House Agriculture Committee on CFTC Reauthorization – Market Participant Views
House Agriculture Commodity Exchanges, Energy, & Credit Subcommittee
“Reauthorizing the CFTC: Market Participant Views”
Wednesday, March 25, 2015
Key Topics & Takeaways
- Leverage Ratio Impact on Clearing: FIA’s Corcoran said the Basel leverage ratio is punitive to bank-owned FCMs and that the regulation does not recognize that these client funds are “in no way able to be leveraged” by the bank. He said bank-affiliated FCMs will exit the market because they will not be able to receive a sufficient return on capital under the new requirements.
- U.S. vs. EU Margining: CME’s Duffy said the U.S.’s one-day gross margining requirement “without question” leads to higher levels of margin collection. He stated that the “competitive trade issue” of EU recognition of U.S. clearing houses will get resolved but “the question is when,” and said Europe is interested in “getting a leg up” for entities in its jurisdiction.
- User-Fee/Transaction Tax: CME’s Duffy said use of such a fee or tax would be “pennywise and dollar foolish” because only a small number of entities create liquidity in these markets and that imposing a fee would cause spreads to widen, which would skew prices.
- U.S. Person Definition: WMBA’s Bernardo said having distinctions like the definition of U.S. person in a global market has impacts on liquidity. He said clients and firms that are global will opt to do business under less prescriptive regimes such as those in Europe and Asia.
Witnesses
- Terrence A. Duffy, Executive Chairman & President, CME Group
- Benjamin Jackson, President and Chief Operating Officer, ICE Futures U.S.
- Daniel J. Roth, President and CEO, National Futures Association (NFA)
- Gerald F. Corcoran, Chairman of the Board & Chief Executive Officer, R.J. O’Brien & Associates, LLC, on behalf of the Futures Industry Association (FIA)
- Shawn Bernardo, Chief Executive Officer, tpSEF – Tullett Prebon, on behalf of the Wholesale Market Brokers Association (WMBA)
Opening Statements
Subcommittee Chairman Austin Scott (R-Ga.), in his opening statement, noted that in the 18 months since the Commodity Futures Trading Commission’s (CFTC) rules for swap execution facilities (SEFs) were finalized there has still yet to be a final registration of one of these swap trading platforms, adding that there is “considerable uncertainty” about these rule sets and the SEF business. He also mentioned that the “further into implementation we get, the more cross-border jurisdiction issues seem to arise” and said witnesses are facing competing and often conflicting rules in international markets.
Ranking Member David Scott (D-Ga.) stressed that Congress needs to ensure the CFTC has adequate funding to do its job. He then said the House Agriculture Committee needs to move “as quickly as we can” on legislation to reauthorize the CFTC that mirrors the last year’s “good, robust, bipartisan” bill (H.R. 4413) “as much as we can.” He noted that points of concern have arisen around: personnel-location tests; European recognition of U.S. centralized counterparties; the “U.S. person” definition; and cross-border regulation.
Witness Testimony
TerrenceDuffy – CME Group
Terrence A. Duffy, Executive Chairman & President, CME Group, stated in his testimony that the most critical issue for the derivatives market is “equivalence.” He explained that U.S. clearing houses must be recognized by European regulators and deemed “equivalent” to those in Europe, otherwise they will be subject to significantly higher capital requirements or limited access to the market. This would harm U.S. and European market participants, he continued, by driving down market participation, resulting in reduced liquidity, which would impede market participants’ ability to manage risk. Duffy said CFTC Chairman Tim Massad has been a “tremendous leader” in working toward a solution but said that all options need to be considered if an agreement is not reached, such as termination of no-action relief that the CFTC has provided to foreign boards of trade.
Duffy also mentioned that there are issues with the CFTC’s position limits rule proposal because it would impose “overly narrow restrictions” on transactions and traditional hedging activity. He said the rule should accommodate all strategies that satisfy the statute and take a flexible approach to allow better use of CFTC resources.
Benjamin Jackson – ICE Futures U.S.
