[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
THE FUTURE OF THE CFTC: COMMISSION PERSPECTIVES
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
GENERAL FARM COMMODITIES
AND RISK MANAGEMENT
OF THE
COMMITTEE ON AGRICULTURE
HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRTEENTH CONGRESS
FIRST SESSION
__________
JULY 23, 2013
__________
Serial No. 113-6
Printed for the use of the Committee on Agriculture
agriculture.house.gov
U.S. GOVERNMENT PRINTING OFFICE
82-368 WASHINGTON : 2013
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC
area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC, Washington, DC
20402-0001
COMMITTEE ON AGRICULTURE
FRANK D. LUCAS, Oklahoma, Chairman
BOB GOODLATTE, Virginia, COLLIN C. PETERSON, Minnesota,
Vice Chairman Ranking Minority Member
STEVE KING, Iowa MIKE McINTYRE, North Carolina
RANDY NEUGEBAUER, Texas DAVID SCOTT, Georgia
MIKE ROGERS, Alabama JIM COSTA, California
K. MICHAEL CONAWAY, Texas TIMOTHY J. WALZ, Minnesota
GLENN THOMPSON, Pennsylvania KURT SCHRADER, Oregon
BOB GIBBS, Ohio MARCIA L. FUDGE, Ohio
AUSTIN SCOTT, Georgia JAMES P. McGOVERN, Massachusetts
SCOTT R. TIPTON, Colorado SUZAN K. DelBENE, Washington
ERIC A. ``RICK'' CRAWFORD, Arkansas GLORIA NEGRETE McLEOD, California
MARTHA ROBY, Alabama FILEMON VELA, Texas
SCOTT DesJARLAIS, Tennessee MICHELLE LUJAN GRISHAM, New Mexico
CHRISTOPHER P. GIBSON, New York ANN M. KUSTER, New Hampshire
VICKY HARTZLER, Missouri RICHARD M. NOLAN, Minnesota
REID J. RIBBLE, Wisconsin PETE P. GALLEGO, Texas
KRISTI L. NOEM, South Dakota WILLIAM L. ENYART, Illinois
DAN BENISHEK, Michigan JUAN VARGAS, California
JEFF DENHAM, California CHERI BUSTOS, Illinois
STEPHEN LEE FINCHER, Tennessee SEAN PATRICK MALONEY, New York
DOUG LaMALFA, California JOE COURTNEY, Connecticut
RICHARD HUDSON, North Carolina JOHN GARAMENDI, California
RODNEY DAVIS, Illinois
CHRIS COLLINS, New York
TED S. YOHO, Florida
______
Nicole Scott, Staff Director
Kevin J. Kramp, Chief Counsel
Tamara Hinton, Communications Director
Robert L. Larew, Minority Staff Director
______
Subcommittee on General Farm Commodities and Risk Management
K. MICHAEL CONAWAY, Texas, Chairman
RANDY NEUGEBAUER, Texas DAVID SCOTT, Georgia, Ranking
MIKE ROGERS, Alabama Minority Member
BOB GIBBS, Ohio FILEMON VELA, Texas
AUSTIN SCOTT, Georgia PETE P. GALLEGO, Texas
ERIC A. ``RICK'' CRAWFORD, Arkansas WILLIAM L. ENYART, Illinois
MARTHA ROBY, Alabama JUAN VARGAS, California
CHRISTOPHER P. GIBSON, New York CHERI BUSTOS, Illinois
VICKY HARTZLER, Missouri SEAN PATRICK MALONEY, New York
KRISTI L. NOEM, South Dakota TIMOTHY J. WALZ, Minnesota
DAN BENISHEK, Michigan GLORIA NEGRETE McLEOD, California
DOUG LaMALFA, California JIM COSTA, California
RICHARD HUDSON, North Carolina JOHN GARAMENDI, California
RODNEY DAVIS, Illinois ----
CHRIS COLLINS, New York
(ii)
C O N T E N T S
----------
Page
Conaway, Hon. K. Michael, a Representative in Congress from
Texas, opening statement....................................... 1
Prepared statement........................................... 2
Scott, Hon. David, a Representative in Congress from Georgia,
opening statement.............................................. 3
Witnesses
O'Malia, Hon. Scott D., Commissioner, U.S. Commodity Futures
Trading Commission, Washington, D.C............................ 4
Prepared statement........................................... 6
Submitted questions.......................................... 51
Wetjen, Hon. Mark P., Commissioner, U.S. Commodity Futures
Trading Commission, Washington, D.C............................ 20
Prepared statement........................................... 22
Submitted questions.......................................... 62
THE FUTURE OF THE CFTC: COMMISSION PERSPECTIVES
----------
TUESDAY, JULY 23, 2013
House of Representatives,
Subcommittee on General Farm Commodities and Risk
Management,
Committee on Agriculture,
Washington, D.C.
The Subcommittee met, pursuant to call, at 10:01 a.m., in
Room 1300 of the Longworth House Office Building, Hon. K.
Michael Conaway [Chairman of the Subcommittee] presiding.
Members present: Representatives Conaway, Neugebauer,
Austin Scott of Georgia, Hartzler, Noem, LaMalfa, Hudson,
Collins, Lucas (ex officio), David Scott of Georgia, Vela,
Gallego, Vargas, Maloney, Walz, Negrete McLeod, and Costa.
Staff present: Debbie Smith, Jason Goggins, Josh Mathis,
Suzanne Watson, Tamara Hinton, Caleb Crosswhite, John Konya, C.
Clark Ogilvie, Liz Friedlander, and Riley Pagett.
OPENING STATEMENT OF HON. K. MICHAEL CONAWAY, A REPRESENTATIVE
IN CONGRESS FROM TEXAS
The Chairman. All right. It is 10 o'clock. We are going to
go ahead and start. This hearing of the Subcommittee on General
Farm Commodities and Risk Management entitled, The Future of
the CFTC: Commission Perspectives, will come to order.
Good morning. I would like to welcome all of you to the
second in a series of Agriculture Committee hearings on the
future of the CFTC. Today's hearing builds on the perspectives
shared at the full Committee hearing in May.
I am pleased to welcome Commissioners Scott O'Malia and
Mark Wetjen to share their perspectives on what works at the
Commission and what doesn't, assuming there is anything that
doesn't work over there. But thank you both for being with us
this morning. I look forward to your perspectives.
About 5 years ago, American's watched in horror as the
financial services industry imploded, draining trillions of
dollars from their investment portfolios and retirement plans.
In response, Congress passed the Dodd-Frank Act requiring
financial regulators to look deeper into the markets that they
oversee. In many ways, Dodd-Frank fundamentally changed the
regulators as much as it sought to remake the financial markets
themselves.
Congress mandated a staggering amount of work for the CFTC
to get done, and it has transformed the Commission, conferring
vast new registration, reporting and oversight powers to it.
