Dec.HFS Subcommittee Discusses Title VII Implementation
AT TODAY’S HOUSE FINANCIAL SERVICES SUBCOMMITTEE HEARING, lawmakers discussed the challenge of implementing Title VII of the Dodd-Frank Act with Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler, Robert Cook, Director of the Securities and Exchange Commission’s (SEC) Division of Trading and Markets, and industry representatives.
Subcommittee Chairman Scott Garrett (R-N.J.) began the hearing by noting various concerns over conflicting regulatory regimes among international regulators during the CFTC’s Global Markets Advisory Committee meeting in November. In particular, he pointed to issues related to the agency’s cross border interpretative guidance and the time restraints market participants have been given to comply with new rules. He called for an “appropriate and workable regime” that promotes transparency, increases efficiency, and allows end users to hedge risk. To ensure such a regime is developed, Garrett said his committee will hold several oversight hearings on Title VII implementation going forward.
Chairman Spencer Bachus (R-Ala.) addressed pending final rules for swap execution facilities in his opening remarks, stating that exchange trading and voice brokerage should be available to market participants and stressed the need for flexibility in the rules. He also pointed to potential conflicts and duplication of rules among regulatory regimes and urged the regulators to ensure that the various rule interpretations and approaches are synchronized.
Panel I Testimony
In his opening statement, Gensler provided an overview of the CFTC’s progress in implementing Dodd-Frank Title VII requirements. He noted that swaps transactions are currently being reported to regulators through swap data repositories and that real time reporting of the price and volume of transactions will begin in early 2013. Gensler said the CFTC Commissioners are currently reviewing final draft rules on swap execution facilities (SEFs) and minimum block sizes, which will likely be taken up in January or February 2013. He also noted that the CFTC staff issued a time-limited no-action letter yesterday to “allow certain swap trading facilities and trading platforms to continue to operating” while the Commission completes its final SEF rules.
Gensler said the CFTC is collaborating closely with the Basel Committee on Banking Supervision and the International Organization of Securities Commissions. He stated the CFTC’s intent cooperate internationally to ensure clear application of the rules and engage in regular consultation with international regulators prior to making final determinations.
In conclusion, Gensler stressed that the CFTC is in need or more resources, including staff and technology, in order to me more effective in their market surveillance and to enhance customer protection.
In his opening statement, Cook discussed the SEC’s progress in implementing Title VII rules, including its proposed cross-border rulemaking. Cook said the cross border release will involve a notice-and-comment rulemaking and will consider “investor protection and incorporate an economic analysis that considers the effects of the proposal on efficiency, competition, and capital formation.” Cook stressed that the development of the SEC’s proposal is being “informed by our discussions with fellow regulators in other jurisdictions, as well as with the CFTC” and that the SEC is “paying close attention to comments on the CFTC’s proposed cross border guidance.” He also outlined measures the SEC is planning on considering in the near future, including reporting requirements, petitions seeking exemptive relief to permit portfolio margining of cleared customers credit default swap positions, and the application of mandatory clearing requirements to single-name credit default swaps.
Question and Answer
Garrett and Rep. Carolyn Maloney (D-N.Y.) both asked about the CFTC’s pending SEF rules, noting how the agency’s proposed rules restricted modes of execution and the pending final rules make clear in the preamble that voice brokerage is allowed, but does not include this clarifying language in the rule. Gensler stated his support for final rules that follow Congressional intent and is technology neutral. He did state, however, that multiple parties must have the ability to transact with multiple parties.
Rep. Brad Sherman (D-Calif.) raised concerns with the CFTC’s process of issuing no-action letters. He explained how market participants have been working to comply with new rules only to find out at the “eleventh hour” that such requirements have been extended, referring to the actions taken by the CFTC regarding the October 12 compliance timeframe. He stated his understanding that the CFTC has been issuing numerous no-action letters and temporary exemptive relief notices in advance of December 31, when many previous orders expire and new requirements start to become operational, and asked whether it would be beneficial for the market to provide a full implementation schedule with adequate compliance timelines. Gensler specifically pointed to the fact that data reporting rules were completed in 2011 and that many firms have had over a year to prepare for compliance. He said the CFTC will be offering further “targeted phased compliance.” In his testimony, Gensler also stated that the CFTC will work to address related compliance questions that come up early and even late in the process.
