It is my hope that in the coming days the Commission will issue clear and concise relief from having to comply with various Dodd-Frank requirements, for both domestic and foreign swap entities, until we have a better sense of the direction in which we are all headed.

I am grateful for the opportunity to speak about these important issues and am happy to answer any questions.