The Commission has spent the past 3 years on this Herculean
task, but today, it is still frustratingly behind schedule on
some of those. Rulemakings that were supposed to be completed
in a year have slipped into the third year.
But perhaps more concerning has been the pattern of 11th-
hour delays of unworkable rules or guidance. The confusion and
delay stemming from the Commission's actions are adding up to
real costs for market participants. Many companies are in
limbo, unsure of how to plan for the impact of the rules that
might change.
Every hearing, I remark that getting Dodd-Frank done
correctly is more important than getting it done quickly, but
the Commission seems to be failing at both, unable to complete
its work correctly or expeditiously. A good example of a rule
that I am concerned about and one that we will get into further
in the weeks to come is the customer protection rule that the
Commission has recently proposed.
The proposed rule requires futures commission merchants to
hold additional margin and capital to cover all potential
shortfalls by customers. This proposal would be expensive to
implement and could harm the very customers it seeks to help by
raising costs and reducing market competition. Proposed last
November, this rule is not ready and has caused needless
concern amongst smaller market participants who would bear the
greatest burdens in complying with this rule.
The Commission must do a better job seeking and considering
objective data at the front end of rulemaking, which is why
Ranking Member Scott and I have introduced legislation to
require the CFTC to conduct an actual analysis of costs and
benefits when it proposes new rules. I hope that Commissioners
O'Malia and Wetjen can testify about additional ways they
believe the internal processes and culture at the Commission
can be improved. I look forward to a fruitful discussion on how
to make sure the rulemaking process at the CFTC is coherent and
transparent and how to ensure the Commission's future actions
are timelier and better prepared.
Finally, as we look at options for how to improve the CFTC,
we cannot forget to look closely at Congressional mandates for
reports, actions, offices, and other requirements on the
Commission that may be outdated or redundant because of newer
requirements. I firmly believe that repealing outdated sections
of law is just as important as implementing new ones.
With that, I would like to again thank both Commissioners
O'Malia and Wetjen. It is critical that the Committee have your
perspectives on what is working at the Commission and what is
not. Your time appearing today and the time you spent preparing
over the past several weeks is much appreciated by David and
myself.
[The prepared statement of Mr. Conaway follows:]
Prepared Statement of Hon. K. Michael Conaway, a Representative in
Congress from Texas
Good morning. I'd like to welcome you all to the second in a series
of Agriculture Committee hearings on the future of the CFTC. Today's
hearing builds on the perspectives shared at the full Committee hearing
in May.
I am pleased to welcome Commissioners Scott O'Malia and Mark Wetjen
to share their perspectives on what works at the CFTC and what doesn't.
Thank you both for being with us this morning.
Almost 5 years ago, Americans watched with horror as the financial
services industry imploded, draining trillions of dollars from their
investment portfolios and retirement plans. In response, Congress
passed the Dodd-Frank Act, requiring financial regulators to look
deeper into the markets they oversee.
In many ways, Dodd-Frank fundamentally changed the regulators as
much as it sought to remake the financial markets. Congress mandated a
staggering amount of work for the CFTC and it has transformed the
Commission, conferring vast new registration, reporting, and oversight
powers to it.
The Commission has spent the past 3 years on this Herculean task,
but today, it is frustratingly behind schedule. Rulemakings that were
supposed to be completed in a year have slipped into their third year.
But, perhaps more concerning has been the pattern of eleventh hour
delays of unworkable rules or guidance.
The confusion and delay stemming from the Commission's actions are
adding up to real costs for market participants. Many companies are in
limbo, unsure of how to plan for the impact of rules that might still
change. Every hearing, I remark that getting Dodd-Frank done right is
more important than getting it done quickly, but the Commission seems
to be failing at both, unable to complete its work correctly or
expeditiously.
A good example of a rule that I am concerned about, and one that we
will get into further in the weeks to come, is the customer protection
rule the Commission has proposed. The proposed rule would require
futures commission merchants to hold additional margin and capital to
cover all potential shortfalls by customers. This proposal would be
expensive to implement and could harm the very customers it seeks to
help by raising costs and reducing market competition. Proposed last
November, this rule is not ready and has caused needless concern among
smaller market participants who would bear the greatest burdens in
complying.
The Commission must do a better job seeking and considering
objective data at the front end of rulemakings, which is why Ranking
Member Scott and I have introduced legislation to require the CFTC to
conduct an actual analysis of costs and benefits when it proposes its
rules.
I hope that Commissioner O'Malia and Commissioner Wetjen can
testify about additional ways they believe the internal processes and
culture at the Commission can be improved. I look forward to a fruitful
discussion on how to make sure the rulemaking process at the CFTC is
coherent and transparent and how to ensure the Commission's future
actions are timelier and better prepared.
Finally, as we look at options for how to improve the CFTC, we
cannot forget to look closely at Congressional mandates for reports,
actions, offices, or other requirements on the Commission that may be
outdated or redundant because of newer requirements. I firmly believe
that repealing outdated sections of law is just as important as
implementing new ones.
With that, I'd like to again thank both Commissioner O'Malia and
Commissioner Wetjen. It is critical that the Committee have your
perspectives on what is working at the Commission--and what is not.
Your time appearing today and the time you've spent preparing over the
past several weeks is appreciated by us all.
I'd like to now turn to my able partner on this Subcommittee,
Ranking Member Scott, for his opening remarks.
The Chairman. I would now like to turn to my able partner
on the Subcommittee, Ranking Member David Scott, for his
opening remarks.
OPENING STATEMENT OF HON. DAVID SCOTT, A REPRESENTATIVE IN
CONGRESS FROM GEORGIA
Mr. David Scott of Georgia. Thank you very much, Mr.
Chairman, and certainly to you, Mr. Wetjen and Mr. O'Malia. We
certainly appreciate your coming here.
Today's hearing is an especially important one but it is
not only important just to hear about the workings of the CFTC
but about you as an agency, about your budget, about your
appropriations, about your needs. Your last appropriations was
5 years ago. So much has been thrown at you over the last 5
years. We have had the financial crisis, meltdown of Wall
Street. We have had to come up with answers to that, and we
have had the birth and the implementation 3 years ago of Dodd-
Frank. You have had to come up with that. We have had an ever-
growing derivatives market now that is valued at $637 trillion,
a piece of the world economy. You have had to have rules for
that.
So you have had a lot thrown at you. You have done a very
good job. And it is important, Mr. Chairman, that as we look at
this 3 year anniversary of Dodd-Frank, it is important to note
that the CFTC has gone from what was once sort of an obscure
parochial regulatory body to now one of the most powerful
governmental agencies in the world. And the task that we in
Congress gave them was not an easy one, but they have done so
and have done an extraordinary job and yeoman's work. And not
just this Commission but their staff. I know, and it has to be,
that the workload of this staff has probably quadrupled what we
have had.