Bachus referred to concerns raised by foreign regulators during the CFTC’s GMAC meeting last month and asked how the CFTC is dealing with conflicts in regulatory regimes. As an example, Gensler pointed to the fact that the U.S. and Japan both implemented rules that require certain products to be cleared through registered clearinghouses, but that such registration actions have not yet been completed. He said the Commission is working on relief that would allow U.S. firms to use a Japanese clearinghouse even though it is not registered with the CFTC and vice versa, and that such relief will be taken up in the next few days.
Bachus also asked whether the SEC has endorsed the CFTC’s proposed cross-border approach. Cook said the SEC is developing a cross border rulemaking that “strikes the right balance.” Noting how the “devil is in the details,” Cook said the SEC and other foreign regulators have been working to identify overlaps and inconsistencies in regulatory regimes through continuing international dialogue.
Rep. Judy Biggert (R-Ill.) asked Gensler if the compliance timeframes are confusing and costly for firms, noting how many firms are focused on closing their books for the year. Gensler said the CFTC has delayed and deferred compliance, and given firms additional time if they requested it. He noted, as an example, how the CFTC is working to grant a four-month delay requested by the International Swaps and Derivatives Association with regard to sales practice regimes, which is currently sitting in front of the Commissioners.
Reps. Gwen Moore (D- Wis.) and Robert Dold (R-Ill.) noted concerns from foreign regulators and Commissioners Jill Sommers and Scott O’Malia over the CFTC’s indemnification interpretations and asked if Gensler would support their legislation, H.R. 4235, which repeals the Dodd-Frank indemnification requirements. Gensler said he supported the CFTC’s indemnification interpretation, stating that it takes into account the principles of international comity
Rep. Steve Stivers (R-Ohio) referenced his legislation (H.R. 2779) which exempts inter-affiliate transactions from the definition of “swap” under the Dodd-Frank Act. Stivers asked Gensler to comment on the CFTC’s progress finalizing an exemption for inter-affiliate swaps from clearing requirements. Gensler said the CFTC will work to finalize the rule in the first quarter of 2013.
Panel II Testimony
Keith Bailey from Barclays, who testified on behalf of the Institute of International Bankers, focused his testimony on the continuing uncertainties surrounding the cross-border application of Title VII’s swap dealer requirements, including: 1) registration requirements; 2) compliance challenges of foreign banks; and 3) the narrow scope of the substituted compliance regime. Bailey said there are many unanswered questions regarding the application and registration requirements of Title VII on foreign headquartered parent entities, especially the definition of “U.S. person” and “substituted compliance.” He stated that without further guidance from the CFTC, the expiration of the interim definition of “U.S. person” will cause uncertainty in the market and restrict counterparty swap dealings.
He also noted that there is discrepancy between the CFTC and the SEC on th definition of “U.S. person” and the adoption of a “substituted compliance” regime, adding that their lack of uniformity is likely to “fractionalize the market.” Bailey concluded that an interim solution should be put in place before December 31, 2012 that includes: 1) relief from the aggregation component to the swap dealer “de minimis” exception until July; 2) adoption of an interim “U.S. person definition”; and 3) certainty regarding entity vs. transaction level rule organization.
Michael Bopp from Gibson, Dunn & Crutcher, who testified on behalf of the Coalition for Derivatives End-Users, stated that his group’s members use derivatives to manage risk, not create it, and explained that end-user trades account for less than ten percent of the notional value of the overall derivatives market.
Bopp expressed concern that the proposed margin requirements would harm “Main Street businesses.” He noted that Congress did not intend to impose margin requirements on end-users as they do not “meaningfully contribute to systemic risk.” He cited a survey taken by the Coalition that found that a three percent initial margin requirement would cause a reduction in capital spending by as much as $5.6 to $6.7 billion and cost 100,000 to 120,000 jobs. He added that exposures that are subject to Basel capital requirements should not be subject to margin requirements.
