CFTC commissioner attacks swaps regulation and proposes alternative agenda
US Commodity Futures Trading Commission Commissioner J. Christopher Giancarlo has condemned the CFTC’s implementation of swaps trading regulation reforms, describing its approach as highly over-engineered, disproportionately modelled on the US futures market and biased against both human discretion and technological innovation.
Giancarlo has set out his own proposals, which he says are better aligned with swaps market dynamics and truer to congressional intent, in an 89-page proposal, Pro-Reform Reconsideration of the CFTC Swaps Trading Rules: Return to Dodd-Frank, published to coincide with his appearance at a Tabb Group event in New York this week, Giancarlo argues that there is a fundamental mismatch between the CFTC’s swaps trading regulatory framework and the distinct liquidity and trading dynamics of the global swaps market.
The paper identifies 10 adverse consequences of flawed swaps trading rules, including: driving global market participants away from transacting with entities subject to CFTC swaps regulation, fragmenting swaps trading into numerous artificial market segments, increasing market liquidity risk, making it highly expensive and burdensome to operate SEFs, hindering swaps market technological innovation, opening the US swaps market to algorithmic and high-frequency trading, wasting taxpayer money when the CFTC is seeking additional resources, jeopardising relations with foreign regulators, threatening US job creation and human discretion in swaps execution and increasing market fragility and the systemic risk that the Dodd-Frank regulatory reform was predicating on reducing. “As such, the CFTC’s framework does not accord with the letter or spirit of the Dodd-Frank Act,” he said.
To counter these problems, Giancarlo is proposing a five-point reform package, based on the themes of comprehensiveness, cohesiveness, flexibility, professionalism and transparency. In practice, this means subjecting the broadest range of US swaps trading activity possible to CFTC oversight, removing the artificial segmentation of swaps trading and regulating trading activity more holistically, returning to the Dodd-Frank Act’s express prescription for flexibility in swaps trading by permitting trade execution through “any means of interstate commerce,” allowing organic development of swaps products and market structure, accommodating beneficial swaps market practices and respecting the general nature of core principles, raising standards of professionalism in the swaps market by establishing requirements for product and market knowledge, professionalism and ethical behaviour for swaps market personnel, and increasing transparency through a “balanced focus” on promoting swaps trading and market liquidity as Congress intended.
The document claims that the benefits of implementing its recommendations would be substantial, including a reduction in fragmentation, an increase in liquidity, the reduction of legal and compliance costs for swap execution facilities and their users, freeing up CFTC resources and saving taxpayer money and allowing for better coordination between the CFTC and other jurisdictions that are implementing their own swaps trading rules.
Outside the US, other countries have also experienced controversy, problems and delays in attempting to come up with new rules for OTC derivatives. The G20 nations set out a common vision of attempting to reduce systemic risk in financial markets at the Pittsburgh summit in 2009, but efforts to align rules between the US and the European Union have previously come unstuck, while within Europe itself the relevant rules being introduced under EMIR have also prompted much debate, scrutiny and adjustment.
However, despite the controversy the International Swaps and Derivatives Association has just published a report that seems to endorse the changes that have already been made by global regulators. According to ISDA, two key policy goals of increased clearing and portfolio compression are being met by the derivatives industry, with a recent surge in compression volumes contributing to a decline in publicly reported interest rate derivatives notional outstanding figures.
The Bank for International Settlements reported that interest rate derivatives gross notional outstanding had fallen from $584.4 trillion in December 2013 to $563.3 trillion in June 2014, a decrease of 3.6% After factoring out the impact of clearing and compression, ISDA’s analysis shows that underlying interest rate derivatives market activity increased by 5.5% between December 2013 and June 2014.
“Clearing and compression are becoming increasingly prevalent, which is a very positive development for the derivatives industry,” said Scott O’Malia, chief executive at ISDA. “These two practices can make it difficult to get a clear picture of the underlying market, however. Our research shows activity in interest rate derivatives before clearing and compression has been growing.”
“Increased clearing and compression are important policy goals for regulators, and significant progress has been made in achieving both of them,” he added. “Close to 70% of the total interest rate derivatives market is now cleared, and compression activity is catching up fast following a big increase in volumes last year. We expect both these trends to continue as clearing services and mandates expand and compression technology continues to develop.”