So it is very important that we hear from you to make sure
that you, as your budget is about to expire in the next 9 weeks
or so, that we hear from you to know exactly what your needs
are because we, this Subcommittee, certainly wants to make sure
that you have the funding that you have needed, the technology
that you have needed. We can sit here and make these laws of
cross-border and push out and having all of these derivatives,
but we have to depend upon you to tell us, ``Congress, you want
us to do this job, you want us to do it right. Here is what we
need to do it and here is why.'' I think that is very important
to get across in this hearing today.
So, Mr. Chairman, with that I will yield back the balance
of my time.
The Chairman. Thank you, David. I appreciate that. It is my
honor to welcome the panel of witnesses to the table today. We
have Mr. Scott O'Malia, Commissioner, U.S. Commodity Futures
Trading Commission, Washington, D.C.; and the Honorable Mark
Wetjen, Commissioner, U.S. Commodity Futures Trading Commission
out of Washington, D.C. So, Mr. O'Malia, we have both of your
written statements for the record but please visit with us
about the things that you think are the most important out of
your written testimony, sir. With that, Scott, you have the
floor.
STATEMENT OF HON. SCOTT D. O'MALIA, COMMISSIONER, U.S.
COMMODITY FUTURES TRADING COMMISSION,
WASHINGTON, D.C.
Mr. O'Malia. Chairman Conaway, Ranking Member Scott, and
Members of the Subcommittee, I am pleased to be invited here
today to discuss the CFTC's implementation of Dodd-Frank. I am
also pleased to be able to participate in this hearing and
joined by my fellow Commissioner and colleague, Commissioner
Mark Wetjen.
In summarizing my testimony, I will focus on three main
topics. First, I would like to discuss the challenges that end-
users face as a result of the Commission's approach to the
implementation of Dodd-Frank. Second, I will discuss the
serious concerns I have with the Commission's rulemaking
process. And finally, I will discuss the challenges in the
Commission's data utilization efforts and the importance of
technology in meeting the Commission's expanded mission.
Even a brief review of the legislative history of the Dodd-
Frank Act demonstrated that it was Congress' intent to protect
commercial end-users from Dodd-Frank's expansive regulatory
reach. The swap dealer rule is a good example of the
Commission's failure to accurately interpret Dodd-Frank. The
rules make it unnecessarily difficult to determine whether an
entity is a swap dealer or an end-user. It broadly applies the
swap dealer definition to all market participants and ignores
the statutory mandate to exclude end-users.
Rather than providing a bright-line test or expressly
excluding end-users, the swap dealer rule lists numerous
factors that should be considered in determining whether an
end-user's commercial activity might be swap dealing. As a
result, end-users have shied away from the ambiguous facts and
circumstances test and instead have relied on provisions that
excuse a dealer from registration with the Commission if its
aggregate dealing activity is below an $8 billion de minimis
threshold, which is an arbitrary amount that is not based on
data. I would encourage Congress to exclude end-users from the
swap dealer definition. In the alternative, Congress should
also consider allowing commercial entities not to count their
cleared swaps as part of their $8 billion de minimis
calculation.
Another area that deserves Congressional attention is
customer protection in bankruptcy. The importance of these
issues is emphasized by the recent cases involving the blatant
misuse of customer funds by FCMs. In 2010, MF Global
misappropriated over $900 million to cover its own proprietary
losses. One year later, Peregrine Financial and its founder
Russell Wassendorf stole over $200 million in customer funds.
Both the industry and the Commission have taken steps to
increase the level of protections to prevent something like
this from happening again. It is inexcusable that these FCMs
failed to protect customer funds. Although these violations
were not because of a lack of regulation, I believe there is
room for improvement.
As I explain in more detail in my written testimony, I
believe that Congress should consider improving customer
protections in bankruptcy. First, I believe customers will
benefit from increased CFTC authority in insolvency proceedings
by appointing a CFTC trustee to look out for futures and swaps
customers.
Second, Congress must ensure that customers are always
first in line in any distribution of assets of an estate in
bankruptcy.
Third, the Congress should revisit the pro-rata
distribution rules, including creating the possibility of
third-party segregation accounts that will not be comingled in
bankruptcy.
Another area that needs improvement is the Commission's
own rulemaking procedures. I think that everyone would agree
that it is virtually impossible to achieve good policy outcomes
without establishing sound processes for reaching these
outcomes. The CFTC staff has issued an unprecedented number of
no-action letters. So far, the staff has issued over 100
letters, including 24 letters that provide indefinite relief
from hastily drafted rules. No-action letters are not voted on
by the Commission. They are not published in the Federal
Register and do not include notice-and-comment periods. Thus,
no-action letters should be used on a very limited basis.
I have always advocated that all Commission rulemaking must
include a thorough cost-benefit analysis, both qualitative and
quantitative, to ensure that our rules do not impose
unreasonable costs. However, the cost-benefit provisions in the
CEA do not currently require quantitative analysis. Thus, I am
pleased that the House has passed the cost-benefit reform bill
requiring the Commission to conduct quantitative analysis to
justify the cost of its rules relative to their benefits.
In considering the Commission's reauthorization, it is
entirely appropriate for Congress to review the Commission's
internal procedures for compliance with the APA and insist on
reforms to the Commission's cost-benefit analysis. It is also
imperative for the Commission to better utilize technology
given the Commission's expanded oversight responsibilities.
Since the beginning of 2013, certain market participants
have been required to report their data to an SDR.
Unfortunately, the Commission has struggled with analyzing this
information. Earlier this spring, our surveillance staff
admitted that they could not spot the London Whale trades in
the current CFTC data. Solving our data dilemma must be the
Commission's top priority. As the Chairman of the Commission's
Technology Advisory Committee, I have formed a working group
comprised of CFTC staff and various market participants,
including the SDRs, to resolve this problem as soon as
possible.
The Commission has been given the momentous task of
creating a regulatory environment that increases transparency
and improves stability in our financial markets. Therefore, the
Commission must faithfully implement the statute in a
consistent, clear, and cost-effective manner. This Committee
has every right and responsibility to make the necessary and
immediate changes it deems fit. I am happy to continue to work
with this Committee to ensure that the Commission is operating
as authorized and mandated under the CEA.
I am happy to answer any questions you have following our
testimony. Thank you.
[The prepared statement of Mr. O'Malia follows:]
Prepared Statement of Hon. Scott D. O'Malia, Commissioner, U.S.
Commodity Futures Trading Commission, Washington, D.C.
Chairman Conaway, Ranking Member Scott, and Members of the
Subcommittee, I am pleased to be invited here today to discuss the
Commodity Futures Trading Commission (``CFTC'' or ``Commission'')'s
implementation of the Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010 (``Dodd-Frank Act''),\1\ as well as the
Commission's oversight of the derivatives markets.
