United States: CFTC Commissioner Giancarlo Sets Forth Priorities For "Making Market Reform Work For America"

In an address at SEFCON VII, CFTC  Commissioner J. Christopher Giancarlo set forth five elements of "Making Market Reform Work for America":

1. Providing Customer Choice in Trade Execution. Commissioner Giancarlo proposed an alternative regulatory framework for swaps trading that will (i) align regulatory oversight with swaps market dynamics, (ii) align fully with Title VII of the Dodd-Frank Act, and (iii) promote swaps trading under CFTC regulation. Commissioner Giancarlo had set forth the alternative regulatory framework in a January 29, 2015 White Paper.
2. Fixing Swap Data Reporting. Commissioner Giancarlo asserted that broadening the implementation of swap data reporting will require a "concerted and cooperative effort by regulators, market participants, commercial technology vendors and academia that draws on the emerging fields of big data analysis, network science and financial cartography."
3. Achieving Cross-Border Harmonization. Commissioner Giancarlo argued that the "best route to regulating the trading of swaps in global markets is thoughtful deference to fellow G-20 regulators within the Pittsburgh Summit's goal of rule consistency." He committed to review various methods for easing the transition by March 1, 2017, the variation margin deadline for uncleared swaps. He stated his intent to address the challenges faced by financial firms that must post collateral to cover uncleared swaps contracts by that date.
4. Encouraging FinTech Innovation. Commissioner Giancarlo urged regulators to adopt a "do-no-harm" approach to facilitating FinTech innovation, particularly by making the CFTC "more accessible to FinTech innovators."
5. Cultivating a Regulatory Culture of Forward-Thinking Effort. Commissioner Giancarlo emphasized that U.S. market reform must catch up with the rapidly changing digitized marketplace. In order for the reforms to work, he asserted, the CFTC must establish itself as the "world's foremost knowledge center of global risk transfer markets." He committed to extending the comment period for the CFTC's supplemental proposal to Regulation Automated Trading.

In his remarks at the conference, outgoing CFTC  Chair Timothy Massad reviewed the main accomplishments of the CFTC during his tenure. Chair Massad expressed his hope that those accomplishments would not be "undone by the next Administration." Specifically, Chair Massad noted:

• the establishment of a regulatory framework for over-the-counter swaps, especially margin requirements for uncleared swaps;
• enhanced clearinghouse strength, resilience, oversight and risk surveillance;
• a reduction in unintended consequences, the elimination of unnecessary requirements, and strengthened protections for commercial end-users;
• "tremendous progress" with international regulatory coordination and cooperation;
• enhanced cybersecurity regulation, and continued analysis of the effects of automated trading on market liquidity and fintech regulation; and
• enhanced enforcement, especially in response to spoofing and benchmark manipulation.

Chair Massad described these efforts as "sensible" and urged future regulators not to "dismantle the framework":

Commentary / Bob Zwirb

Notwithstanding their differences of opinion regarding the implementation of Dodd-Frank, both Chair Massad and soon-to-be Acting Chair Giancarlo support the regulatory framework set out by that statute. In fact, that shared support is reflected in Chair Massad's call not to "dismantle the framework," and Commissioner Giancarlo's advocacy of the "core reforms of Title VII of Dodd-Frank, namely swap data reporting and central counterparty clearing and registration of swaps dealers," including the "swaps clearing mandate."

Underlying this bipartisan support for Dodd-Frank is a narrative that pins responsibility largely on derivatives for the financial crisis in 2008, and strives to prevent the recurrence of that crisis by regulating swaps "like commodity futures," including by channeling them through clearinghouses (though Mr. Giancarlo does deviate from the narrative somewhat by criticizing the CFTC's current framework for being "disproportionately modeled on the U.S. futures market"). See Gary Gensler, "Clearinghouses Are the Answer: Complex Derivatives Should Be Regulated Like Commodity Futures," Wall St. J. (Apr. 21, 2010).

Even outside the CFTC, the proposition that Title VII should stand is shared by many who otherwise reject Dodd-Frank. See, e.g., this interview with Senator Pat Toomey about Dodd-Frank, in which the Senator calls for "getting rid of the whole thing," but observes that "Title VII, the part that deals with derivatives, is probably fine." This popular narrative is not supported by everyone. In attributing the 2008 financial crisis to poor mortgage lending by banks, Peter Wallison has written that "[t]he answer is unlikely to relate to the vehicles in which the credit was packaged after it was issued."

Similarly, mandatory clearing is not without its own problems, as the CFTC itself has acknowledged. See " Enhanced Risk Management Standards for Systemically Important Derivatives Clearing Organizations," 78 Fed. Reg. 49663, 49672 (Aug. 15, 2013) (noting that in extreme circumstances, margin calls by a clearinghouse "could trigger a downward spiral and lead to the destabilization of the financial markets"). See also Craig Pirrong, "It's a Wonderful Life, AIG Edition," Streetwise Professor (March 28, 2009) (observing that the total loss from a default by a firm like AIG is "the same with clearing or without," and that all clearing does is to "affect[] the allocation of those losses among counterparties").

Commentary / Steven Lofchie

Commissioner Giancarlo's remarks are positive, given that he must work within the existing Dodd Frank legislation. Under prior management, the CFTC managed to take a bad piece of legislation and turn it into rulemaking that proved to be even worse. Under new management, which understands the benefits that hedging through swaps provides to the financial markets, and which does not bear the burden of having to justify flawed rulemakings from the past, material regulatory progress is possible for the CFTC. This is not to discount the benefits of remedial legislation, however, since Commissioner Giancarlo's reasoning seems consistent with the recently proposed  Commodity End User Relief Act.

Most regulators now concede the risks created by mandatory central clearing. Its implementation has stalled completely since the acknowledgment of those risks. Even if implementation moves forward to some extent, it will still be obvious that most swaps other than the most widely traded and easily valued never will be centrally cleared. Commissioner Giancarlo should concentrate on practical goals that can be accomplished readily and leave discussions of the mandatory central clearing of vanilla products for another day.

Even assuming that Dodd-Frank is fundamentally flawed (an assumption that requires no suspension of disbelief), most market participants would settle for material improvements to it on which all sides can agree (even if Dodd-Frank proponents won't (because they just won't)).

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