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CFTC MRAC Meeting

Commodity Futures Trading Commission (CFTC)

Market Risk Advisory Committee (MRAC) Meeting

Tuesday, December 4, 2018

Discussion Panels

Opening Statements

Rostin Behnam, MRAC Sponsor and Commissioner, CFTC

In his opening statement, Commissioner Behnam gave a broad overview of the topics on the agenda for the MRAC’s discussion. Behnam discussed: (1) the Interest Rate Benchmark Reform Subcommittee; (2) central counterparties (CCPs), clearing, and current events; and (3) oversight of third-party service providers and vendor risk management. On the Interest Rate Benchmark Reform Subcommittee, Behnam supported CFTC Chairman Chris Giancarlo’s recent remarks that despite huge improvements in the governance process to produce the London Interbank Offered Rate (LIBOR), the market for unsecured interbank term lending that underlies LIBOR has dried up, and he is supportive of the intatitives of the Alternative Reference Rate Committee (ARRC). Behnam announced the 21 individuals chosen to serve on the Subcommittee and stated that his goal is to use the Subcommittee to complement the work of the ARRC by providing additional insight into the potential challenges leading up to 2021, to identify the risks for financial markets and individual consumers, and to provide solutions within the derivatives space. On CCPs, Behnam outlined the agenda for the MRAC panels and stated that the CFTC and international regulators are continually confronting the challenge of building and maintaining the appropriate regulatory framework for clearing in and among a population of CCPs with unique risk profiles that will withstand routine shocks and demonstrate resilience in a crisis.

Christopher Giancarlo, Chairman, CFTC

In his opening statement, Giancarlo supported Behnam’s focus on Benchmark Reform. On CCPs, Giancarlo stated that there is more to do in terms of CCP resolution planning, and that as the size and complexity of CCPs increase, so has the importance of their risk management and governance programs. Further, Giancarlo supported CFTC Commissioner Dan Berkovtiz’s concerns about the concentration of clearing services in the cleared swaps market.

Brian D. Quintenz, Commissioner, CFTC

In his opening statement, Quintenz discussed the Basel Committee on Banking Supervision’s adoption of leverage ratio as a non-risk based “backstop” to prevent the buildup of excessive leverage in the banking sector. He stated that as a true and remote backstop metric, the leverage ratio can work, but as a binding capital constraint it creates many perverse outcomes and is a poor regulator construct. He added that if the goal of leverage ratio is to calculate the clearing member’s most accurate exposure for a cleared trade, then it should always use the amount of segregated client margin as an offset. Quintenz stated that unless the treatment of client margin changes, he fears that we will see futures commission merchants (FCMs) continue to exit the clearing business and the trend of FCM consolidation will continue. He supported both the Basel Committee’s and the Federal Reserve’s consultation requesting input on leverage ratio and the Standardized Approach for Calculating the Exposure Amount of Derivatives.

Dawn DeBerry Stump, Commissioner, CFTC

In her opening statement, Stump emphasized the important role of clearinghouses in the financial system and that she is looking forward to hearing from the panels on clearinghouse infrastructure risk, more specifically, settlement bank and custodian bank failures, cyber security, and the use of third-party service providers.

Dan M. Berkovitz, Commissioner, CFTC

In his opening statement, Berkovitz stated that he is interested in two topics discussed in the panels ahead, clearinghouse risk management and treatment of derivatives exposures and margin under Prudential regulator rules. On clearinghouse risk management, Berkovitz stated that it is critical for the CFTC to oversee and monitor clearinghouse risk management practices due to push to centrally clear derivatives post Dodd-Frank. On treatment of derivatives exposures and margin under the Prudential rules, Berkovitz stated that he is interested in the capital treatment of derivatives exposures due to increased concentration of clearing business to the top FCMs. Further, he stated that he is aware of the concerns around bank leverage and supports efforts to restrict excessive risk taking by banks, but a reduction in availability of clearing serves by a few firms can become a risk issue in its own right.

