Noting the critical role derivative and risk markets play in fostering robust and durable economic growth, CFTC Chairman J. Christopher Giancarlo underscored the importance of optimizing swaps execution as well as central counterparty (CCP) supervision in his remarks before the ISDA Regulators and Industry Forumin Singapore. Additionally, Giancarlo called for the CFTC to work with European Union authorities on clearing related matters in a collaborative manner. These were somewhat more conciliatory tones compared to his strongly-worded statement issued last week referring to a post-Brexit EU "plan to invade U.S. Markets."
In Chairman Giancarlo’s view, optimizing the CFTC’s swap execution facility (SEF) rules will enhance market productivity and efficiency, while improving CCP stress testing will ensure that swap markets operate upon a strong and durable foundation. By these means, Giancarlo sees the derivatives markets supporting economic health and furthering the goal of enhancing market functionality through intelligent regulations.
Swaps execution. The chairman began his remarks by again expressing his commitment to the swaps market reforms contained in Title VII of the 2010 Dodd-Frank Act, noting, "I believe the policy prescription of the U.S. Congress was clear: swaps should trade on properly regulated platforms with a standard of professional conduct comparable to other financial markets—equities, fixed income and futures." He further observed that Dodd-Frank changed the legal framework by requiring that swaps transactions be traded and executed on regulated platforms now known as SEFs, and that those platforms be licensed by the CFTC.
Giancarlo expressed serious concerns with the regulatory course that has been taken by the Commission in implementing Congress’s mandates under Dodd-Frank. "The path the CFTC pursued was an attempt to re-engineer the entire market structure of swaps execution. Instead of raising the standards of conduct of the professionals handling swaps transactions on SEFs, the CFTC sought to dictate the business models of the SEFs themselves … Instead of achieving desired outcome, the CFTC’s efforts have been effective at achieving unintended ones," he stated.
Echoing his prior criticisms, Giancarlo noted that the CFTC grafted into its SEF rules a number of market practices from futures markets that are antithetical to swaps trading. He continued, "The CFTC should have followed the clear intent of Title VII of Dodd-Frank and left it to the SEFs to determine their business models. It should have recognized that swaps markets have unique challenges in liquidity formation that are only exacerbated by imposing forms and practices taken from listed futures markets."
The chairman, however, struck an optimistic chord, noting that it is not too late to take the appropriate steps which will encourage liquidity formation, price discovery, and trade execution that will take place in a self-contained, licensed SEF environment, and which will raise professional standards and regulatory transparency for the greater benefit and durability of the marketplace.
CCP supervision and swaps clearing. Chairman Giancarlo observed, "The most far-reaching and consequential of the swaps reforms adopted through Dodd-Frank Title VII was perhaps the clearing mandate. At heart, clearing serves to promote contract performance, which in turn reduces risk and instills confidence in our markets." He further noted that since the CFTC issued final rules for clearing in 2012, "the impact on the swaps market has been remarkable." According to ISDA, in the second quarter of 2017, 80 percent of trades in both interest rate and credit default index swaps were cleared. "The default risk of swaps counterparties that was once spread across Wall Street is now pooled and managed within regulated CCPs. That’s a good thing," Giancarlo said.
The chairman pointed to the role of stress testing in gauging CCP efficacy. The CFTC conducted its first multi-CCP stress test in 2016 and recently announced the results of its second stress test, which focused on CCPs’ funding liquidity. The recent stress test concluded that all three CCPs had the ability to generate sufficient liquidity to fulfill settlement obligations during the immediate end-of-day cycle, and in the case of those clearing interest rate swaps, during subsequent payment cycles.
Giancarlo explained that going forward, the CFTC will continue to develop and refine its program of multi-CCP stress testing, and that what is learned in one test will be factored into the design of future tests. "The goal is to establish a stress testing regime that is thorough, data driven, econometrically sound and reflective of multi-CCP operations and their role in dynamic market ecosystems," he noted.
The chairman also indicated that the Commission will look to strengthen the CCP testing regime by collaborating further with other prudential and market regulators, as well as drawing upon the insights of leading economists and academics. In particular, the commission will seek input from the Federal Reserve Board, the SEC and the Federal Deposit Insurance Commission, which is the resolution authority under Dodd-Frank.
On Wednesday, November 15, 2017, Chairman Giancarlo is scheduled to speak at the Singapore FinTech Festival, and will discuss the CFTC’s agenda to address the impact of technological innovation and changing market dynamics.
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