He concluded that the proposed cross-border guidance would impose additional costs on end-users and would “diminish their available choices of counterparties.”
Samara Cohen of Goldman, Sachs & Co. stated that the CFTC has taken a “sweeping approach” to its jurisdiction beyond the U.S. that is “without precedent,” and many swap market participants and non-U.S. regulators have substantial concerns about this “expansive approach.” She added that this may encourage foreign regulators to be similarly expansive.
Cohen said that while the CFTC has not finalized a definition of “U.S. person” yet, the current one is vague and problematic, and may cause unnecessary overlap and conflicts in regulation. She expressed concern with the timing of compliance with Title VII rulemakings and said market participants face uncertainty as to how these rules will apply to them. She said Goldman Sachs feels strongly that the CFTC should perform a cost-benefit analysis on the subject, as one has not been performed under the interpretations for guidance.
Cohen also expressed her concern that the CFTC’s cross-border approach has not been coordinated with non-U.S. regulatory regimes. She stated that overlap in regulation will increase costs to firms and clients, create confusion over the application of the rules, and will decrease the effectiveness of the regulation. In conclusion, Cohen recommended the CFTC permit market participants to use the simplified form of the “U.S. person” definition from the October 12 no-action letter for all Title VII compliance obligations until 90 days after the CFTC publishes a final rule that reflects coordination between U.S. and foreign regulators.
Tom Deutsch of the American Securitization Forum stated that his group did not think commodity pool and margin regulations were intended to apply to most securitizations. He said that most of the derivatives used in securitization transaction are of the “most plain-vanilla type.” Deutsch said that if these transactions are required to post cash margin and take on the risk of margin calls, there would be higher costs for consumers without tangible benefits. He added that posting this margin would tie up capital, make securitizations less efficient, and restrict the credit market.
He expressed concern that a clearing mandate may make the use of swaps by securitization “unworkable” by exposing the vehicle to risks or creating significant financial costs that change the economies of the transactions. Deutsch concluded by commending the CFTC for providing securitizations relief from the “commodity pool” designation providing no-action relief for “legacy” securitizations
Question and Answer
Garrett asked about the risks associated with central clearing. Parsons responded that central clearing reduces risk overall and because of this more derivatives can be sold at a lower cost. He also noted that since all of the risk is in one place, there may be an issue with the central clearing houses being deemed as “too big to fail.”
Garrett asked Cohen about the sequencing effects of the SEC’s and CFTC’s actions. She responded that the SEC has been much more informative and consistent with the timing of their rules than the CFTC, which is helpful for implementation.
Moore asked if there is a preference seen for the futures market over the swaps market and if this creates regulatory arbitrage and unintended consequences. Parsons responded that the CFTC is “between a rock and a hard place” when treating swaps. He noted that customized swaps will always have to be over-the-counter but that standardized swaps are virtually indistinguishable from futures. Thus any difference in regulatory treatment between the two will cause movement from one marketplace to another. Giancarlo added that if this is the case, there should be no difference in the amount of margin that is required to be posted.
Chairman Garrett asked Deutsch about his thoughts on the exemptions from commodity pools and what it does to the marketplace. Deutsch replied that most “plain-vanilla” securitizations are not conceived for commodity interests and that they already have regulations that provide transparency to this marketplace.
Rep. Schweikert asked what the panel would change about the swaps and futures markets. Giancarlo responded that margin should be the same for economically equivalent products and that there should be consistency in business conduct rules and the setting of block trade sizes. Deutsch responded that differences in the two marketplaces may reduce consumer credit.
Rep. Canseco asked if the SEC and CFTC should harmonize their cross border regulations before implementation. Cohen replied yes, and that cross border regulation is foundational to derivative reform. She said that having two different regulators in the U.S. in this area creates confusion. Rep Canseco asked if there would be flight to other countries if margin requirements were placed on end-users. Bopp stated that flight would be an option, but he is hopeful that relief will be provided from a regulatory standpoint.