Benjamin Jackson, President and Chief Operating Officer, ICE Futures U.S., stated in his testimony that his organization has a strong history of overseeing position limits, accountability levels, and exemption requests along with decades of surveillance and compliance expertise. He said the Committee should encourage the CFTC, in revisiting its rules, to reexamine the position limit proposal, especially the effects on bona fide hedging and position limits in the non-spot month. Jackson stated that the current regulatory regimes in place, overseen by the CFTC, should remain in effect.
Daniel Roth – National Futures Association
Daniel J. Roth, President and CEO, National Futures Association (NFA), explained in his testimony that the NFA helps the CFTC with its responsibilities as an industry-wide self-regulatory organization (SRO). In this function, he noted, the NFA performs reviews of disclosures, processes registrations, and takes enforcement actions where necessary. Roth noted that the NFA has “built from scratch” infrastructures to regulate over 100 swap dealers and has prepared examination modules in areas of CFTC rulemakings. He said all of this activity has impacted the NFA’s budget, causing it to more than double over the last four years.
Roth expressed support for last year’s CEA bill, especially its provisions on futures commission merchant (FCM) insolvencies and customer protections.
Gerald Corcoran – Futures Industry Association
Gerald F. Corcoran, Chairman of the Board & Chief Executive Officer, R.J. O’Brien & Associates, LLC, and testifying on behalf of the Futures Industry Association (FIA), stated in his testimony that if global regulation is not coordinated, markets will fragment and become less liquid to the detriment of end-users, and said that the practicality of a dual registration and recognition regime “hinges upon the various jurisdictions’ ability to acknowledge regulatory differences and rely upon each other as front line regulators.”
Corcoran also noted that there are issues related to the Basel III capital requirements, specifically the leverage ratio which counts client margin toward the capital calculation for bank-affiliated FCMs. He said this rule would make it more expensive for these firms to provide clearing services for their clients and may result in fewer FCMs participating in the market.
Shawn Bernardo – Wholesale Market Brokers Association
Shawn Bernardo, Chief Executive Officer, tpSEF – Tullett Prebon, testifying on behalf of the Wholesale Market Brokers Association (WMBA), explained in his testimony that SEFs do not hold securities or customer funds and that they compete on price, service, and liquidity. He said SEFs have been working diligently to meet the requirements set forth by the CFTC, but that this has been “no easy task” because the regulatory landscape continues to shift. He also noted that the CFTC has imposed “impractical burdens” such as requirements to collect underlying master agreements, and has failed to provide the legal certainty and stability needed for swap trading to flourish. He stressed the need for less prescriptive and more flexible rules to fit the current market structure.
Question and Answer
ClearinghouseRecognition
Chairman Scott asked if is there is any cause for optimism that the U.S. and Europe will come to an agreement on clearing house recognition.
Jackson replied that “the short answer is yes” because he thinks the CFTC and European regulators are focused on “true equivalence.” He explained that the U.S. today uses “one-day gross” margining while Europe uses “two-day net” margining. These two approaches are close when an FCM has a portfolio of market makers where positions “tend to offset,” he continued, but explained that the results differ in smaller FCMs that may have more directional portfolios consisting of end-users.
Duffy added that one-day gross margining “without question” leads to higher levels of margin collection. He added that this “competitive trade issue” will get resolved but “the question is when,” and said Europe is interested in “getting a leg up” for entities in its jurisdiction.
BaselIII
Ranking Member Scott expressed concern about the impact that the Basel III capital requirements will have on central clearing, particularly the supplemental leverage ratio (SLR), and asked what effect this will have on business.
Corcoran said the SLR will have an impact on the ability of clearing firms to serve customers and will increase prices. He said the rule is punitive to bank-owned FCMs and that the regulation does not recognize that these client funds are “in no way able to be leveraged” by the bank. He said bank-affiliated FCMs will exit the market because they will not be able to receive a sufficient return on capital under the new requirements.
