CFTC CHAIRMAN GENSLER'S STATEMENT ON CUSTOMER PROTECTION REFORMS IN DERIVATIVES MARKET PLACE

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION 
Opening Statement of Chairman Gary Gensler: Open Meeting to Consider Customer Protection Reforms
October 30, 2013

Good morning. This meeting will come to order. This is a public meeting of the Commodity Futures Trading Commission (CFTC). I’d like to welcome members of the public, market participants and members of the media, as well as those listening to the meeting on the phone or watching the webcast.

I would like to thank Commissioners Chilton, O’Malia and Wetjen for their contributions to the rule-writing process and the CFTC’s hardworking and dedicated staff.

This is a public meeting that is partially related to the Dodd-Frank Wall Street Reform and Consumer Protection Act related because it relates to swaps funds. This meeting is about customer funds and customer protections.

Segregation of customer fund is the core foundation of the commodity futures and swaps markets. Segregation must be maintained at all times. That means every moment of every day.

Market events, though, of these last two years highlighted that the Commission must do everything within our authorities and resources to strengthen oversight programs and protection of customer funds.

And today's reforms are the sixth set of rules to be finalized by this Commission, if we move forward to finalize them, during a two-year process to ensure that customers have confidence that their funds are segregated and protected. These reforms benefit from the Commission's thorough review of existing customer protection rules – looking for any gaps in those rules and the oversight of these markets.

They benefit from significant public input, including staff roundtables and the Technology Advisory Committee, Agricultural Advisory Committee meetings, and numerous reports submitted by market participants.

They also benefit from input through a coordinated effort of the CFTC with other regulators; the self-regulatory organizations (SROs), such as the CME and the National Futures Association (NFA); as well as Congressional reports and input on these matters.

I will be supporting today's rules, in summary, for at least for six reasons. They are quite comprehensive, but here are six points I want to highlight:

First, FCMs, clearing members, have to significantly enhance their supervision of and accounting for customer funds. They will have to put in place additional policies and procedures for these new protections.

Second, significant enhancements around outside accounting and auditing – regarding the actual accountants or certified public accountants that audit futures commission merchants (FCMs), and also regarding the SROs and how they audit the FCMs.

Third, significant customer fund protections with regard to how funds are moved around. Basically, when a firm moves money within a firm, how can they move that money around? Some of these reforms were adopted by SROs last year, such as requiring senior management signoff, and the pre-approval of moving those monies. There are also significant new protections coming from changes in the required acknowledgment letters from the banks and custodians.

Fourth, reforms related to investing in international futures accounts. Our Part 30 regime really had not kept pace with protections for domestic futures accounts. With these reforms and the reforms that the NFA had put in place last year, investing in foreign futures accounts will be significantly aligned with the domestic protections. They won't be identical, but they will be significantly aligned with the protections for domestic futures accounts.

Fifth, there's significant new transparency. Transparency to the regulators – we will be able to see electronically custodial accounts and cash accounts on a daily basis. There is transparency to the public, as well, with the twice-a-month statements of the details of their funds in the investment accounts. These reforms also have been put in place by the SROs, but it is important that we do this at the federal level as well, and put it in our rules.

Sixth, the final rules include provisions on capital and residual interest of the FCMs themselves. This was quite possibly the most debated feature of these reforms, but I think they are important. In response to commenters on this provision, we are phasing in compliance to smooth implementation. As the staff will present, this section calls for significant new studies and roundtables and provides for a five-year phase in on these matters.

It is important that we look very closely at the law and ensure that one customer's funds or property are not used in some way to secure or guarantee other people's accounts.
Prior to this final rule set, the Commission had already made important improvements to protections for customers. In a longer statement for the record I go through those. But this is really a remarkable achievement, and I want to thank my fellow Commissioners

I also wanted to address three other matters.

This morning, unanimously as a Commission, we actually finalized two other rule sets. Since they were noticed for this meeting, I just wanted to inform the public about them. The first is one of the five other matters that we did to help customers and protect their funds. It relates to the choice that customers will have to segregate their collateral and funds -- the initial margin standing behind swaps that are not cleared. Congress gave the clear right to counterparties of swap dealers that they can chose to have those funds segregated. I'm pleased to report that we unanimously moved that this morning. It’s a key tenant of customer protection.

Another rule that we moved on was from the Division of Market Oversight, the Office of the Chief Economist and all of our surveillance teams across the agency. It is called ownership and control reporting. This has been on our docket for four-plus years. We had an advanced notice of proposed rulemaking, and then a proposal. We re-proposed it after some staff roundtables.