Report from Interest Rate Benchmark Reform Subcommittee

Thomas Wipf, Subcommittee Chairman, Vice Chairman, Institutional Securities, Morgan Stanley, delivered a report from the MRAC’s Interest Rate Benchmark Reform Subcommittee (Subcommittee). Wipf provided an update on public and private sectors’ efforts in planning for the cessation of the London Interbank Offered Rate (LIBOR), relayed the principles established by the Subcommittee, and discussed the Subcommittees next steps.

The Subcommittee set forth the following principles: (1) Aim to remove hurdles to the transition to Secured Overnight Financing Rate (SOFR); (2) Aim to suggest incentives for market participants to transition to SOFR; (3) Aim to accomplish this while avoiding inadvertent creation of a safe harbor and policy changes that would create any activity that was away from the transition to new rates. Wipf also recognized the responsibility of the Subcommittee to raise awareness of the transition to risk free rates among market participants.

As for next steps, the Committee will: (1) Charter a plan of attack to accomplish its goals; (2) Leverage work done by the Alternative Reference Rate Committee (ARRC) in their July 12, 2018 letter to U.S. Regulators relating to legacy swaps; (3) Meet in January, and afterwards on a monthly basis, to put together work product for the MRAC. Wipf also stated the Subcommittee will give a progress update at each MRAC meeting and will memorialize its work.

Q&A

Chairman Giancarlo asked whether there was a role for the CFTC to play in getting the word out about benchmark reform. Wipf responded that there is a wide variety of where firms are in the transition process, whether big or small institutions, and the CFTC can play the role of distributing information, educating the public, and continue to be supportive of the ARRC’s efforts.

Panel 1: Clearinghouse Risk Management and Governance Today

Robert Steigerwald, Federal Reserve Bank of Chicago, opened the panel by laying out the two topics of discussion, which were: (1) Central counterparty (CCP) governance and risk management practice, and policy; and (2) Best practices that can be utilized by the industry. Steigerwald stated that CCP governance can be further broken down in a narrow sense, and a broad sense. In the broad sense, governance can include the rules of public regulators overseeing the CCP, certain arrangements, rule settings, etc., while in the narrow sense it includes corporate governance established to manage risk to the benefit of users and the public. Many of these issues, Steigerwald stated, include decision making and technical issues relating to risk management, practice and policy. On best practices, Steigerwald stated that there is not a single path for best practices, but flexibility can be an important contributing factor to the coordination and cooperation that is necessary for these markets to operate properly.

Marnie Rosenberg, JP Morgan Chase & Co., stated that derivatives market reforms have increased the volume of cleared transactions, which has to led to concentration of risk in CCPs and increased interconnectedness within the system. Rosenberg stated that opportunities remain to improve CCP governance, margin, and stress testing frameworks, as well as increase CCP capital contributions. Moreover, Rosenberg stated that in terms of risk management, most global CCPs are subsidiaries of public companies with competitive pressure and that risk governance rules should ensure that those that bear the potential losses have a meaningful voice with regard to how risk is managed. Further, she stated that there is a need to enhance the CCP risk management process so that its CCP risk committee incorporates the independent views of experts from clearing member firms. Rosenberg noted that there is a need for more CCP skin-in-the-game, and on margin frameworks, she explained that they must be robust, stable, and adequate for the time it takes to close out a defaulter’s position. Further, she added that procyclical calls can trigger defaults by smaller members. Rosenberg concluded that participants need enough transparency over CCP margins and stress testing methodology to enable in-depth risk analysis.

Alicia Crighton, Goldman Sachs, representing FIA, outlined three relevant categories relating to CCP risk management and governance, and provided FIA’s recommendations per each category: (1) Governance; (2) Adequacy in resources of CCP member firms; and (3) CCP skin-in-the-game. On governance, Crighton highlighted four areas of concern for FIA members: (a) Regulatory supervision of CCPs should include regular and granular assessments; (b) CCPs should establish a framework to give clearing members a more robust role on risk committees; (c) CCP default management processes should be transparent and CCPs should permit clearing member participation; and (d) CCPs should enhance governance around the development of margin models to the bring quantitative and risk management experience and resources of clearing members to bear. On adequacy of resources of CCP member firms, Crighton stated that CCP membership criteria should be transparent, detailed, and specific. Additionally, she stated a rulebook and framework should be included for CCPs that allow self-clearing members. Finally, Crighton stated that CCP skin-in-the-game should align interests of CCPs with those of its members.