For a webcast and testimony of this hearing, please click here.
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AT TODAY’S HOUSE FINANCIAL SERVICES SUBCOMMITTEE HEARING, lawmakers discussed the challenge of implementing Title VII of the Dodd-Frank Act with Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler, Robert Cook, Director of the Securities and Exchange Commission’s (SEC) Division of Trading and Markets, and industry representatives.
Subcommittee Chairman Scott Garrett (R-N.J.) began the hearing by noting various concerns over conflicting regulatory regimes among international regulators during the CFTC’s Global Markets Advisory Committee meeting in November. In particular, he pointed to issues related to the agency’s cross border interpretative guidance and the time restraints market participants have been given to comply with new rules. He called for an “appropriate and workable regime” that promotes transparency, increases efficiency, and allows end users to hedge risk. To ensure such a regime is developed, Garrett said his committee will hold several oversight hearings on Title VII implementation going forward.
Chairman Spencer Bachus (R-Ala.) addressed pending final rules for swap execution facilities in his opening remarks, stating that exchange trading and voice brokerage should be available to market participants and stressed the need for flexibility in the rules. He also pointed to potential conflicts and duplication of rules among regulatory regimes and urged the regulators to ensure that the various rule interpretations and approaches are synchronized.
Panel I Testimony
In his opening statement, Gensler provided an overview of the CFTC’s progress in implementing Dodd-Frank Title VII requirements. He noted that swaps transactions are currently being reported to regulators through swap data repositories and that real time reporting of the price and volume of transactions will begin in early 2013. Gensler said the CFTC Commissioners are currently reviewing final draft rules on swap execution facilities (SEFs) and minimum block sizes, which will likely be taken up in January or February 2013. He also noted that the CFTC staff issued a time-limited no-action letter yesterday to “allow certain swap trading facilities and trading platforms to continue to operating” while the Commission completes its final SEF rules.
Gensler said the CFTC is collaborating closely with the Basel Committee on Banking Supervision and the International Organization of Securities Commissions. He stated the CFTC’s intent cooperate internationally to ensure clear application of the rules and engage in regular consultation with international regulators prior to making final determinations.
In conclusion, Gensler stressed that the CFTC is in need or more resources, including staff and technology, in order to me more effective in their market surveillance and to enhance customer protection.
In his opening statement, Cook discussed the SEC’s progress in implementing Title VII rules, including its proposed cross-border rulemaking. Cook said the cross border release will involve a notice-and-comment rulemaking and will consider “investor protection and incorporate an economic analysis that considers the effects of the proposal on efficiency, competition, and capital formation.” Cook stressed that the development of the SEC’s proposal is being “informed by our discussions with fellow regulators in other jurisdictions, as well as with the CFTC” and that the SEC is “paying close attention to comments on the CFTC’s proposed cross border guidance.” He also outlined measures the SEC is planning on considering in the near future, including reporting requirements, petitions seeking exemptive relief to permit portfolio margining of cleared customers credit default swap positions, and the application of mandatory clearing requirements to single-name credit default swaps.
Question and Answer
Garrett and Rep. Carolyn Maloney (D-N.Y.) both asked about the CFTC’s pending SEF rules, noting how the agency’s proposed rules restricted modes of execution and the pending final rules make clear in the preamble that voice brokerage is allowed, but does not include this clarifying language in the rule. Gensler stated his support for final rules that follow Congressional intent and is technology neutral. He did state, however, that multiple parties must have the ability to transact with multiple parties.
Rep. Brad Sherman (D-Calif.) raised concerns with the CFTC’s process of issuing no-action letters. He explained how market participants have been working to comply with new rules only to find out at the “eleventh hour” that such requirements have been extended, referring to the actions taken by the CFTC regarding the October 12 compliance timeframe. He stated his understanding that the CFTC has been issuing numerous no-action letters and temporary exemptive relief notices in advance of December 31, when many previous orders expire and new requirements start to become operational, and asked whether it would be beneficial for the market to provide a full implementation schedule with adequate compliance timelines. Gensler specifically pointed to the fact that data reporting rules were completed in 2011 and that many firms have had over a year to prepare for compliance. He said the CFTC will be offering further “targeted phased compliance.” In his testimony, Gensler also stated that the CFTC will work to address related compliance questions that come up early and even late in the process.