I'm glad to say we again reached conclusion, and I want to thank Commissioner O'Malia for his doggedness on this. We will finally have in our rulebook that it is required to file these various forms electronically -- no longer by mail and fax. I also want to thank staff.

Many of the things in this document that we are considering today also relate to filing things electronically, which is the right place to be in the 21st century.

The ownership and control reporting will give us a greater window into those parties that actually own accounts and control those accounts -- not only for positions, but also, in the world of high frequency trading, for accounts that have high volume on a particular day, but might end the day flat or without a position.

For the first time, we'll have this enhanced ability to oversee markets.

I also wanted to give a public thanks to my friend, my colleague and a wonderful head of the Division of Enforcement, David Meister. Today is, in fact, his last day of service at the CFTC.

David, you have brought tremendous energy, wisdom, talent, and, yes, expertise from the Southern District of New York. I think you've shown how to be a tough but fair prosecutor, and you've led a remarkable team, often strapped with not enough resources. I wish you well in your next professional adventures.

Note: this transcript was edited for clarity.

CFTC GARY GENSLER'S REMARKS AT 2013 ANNUAL GLAUBER LECTURE AT HARVARD UNIVERSITY

FROM:  COMMODITY FUTURES TRADING COMMISSION 
Remarks of Chairman Gary Gensler at the 2013 Annual Glauber Lecture at Harvard University
October 29, 2013

Thank you, Bob, for that kind introduction. I also would like to thank you and Harvard University for the invitation to speak today. I’m particularly pleased to be here as Bob and I are both examples that there is life after serving as an undersecretary of the Treasury.

Five years ago, the U.S. economy was in a free fall.

Five years ago, the swaps market was at the center of the crisis. It cost middle-class Americans – and hardworking people around the globe – their jobs, their pensions and their homes.

Five years ago, the swaps market contributed to the financial system failing corporate America and the economy as a whole. Thousands of businesses closed their doors.

President Obama met in 2009 with the G-20 leaders in Pittsburgh. They committed to bringing the swaps market into the light through transparency and oversight.

The President and Congress in 2010 gave the task of implementing swaps market reform to the Commodity Futures Trading Commission (CFTC) and security-based swaps market reform to the Securities and Exchange Commission.

With the CFTC’s near completion of these reforms, the shift to a transparent, regulated marketplace benefitting investors, consumers and businesses is fully in motion.

The CFTC’s 62 final rules, orders and guidance have brought traffic lights, stop signs, and speed limits to the once dark and unregulated swaps roads.

There are bright lights and robust safety measures in place that didn’t exist in 2008.

With these reforms, farmers, ranchers, producers and commercial companies can continue to rely on transparent, competitive markets to lock in a price or a rate and focus on what they do best – innovating, producing goods and services for the economy, and creating jobs.

These reforms are not based on new ideas. Economists have written about them for centuries. Just start with Adam Smith in the Wealth of Nations where he wrote about the benefits of lowering the price of information and the price of access. In essence, if you make information free, the economy benefits. Similarly, if access to the market is free, everybody gets to compete.

Transparency

Thus, in line with Adam Smith, the first critical component of swaps market reform is transparency.

Today, the public can see the price and volume of each swap transaction as it occurs on a website, like a modern-day tickertape.

This transparency lowers costs for investors, consumers and businesses. It increases liquidity, efficiency and competition.

Regulators have benefited as well. Nearly $400 trillion in market facing swaps are being reported into data repositories.

This transparency spans the entire marketplace – cleared as well as bilateral or customized swaps. Every product, without exception, now must be reported.

Further, starting this month, the public is benefitting as swap trading platforms come under new common-sense rules of the road.

Over time, market participants will benefit from the enhanced pre-trade transparency and competition of these new trading platforms, called swap execution facilities (SEFs).

SEFs are required to provide all market participants – dealers and non-dealers alike – with impartial access, once again following Adam Smith’s observations on how to benefit the economy.

Further, SEFS provide the ability to compete by leaving live, executable bids or offers in an order book.

Requiring trading platforms to be registered and overseen by regulators was central to the swaps market reform President Obama and Congress included in the Dodd-Frank Wall Street Reform and Consumer Protection Act. They expressly repealed exemptions, such as the so-called “Enron Loophole,” for unregistered, multilateral swap trading platforms.