Rep. Doug LaMalfa (R-Calif.) asked if problems will arise in the market due to concentration of risk if the number of FCMs decreases. Roth said it is problematic to have FCMs leave the market because as the number of FCMs serving clients decreases there will be greater concentrations of risk in each one. He added that the regulators should be sensitive to the costs imposed by their rules. Corcoran agreed and stressed the challenges that FCMs now face to invest in the proper technology and infrastructure to meet compliance needs.
Position Limits/Bona Fide Hedge
LaMalfa asked if Congress should intervene in the definition of “bona fide hedge” due to issues with the CFTC’s interpretation. Jackson said Congress should “get involved” on what is being interpreted as a bona fide hedge. He noted as an example that Hershey’s Chocolate historically negotiates its deals 18 months in advance, but that the CFTC’s rules would prevent hedges done more than 12 months in advance.
CFTC Funding
Ranking Member Scott asked Duffy why it is important to fully fund the CFTC. Duffy replied that in order for the markets to prosper there needs to be a regulator with the “utmost credibility,” and said the CFTC “serves a great purpose.” Roth added that the NFA helps to relieve some of the stresses from the CFTC and allows it to make better use of its resources.
Rep. Frank Lucas (R-Okla.) asked for Duffy’s opinion on funding the CFTC by imposing a user-fee or a transaction tax. Duffy said that use of such a fee or tax would be “pennywise and dollar foolish” because only a small number of entities create liquidity in these markets and that imposing a fee would cause spreads to widen, which would skew prices.
Enforcement
Rep. Ann Kirkpatrick (D-Ariz.) asked how much of the CFTC’s enforcement action is seen as just a “cost of doing business” by bad actors. Roth replied that enforcement is “way more” than a cost of doing business. He then explained that the NFA builds relationships with prosecutors around the country to make them more comfortable with the subject matter, and said putting people in jail is the most effective way to prevent fraud. Corcoran agreed and said compliance is taken very seriously because the brand name and value of his company is very important.
Ranking Member Scott noted that there is public awareness of wrongdoing but that no one has gone to jail. He asked how the CFTC’s enforcement can be improved and strengthened. Roth said the CFTC’s enforcement has been vigorous over the past few years, but noted that it only has the authority to bring civil cases. He said that criminal prosecutions have more impact.
Ranking Member Scott then asked for the panel’s views on the “failure to supervise” rule being considered in England. Duffy said the market has seen changes in failure to supervise rules over the years and that the market is seeing CFTC enforcement “take hold.”
CFTC Process
Chairman Scott asked if the CFTC’s practice of issuing no-action letters and interpretative guidance has caused difficulties in compliance. Bernardo said it has, and that uncertainty can push liquidity offshore, which will impact prices for end-users.
Skin in the Game
Rep. Rodney Davis (R-Ill.) noted that there have been calls for clearing houses to have more “skin in the game” in a default waterfall and asked what cost impact such action would have on a clearing house.
Duffy replied that the CME has the largest contribution to the default fund of any exchange and that the clearing houses contribution comes before any of the other clients, after a defaulting member’s contribution. He said calls for more “skin in the game” could create potential moral hazards as having the exchange put more money at risk may induce bad behavior. He noted that exchanges manage risk and do not bring any risk to the system themselves.
Definitionof U.S. Person
Ranking Member Scott asked how the market has been affected by the CFTC’s definition of “U.S. person.” Bernardo said having distinctions like the definition of U.S. person in a global market has impacts on liquidity. He said clients and firms that have global operations will opt to do business under less prescriptive regimes such as those in Europe and Asia. He said the CFTC’s rules should be more flexible and suggested that the CFTC follow the statutory language to allow “any means of inter-state commerce.”
Unnecessary Mandates
Davis asked if there are any obligations and mandates of the CFTC from Congress that may no longer be needed. Roth explained that the NFA is working with the CFTC and CME to identify activity being done by both the regulator and the SROs in order to eliminate duplicative efforts.
Jackson expressed concern that the CFTC may take away the ability of exchanges to grant enumerated hedge exemptions.
For more information on this hearing, please click here.