Bachus referred to concerns raised by foreign regulators during the CFTC’s GMAC meeting last month and asked how the CFTC is dealing with conflicts in regulatory regimes. As an example, Gensler pointed to the fact that the U.S. and Japan both implemented rules that require certain products to be cleared through registered clearinghouses, but that such registration actions have not yet been completed. He said the Commission is working on relief that would allow U.S. firms to use a Japanese clearinghouse even though it is not registered with the CFTC and vice versa, and that such relief will be taken up in the next few days.
Bachus also asked whether the SEC has endorsed the CFTC’s proposed cross-border approach. Cook said the SEC is developing a cross border rulemaking that “strikes the right balance.” Noting how the “devil is in the details,” Cook said the SEC and other foreign regulators have been working to identify overlaps and inconsistencies in regulatory regimes through continuing international dialogue.
Rep. Judy Biggert (R-Ill.) asked Gensler if the compliance timeframes are confusing and costly for firms, noting how many firms are focused on closing their books for the year. Gensler said the CFTC has delayed and deferred compliance, and given firms additional time if they requested it. He noted, as an example, how the CFTC is working to grant a four-month delay requested by the International Swaps and Derivatives Association with regard to sales practice regimes, which is currently sitting in front of the Commissioners.
Reps. Gwen Moore (D- Wis.) and Robert Dold (R-Ill.) noted concerns from foreign regulators and Commissioners Jill Sommers and Scott O’Malia over the CFTC’s indemnification interpretations and asked if Gensler would support their legislation, H.R. 4235, which repeals the Dodd-Frank indemnification requirements. Gensler said he supported the CFTC’s indemnification interpretation, stating that it takes into account the principles of international comity
Rep. Steve Stivers (R-Ohio) referenced his legislation (H.R. 2779) which exempts inter-affiliate transactions from the definition of “swap” under the Dodd-Frank Act. Stivers asked Gensler to comment on the CFTC’s progress finalizing an exemption for inter-affiliate swaps from clearing requirements. Gensler said the CFTC will work to finalize the rule in the first quarter of 2013.
Panel II Testimony
Keith Bailey from Barclays, who testified on behalf of the Institute of International Bankers, focused his testimony on the continuing uncertainties surrounding the cross-border application of Title VII’s swap dealer requirements, including: 1) registration requirements; 2) compliance challenges of foreign banks; and 3) the narrow scope of the substituted compliance regime. Bailey said there are many unanswered questions regarding the application and registration requirements of Title VII on foreign headquartered parent entities, especially the definition of “U.S. person” and “substituted compliance.” He stated that without further guidance from the CFTC, the expiration of the interim definition of “U.S. person” will cause uncertainty in the market and restrict counterparty swap dealings.
He also noted that there is discrepancy between the CFTC and the SEC on th definition of “U.S. person” and the adoption of a “substituted compliance” regime, adding that their lack of uniformity is likely to “fractionalize the market.” Bailey concluded that an interim solution should be put in place before December 31, 2012 that includes: 1) relief from the aggregation component to the swap dealer “de minimis” exception until July; 2) adoption of an interim “U.S. person definition”; and 3) certainty regarding entity vs. transaction level rule organization.
Michael Bopp from Gibson, Dunn & Crutcher, who testified on behalf of the Coalition for Derivatives End-Users, stated that his group’s members use derivatives to manage risk, not create it, and explained that end-user trades account for less than ten percent of the notional value of the overall derivatives market.
Bopp expressed concern that the proposed margin requirements would harm “Main Street businesses.” He noted that Congress did not intend to impose margin requirements on end-users as they do not “meaningfully contribute to systemic risk.” He cited a survey taken by the Coalition that found that a three percent initial margin requirement would cause a reduction in capital spending by as much as $5.6 to $6.7 billion and cost 100,000 to 120,000 jobs. He added that exposures that are subject to Basel capital requirements should not be subject to margin requirements.