Seventeen SEFs are temporarily registered. This is truly a paradigm shift – a transition from a dark to a lit market. It’s a transition from a mostly dealer-dominated market to one where others have a greater chance to compete.

Clearing

Another key component of completed swaps reforms is bringing transactions among financial institutions into central clearing.

This month, mandatory clearing of interest rate and credit index swaps is a reality for swap dealers, hedge funds and other financial institutions.

Clearinghouses lower risk and promote access for market participants.

As of October 25, 80 percent of new interest rate swaps were cleared. In total, over $190 trillion of the approximately $340 trillion market facing interest rate swaps market, or 57 percent, was cleared. This compares to only 21 percent of the market in 2008.

Earlier this month, the guaranteed affiliates and branches of U.S. persons were required to come into central clearing. Further, hedge funds and other funds whose principal place of business is in the United States or that are majority owned by U.S. persons are required to clear as well. No longer will a hedge fund with a P.O. Box in the Cayman Islands for its legal address be able to skirt the important reforms Congress put in place.

Swap Dealer Oversight

The third key component of swaps market reform is bringing oversight to swap dealers.

In 2008, swaps activity was basically not regulated in the United States, Europe or Asia. Among the reasons for this, it was claimed that financial institutions did not need to be specifically regulated for their swaps activity, as they or their affiliates already were generally regulated as banks, investment banks or insurance companies.

AIG’s downfall was a clear example of what happens with such limited oversight.

Today, we have 88 swap dealers and two major swap participants registered. This group includes the world’s 16 largest financial institutions in the global swaps market, commonly referred to as the G16 dealers. It also includes a number of energy swap dealers.

Swap dealer oversight helps protect the public. It lowers risk and increases market integrity. Swap dealers throughout this year have had to report their transactions and comply with sales practice and other business conduct standards.

International Coordination on Swap Market Reform

Since the 2009 meeting in Pittsburgh, the CFTC has been consistently coordinating with our international counterparts on swaps market reform. The United States, Europe, Japan and the largest provinces in Canada all have made substantial progress.

As the CFTC and the international regulatory community move forward with reform, we all recognize that risk knows no geographic border. AIG nearly brought down the U.S. economy through the operations of its offshore guaranteed affiliate.

It wasn’t the only U.S. financial institution that brought risk back home from its far-flung operations during the 2008 crisis.

It was also true at Lehman Brothers, Citigroup, and Bear Stearns. Ten years earlier, it was true at Long-Term Capital Management.

The nature of modern finance is that financial institutions commonly set up hundreds, or even thousands, of legal entities around the globe. When a run starts on any part of an overseas affiliate or branch of a modern financial institution, risk crosses international borders.

The U.S. Congress was clear in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) that the far-flung operations of U.S. enterprises are to be covered by reform.

The CFTC, coordinating closely with global regulators, completed guidance on the cross-border application of the Dodd-Frank Act in July. Swaps market reform covers transactions between non-U.S. swap dealers and guaranteed affiliates of U.S. persons, as well as swaps between two guaranteed affiliates.

The guidance embraces the concept of substituted compliances, or relying on another country’s rules when they are comparable and comprehensive.

This guidance is critical to protecting the public from the risk of foreign-affiliate failures in the future.

Benchmark Interest Rates

Today, the CFTC announced its fifth settlement against a bank for pervasively rigging key interest rate benchmarks, LIBOR and Euribor.

LIBOR and Euribor are critical reference rates for global futures and swaps markets. In the U.S., LIBOR is the reference rate for 70 percent of the futures market and more than half of the swaps market. It is the reference rate for more than $10 trillion in loans.

Unfortunately, we once again see how the public trust can be violated through bad actors readily manipulating benchmark interest rates.

Through hundreds of manipulative acts spanning six years, in six offices, and on three continents, more than two dozen Rabobank employees, including a senior manager, manipulated, attempted to manipulate and falsely reported crucial reference rates in global financial markets. Rabobank employees also aided and abetted other banks to manipulate benchmark interest rates.

I wish I could say that this won’t happen again, but I can’t.

LIBOR and Euribor are not sufficiently anchored in observable transactions. Thus, they are basically more akin to fiction than fact. That’s the fundamental challenge so sharply revealed by Rabobank and our prior cases.

This fifth instance of benchmark manipulative conduct highlights the critical need to find replacements for LIBOR and Euribor – replacements truly anchored in observable transactions.

Though addressing governance and conflicts of interest regarding benchmarks is critical, that will not solve the lack of transactions in the market underlying these benchmarks.