To view an archived webcast, please click here.
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House Agriculture Commodity Exchanges, Energy, & Credit Subcommittee
“Reauthorizing the CFTC: Market Participant Views”
Wednesday, March 25, 2015
Key Topics & Takeaways
- Leverage Ratio Impact on Clearing: FIA’s Corcoran said the Basel leverage ratio is punitive to bank-owned FCMs and that the regulation does not recognize that these client funds are “in no way able to be leveraged” by the bank. He said bank-affiliated FCMs will exit the market because they will not be able to receive a sufficient return on capital under the new requirements.
- U.S. vs. EU Margining: CME’s Duffy said the U.S.’s one-day gross margining requirement “without question” leads to higher levels of margin collection. He stated that the “competitive trade issue” of EU recognition of U.S. clearing houses will get resolved but “the question is when,” and said Europe is interested in “getting a leg up” for entities in its jurisdiction.
- User-Fee/Transaction Tax: CME’s Duffy said use of such a fee or tax would be “pennywise and dollar foolish” because only a small number of entities create liquidity in these markets and that imposing a fee would cause spreads to widen, which would skew prices.
- U.S. Person Definition: WMBA’s Bernardo said having distinctions like the definition of U.S. person in a global market has impacts on liquidity. He said clients and firms that are global will opt to do business under less prescriptive regimes such as those in Europe and Asia.
Witnesses
- Terrence A. Duffy, Executive Chairman & President, CME Group
- Benjamin Jackson, President and Chief Operating Officer, ICE Futures U.S.
- Daniel J. Roth, President and CEO, National Futures Association (NFA)
- Gerald F. Corcoran, Chairman of the Board & Chief Executive Officer, R.J. O’Brien & Associates, LLC, on behalf of the Futures Industry Association (FIA)
- Shawn Bernardo, Chief Executive Officer, tpSEF – Tullett Prebon, on behalf of the Wholesale Market Brokers Association (WMBA)
Opening Statements
Subcommittee Chairman Austin Scott (R-Ga.), in his opening statement, noted that in the 18 months since the Commodity Futures Trading Commission’s (CFTC) rules for swap execution facilities (SEFs) were finalized there has still yet to be a final registration of one of these swap trading platforms, adding that there is “considerable uncertainty” about these rule sets and the SEF business. He also mentioned that the “further into implementation we get, the more cross-border jurisdiction issues seem to arise” and said witnesses are facing competing and often conflicting rules in international markets.
Ranking Member David Scott (D-Ga.) stressed that Congress needs to ensure the CFTC has adequate funding to do its job. He then said the House Agriculture Committee needs to move “as quickly as we can” on legislation to reauthorize the CFTC that mirrors the last year’s “good, robust, bipartisan” bill (H.R. 4413) “as much as we can.” He noted that points of concern have arisen around: personnel-location tests; European recognition of U.S. centralized counterparties; the “U.S. person” definition; and cross-border regulation.
Witness Testimony
TerrenceDuffy – CME Group
Terrence A. Duffy, Executive Chairman & President, CME Group, stated in his testimony that the most critical issue for the derivatives market is “equivalence.” He explained that U.S. clearing houses must be recognized by European regulators and deemed “equivalent” to those in Europe, otherwise they will be subject to significantly higher capital requirements or limited access to the market. This would harm U.S. and European market participants, he continued, by driving down market participation, resulting in reduced liquidity, which would impede market participants’ ability to manage risk. Duffy said CFTC Chairman Tim Massad has been a “tremendous leader” in working toward a solution but said that all options need to be considered if an agreement is not reached, such as termination of no-action relief that the CFTC has provided to foreign boards of trade.
Duffy also mentioned that there are issues with the CFTC’s position limits rule proposal because it would impose “overly narrow restrictions” on transactions and traditional hedging activity. He said the rule should accommodate all strategies that satisfy the statute and take a flexible approach to allow better use of CFTC resources.
Benjamin Jackson – ICE Futures U.S.