Lee Betsill, CME Group, stated that CME has two mandates, which are to focus on safety and efficiency of the clearinghouse and the stability of the financial system. These mandates, he stated, guide every level of CME clearinghouse governance programs. Moreover, Bestil stated that decisions of their risk management programs are both transparent to market participants through consultation, rule changes, advisories, and disclosures, and diverse in representation on their risk committees. Betsill commented that he is in agreement with most of the other member statements, except the implication being drawn that incentives between CCPs and its clearing members are misaligned. He continued that he does not believe this to be true because there are no incentives to shortcut risk management for a CCP risk manager because its revenue is dependent upon sound risk management. On margining, Betsill stated that it is only one tool in the arsenal and CME looks to improve their margining practices as they conduct their risk management, adding that it is important that CCP risk managers work with the risk managers of its members to monitor exposure int the CCP ecosystem. On default management, Betsill stated that a CCP is not a market participant itself, and although its teams have an expertise in risk management, it is reliant on the clearing member community to support default management practices and liquidations. The main incentive for member participation in default management, he stated, is the guarantee fund contributions. On skin-in-the-game, Betsill stated that the need to be careful in reaching a balance of capital provided in waterfall by CCPs with those contributions to ensure that moral hazard is avoided and incentivize participation in default management.

Dale Michaels, The Options Clearing Corporation (OCC), stated that CCPs do not take on market risk, they manage it, and as CCPs have become more critical to the system, they have strived to make their processes more transparent so that users can better understand the overall risk management of CCPs and participate in risk committees and other advisory forums. On clearing memberships, Michaels stated that they should include all qualified participants, not just big firms, and to manage credit risk of clearing members, the OCC performs risk reviews of each members at the beginning of their membership, and periodically. On margin, Michaels stated that CCPs cannot only look at one aspect of a margin model to determine that its appropriate. On default management, Michaels stated that CCPs work closely with clearing member firms to have robust default management processing, especially with regard to the auction process, and that CCPs must retain flexibility to react to facts and circumstances during stress events, given the next stress event will likely be different then the prior event.

Tyson Slocum, Public citizen, emphasized that it is prudent for the CFTC to ensure that the ownership structures, legal and regulatory obligations, and transparency of operations of these CCPs are aligned with the maximum protections for members, end users, and the public interest. Slocum stated the CFTC should revive efforts to codify and strengthen related rulemakings, including but not limited to, explicit standards for composition of boards of directors, disciplinary panels, risk management committees, ensuring that incentives from CCP business models, inter affiliate interactions, and reporting requirements.

Rosenberg reiterated that CCPS do take risk and that is important to emphasize because they make decisions every day that affect individual clearing members, clients, and the market overall. Further, Rosenberg reiterated that communicating and being transparent in terms of the shaping rulemaking and risk committees is effective way to engage with members and clients to get input, while traditional public filings are not as effective.

Crighton stated that governance around membership criteria is important, particularly in the case of self-clearing members, where clearing members are reliant on CCPs to manage their risk. Betsill responded that diversity of membership is important in the clearing infrastructure and ecosystem and many of the largest self-clearing members are the same banks that own large Futures Commission Merchants (FCMs) and he does not think they’re inherently riskier in the self-clearing space than other FCMs. He added that CCPs need to ensure that all members can support the clearing business that they bring into the CCP.

Crighton also emphasized the importance of member input on liquidation proceedings. On the default management process, Michaels commented that CCPs sometimes have difficulty getting the attention and cooperation of certain market participations during their default management drills and need to go straight to the risk committees.