That is why the work of the Financial Stability Board to find alternatives and consider potential transitions to these alternatives is so important. The CFTC looks forward to continuing to work with the international community on much-needed reforms.

Resources

I’d like to close on one of the greatest challenges to well-functioning swaps and futures markets. That challenge is that the agency tasked with overseeing these markets is not sized to the task at hand.

At 675 people, we are only slightly larger than we were 20 years ago. Since then though, Congress gave us the job of overseeing the $400 trillion swaps market, which is more than 10 times the market we oversaw just four years ago. Further, the futures market itself has grown fivefold since the 1990s.

You might not have liked the umpire’s call in the game this week on obstruction, but would you want Major League Baseball to expand tenfold and not add to its corps of umpires?

We’ve basically completed the task of writing all the reforms and are past the initial market implementation dates. We’ve brought the largest and most significant enforcement cases in the Commission’s history.

These successes, however, should not be confused with the agency having sufficient people and technology to oversee these markets.

We need people to examine the clearinghouses, trading platforms and dealers. We need surveillance staff to actually swim in the new data pouring into the data repositories. We need lawyers and analysts to answer the many hundreds of questions that are coming in from market participants about implementation. We need sufficient funding to ensure this agency can closely monitor for the protection of customer funds. And we need more enforcement staff to ensure this vast market actually comes into compliance and go after bad actors in the futures and swaps markets.

The President has asked for $315 million for the CFTC. This year we’ve been operating with only $195 million.

Worse yet, as a result of continued funding challenges, sequestration and a required minimum level Congress set for the CFTC’s outside technology spending, the CFTC already has shrunk 5 percent, and just last week, was forced to notify employees that they would be put on administrative furlough for up to 14 days this year.

I recognize that Congress and the President have real challenges with regard to our federal budget. I believe, though, that the CFTC is a good investment for the American public. It’s a good investment to ensure the country has transparent and well-functioning markets.

Thank you, and I look forward to your questions.

CFTC COMMISSIONER O'MALIA'S DISSENTING STATEMENT ON CUSTOMER PROTECTION ENHANCEMENTS IN DERIVATIVES MARKET

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION 
Dissenting Statement of Commissioner Scott D. O’Malia, Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations1

October 30, 2013

I respectfully dissent from the Commission’s approval today of the final Customer Protection Rules.

I supported the proposed rules because I wanted to solicit public comment and engage market participants in an open discussion about how the Commission should improve its customer protection regulatory oversight.

In the wake of the global financial crisis, it is extremely important to intensify regulatory efforts to strengthen customer protection policies in order to promote the financial stability of the derivatives markets. There is no dispute customer protection must be the cornerstone of the Commission’s oversight. Sound customer protection policies and measures, such as the electronic customer verification confirmation services will improve the efficiency and transparency of financial markets.2

The Commission must promulgate workable regulations that provide clear guidance to industry participants and ensure cost-effective access to markets. Such regulations must be designed to address real weaknesses in the current regulatory regime and allow industry participants to continue with well-established industry practices that had nothing to do with the financial crisis or the recent bankruptcies of MF Global and Peregrine Financial.

Unfortunately, the Commission’s customer protection rules fall short of these objectives. Instead of mitigating customer risk, the rules create a false sense of security by imposing broad and ambiguous requirements and introducing another layer of governmental oversight. Even worse, they force a change in a longstanding and generally accepted industry practice that will likely result in seriously harmful consequences for small FCMs and their end-user customers.

I do support several provisions that allow customers greater insight into the operations of an FCM. These provisions include: an improved FCM disclosure regime that will give customers new and critical information about their FCM exposures, elimination of the alternative method of calculating segregation requirements for §30.7 funds (treatment of foreign futures or foreign options), improved reporting of segregated fund balances, and enhancements to risk management procedures. However, I am unable to support the final rule for the reasons stated below.

Reinterpretation of the residual interest deadline will result in costly prefunding of margin payments.

My main concern with the final rules is their radical reinterpretation of the longstanding residual interest deadline. This reinterpretation decreases the time in which customers’ margin calls must arrive to their FCM from the current three days to just one day.

Such a change would mean a drastic increase in pre-funding of margin, perhaps nearly double the amounts currently required. As a result, many small agribusiness hedgers will have to consider alternative risk management tools or, even worse, will be forced out of the market.3 I am disappointed that yet again the Commission has rushed to implement a rule that disregards the express Congressional directive to protect end-users.

