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Commodities Futures Trading Commission Open Meeting

U.S. Commodities Futures Trading Commission

Open Meeting of the Commission

Thursday, July 11, 2019

Opening Statements

Chairman J. Christopher Giancarlo

In his opening statement, Giancarlo stated that two proposals under consideration deal with the registration of derivative clearing organizations. He also recognized that each of the proposals benefited from strong bipartisan work of the commissioners.

Commissioner Rostin Behnam

Behnam said he supports more harmonization with foreign counterparts and believes the two proposals discussed in the hearing point in the right direction.

Commissioner Dan Berkovitz

Berkovitz stated that he looks forward to working in the American people’s best interest.

Commissioner Brian Quintenz

Quintenz stated that he appreciates the “multi-prong” approach of the proposals, and hopes the commission takes a similar stance on foreign policy as it has in previous sessions. He said he hopes that the Commodity Futures Trading Commission (CFTC) can create more meaningful discussion around 2I that affects commerce on the U.S. and rules abroad.

Commissioner Dawn Deberry Stump

Stump stated that the CFTC is responsible for fostering strong relationships between foreign nations and that the CFTC should establish a more comprehensive structure for central counterparties (CCPs) in foreign jurisdictions. She also stated that she worries that the proposals may be too rigid for U.S. customers.

Staff Presentation: Proposed Rule – Registration with Alternative Compliance for Non-U.S. Derivatives Clearing Organizations

Participants:

  • Brian Bussey, Division of Clearing and Risk (DCR)
  • Eileen Donovan, DCR
  • Parisa Abadi, DCR
  • August Imholtz, DCR
  • Abigail Knauff, DCR

Imholtz began the presentation by emphasizing that this proposed rulemaking would create the option for a non-U.S. derivatives clearing organization (DCO) that doesn’t pose a substantial risk to the U.S. market to register through alternative compliance. He clarified that these are generally those that are clearinghouses organized outside of the U.S. and registered as DCOs in their home country. Imholtz explained that the proposal consists of an alternative compliance regime that would permit a non-U.S. DCO to comply with the core principles set forth in Part 39 of the CFTC’s regulations by complying with legal requirements in their home country. Imholtz emphasized that although non-U.S. DCOs, if eligible, could avail themselves of alternative compliance, DCOs would still be required to comply with the CFTC’s customer protection requirements, swap data reporting requirements, and that customer funds would receive the same U.S. bankruptcy protection.

Eligibility

Imholtz iterated the eligibility standard for alternative compliance stipulates that the non-U.S. DCO must not post a substantial risk to the U.S. financial system. More specifically, Imholtz clarified this standard as a two-part test that askes: (1) whether the required initial margin (IM) from U.S. clearing members constitutes 20 percent or more of the IM of U.S. clearing members at all U.S. DCOs; and (2) whether 20 percent or more of the required IM at the DCO is attributable to U.S. clearing members. He explained that if the DCO does not satisfy or exceed 20 percent for both prongs, then it does not pose a substantial risk to the U.S. financial system. The CFTC may exercise discretion when determining whether a DCO poses a substantial risk and look to other factors that may provide a better indication. Additionally, he explained the CFTC must determine that compliance with the home country regulation would satisfy compliance with the U.S. core principles. Finally, the non-U.S. DCO must be in good regulatory standing in their home country and there must be a Memorandum of Understanding (MOU) or similar contract in effect with the DCO of their home country’s regulator.

Imholtz outlined a requirement under the proposal that an applicant would be required to demonstrate the extent of the compliance requirements from their home country that coincides with compliance under the Commodity Exchange Act (CEA). He clarified that this would consist of providing a regulatory compliance comparison chart that includes the citation and the applicable legal requirement that corresponds with each core principle and how the non-U.S. DCO would satisfy each requirement.