Q&A

An MRAC member from Goldman Sachs commented that they view well-functioning risk committees as those that allow a high volume of member participation. On skin-in-the-game, the member relayed the position that their firm believes that CCPs having appropriate amounts of skin-in-the-game aligns interests, and they assume that clearinghouses will be more incentivized to make the strongest and best risk management decisions. On best practices, she iterated that CCPs should avoid alluding to risk management standards being different between listed and OTC products, and further, that appropriate input from direct clearing members and members of the risk committee is necessary.

John Murphy, Commodity Markets Council, asked whether panel members had any opinions on the appropriate auction process, given the issues recently seen in Europe. Betsill responded that liquidation is difficult to get right, and there is a balance in having enough participants to be able to support a good auction, in the sense you get the best prices, and telegraphing the position you are about to unload on the market. He continued by stating that CME regularly conducts default management and liquidation drills, and it is important to get the operational elements right and to ensure everyone knows what action teh CCP will be taking during auctions.

Kristen Walters, Blackrock, alluded to the recent NASDAQ default, emphasizing that steps need to be taken to improve CCPs reliance, to reduce systemic risk and prevent loss allocation to investors. On skin-in-the-game, Walters stated that there should not be just more skin in the game, but Blackrock would like to see regulatory bodies develop a framework for applying skin-in-the-game going forward. Additionally, Walters emphasized the need for disclosure standards to be improved, end users and taxpayers need to be protected, and that market participants, CCPs and regulators must focus on the buy-side perspective.

Commissioner Berkovitz asked panelists about the numbers published in the recent Financial Stability Board (FSB) report that 5 clearing members have 80 percent of certain markets. Betsill responded that CCPs benefit from diverse clegin members, and further made that point that there is a difference, in terms of the number of clearing members, in the OTC space versus the listed business. Bestill agreed with Berkvotiz’s fear that there could be too few firms providing clearing, and the industry should be looking to enhance things like capital rules for banks to ensure that there is diversification and enough clearing members offering services to clients that way we can achieve porting in the case of a default. Michaels then responded that the OCC is cognizant to try and bring in clearing memberships that may not be the largest of the large members and that more of the smaller members are needed to decrease concentration risk.

Betsill stated that CME is very much in agreement that there should be skin-in-the-game but it should be the appropriate amount. He continued that when looking at the appropriate amount it needs to be large enough to incentivize clearinghouses to get ists risk management practices right, but not too large that it disincentivizes clearing members from participating in a productive and effective way in the default management process. Walters then stated that given NASDAQ was a publicly traded holding company, she does not think it is unreasonable to ask CCPs of a large size to provide reasonable amount to a default fund, rather than having losses allocated to end users.

Panel 2: Non-Default Losses in Recovery and Resolution

Isaac Chang, AQR, began by laying out three different types of non-default losses, which are: (1) losses from business and operational failure; (2) losses from investments; and (3) losses from custodial failures. After outlining the types of non-default losses (NDLs), Chang stated that policies, practices, and regulations vary across clearinghouses and jurisdictions on how to handle NDLs.

Biswarup Chatterjee, Citigroup, added a fourth source for NDLs: losses resulting from fines, regulatory actions, and monetary penalties. Chatterjee stated that an NDL is an unnecessary loss, that the focus should be on preventing NDLs, and that it should be the responsibility of the entire system, rather than just the CCP, because an NDL can come from clearing members and clients as well. He continued by stating that transparency and spreading the awareness about the sources of NDLs and how they can be prevented should be the focus of discussion. On loss allocation, Chatterjee stated that depending on the circumstances surrounding the NDLs, loss allocation should be borne by CCPs, clearing members and clients, or even both. Further, Chatterjee stated that resources for handling NDLs should be distinct from those that are set aside for a clearing member default, and that there should be consideration of creative solutions in setting aside separate resources because they will add costs to the clearing system.