I recognize that the Commodity Exchange Act (CEA) does not permit an FCM to use the money or property of one customer to margin the futures or option positions of another customer.4 Despite this fact, it has been the prevailing industry practice authorized by the Commission for decades.

To the extent that the Commission must reinterpret this statutory provision, I believe this reinterpretation must be based on the thorough analysis of the market data and the full evaluation of the costs of strict compliance with the statute before implementing policy changes, and not after as is the case with the residual interest deadline.

The residual interest deadline rule makes no effort to respond to the commenters’ concerns that the residual interest deadline would be especially costly for smaller FCMs and end-users.5 Given the express Congressional directive to protect end-users, I would have expected the Commission to conduct meaningful cost-benefit analysis to justify the costs when compared to the actual risk to customer accounts and the derivatives markets and to explain why the Commission could not have adopted an alternative approach. Regrettably, the Commission has failed to do so.

Even the Commission’s own cost benefit analysis points out, while significantly understating the impact, that:

“Smaller FCMs may have more difficulty than large FCMs in absorbing the additional cost created by the requirements of the rules (particularly §1.22). It is possible that some smaller FCMs may elect to stop operating as FCMs as a result of these costs.”6

I cannot support a rule that will impose such onerous costs and compliance burdens on the smallest FCMs and small, non-systemically relevant customers.

Finally, although I support a phase-in compliance schedule for the residual interest deadline, I am disappointed that the Commission, in deciding whether to change the deadline at a future time, is not required to make such a decision based on data. Instead, the Commission will simply come up with another arbitrary residual interest deadline that has nothing to do with customer or FCM risk exposure.

Yet again, the Commission has chosen to avoid fact-based analysis. I strongly believe that the Commission should utilize facts and data to make an informed decision about the appropriate time for the residual interest deadline.

The rules fail to provide a clear standard for compliance.

In addition to my serious concerns about the final rules’ treatment of the residual interest deadline, I am concerned that the rules unreasonably expand the scope of the new regulatory compliance regime without providing a clear regulatory objective.

For example, the rules require that a Self-Regulatory Organization (SRO) supervisory program “address all areas of risk to which [FCMs] can reasonably be foreseen to be subject (emphasis added).”7 This broad language requires the SRO to guess at what criteria the programs would be measured against, and under what framework the SRO would make this determination. In short, the new language does nothing but adds more ambiguity to the SRO’s customer protection program and increases the cost of compliance with vague requirements.

Examination experts do not add value to the customer protection regime.

I also have concerns about the requirement that each SRO supervisory program of its member FCMs be reviewed by an “examinations expert.”8 I question the benefit of this requirement given the fact that the Joint Audit Committee (JAC) currently performs this function. The JAC’s primary responsibility is to oversee the practices and procedures that each SRO must follow when it conducts audits and financial reviews of FCMs. This regulatory task is already in place and implemented in a less costly and more efficient manner than set forth in the final rules.

Moreover, in light of the Commission’s regulatory oversight of all SROs and the Commission’s review of all JAC examination programs, this additional layer of review does not provide any benefit except for isolating the Commission from its primary responsibility to oversee customer protection programs.

Customers deserve better protections in bankruptcy proceedings

Going forward, the Commission should address key customer protections in the areas of bankruptcy. Congress should make changes to the Bankruptcy Code to ensure that certain bankruptcy protections are afforded to FCM customers. Specifically, Congress should amend the pro-rata distribution rules in bankruptcy. Despite the Commission’s customer segregation requirements, individual customer accounts are still subject to a pro-rata distribution in bankruptcy. In addition to these changes to the Bankruptcy Code, the Commission should amend its rules to allow the Commission to appoint a trustee to oversee derivatives customers’ accounts in the bankruptcy of a broker-dealer FCM.

Conclusion

I support implementation of a rigorous customer protection program that provides clear and meaningful mechanisms for mitigating customer risks. However, the customer protection rules approved today have missed the mark.

In sum, many of the new rules impose overly broad and nonsensical regulatory requirements and, in doing so, impede the industry’s ability to operate in an efficient manner. Regrettably, the negative effects will be felt most by farmers and other end-users, whose ability to hedge risk in a cost-effective manner will be hampered if not eliminated altogether. This is contrary to the Congressional directive, and I cannot support rules that result in such an outcome.

1 “Customer Protection Rules”

2 In this regard, I applaud the efforts of the Chicago Mercantile Exchange Inc. (CME) and the National Futures Association (NFA) to protect customer accounts by introducing daily electronic confirmation services. This new technology allows CME and NFA to review balances held at bank depositories and compare the balances with customer account information provide by futures commission merchants (FCMs).