Question & Answer

Quintenz inquired about the impact of this proposal on DCR staff resources as they consider new applications and ongoing requirements after registration. Bussey explained that even though there is the possibility of adding additional clearing organizations that are not within DCR’s ambit, he believes that the proposal will result in a reduction of resource demands at DCR. Bussey described the current state of play for registered DCOs, and noted if the proposal was finalized and DCR granted deference to the home country regulators that govern eligible DCOs, it would allow DCR to focus on domestic DCOs and reduce demands. Quintenz then asked whether DCR will still have the ability to conduct exams, and if so, how DCR would expect to exercise that authority with respect to coordinating with other jurisdictions. Bussey responded that there has already been an excellent amount of coordination with foreign jurisdictions. However, he noted that the exams under this regime would be much narrower and more focused on customer fund protection in the event of a Futures Commission Merchant (FCM) bankruptcy. Bussey said he expects that successful coordination with foreign jurisdictions will continue.

Benham asked whether there was a projected amount of DCOs that will avail themselves of this regime. Bussey responded that out of the 6 foreign clearinghouses, only 2 in the U.K. would not be able to utilize this alternative compliance regime. For example, ICE Clear Europe would be able to utilize the alternative compliance for their swaps clearing business but not their futures business. Bussey went on to explain that there is already a lot of interest in the E.U. in the alternative compliance regime, including clearinghouse operators not currently in the regime at all. Further, he noted that clearinghouse operators in Asia have also expressed interest in the alternative compliance regime rather than the exempt registration regime. Benham then questioned the methodology for choosing the 20 percent threshold. Bussey answered that the efforts were extensive and included utilization of many resources including the Chief Economist Office. Ultimately, Bussey stated, the 20 percent threshold resulted from looking at key metrics such as: (i) LCH constitutes 48 percent of clearing in the U.S. swaps market, and together with CME and ICE Clear Credit these three clearinghouses represent 94 percent of the U.S. cleared swaps market; and (ii) Eurex, ICH SA, SCGX, Canadian NGX only represent six percent of the overall cleared swaps market and the next largest foreign clearinghouse only represents four percent. He concluded by emphasizing the 20 percent threshold was carefully calibrated and that DCR welcomes any comments on this issue.

Benham then questioned the discretion provided to the CFTC when a DCO is slightly above the threshold and asked about what measures will be taken to engage in ongoing measurements for substantial risk. On CFTC discretion, Donovan responded that this concept exists in order to ensure the 20 percent threshold was not merely a black and white test. On ongoing measurement, Bussey responded that this is not a critical concern given the stability and consistency of clearinghouses. However, he noted, the DCOs do have new data available to them on a daily, weekly, and monthly basis so oversight on that issue would be relatively low maintenance.

Berkovitz asked whether it would be possible for a clearinghouse to fall under the 20 percent threshold but still post a substantial risk. Bussey responded that it is highly unlikely because IM is calculated on margining systems according to the risk of the product on a linear scale versus a non-liner and therefore it is focused on the risk that the clearinghouse poses by way of the FCM’s not the intermediaries.

CFTC Statements

Quintenz strongly supported this proposal. He stated that it would reduce the efforts of the CFTC and their home country regulation because it appropriately defers to the oversight of foreign regulators when their home country regulatory regime would achieve the same goals as the core principle and don’t pose a risk to the U.S. Quintenz said he believes the proposal is in line with the CFTC’s equivalence agreement, and implements a transparent, fact-based, two prong procedure for determining risk. Further, he stated that it correctly assesses that DCOs focus on U.S. firms and their impact on the U.S. marketplace. He urged ESMA to adopt a similarly calibrated regime for these regulatory determinations.

Benham stated that in the interest of efficiency and resource allocation, this proposal is the appropriate situation for deference towards a foreign jurisdiction that is comparable. However, he urged the CFTC to proceed with caution in order to avoid using the congressional mandate afforded to them in a way that gives responsibilities away to other regulators. He expressed concern that the 20 percent threshold is an arbitrary line since IM is supported by conclusory evidence. Overall, Benham concurred with the proposal and said he viewed it as a step in the right direction.

Stump supported the proposal but also raised concern. She stated that under the proposal non-U.S. DCOs would be required to utilize the alternative compliance only through clearing members that are not FCMs and only through a country that is already a DCO. Stump said she believes consideration should be given to the usage of an affiliated entity that would allow this to be a business decision rather than a regulatory impediment. Further, she noted this may limit U.S. choice to clearing, and to clear under this regime, two affiliate entities may be subjected to risk obligations at the same CCP and this proposal doesn’t discuss how to address this duplicative burden.