He concluded that the proposed cross-border guidance would impose additional costs on end-users and would “diminish their available choices of counterparties.”
Samara Cohen of Goldman, Sachs & Co. stated that the CFTC has taken a “sweeping approach” to its jurisdiction beyond the U.S. that is “without precedent,” and many swap market participants and non-U.S. regulators have substantial concerns about this “expansive approach.” She added that this may encourage foreign regulators to be similarly expansive.
Cohen said that while the CFTC has not finalized a definition of “U.S. person” yet, the current one is vague and problematic, and may cause unnecessary overlap and conflicts in regulation. She expressed concern with the timing of compliance with Title VII rulemakings and said market participants face uncertainty as to how these rules will apply to them. She said Goldman Sachs feels strongly that the CFTC should perform a cost-benefit analysis on the subject, as one has not been performed under the interpretations for guidance.
Cohen also expressed her concern that the CFTC’s cross-border approach has not been coordinated with non-U.S. regulatory regimes. She stated that overlap in regulation will increase costs to firms and clients, create confusion over the application of the rules, and will decrease the effectiveness of the regulation. In conclusion, Cohen recommended the CFTC permit market participants to use the simplified form of the “U.S. person” definition from the October 12 no-action letter for all Title VII compliance obligations until 90 days after the CFTC publishes a final rule that reflects coordination between U.S. and foreign regulators.
Tom Deutsch of the American Securitization Forum stated that his group did not think commodity pool and margin regulations were intended to apply to most securitizations. He said that most of the derivatives used in securitization transaction are of the “most plain-vanilla type.” Deutsch said that if these transactions are required to post cash margin and take on the risk of margin calls, there would be higher costs for consumers without tangible benefits. He added that posting this margin would tie up capital, make securitizations less efficient, and restrict the credit market.
He expressed concern that a clearing mandate may make the use of swaps by securitization “unworkable” by exposing the vehicle to risks or creating significant financial costs that change the economies of the transactions. Deutsch concluded by commending the CFTC for providing securitizations relief from the “commodity pool” designation providing no-action relief for “legacy” securitizations
Question and Answer
Garrett asked about the risks associated with central clearing. Parsons responded that central clearing reduces risk overall and because of this more derivatives can be sold at a lower cost. He also noted that since all of the risk is in one place, there may be an issue with the central clearing houses being deemed as “too big to fail.”
Garrett asked Cohen about the sequencing effects of the SEC’s and CFTC’s actions. She responded that the SEC has been much more informative and consistent with the timing of their rules than the CFTC, which is helpful for implementation.
Moore asked if there is a preference seen for the futures market over the swaps market and if this creates regulatory arbitrage and unintended consequences. Parsons responded that the CFTC is “between a rock and a hard place” when treating swaps. He noted that customized swaps will always have to be over-the-counter but that standardized swaps are virtually indistinguishable from futures. Thus any difference in regulatory treatment between the two will cause movement from one marketplace to another. Giancarlo added that if this is the case, there should be no difference in the amount of margin that is required to be posted.
Chairman Garrett asked Deutsch about his thoughts on the exemptions from commodity pools and what it does to the marketplace. Deutsch replied that most “plain-vanilla” securitizations are not conceived for commodity interests and that they already have regulations that provide transparency to this marketplace.
Rep. Schweikert asked what the panel would change about the swaps and futures markets. Giancarlo responded that margin should be the same for economically equivalent products and that there should be consistency in business conduct rules and the setting of block trade sizes. Deutsch responded that differences in the two marketplaces may reduce consumer credit.
Rep. Canseco asked if the SEC and CFTC should harmonize their cross border regulations before implementation. Cohen replied yes, and that cross border regulation is foundational to derivative reform. She said that having two different regulators in the U.S. in this area creates confusion. Rep Canseco asked if there would be flight to other countries if margin requirements were placed on end-users. Bopp stated that flight would be an option, but he is hopeful that relief will be provided from a regulatory standpoint.
For a webcast and testimony of this hearing, please click here.