3 See e.g.; National Grain and Feed Association Comment Letter at 2 (Dec. 28, 2012) (stating that the Commission’s proposed changes “could have the unintended impact of disadvantaging smaller and mid-size FCMs that provide ‘hands-on’ service to many of the relatively smaller hedgers in agribusiness”); Texas Cattle Feeders Association Comment Letter (Jan. 14, 2013) (warning that such changes “could have the potential to cause unintended consequences such as added costs eventually borne by customers”); Iowa Cattlemen’s Association Comment Letter (Feb. 15, 2013) (“it is imperative that the CFTC understand all sizes of businesses . . . [in order to have] . . . a better opportunity to write rules that provide a logical fit. Our fear is that if this rule is put in place, we will have members who will not take advantage of the risk management tools . . ..”).

4 CEA § 4d(a)(2).

5 Futures Industry Association Comment Letter at 16 (Feb. 15, 2013).

6 Customer Protection Rules at 313.

7 § 1.52 (c)(2).

8 § 1.52.

CFTC COMMISSIONER WETJEN'S STATEMENT REGARDING CONSUMER PROTECTIONS IN THE DERIVATIVES MARKETPLACE

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION 
Statement of Commissioner Mark P. Wetjen, Public Meeting of the Commodity Futures Trading Commission
October 30, 2013

Thank you Chairman Gensler. And my thanks to the professional staff for their hard work on the important final rule we are considering today regarding customer protection.

Customer Protection

The CFTC's core mission is to protect futures and swaps customers from fraud, manipulation, abusive practices and systemic risk. In pursuing this mission, it is vital that the commission unceasingly look to update and improve the protections we have in order to better protect the public and ensure the safety, soundness, and integrity of those operating in the derivatives marketplace.

The final customer protection rule before us today requires important improvements to a range of protections that have been implemented by the commission and industry in recent months. It fills certain remaining regulatory gaps to prevent future failures in the FCM community, and enhances nearly every protection afforded customers of FCMs in the futures and cleared-swaps markets. Customers will benefit from enhancements to FCM risk management programs, modernized audit programs and streamlined measures that will better insulate customers from fellow customer risk.

Residual Interest

The residual-interest provisions have been the most discussed part of the proposal. The commission received a significant number of comment letters in response to that proposal, which would have required FCMs to maintain “at all times” enough residual interest in their segregated accounts to cover all customer margin deficits. That approach was intended to limit fellow-customer risk by ensuring that one customer would in no circumstance be responsible for unwittingly covering another customer’s margin obligations.

Although the proposal offered one permissible construction of the Commodity Exchange Act, it suffered from some practical shortcomings. Those practical shortcomings, in my judgment, are appropriately addressed in the document before us today.

For example, many suggested that the “at all times” requirement under the proposal likely would have imposed significant capital costs on FCMs, which could have led to the unintended effect of limiting access to the derivatives markets. Many contended that this would be too high a price to pay when measured against the corresponding benefit of mitigating fellow-customer risks. The commission has considered these comments and has taken a different approach in today’s release.

The compromise reflected in the final rule is intended to usher in improvements to margin-collection practices over time and to protect access to the markets for a broad cross-section of participants. As a general matter, I strongly support improvements to the residual-interest requirements because of the critical policy objectives they are designed to achieve. First, they will better protect the excess segregation funds of a customer in the event of an FCM bankruptcy. Second, they will encourage FCMs to more actively monitor customer accounts for instances when those accounts are under-margined. And third, they will incentivize FCMs to address those circumstances when an account is under-margined. Together, these enhancements will better protect the safety and soundness of the FCM.

Importantly, the commission has given itself sufficient time to evaluate the FCM community’s progress in implementing the residual-interest policy in the final rule, and to change course if necessary. Indeed, the phased compliance schedule provided in today’s release was a critical component of getting to this final compromise on residual interest.

That compromise is reasonable and measured. For one year, there will be no change to current practice with respect to the treatment of residual interest. After that year, FCMs will be required to comply with the residual-interest requirement as of the close of business on the day following the margin-deficit calculation. This is a necessary and significant change to current market practice.

Thirty months after today’s release is published, commission staff is obligated to conduct a study determining the feasibility, costs and benefits of moving the residual-interest deadline to the completion of the first clearing-settlement cycle following the trade date. The study will be published for public comment, and a public roundtable will be held to solicit the views of market participants.