---------------------------------------------------------------------------
\1\ Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub.
L. 111-203, 124 Stat. 1376 (2010).
---------------------------------------------------------------------------
I'd like to first recognize the tremendous efforts by CFTC staff to
implement the sweeping reforms of the Dodd-Frank Act, including the
Commission's new authority to oversee the over $600 trillion swaps
market. They have put in many hours of hard work over the past 3 years
to carry out the CFTC's mission, and should be commended for their
achievements.
The Dodd-Frank Act was enacted to implement the four principles
agreed to by the G20 nations who finalized the Pittsburgh Communique on
September 25, 2009.\2\ These four principles are (1) reporting of all
trades to a trade repository, (2) requiring that ``all standardized OTC
derivatives should be traded on exchanges or electronic trading
platform, where appropriate,'' (3) ``clearing through central
counterparties,'' and (4) higher collateral charges for all uncleared
over-the-counter (``OTC'') derivatives contracts.
---------------------------------------------------------------------------
\2\ http://www.treasury.gov/resource-center/international/g7-g20/
Documents/pittsburgh_summit_leaders_statement_250909.pdf at 9.
---------------------------------------------------------------------------
The CFTC was charged with the mandate to reduce risk, increase
transparency, and promote market integrity under the reforms set forth
in Title VII of the Dodd-Frank Act. Unfortunately, the Commission's
implementation of Dodd-Frank has made it difficult for commercial end-
users to comply with CFTC regulations and made hedging more complicated
and expensive.
My testimony today will focus on three main topics. First, I will
discuss challenges presented by the Commission's policy approach to the
implementation of Dodd-Frank and its negative impact on commercial end-
users. I will include suggestions to improve CFTC regulations so that
end-users receive fair treatment. I will also discuss several policy
initiatives related to customer protection.
Second, I will discuss serious concerns that I have with the
Commission's rulemaking process, including the abuse of no-action
relief and the lack of strict adherence to the provisions of the
Administrative Procedure Act (``APA''). It is my hope that Congress
will be able to assist the Commission with imposing discipline on its
internal policies and procedures, including amendments to the Commodity
Exchange Act (``CEA'').
Finally, I will discuss challenges in CFTC data utilization and the
importance of technology in meeting the Commission's greatly expanded
surveillance and oversight responsibilities under the sweeping reforms
enacted by the Dodd-Frank Act.
I. Improving CFTC Regulations Under the Dodd-Frank Act
Protecting Commercial End-Users in Hedging and Mitigating Risk
Even a brief review of the legislative history of the Dodd-Frank
Act demonstrates that it was Congress' intent to protect commercial
end-users from Dodd-Frank's expansive regulatory reach. Many end-users
assumed that CFTC regulations would not affect them and supported
aspects of reform, without realizing the policy approach that the
Commission would take in implementing the Dodd-Frank Act.
Excluding End-Users from the Swap Dealer Definition
The swap dealer rule is a good example of how the Commission failed
to accurately interpret Dodd-Frank by broadly applying the swap dealer
definition to all market participants and ignoring the express
statutory mandate to exclude end-users from its reach.\3\ Instead, the
swap dealer rule makes it unnecessarily difficult to determine whether
an entity is a swap dealer or an end-user. For example, rather than
providing for a clear bright-line test, the swap dealer rule lists
numerous factors that should be considered.
---------------------------------------------------------------------------
\3\ Further Definition of ``Swap Dealer,'' ``Security-Based Swap
Dealer,'' ``Major Swap Participant,'' ``Major Security-Based Swap
Participant'' and ``Eligible Contract Participant,'' 77 FR 30595 at
30744 (May 23, 2012).
---------------------------------------------------------------------------
Further, as I noted in my dissent to the swap dealer rule,\4\ the
rule exclusively implements the swap dealer definition provided by the
Dodd-Frank Act in section 1a(49)(A) of the CEA,\5\ and fails to
implement the exclusion for persons that are not engaged in swaps
trading as part of ``a regular business'' in section 1a(49)(C).\6\ Not
only that, but the Commission also failed to interpret section
1a(49)(B) of the CEA, which provides express authority for the
Commission to exclude specific entities from the dealing definition for
``types, classes or categories of swaps,'' such as physical
commodities.\7\
---------------------------------------------------------------------------
\4\ Statement of Dissent, Commissioner Scott D. O'Malia (April 18,
2012), available at
http://www.cftc.gov/PressRoom/SpeechesTestimony/omaliastatement041812b.
\5\ 7 U.S.C. 1a(49)(A).
\6\ 7 U.S.C. 1a(49)(C).
\7\ 7 U.S.C. 1a(49)(B).
---------------------------------------------------------------------------
As a result, because the rule's swap dealer definition focuses on
characteristics of entities rather than their activities and ignores
two important exclusions, it captures commercial end-users even though
their activities involve hedging and risk mitigation and have nothing
to do with swap dealing activities. As a result, end-users have to seek
numerous exemptions from various CFTC regulations. This inefficient
regulatory process creates uncertainty for end-users and increases the
costs of hedging and mitigating risk.
This concerns me even more because Members of Congress who drafted
the Dodd-Frank Act repeatedly attempted to make it clear to the
Commission that commercial end-users should be exempted from Dodd-
Frank's swap provisions. In June 2010, Senate Banking Committee
Chairman Chris Dodd and Senate Agriculture Committee Chairman Blanche
Lincoln circulated a joint letter stating, ``Congress does not intend
to regulate end-users as Major Swap Participants or Swap Dealers just
because they use swaps to hedge or manage commercial risks associated
with their business.'' \8\ And in March 2012, Senate Agriculture
Committee Chairman Debbie Stabenow and House Agriculture Committee
Chairman Frank Lucas also sent a joint letter to the Commission to
reiterate these points:
---------------------------------------------------------------------------
\8\ Letter from Senators Christopher Dodd and Blanche Lincoln to
Congressmen Barney Frank and Collin Peterson (June 30, 2010).
``[I]t is important for the Commission to finalize the swap
dealer definition in a manner that is not overly broad, and
that will not impose significant new regulations on entities
that Congress did not intend to be regulated as swap dealers.
The Commission's final rulemaking further defining `swap
dealing' should clearly distinguish swap activities that end-
users engage in to hedge or mitigate the commercial risk
associated with their businesses, including swaps entered into
by end-users to hedge physical commodity price risk, from
dealing . . . .'' \9\
---------------------------------------------------------------------------
\9\ Letter from Senator Debbie Stabenow and Congressman Frank Lucas
to CFTC Chairman Gary Gensler (March 29, 2012).
Unfortunately, the Commission failed to listen to these
Congressional directives in its implementation of the swap dealer rule.