Berkovitz supported the proposal because it would allow U.S. persons access to foreign clearing while maintaining key compliance with U.S. regulations under an alternative compliance framework that protects U.S. funds. He expressed concern regarding the 20/20 rule because it may not fully capture the risk of a foreign DCO. Berkovitz urged the CFTC to reconsider this risk-based approach and instead adopt an activity-based approach. Berkovitz also expressed concern regarding the different standards for alternative versus substituted compliance. While the recognition of foreign regulatory regimes is in line with national comity, he urged that where foreign standards are not enough, U.S. standard should be imposed. Prior to granting any applications for alternative compliance, he said the CFTC should determine that the foreign DCO has formed compliance that aligns with the US. He said he believes reciprocity or a similar mechanism should be considered.

Giancarlo stated that the main purpose of this rulemaking is to address the current informality of the CFTC’s approach and, in doing so, introduce areas where the CFTC can defer, appropriately and consistent with its risk oversight responsibilities, to non-U.S. DCOs’ home country supervisors. He explained that this proposal sets forth a framework under which non-U.S. DCOs that do not pose a substantial risk to the U.S. financial system would have the option of being fully registered with the CFTC as a DCO but meet their registration requirements through compliance with their home country requirements. He concluded that the objective and transparent criteria, such as the ones set forth in this proposal, are what all regulators around the world should strive for to provide appropriate predictability and stability to the markets.

The proposed rule was unanimously agreed to.

Staff Presentation: Supplemental Proposal – Exemption from Derivatives Clearing Organization Registration

Participants:

  • Brian Bussey, DCR
  • Eileen Donovan, DCR
  • Parisa Abadi, DCR
  • August Imholtz, DCR
  • Abigail Knauff, DCR

Knauff stated that the CFTC is recommending a supplement to its August 2018 proposal that would codify procedures to grant exemptions from registering as a DCO, and that this supplement does not replace or withdraw the 2018 proposal, which remains under active consideration as a final rule.

Knauff stated the supplemental rule allows DCOs to clear swaps for U.S. customers in addition to clearing propriety swaps for DCOs. She explained U.S. customers would only be able to clear an exempt ECO through a foreign intermediary and not through FCMs. Staff is not recommending at this time that the CFTC propose an FCM either directly or indirectly through a foreign member of the DCO to clear U.S. customer positions and an exempt DCO due to language in the bankruptcy code that suggests that the customer funds may not be protected in the FCM’s insolvency. She said the CFTC staff continue to examine this issue and possible approaches to deal with that uncertainty, and the possible risk to customers that may result from that uncertainty.

Question & Answer

Quintenz asked about the rationale behind disclosure that would be provided to U.S. customers clearing through an exempt DCO that are not registered with the CFTC or FCMs, to which Donovan replied that the disclosure would allow U.S. customers to be fully aware that U.S. bankruptcy would not apply and therefore the customer could compare the two regimes and make their own business decision as to which regime they preferred.

Quintenz then asked how the 20/20 test would be implemented and monitored. Bussey said that CFTC has a comprehensive risk surveillance team and access to data, which the new Deputy Director continues to improve. Bussey stated that the proposal provides substantial lead time for users to comply with registration such as in a Brexit situation, wherein customers would not be expected to be in full compliance immediately.

Quintenz asked about the second part of the 20 percent test on total margin held across the global markets. Bussey clarified that the CFTC is looking at shares of U.S. cleared markets (domestic and foreign clearing houses that are serving U.S. market. Quintenz asked for a sense as to the foreign custody issues approach and similarities between that and other proposals. Bussey stated that during his time at the Securities and Exchange Commission (SEC), the organization established the modern approach to foreign mutual funds and investment advisers. The SEC, Bussey said, put the burden on investment advisers based on their fiduciary duties before placing a customer’s assets in foreign investments. He explained that the CFTC’s proposal dovetails with that and would provide investment advisers with information on bankruptcy regimes that would assist them with satisfying fiduciary duty. In the investment company context, Bussey said, there would be a more specific regime and investment advisers would be eligible to use this proposed exempt ECO proposal.