Eileen Kiely, BlackRock, stated that default loses and NDLs should be considered separately. In terms of default losses, Kiely stated that they should not be allocated to the end investor unless it is done so by a resolution authority, given a CCP’s role as being in the business of credit mitigation. Kiely also stated that if CCPs should fail, then they should fail, and any losses paid by participants in this process should be repaid by a reconstituted CCP. On NDLs, Kiely stated that at no point should NDLs be passed on to the end investor.

Dennis McLaughlin, LCH, stated that although default losses are traditionally what a CCP must manage, there are other losses that may be incurred when carrying out that function. McLaughlin then described examples of investment and custodial NDLs and some of the mechanisms that LCH uses to handle those NDLs.

Eric Nield, ICE, stated that ICE spends a significant amount of time coordinating across their clearinghouses for consistent practices. On business and operational risk, Nield stated that ICE is responsible for any losses resulting from those activities, just like any other business. However, Nield noted that there are exceptions in terms of investment and custodial losses. Expanding on that point, Nield stated that a material aspect of a CCPs business is to collect margin and guarantee deposits from FCMs, and to fulfill that function, CCPs need to rely on third parties and their services because they are not custodians. Nield then stated that there should be a middle group in the form of sharing liability amongst clearinghouses, who would assume a first loss liability layer, then mutualizing liability to clearing members. Finally, he noted that in the absence of regulation in this area, it is effectively a business decision.

Teo Floor, Eurex Clearing AG, stated that CCPs should bear the losses for NDLs, with exceptions relating to CCPs holding cash and non-cash collateral for members and risks associated with this function.

Q&A

Chang asked whether the industry needs more prescriptive and clear regulatory guidance to ensure the appropriate policies for handling NDLs across clearinghouses. McLaughlin stated yes, but this is already being done in an organized way by CCPs in certain drills they run, and there are trends and weaknesses that you can isolate. Kiely stated that default and NDLs need to have a more reasoned and thoughtful founding upon which capital should be held against, and that both need to have a more fulsome approach by the regulatory community. Floor responded that he agrees that further regulatory guidance on the matter is needed, and posed an issue relating to a CCPs ability to access central banks.

Chairman Giancarlo stated that he would have thought that good risk management practices would have led to a way of addressing this before a prescriptive approach from regulators and asked why that is not the case. Chatterjee responded that it is very hard to see the market asking for more regulation, but rather clarity and transparency would solve issues relating to NDLs. Chatterjee added that guidelines and transparency efforts should be given a shot before asking for regulation. Nield responded that ICE did not advocate for additional regulation.

Tyson Slocum, Public Citizen, asked whether there was any type NDL that is the largest share of the losses, and in terms of cyber breaches, what are the current disclosure requirements by CCPs to report breaches to the CFTC, regardless of whether they result in an NDL. Chatterjee responded that it is really hard to model which NDL is the largest share, because some may be more frequent, but others may be costlier. Nield stated that there are extensive event-specific reporting obligations for system failures, cyber-attacks, regardless of whether NDLs occur. He added that his firm does not necessarily agree with the IOSCO position that NDLs should be ring fenced and taking certain assets off the table may not be the best thing in a world short of resources.

Walters stated that an asset manager is paid in fees outlined in its mandate and that as a part of that mandate, asset managers are required to manage enterprise risk, including third party risk. Walters added that CCPs generate significant profits and the expectation is they seek third party risks and should manage these risks appropriately.

McLaughlin stated LCH is working on enterprise risk management, but there is only so far that they can go. He added that it would be good to have a consistent risk management standard, because reporting is very inconsistent across various institutions in terms of what they are actually recognizing internally as risk.

Marnie Rosenberg, JP Morgan, responded that her firm believes that CCPs should be accountable for losses arising from NDLs since they make the decisions in managing the risk.