Solutions that Remove End-Users from the Swap Dealer Definition
Given the policy challenges that the Commission faces regarding the
fair treatment of end-users, I would encourage Congress to expressly
exclude end-users from the swap dealer definition. In the alternative,
Congress may want to consider other approaches that would both
encourage risk-mitigating behavior by end-users and also remove the
costly burden imposed by the swap dealer definition. For example,
Congress should consider permitting commercial entities to not count
any of their swap trades that are cleared toward their de minimis swap
dealing calculation, and consider applying a consistent definition of
hedging activity that allows end-users to mitigate both physical and
financial commercial risk.
Fixing Hedging and Clearing
I am concerned that the swap dealer rule does not provide any legal
or factual justification for the threshold amounts used in aggregation
of swap dealing activity. Under CFTC regulations, a swap dealer does
not need to register with the Commission if its aggregate swap dealing
activity on a yearly basis is below the arbitrary $8 billion
threshold.\10\ The threshold is then reduced to $3 billion after a 5
year phase-in period.\11\ The Commission has failed to support this
decision with a fact-based rationale and has made the reduction of the
threshold amount non-discretionary, instead of allowing a future
Commission to determine the appropriate de minimis levels based on
market conditions at that time.
---------------------------------------------------------------------------
\10\ See Further Definition of ``Swap Dealer,'' ``Security-Based
Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based Swap
Participant'' and ``Eligible Contract Participant,'' 77 FR 30595 at
30634 (May 23, 2012).
\11\ Id. at 30744.
---------------------------------------------------------------------------
In calculating the de minimis threshold, market participants are
permitted to exclude trades that are executed to hedge physical
positions.\12\ But for some reason, the Commission's definition of
``hedging activity'' is different from the definition used in other
rules.\13\ For purposes of both simplicity and consistency, the
Commission should adopt one uniform definition of hedging for all CFTC
regulations, and the same definition of hedging should be applied to
both swap dealers (``SDs'') and major swap participants (``MSPs''). I
would welcome Congressional action to clarify the scope and level of
permissible hedging activity, which is the foundation of the swaps and
futures markets.
---------------------------------------------------------------------------
\12\ 17 CFR 1.3(ggg)(6)(iii) (excluding swap transaction entered
into to hedge physical positions from the de minimis swap dealer
calculation).
\13\ See 1.3(z) and 151.5 (defining bona fide hedge transactions
in the context of position limits), 1.3(kkk) (defining hedging or
mitigating commercial risk in the context of the major swap participant
de minimis calculation), 50.50 (defining hedging or mitigating
commercial risk in the context of clearing exceptions).
---------------------------------------------------------------------------
Swaps used to hedge risk are not the only category of transactions
that should be removed from the $8 billion de minimis threshold amount.
Swap transactions that are cleared through a derivatives clearing
organization (``DCO'') mitigate risk and ensure that both parties deal
at arm's length. Accordingly, these cleared swaps should also be
excluded from the de minimis calculation either by the Commission or by
Congressional action.
Defining ``Financial Entity'' in the CEA
Another major issue that Congress needs to address is the
definition of ``financial entity'' in section 2(h) of the CEA, which
addresses mandatory clearing.\14\ This provision includes the
definition of a financial entity as a person ``predominantly engaged''
in either activities that are within ``the business of banking'' or
``activities that are financial in nature'' as defined in the Bank
Holding Company Act (``BHCA'').\15\ The term ``financial entity'' has
material significance throughout Title VII and affects not only these
entities' domestic operations, but also has global impact due to the
recent cross-border swaps guidance.
---------------------------------------------------------------------------
\14\ 7 U.S.C. 2(h)(7)(C)(i)(VIII).
\15\ Id.
---------------------------------------------------------------------------
Unfortunately, using the BHCA as the source of this part of the
definition of financial entity actually hurts end-users because certain
technical aspects of end-users' physical commodities transactions would
fall under the banking regulators' interpretation of ``activities that
are financial in nature.'' Using the definition of ``financial in
nature'' under the banking laws applies unnecessary restrictions to
these end-users and interferes with their business operations. The
definition also interferes with the Commission's mandate to ensure that
the commodity markets are liquid and promote hedging and price
discovery. It would be helpful if Congress could clarify the definition
of ``financial entity'' under the CEA.
As an alternative solution, section 102(a)(6) of the Dodd-Frank Act
sets forth a predominance test to determine whether or not a firm is a
``nonbank financial company.'' The statute applies an 85% standard for
gross revenue from financial activity to determine if a company is
predominantly engaged in financial activities, and ultimately, a
nonbank financial company. One could assume from this standard that a
de minimis amount is, therefore, less than 15% of gross revenue from
non-financial activity. Accordingly, I wonder whether the Commission
should apply a similar 85/15 standard as part of our de minimis
exception in order to provide a bright-line test for end-users (both
commercial and non-bank financial) to demarcate themselves from swap
dealers.
Excluding Forward Contracts with Volumetric Optionality from Swap
Definition
Another example where CFTC regulations have unnecessarily
complicated common commercial transactions, and confounded end-users
who want to both comply with the law and use volumetric options in
their regular business, is the treatment of volumetric options in the
swap definition.
The definition of swap is fundamental to CFTC regulations that
oversee the derivatives markets and mitigate systemic risk. Determining
whether a contract is a swap affects the determination of swap dealer
registration, position limits calculations, the scope of the bona fide
hedge exemption, and clearing and reporting requirements. Equally
important to the definition of swap is ensuring that it does not
capture the legitimate business activity of end-users.
Dodd-Frank explicitly excludes forward contracts from the
definition of ``swap.'' \16\ As you know, flexibility of the terms of
commodity forward contracts is essential for commercial end-users. The
parties cannot always accurately predict the required needs of certain
commodities at some point in the future to meet their business needs.
---------------------------------------------------------------------------
\16\ 7 U.S.C. 1a(47)(B)(ii).
---------------------------------------------------------------------------
Unfortunately, the Commission has created a lot of confusion as to
whether and under what conditions forward contracts containing terms
that provide for some form of flexibility in delivered volumes (i.e.,
contracts with ``embedded volumetric optionality'') fall within the
forward exclusion.
The swap definition rule suggests that an agreement with embedded
optionality falls within the forward exclusion when seven criteria are
met. The seventh criterion, however, caused a lot of anxiety among end-
users. In essence, the Commission interpreted this criterion as
requiring market participants to determine whether their exercise or
non-exercise of volumetric optionality is based on factors outside
their control and not on the economics of the option itself.\17\ This
interpretation makes no commercial sense and does not achieve any
objectives of Dodd-Frank.
---------------------------------------------------------------------------
\17\ The seventh criterion states that the exclusion applies only
when ``[t]he exercise or non-exercise of the embedded volumetric
optionality is based primarily on physical factors, or regulatory
requirements, that are outside the control of the parties and
influencing demand for, or supply of the nonfinancial commodity.'' 77
FR 48208 at 48238 n. 341 (Aug. 13, 2012).