Benjamin Jackson, President and Chief Operating Officer, ICE Futures U.S., stated in his testimony that his organization has a strong history of overseeing position limits, accountability levels, and exemption requests along with decades of surveillance and compliance expertise. He said the Committee should encourage the CFTC, in revisiting its rules, to reexamine the position limit proposal, especially the effects on bona fide hedging and position limits in the non-spot month. Jackson stated that the current regulatory regimes in place, overseen by the CFTC, should remain in effect.
Daniel Roth – National Futures Association
Daniel J. Roth, President and CEO, National Futures Association (NFA), explained in his testimony that the NFA helps the CFTC with its responsibilities as an industry-wide self-regulatory organization (SRO). In this function, he noted, the NFA performs reviews of disclosures, processes registrations, and takes enforcement actions where necessary. Roth noted that the NFA has “built from scratch” infrastructures to regulate over 100 swap dealers and has prepared examination modules in areas of CFTC rulemakings. He said all of this activity has impacted the NFA’s budget, causing it to more than double over the last four years.
Roth expressed support for last year’s CEA bill, especially its provisions on futures commission merchant (FCM) insolvencies and customer protections.
Gerald Corcoran – Futures Industry Association
Gerald F. Corcoran, Chairman of the Board & Chief Executive Officer, R.J. O’Brien & Associates, LLC, and testifying on behalf of the Futures Industry Association (FIA), stated in his testimony that if global regulation is not coordinated, markets will fragment and become less liquid to the detriment of end-users, and said that the practicality of a dual registration and recognition regime “hinges upon the various jurisdictions’ ability to acknowledge regulatory differences and rely upon each other as front line regulators.”
Corcoran also noted that there are issues related to the Basel III capital requirements, specifically the leverage ratio which counts client margin toward the capital calculation for bank-affiliated FCMs. He said this rule would make it more expensive for these firms to provide clearing services for their clients and may result in fewer FCMs participating in the market.
Shawn Bernardo – Wholesale Market Brokers Association
Shawn Bernardo, Chief Executive Officer, tpSEF – Tullett Prebon, testifying on behalf of the Wholesale Market Brokers Association (WMBA), explained in his testimony that SEFs do not hold securities or customer funds and that they compete on price, service, and liquidity. He said SEFs have been working diligently to meet the requirements set forth by the CFTC, but that this has been “no easy task” because the regulatory landscape continues to shift. He also noted that the CFTC has imposed “impractical burdens” such as requirements to collect underlying master agreements, and has failed to provide the legal certainty and stability needed for swap trading to flourish. He stressed the need for less prescriptive and more flexible rules to fit the current market structure.
Question and Answer
ClearinghouseRecognition
Chairman Scott asked if is there is any cause for optimism that the U.S. and Europe will come to an agreement on clearing house recognition.
Jackson replied that “the short answer is yes” because he thinks the CFTC and European regulators are focused on “true equivalence.” He explained that the U.S. today uses “one-day gross” margining while Europe uses “two-day net” margining. These two approaches are close when an FCM has a portfolio of market makers where positions “tend to offset,” he continued, but explained that the results differ in smaller FCMs that may have more directional portfolios consisting of end-users.
Duffy added that one-day gross margining “without question” leads to higher levels of margin collection. He added that this “competitive trade issue” will get resolved but “the question is when,” and said Europe is interested in “getting a leg up” for entities in its jurisdiction.
BaselIII
Ranking Member Scott expressed concern about the impact that the Basel III capital requirements will have on central clearing, particularly the supplemental leverage ratio (SLR), and asked what effect this will have on business.
Corcoran said the SLR will have an impact on the ability of clearing firms to serve customers and will increase prices. He said the rule is punitive to bank-owned FCMs and that the regulation does not recognize that these client funds are “in no way able to be leveraged” by the bank. He said bank-affiliated FCMs will exit the market because they will not be able to receive a sufficient return on capital under the new requirements.