Panel 3: Central Counterparty Resolution, Leverage Ratio, and Incentives to
Clear

Alicia Lewis, MRAC Designated Federal Officer and Acting Chair, introduced the following discussion or recent reports, proposed rules, and discussion papers by global standard setting bodies and prudential regulators: (1) the Financial Stability Board’s (FSB) discussion paper “Financial Resources to support CCP Resolution and the Treatment of CCP Equity in Resolution”; (2) the Basel Committee on banking Supervision’s (BCBS) consultative document “Leverage Ratio Treatment of Client Cleared Derivatives; and (3) the FSB, BCBS, and the Committee on Payments and Market Infrastructures’ (CPMI) and the International Organization of Securities Commissions’ (IOSCO) final report “Incentives to Centrally Clear Over-The-Counter (OTC) Derivatives.”

Sayee Srinivasan, CFTC, walked through the FSB, BCBS, CPMI, IOSCO paper on incentives to centrally clearing. Srinivasan explained the conclusions and methodology behind the paper and discussed next steps. He continued that the Derivatives Assessment Team (DAT) that conducted the study was not mandated to make policy recommendations, but they specifically highlighted areas where rules were not robust enough, and intentionally asked leading questions so that the standard setting bodies can know additional work that can be done. Further, he stated that we will wait and see what the standard setting bodies decide to do.

Robert Wasserman, CFTC, walked through the FSB’s discussion paper on the treatment of CCP equity in resolution, and the BCBS consultative document on Leverage ratio treatment of client cleared derivatives. Mr. Wasserman urged folks to treat these as opportunities to be nurtured. Further, Wasserman responded to concerns raised in the previous panels stating that he agrees with the concerns regarding effectively designed margin models but reiterated that a simple statistical approach is not enough if you are developing scenarios for stress testing and that you need to have market experts’ input in creating these scenarios.

Panel 4: Oversight of Third-Party Service Providers and Vendor Risk
Management

Anne Hunter, Federal Home Loan Bank of Atlanta, began the conversation by noting that the goal of the discussion was to consider the adequacy of CFTC regulation of vendor management, relationships, and accountability. Problem focus areas she identified included major service provider issues resulting in system failure, vendor accountability, and the resources allocated toward the management and development of relationships with vendors. Hunter asked the panel whether there should be different requirements for critical and non-critical service providers, as well as whether any challenges arise in light of advancements in technology.

Lazaro Barreiro, Office of the Comptroller of the Currency (OCC), emphasized that third parties providing critical activities require a heightened level of oversight and due diligence in selection, planning, and guidance. He outlined important elements of a risk management program, such as the establishment of distinct roles and responsibilities for oversight and management, including board oversight and policies and procedures. He noted that the OCC expects proper documentation to support decisions that are made throughout the lifecycle of a third-party relationship, and that the OCC expects banks to have their processes independently audited periodically.

Julie Mohr, CFTC, spoke about the CFTC’s examination of derivatives clearing organizations (DCOs) and vendor risk management. She noted that DCOs must maintain resources that are necessary to fulfill all of its obligations, and that a DCO entering into a contractual outsourcing arrangement retains responsibility for any failure in meeting those obligations. Mohr noted that the National Institute of Standards and Technology (NIST) is among the standards and best practices the CFTC looks to in its examinations, which may also include a review of arrangements with vendors providing I.T. services, at which point the CFTC would then examine the relationships containing the most risk. Mohr listed documentation the CFTC may request and stated the CFTC studies them with the goal of identifying any areas that haven’t been adequately reviewed or addressed by the DCO.

Salman Banaei, IHS Markit, the only panelist representing a third-party vendor, began by distinguishing between what he called “direct regulation,” where an entity is under direct supervision of a regulator, and “indirect regulation,” where an entity is supervised by a firm that is regulated in a similar way to it. Banaei stated that, particularly for fintech and his firm’s services, the distinction was important, as many of his firm’s services are indirectly regulated. Banaei introduced the FSB’s 2017 definition of fintech, which comprises a subset of his firm’s services. He noted that companies outsource to fintech companies largely to save on cost, while also achieving higher levels of performance and efficiency. Banaei cited five core principles his firm developed in considering oversight and regulation of fintech firms and third-party risk management: documentation, non-discrimination in the amount of oversight as opposed to an in-house function, an open dialogue between third-parties and regulators, regulator responsiveness to new approaches and innovation, and proportionality in terms of the extent to which the third-party is overseen relative to the principal’s reliance on it. Banaei then discussed the circumstances under which direct regulation of fintech is most appropriate, stating that direct regulation is appropriate where it ensures proper conduct and operational integrity, but that regulation should be avoided where it would create a barrier to entry, discourage innovation, or be disproportionately costly.