Finally, after five years, the residual-interest requirement will move up to the first clearing settlement cycle of the day, typically first thing in the morning, should the commission choose not to change course based upon recommendations in the study or in reaction to public feedback at the roundtable.

To be sure, if this end-state were implemented today it would no doubt create a significant cost to FCMs and to market participants. The five-year phase-in period, however, provides the industry an opportunity to streamline margin-collection practices and to take advantage of any technological solutions that may be developed in the meantime.

Equally important, today’s release ensures that future residual-interest requirements will not be imposed on the FCM community if the facts on the ground regarding feasibility and cost do not support it. It is important to note that the study and roundtable are not optional but rather mandated by law, which means that the newly updated information will be brought to the commission before the phase-in period would end.

If the commission decides that it is appropriate to change the residual-interest deadline, the commission may act nimbly and implement a new compliance schedule for that deadline by order, without the procedural hurdles of notice and comment. I am confident that if the commission is presented with convincing facts through this process, it will be compelled to respond appropriately.

All stakeholders in today’s release – including policymakers, FCMs and their customers – rightly anticipate that new services and technologies will provide solutions to today’s compliance challenges. I know that all of us not only welcome those advancements but hope they are brought to market as quickly as practicable. The approach of this rulemaking appropriately incentivizes that outcome.

For that reason, I anticipate that technological solutions will facilitate compliance with residual-interest requirements in the near future for those who could not comply today. I must point out that the comment file to this rule suggests that the vast majority of the marketplace could comply with more abbreviated timelines for margin calls and payments today.

I also anticipate that the flexibility built into this final rule will help avoid the less desirable, alternative methods of compliance suggested by commenters, including self-funding or pre-funding residual interest or margin obligations, as some have predicted. To be more clear, I strongly prefer, and indeed expect, that FCMs will not pursue these options in order to comply with today’s release. This judgment is based in part on the rapid advancement in settlement solutions in recent years, as well as the fact that the latter options may not – all things considered – be as commercially viable.

The expense of pre-funding margin accounts was a special concern of the agricultural community raised in their comments. I spent many days with agricultural producers over the last several months, discussing this issue and others. I met with a number of producers in my home state of Iowa who actively use the derivatives markets to hedge their production risks. I have listened to and carefully considered their concerns about the residual-interest requirement. Today’s release takes those concerns into account, and I believe that their most-pressing fears will not be realized because of this rule.

Meanwhile, even today producers can make intra-day margin payments to FCMs through banking or credit relationships once a margin call is received. Based on what I have learned over recent months, these types of relationships are at a minimum common in the producer community, and seemingly the norm for larger producers. For those producers who do not currently rely on these services, again, I expect other solutions to payment settlement will be offered, or producers will in time embrace those already available, with marginal added expense to them.

I also would like to clarify that today’s release does require FCMs to take a capital charge for failure to meet its residual-interest requirement, but this falls on the FCM at the close of business the day after its residual-interest obligation. Importantly, today’s release phases in the timing of this capital-charge obligation until one year after its publication in the federal register, as some commenters suggested.

I would like to thank the staff for their work in putting together this balanced approach. With the concerns about residual interest properly addressed, I am happy to support the final rule as an important step forward in the commission’s ongoing efforts to protect customers.

As a final note, I look forward to taking up the Volcker Rule and the position-limits proposal by year-end, along with a number of commission determinations on substituted compliance. As I said at the time we finalized our cross-border guidance, those determinations will benefit from as much transparency as practicable. With that, I look forward to supporting the staff’s recommendations on the rule before the commission today.

CFTC COMMISSIONER O'MALIA'S STATEMENT ON CUSTOMER FUND PROTECTIONS IN DERIVATIVES MARKETS

FROM:  COMMODITY FUTURES TRADING COMMISSION 
Opening Statement, Commissioner Scott D. O’Malia, Open Meeting On Rules Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations

October 30, 2013

Mr. Chairman,

I would like to thank staff for their hard work on the customer protection rules. I appreciate the hard work of the staff of DSIO, DCR and OGC who have contributed to this rulemaking.

In the wake of the global financial crisis, it is extremely important to intensify regulatory efforts to strengthen customer protection policies in order to promote the financial stability of the derivatives markets. There is no dispute customer protection must be the cornerstone of the Commission’s oversight. Sound customer protection policies and measures will improve the efficiency and transparency of financial markets.