Giancarlo asked for clarification whether the proposal would be well-aligned with current SEC practices regarding custodian practices, and Bussey confirmed that it would. Behnam asked how the CFTC could be assured that retail customers would not be offered access by foreign intermediaries, and Bussey stated that CFTC prohibition 2E is at the forefront of industry, going back to the adoption of Dodd-Frank in 2010. Bussey said that there are systems in place to ensure that customers that are doing swaps in the market are aware of the prohibition and the analog prohibition and would work to make sure that they are not doing over-the-counter swaps on the non-national securities swaps with retail customers.

Behnam stated that there are significant issues with respect to the foreign intermediaries understanding U.S. laws. Regarding bankruptcy, he stated, the proposal supplement suggests that there are two prongs to mitigate the bankruptcy concerns: 1) ensure that the DCO in good-standing and, 2) require the foreign intermediary to write notice and obtain acknowledgement of a U.S. person engaging on their behalf. Donovan stated that the expectation would be that the exempt DCO would do the analysis and provide that for their members, with the CFTC having the chance to review the disclosure.

Stump asked if, for the purpose of enabling futures customers who do not have to be ECPs, the proposal would allow for foreign depository of non-U.S. clearing members at non-U.S. registered clearing houses, and Bussey stated that the proposal does not only cover eligible contract participants, but also retail in foreign futures context. Stump then asked, under 39.6B2 in the proposal, what the common practice employed by FCM for disclosures of treatment outside the U.S. who clear foreign futures for U.S. clients. Smith stated that if the FCM has U.S. or foreign customers, they are going to trade foreign futures contracts and this requires the FCM to provide disclosure to that customer.

Berkovitz asked for the benefits of the bankruptcy code for derivatives markets and how the code can help reduce systemic risk, and Bussey stated that a customer accessing a clearing house through an FCM for swaps has substantial bankruptcy protections due to a clear bankruptcy code. As a result, Bussey stated, a customer who ends up having FCM that goes to bankruptcy will be able to make a transfer to another FCM.

Berkovitz asked if there were systemic benefits for other participants and if failure of a single firm could have systemic importance. Bussey stated the systemic importance depends on the firm, and that in the proposal the CFTC wants a sophisticated U.S. person to make the choice based on full disclosure.

CFTC Statements

Behnam closed by saying that the proposal has a lack of appropriate scrutiny and evaluation of potential consequences, and that the critical issues raised by the supplemental proposal should be considered in context of more fulsome discussion. Stump stated that it is time to revisit the policy rationale that compels DCO registration for comparable and comprehensively regulated foreign DCPs. Under this proposal, non-U.S. DCPs that do not pose substantial risk to the U.S. financial system will have another option for offering swap clearing services to U.S. customers. She welcomed the public’s input to address concerns related to the fact that the proposal allows non-U.S. DCPs that do not pose substantial risk to the U.S. financial system to have another option for offering swap-clearing services and may request an exemption from registration as provided in the Dodd-Frank Act. The G20 in 2009, she stated, did not expect the CFTC to ignore the global nature of the derivatives markets and that U.S. persons increasingly need access to clearing houses around the world.

Berkovitz closed by stating that the proposal would jeopardize the U.S. by dismissing key protections provided by the U.S. bankruptcy code and would also hurt U.S. businesses with respect to clearing and non-U.S. swaps markets.

Giancarlo said that swaps only trade in major economies with well-developed bankruptcy law, and that the proposal is similar to the CFTC’s long-standing approach to foreign futures clearing which currently provides U.S. customers (including retail customers) with the ability to opt out of the bankruptcy protection afforded under US law to foreign futures funds. If this proposal’s approach is hazardous, Giancarlo stated, then the CFTC’s existing approach must also be similarly hazardous, but he said that he doesn’t think that it is.

The final vote was 3-2. Commissioners Berkovitz and Behnam voted no.

For more information about this event, click here.