Hunter asked the panelists about their experiences with any vendor risk operational losses or incidents. Barreiro responded that such incidents are seen very frequently. Banaei then stated that his firm is registered with the FCA and notifies the FCA any time there is an operational issue.

Q&A

Betty Simpkins, Oklahoma State University, expressed concern about disclosures to the public regarding risk management, noting that the disclosures are often very generic, and that from a public perspective it is not clear that adequate risk management is taking place.  She cited issues including cyber breaches, and noted that even after a cyber breach, some companies do not include information in their risk disclosure to affirm that they are addressing it. Simpkins noted that while she is not suggesting that there be more regulation, she is in favor of the CFTC’s encouragement of best practices, with the hope that self-regulation would be improved.

Commissioner Behnam asked the panel about the extent to which they believe companies have a vested interest in protecting their third-party vendor relationships. Benham noted that there may be some areas where the CFTC could take action as technology continues to advance and evolve. He asked the panel whether they think existing rules, guidance, or principles that already exist are appropriate for regulatory purposes, or whether there is room for improvement and growth in regulation and oversight. He also asked more specifically if they feel that the CFTC should contemplate more third-party vendor management guidance, principles, or rules in the future.

Banaei responded by stating that third-party service providers are currently under scrutiny from both regulators and customers. He noted that his firm provides requesting customers with results of an external audit of their operations. Banaei stated that the combination of market discipline and existing regulation constitute adequate supervision, but that there would not be opposition to more direct supervision from a market regulator such as the CFTC as long it follows principles such as proportionality.

Craig Messinger, Virtu Financial, noted that he was in favor of guidance, but expressed concern that regulation may hinder innovation.

Frank Hayden, Calpine Corporation, discussed the concept of non-default loss and first loss, and emphasized the importance of distinguishing the types of risks associated with vendors. Specifically, he distinguished instances where loss occurs due to vendor incompetence, as opposed to instances where a company was itself incompetent in the vendor-hiring process. Hayden stated that where the company itself was incompetent, there is a more obvious basis for first-loss.

Banaei agreed and emphasized that any vendor operating in a free market operates subject to market discipline, where their business fails if they do not properly deliver the services requested of them. He noted that the CFTC, in considering whether new guidance or policy is necessary, should take into consideration the presence of and impact of market discipline.

The MRAC then discussed the concept of concentration risk where a vendor used by a CCP is also used by a clearing member. Derek Kleinbauer, Bloomberg SEF LLC, stated that SEFs have an obligation to get a trade from the execution point to the clearinghouse, and in doing that they are required to use platforms and services elected by their participants. He added that any services leveraged on behalf of customers in compliance with their requests should face the same level of scrutiny and oversight.

Biswarup Chatterjee, Citigroup, emphasized that the MRAC should consider clearinghouse issues that may arise from vendor concentration, such as temporary multi-day outage where the same vendor services multiple clients.

Dale Michaels, The Options Clearing Corporation, noted that clearing members exercise due diligence and that business decisions made have resulted in concentration. He suggested that the best approach would be to proactively understand and anticipate any implications of concertation and mitigate accordingly. Michaels added that guidance is always welcome and communication with regulators is important but expressed concern about the imposition of further regulation. He emphasized that concentration exists because of how the market itself has evolved.

Lee Betsill, CME Group, stated that part of CME’s obligations is the obligation to identify critical service providers as part of recovery planning, and that concentration is considered in making those identifications. He added that those critical service providers are held to higher standards and subject to due diligence more regularly than non-critical vendors.

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