I do support several provisions of the rules that allow customers greater insight into the operations of an FCM. These provisions include: an improved FCM disclosure regime that will give customers new and critical information about their FCM exposures, elimination of the alternative method of calculating segregation requirements for §30.7 funds (treatment of foreign futures or foreign options), improved reporting of segregated fund balances, and enhancements to risk management procedures.

However, my main concern with the draft final rules is their radical reinterpretation of the longstanding residual interest deadline. This reinterpretation decreases the time in which customers’ margin calls must arrive to their FCM from the current three days to just one day.

Such a change would mean a drastic increase in pre-funding of margin, perhaps nearly double the amounts currently required. As a result, many small agribusiness hedgers will have to consider alternative risk management tools or, even worse, will be forced out of the market.

I recognize that the Commodity Exchange Act (CEA) does not permit an FCM to use the money of one customer to margin the futures or option positions of another customer.1 However, I believe that the Commission, in deciding whether to reinterpret this provision, must make such a decision based on data.

Therefore, I am proposing my amendment that would continue to make progress to accelerate the collection of margin of customers from 3 days after the settlement date to 1 day after settlement at 6 pm EST. Just like the draft final rule, the amendment would be phased in one year following the date of publication of the rules in the Federal Register; and just like the draft final rule, the amendment will also require a study to determine the feasibility of changing the collection date and the costs associated with such a move.

The main difference between my amendment and the draft final rule is that my amendment doesn’t mandate that in 5 years’ time, customers will need to meet their margin obligations by the end of the settlement cycle. The amendment simply lets a future Commission make a determination about the best way to proceed after it has collected all the evidence.

In other words, the amendment does not bias the study with an outcome that has been previously determined. Instead, my amendment will task a future Commission to perform the analysis and decide at that point, analyzing against future technology and payment methodologies what the best course of action should be. This way, the future Commission can make an informed and unbiased decision.

If the Commission votes for my amendment, I will be able to support this rule.

Again, I want to express my thanks to the Commission staff for their efforts on this rule.

Let me close by also thanking so many staff from the Division of Enforcement, who devoted their efforts and long hours bringing the recent charges against Rabobank and all of the other LIBOR settlements. Their work must be recognized by the Commission as well as the work from staff from OCE and DMO. We couldn’t do it without their hard work.

Anne M. Termine
Stephen T. Tsai
Maura M. Viehmeyer
Philip P. Tumminio
Timothy Kirby
Jonathan Huth
Brian Mulherin
Rishi Gupta
Aimée Katimer-Zayets
Jason Wright
Elizabeth Padgett
Terry Mayo

Mr. Chairman, thank you for you indulgence to all us to recognize all of their hard work.

1 CEA § 4d(a)(2).

STATEMENT OF CFTC CHAIRMAN GARY GENSLER ON LIBOR MANIPULATION SETTLEMENT WITH RABOBANK

FROM:  COMMODITY FUTURES TRADING COMMISSION 
Statement of Chairman Gary Gensler on Settlement Order against Rabobank
October 29, 2013

Washington, DC — Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler today made the following statement on the CFTC’s enforcement action that requires Coöperatieve Centrale Raiffeisen-Boerenleenbank B.A. (Rabobank) pay a $475 million penalty for manipulation and false reporting charges related to LIBOR and Euribor:

“With today’s settlement, the CFTC has shown – now for the fifth time – how banks have pervasively rigged key interest rate benchmarks, such as LIBOR and Euribor.

“Unfortunately, we once again see how the public trust can be violated through bad actors readily manipulating benchmark interest rates.

“Through hundreds of manipulative acts spanning six years, in six offices, and on three continents, more than two dozen Rabobank employees, including a senior manager, manipulated, attempted to manipulate and falsely reported crucial reference rates in global financial markets.  Rabobank employees also aided and abetted other banks to manipulate benchmark interest rates.

“I wish I could say that this won’t happen again, but I can’t.  LIBOR and Euribor are not sufficiently anchored in observable transactions.  Thus, they are basically more akin to fiction than fact. That’s the fundamental challenge so sharply revealed by Rabobank and our prior cases.

“This fifth instance of benchmark manipulative conduct highlights the critical need to find replacements for LIBOR and Euribor – replacements truly anchored in observable transactions.

“Though addressing governance and conflicts of interest regarding benchmarks is critical, that will not solve the lack of transactions in the market underlying these benchmarks.

“That is why the work of the Financial Stability Board to find alternatives and consider potential transitions to these alternatives is so important. The CFTC looks forward to continuing to work with the international community on much needed reforms.”