---------------------------------------------------------------------------
Needless to say, the Commission's ambiguous interpretation of the
seventh criterion has made it very difficult for end-users to utilize
volumetric optionality without the fear of being dragged into the swaps
world. A number of end-users requested that the Commission provide
clarity on this issue.\18\ So far, the Commission has ignored their
requests. Given the importance of these contracts, I believe that the
forward-contract exclusion in section 1a(47)(B)(ii) of the CEA should
be amended to exclude these types of forward contracts from the swap
definition.
---------------------------------------------------------------------------
\18\ See, e.g., National Gas Supply Association Comment Letter
(Oct. 12, 2012), American Petroleum Institute Comment Letter (Oct. 11,
2012), Edison Electric Institute Comment Letter (Oct. 12, 2012).
---------------------------------------------------------------------------
Raising the De Minimis Threshold for Special Entities
Another group that deserves to be reevaluated for fair treatment is
state, city, and county municipalities that fall within the swap dealer
rule as ``Special Entities.'' As currently drafted, the rule
discourages market participants from trading with Special Entities.
When trading with municipal energy companies, the $8 billion de minimis
threshold drops to only $25 million.\19\ The reasoning behind this
distinction was that Special Entities need even more protection because
any loss incurred by a Special Entity would result in the public being
left holding the bag.\20\ While this rule was written with the best of
intentions, by reducing the de minimis threshold to $25 million, the
end result has been a reduction in the number of market participants
that are willing to do business with Special Entities. Many
counterparties that would fall well below the $8 billion de minimis
threshold are not willing to trade with Special Entities for fear of
exceeding the $25 million cap and then having to register with the
Commission as swap dealers.
---------------------------------------------------------------------------
\19\ 77 FR 48208 at 30642, 30744.
\20\ Id. at 30628 (referring to documented cases of municipalities
losing millions of dollars on swaps transactions because they did not
fully understand the underlying risks of the instrument).
---------------------------------------------------------------------------
In a quick fix to repeated requests from various Special Entities,
the Commission issued no-action relief allowing the de minimis
threshold to be increased to $800 million for utility commodity
swaps.\21\ In trying to protect Special Entities from the perils of
trading in the swaps market, we have forced them to trade with large
Wall Street banks since no other entity is willing to trade with them
for fear of becoming a swap dealer. Instead of providing them with
greater protection, the Commission has limited the pool of
counterparties with which Special Entities can trade, concentrating
risk in fewer market participants. This plainly goes against the goal
of reducing systemic risk.
---------------------------------------------------------------------------
\21\ Staff No-Action Relief: Temporary Relief from the De Minimis
Threshold for Certain Swaps with Special Entities, October 12, 2012.
---------------------------------------------------------------------------
Exempting Cooperatives from Clearing Certain Swaps
On a more positive note, I am pleased that the Commission has
provided cooperatives representing smaller financial institutions, such
as credit unions or farm credit organizations, an exemption for
clearing certain swaps. The smaller institutions themselves have
already been exempted, but after receiving requests from the
cooperatives that represent groups of such organizations, the
Commission has exempted them as well. Cooperatives act on behalf of
their members, the end-users, when they transact in the financial
markets. Therefore, the same clearing exemption should be available to
these groups.
Incidentally, at least in the energy markets, traders have moved to
the futures market to avoid the onerous swap dealer definition. Trading
futures doesn't contribute to any swap dealer de minimis levels and all
futures trades are cleared, thus mitigating counter party risk. This
brings me to my next area of discussion--futurization.
Futurization of Swaps
As a good example of the effect of the complexity and regulatory
uncertainty created by CFTC regulations implementing the Dodd-Frank
Act, commercial end-users moved the lion's share of swaps trading to
the futures markets. Last year, on October 15, 2012, which is the day
that the swap dealer and swap definition rules took effect, the
IntercontinentalExchange (``ICE'') converted all of its energy swaps
into futures as requested by their customers. The exact same products
that were swaps the day before were traded seamlessly as futures on a
designated contract market (``DCM'').
There are three main drivers behind futurization: (1) vague and
over-inclusive swap dealer definition rules as I mentioned earlier, (2)
the Commission's differential regulatory treatment of futures vis a vis
swaps with respect to the margining requirements and (3) margin
requirements for swaps.
With respect to margining, futures are margined assuming a 1 or 2
day liquidation period.\22\ However, swaps (except for energy and
agricultural swaps) require a minimum liquidation period of 5 days for
calculating initial margin.\23\ The margin is set based on a
liquidation period in order to cover potential losses on a defaulted
position before that position can be liquidated by the clearinghouse.
This substantially higher margin for swaps results in a significant
economic disadvantage to swaps contracts compared to futures contracts
that have similar economic characteristics. Such differential treatment
of economically equivalent contracts, simply because one is called a
``swap'' and the other is called a ``future,'' makes no sense from a
risk management standpoint. Instead, the liquidation period should
depend on the economic characteristics of a particular contract
(regardless of whether it is a swap or future) and the level of
liquidity of that contract. All of these conditions should the same for
two economically equivalent contracts.
---------------------------------------------------------------------------
\22\ 17 CFR 39.13(g)(2)(ii)(A).
\23\ 17 CFR 39.13(g)(2)(ii)(C).
---------------------------------------------------------------------------
Historically, the Commission has allowed DCOs to set the minimum
liquidation time horizons and the Commission has relied entirely on the
expertise of clearing houses to set all margin levels. Allowing the
clearinghouse to set the risk, rather than the Commission's prescribing
rules with arbitrary time periods, is more appropriate because of the
risk management functions of clearinghouses. There is also no incentive
for a DCO to lower margin levels because the DCO ultimately bears the
loss for any of its members' default.
Harmonizing Capital and Margin Requirements for OTC Swaps
Another rule that is yet to be finalized that impacts end-users'
activities is the capital and margin requirements for OTC swaps. In
their letter, Senators Dodd and Lincoln point out that ``Congress
clearly stated that the margin and capital requirements are not to be
imposed on end-users.'' \24\
---------------------------------------------------------------------------
\24\ Letter from Senators Christopher Dodd and Blanche Lincoln to
Congressmen Barney Frank and Collin Peterson (June 30, 2010).
---------------------------------------------------------------------------
On April 13, 2011, the Commission proposed rules regarding capital
and margin requirements for uncleared swaps.\25\ I supported the
proposal and the exemptive relief that rule would provide to end-users.
Under the proposal, when swap dealers trade with end-users, the swap
dealer is not required to pay or collect initial or variation margin.
This is consistent with Congressional intent.
---------------------------------------------------------------------------
\25\ 76 FR 23732 (April 13, 2011).