Rep. Doug LaMalfa (R-Calif.) asked if problems will arise in the market due to concentration of risk if the number of FCMs decreases. Roth said it is problematic to have FCMs leave the market because as the number of FCMs serving clients decreases there will be greater concentrations of risk in each one. He added that the regulators should be sensitive to the costs imposed by their rules. Corcoran agreed and stressed the challenges that FCMs now face to invest in the proper technology and infrastructure to meet compliance needs.
Position Limits/Bona Fide Hedge
LaMalfa asked if Congress should intervene in the definition of “bona fide hedge” due to issues with the CFTC’s interpretation. Jackson said Congress should “get involved” on what is being interpreted as a bona fide hedge. He noted as an example that Hershey’s Chocolate historically negotiates its deals 18 months in advance, but that the CFTC’s rules would prevent hedges done more than 12 months in advance.
CFTC Funding
Ranking Member Scott asked Duffy why it is important to fully fund the CFTC. Duffy replied that in order for the markets to prosper there needs to be a regulator with the “utmost credibility,” and said the CFTC “serves a great purpose.” Roth added that the NFA helps to relieve some of the stresses from the CFTC and allows it to make better use of its resources.
Rep. Frank Lucas (R-Okla.) asked for Duffy’s opinion on funding the CFTC by imposing a user-fee or a transaction tax. Duffy said that use of such a fee or tax would be “pennywise and dollar foolish” because only a small number of entities create liquidity in these markets and that imposing a fee would cause spreads to widen, which would skew prices.
Enforcement
Rep. Ann Kirkpatrick (D-Ariz.) asked how much of the CFTC’s enforcement action is seen as just a “cost of doing business” by bad actors. Roth replied that enforcement is “way more” than a cost of doing business. He then explained that the NFA builds relationships with prosecutors around the country to make them more comfortable with the subject matter, and said putting people in jail is the most effective way to prevent fraud. Corcoran agreed and said compliance is taken very seriously because the brand name and value of his company is very important.
Ranking Member Scott noted that there is public awareness of wrongdoing but that no one has gone to jail. He asked how the CFTC’s enforcement can be improved and strengthened. Roth said the CFTC’s enforcement has been vigorous over the past few years, but noted that it only has the authority to bring civil cases. He said that criminal prosecutions have more impact.
Ranking Member Scott then asked for the panel’s views on the “failure to supervise” rule being considered in England. Duffy said the market has seen changes in failure to supervise rules over the years and that the market is seeing CFTC enforcement “take hold.”
CFTC Process
Chairman Scott asked if the CFTC’s practice of issuing no-action letters and interpretative guidance has caused difficulties in compliance. Bernardo said it has, and that uncertainty can push liquidity offshore, which will impact prices for end-users.
Skin in the Game
Rep. Rodney Davis (R-Ill.) noted that there have been calls for clearing houses to have more “skin in the game” in a default waterfall and asked what cost impact such action would have on a clearing house.
Duffy replied that the CME has the largest contribution to the default fund of any exchange and that the clearing houses contribution comes before any of the other clients, after a defaulting member’s contribution. He said calls for more “skin in the game” could create potential moral hazards as having the exchange put more money at risk may induce bad behavior. He noted that exchanges manage risk and do not bring any risk to the system themselves.
Definitionof U.S. Person
Ranking Member Scott asked how the market has been affected by the CFTC’s definition of “U.S. person.” Bernardo said having distinctions like the definition of U.S. person in a global market has impacts on liquidity. He said clients and firms that have global operations will opt to do business under less prescriptive regimes such as those in Europe and Asia. He said the CFTC’s rules should be more flexible and suggested that the CFTC follow the statutory language to allow “any means of inter-state commerce.”
Unnecessary Mandates
Davis asked if there are any obligations and mandates of the CFTC from Congress that may no longer be needed. Roth explained that the NFA is working with the CFTC and CME to identify activity being done by both the regulator and the SROs in order to eliminate duplicative efforts.
Jackson expressed concern that the CFTC may take away the ability of exchanges to grant enumerated hedge exemptions.
For more information on this hearing, please click here.
To view an archived webcast, please click here.