---------------------------------------------------------------------------
While the margin rules, as proposed, would provide some relief to
end-users, I believe end-users will be required to take a capital
charge. The final result is that end-users will ultimately pay more for
these transactions than they did before. It is imperative that the
Commission's regulations not divert working capital into margin
accounts in a way that would discourage hedging by end-users or impair
economic growth. Whether swaps are used by an airline hedging its fuel
costs or a manufacturing company hedging its interest rates,
derivatives are an important tool that companies use to manage costs
and market volatility. I agree with Sean Owens, an economist with
Woodbine Associates, who stated that under the Dodd-Frank rules, ``end-
users face a tradeoff between efficient, cost-effective risk transfer
and the need for hedge customization. The costs implicit in this
tradeoff include: regulatory capital, funding initial margin, market
liquidity and structural factors.'' \26\
---------------------------------------------------------------------------
\26\ See Sean Owens, Optimizing the Cost of Customization, Review
of Futures Market (Jul. 2012).
---------------------------------------------------------------------------
Swap Execution Facilities
Another rule that could potentially impact end-users is the
Commission's swap execution facility (``SEF'') rulemaking that was
finalized by the Commission in June.\27\ I am pleased that in some
ways, the SEF rules have made great strides to allow for a smooth
transition to this new trading environment. The rules provide a
streamlined registration process and allow for flexible methods of
execution, but it remains to be seen whether the Commission will be
able to deliver on the requirements to approve temporary SEF
registration on an expedited basis. Now, it is incumbent upon the
Commission to move quickly, consistently, and transparently to approve
SEF applications and provide market participants adequate time to test
the new trading facilities, before mandatory trading requirements are
effective.
---------------------------------------------------------------------------
\27\ 78 FR 3347 (June 6, 2013).
---------------------------------------------------------------------------
In many ways, the final rule is consistent with the goals of the
SEF clarification bill as it acknowledges the ``any means of interstate
commerce'' clause contained in the SEF definition and provides for a
role of voice and other means of execution. I am aware that the final
rules may have created an uneven playing field for those SEFs that are
trading products that are not required to be traded on a SEF. The rule
requires all multilateral facilities to register as a SEF and comply
with all the regulatory requirements if they trade these products,
while platforms that have one-to-many facilities are not required to
register with the Commission and are allowed to offer these products
for trading. I believe the Commission should address this regulatory
arbitrage as soon as possible to establish a level playing field for
the new swap execution platforms.
Protecting Customers in FCM Bankruptcy Proceedings
I have now identified several areas where the Commission's policy
approach and rule implementation have failed to appropriately exclude
commercial end-users from the more onerous aspects of the Dodd-Frank
Act that address systemic risk, and offered suggestions to solve these
challenges. But in the important area of customer protection, there are
a couple issues where the Commission could use help from Congress.
Lessons Learned from MF Global and Peregrine
The importance of customer protection is emphasized by the recent
cases involving the blatant misuse of customer funds by futures
commission merchants (``FCMs''). In 2010, MF Global misappropriated
over $900 million in customer funds in order to cover losses incurred
by the FCM in its own proprietary trading accounts. This was made worse
by the $700 million in funds that were held in MF Global's UK affiliate
that remained out of reach of U.S. customers that were entitled to
these funds. It goes without saying that this was a devastating loss to
the customers of MF Global.
One year later, Peregrine Financial Group and its founder and chief
executive Russell Wassendorf were found to have misappropriated over
$200 million in customer funds. In light of these sizable and high
profile cases of FCM misconduct, both the industry and Commission have
taken steps to increase the level of protection afforded to customer
assets to prevent something like this from happening again.
It is inexcusable that these FCMs failed to protect customer funds.
These violations were not because of a lack of regulation, but were due
to the failure of these FCMs to comply with rules under the CEA. In
both cases, the Commission used its enforcement authority to prosecute
those responsible at these FCMs. In the case of MF Global, the
Commission recently filed a law suit against Jon Corzine and Edith
O'Brien that has not yet gone to trial.\28\ But importantly, customers
have fared better in recovering their funds that were misused. Today,
customers are expected to recover approximately 96 percent of their
funds,\29\ albeit 3 years after wrongdoing was discovered. In the case
of Peregrine Financial, Russell Wassendorf was convicted of mail fraud,
embezzlement, and making false statements to the CFTC and the National
Futures Association. Regrettably, however, customers of Peregrine
continue to seek repayment of the more than $200 million in customer
funds that were stolen by Mr. Wassendorf.
---------------------------------------------------------------------------
\28\ http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/
documents/legalpleading/enfmfglobalcomplaint062713.pdf.
\29\ While futures customers of MF Global are expected to receive
96% of their assets, MF Global customers that had foreign investments
are expected to recover between 84-91% of their assets.
---------------------------------------------------------------------------
As I noted earlier, the Commission did have regulations in place to
make these actions by the respective CEOs unlawful.\30\ Even so, I
believe there are opportunities to make improvements in Commission
oversight of customer funds. As I mention in more detail below, I
believe Congress should carefully consider improving customer
protections in the event of FCM insolvency.
---------------------------------------------------------------------------
\30\ See 7 U.S.C. 13c(b).
---------------------------------------------------------------------------
Creating a Bankruptcy Trustee for Futures and Swaps Customers
Let me first address post-bankruptcy reforms. Since over 90% of
customer assets that are held in FCMs are held by jointly registered
and regulated broker-dealers/FCMs, I would support increasing the
authority of the CFTC in the insolvency proceedings for these jointly-
regulated entities. For example, in the case of MF Global, the
Securities Investor Protection Corporation (``SIPC'') placed the firm
into bankruptcy, with SIPC as its trustee and the exclusive mandate to
protect securities customers. Since the interests of futures customers
may not align with securities investors, it makes sense for the
Commission to have the power to appoint its own trustee who is familiar
with the CEA.
Ensuring that Customers Come First: ``Super Lien'' Reforms
Further, I believe Congress should pursue granting new authority to
the Commission in the U.S. Bankruptcy Code to ensure that customers are
always first in order of priority in any distribution of assets of the
estate by the bankruptcy trustee. Claiming customers are first in line
only within the FCM is not enough, especially if they are deemed a
general creditor amongst the other claimants against the holding
company. The reality is--and this was the case in MF Global--that the
decision of the CEO of the controlling parent company can directly
impact the operation of the FCM and, therefore, its customers. By
making customers first in line for the proprietary assets of the FCM
and its controlling parent, the company has every incentive to
strengthen its internal controls to protect customer funds. And
creditors, knowing their claims would be subordinate to customers in
the event of a shortfall in the bankruptcy accounting, would also be
incentivized to ensure good internal controls are in place.
Reconsidering Pro Rata Distribution for Customers
Next, I believe Congress should carefully consider the pro-rata
distribution rules in bankruptcy proceedings, including creating the
opportunity for certain entities (that are willing to purchase such
protection) the ability to establish third-party segregation accounts
that will not be commingled in bankruptcy. Currently, if there is a
shortfall in segregation, customers share the loss proportionally.\31\
This is the law whether or not customer funds are held in one account
(commingled) or in a separate individual account. The Commission has
explored various options, but has been unable to change the pro-rata
requirements without statutory amendments.
---------------------------------------------------------------------------
\31\ See 11 U.S.C. 766(h).
---------------------------------------------------------------------------
Rulemaking on FCM Residual Interest
The Commission has also proposed a new customer protection rule
seeking to improve the Commission's FCM oversight.\32\ The comment
period is closed and the draft final rule is nearing completion. One
element of this rule that has drawn significant attention is the rule
changing the Commission's interpretation of residual interest. The
practical effect of this rule would require FCMs to maintain a level of
excess margin so that one customer's excess margin does not fund the
margin shortfall of another customer 100 percent of the time. While the
clearing house will view the FCM's omnibus account as being properly
funded,\33\ one customer's assets are being used to fund another's
shortfall, which is a direct violation of the CEA.\34\
---------------------------------------------------------------------------
\32\ See Enhancing Protections Afforded Customers and Customer
Funds Held by Futures Commission Merchants and Derivatives Clearing
Organizations; Proposed Rule, 77 FR 67866 at 67934 (Nov. 14, 2012).
\33\ This is better illustrated by means of an example: FCM A has
customers B and C. Customer B has a long futures position that requires
$110 in margin. Customer C has a short futures position that requires
only $100 in margin. FCM A then reports these positions to the clearing
house within its single customer account without identifying the
individual customer positions. Since the clearing house views this as
one single account, it views FCM A as having a $10 surplus. In the
event Customer C's position reduces in value to the point that
additional margin is required, FCM A should collect that amount
directly from Customer C. If the loss in C's position only requires an
additional margin contribution of $10 or less however, FCM A could use
the $10 excess in Customer B's account to fund Customer C's deficiency
until it collects that additional margin requirement from Customer C at
a later date.
\34\ ``It shall be unlawful for any person to be a futures
commission merchant unless . . . such person shall . . . treat and deal
with all money . . . received by such person to margin . . . the trades
. . . of any customer of such person . . . as belonging to such
customer.'' 7 U.S.C. 6d(a)(2).
---------------------------------------------------------------------------
We have heard significant concerns from small FCMs in the Midwest
who serve farmers and ranchers in agriculture markets. The small FCMs
are less likely to be able to cover the additional funds, unlike larger
firms. This could result in less competition and higher concentration
of risk and counterparty exposure among FCMs.
II. Improving CFTC Policies and Procedures
I have now identified several examples where the Commission's
policy approach has resulted in negatively impacting commercial end-
users in a way that I do not believe Congress intended, and outlined
solutions to get us back on track with our mission to protect market
participants and ensure open, competitive markets that efficiently
hedge risk and foster price discovery. But, it is virtually impossible
to achieve good policy outcomes without establishing a sound process
for reaching those outcomes. Unfortunately, the Commission has failed
to do so in our implementation of the Dodd-Frank Act.
I have serious concerns that the Commission has sidestepped many
requirements that all administrative agencies must follow under the
APA.\35\ I believe that strong Congressional oversight of our internal
policies and procedures and strong Commission oversight of CFTC staff
action will help us to improve our process, ensure that public
participation is a core component in our deliberations, and that
decisions that significantly impact market participants happen in an
open and transparent manner.
---------------------------------------------------------------------------
\35\ 5 U.S.C. 551 et seq.
---------------------------------------------------------------------------
Administrative Procedure Act
For example, the Commission's position limits rule was struck down
last year by the United States District Court for the District of
Columbia. The court held that before setting position limits, the
Commission is required by statute to determine whether position limits
were ``necessary and appropriate'' to prevent excessive speculation in
the commodity markets. Unfortunately, the Commission ignored the
district court order to undertake the required analysis and is gearing
up to defend the position limits rule in the United States Court of
Appeals for the District of Columbia Circuit. Concurrently with its
appeal, the Commission is drafting a new rule all over again, instead
of simply evaluating the necessity for position limits as it should
have done in the first place. I believe that the district court sent a
strong message to the Commission in its decision to vacate the position
limits rule, namely, that the Commission must carefully follow the
letter of the law in its rulemaking and that shortcuts will not be
tolerated. Instead of heeding the warning of the district court and
recent DC Circuit opinions vacating SEC rules for violating the APA,
the Commission has chosen to skirt the requirements of the APA.
Abusing No-Action Relief
To date, the Commission has promulgated 45 final rules, three
interim final rules, and four interpretive statements in its
implementation of the Dodd-Frank Act.\36\ However, in its haste, the
Commission has finalized some rules that are either unworkable or
simply make no sense. As a result, the Commission has also had to adopt
seven exemptive orders related to Dodd-Frank requirements.\37\
---------------------------------------------------------------------------
\36\ http://www.cftc.gov/LawRegulation/DoddFrankAct/Dodd-
FrankFinalRules/index.htm.
\37\ Id.
---------------------------------------------------------------------------
Not only that, but instead of undertaking Commission action to
amend problematic rules, CFTC staff has issued an unprecedented number
of no-action letters, some of which are indefinite and have no
expiration. So far, CFTC staff has issued over 100 no-action letters
granting relief from its new regulations under Dodd-Frank, and I won't
be surprised if this number continues to grow.\38\ No-action letters
are not voted on by the Commission and are not published in the Federal
Register. They do not include comment periods and many impose
conditions on affected parties. This process is at odds with basic
principles of the APA, like public participation and the opportunity to
be heard. It also goes against President Obama's Executive Orders Nos.
13563 and 13579, mandating that administrative agencies ``create an
unprecedented level of openness in Government'' and ``establish a
system of transparency, public participation, and collaboration.'' \39\
---------------------------------------------------------------------------
\38\ http://www.cftc.gov/LawRegulation/CFTCStaffLetters/No-
ActionLetters/index.htm.
\39\ Executive Order 13563, ``Improving Regulation and Regulatory
Overview,'' (Jan. 18, 2011); Executive Order 13579, ``Regulation and
Independent Regulatory Agencies,'' (Jul. 14, 2011).
---------------------------------------------------------------------------
I believe that the use of the no-action relief process by CFTC
staff is inappropriate for changes in Commission policy. A no-action
letter is issued by a division of the CFTC and states that, for the
reasons and under the conditions described therein, the staff will not
recommend that the Commission commence an enforcement action against an
entity or group of entities for failure to comply with obligations
imposed by CFTC regulations. Although the relief is not available to
all entities, usually because of some complicated precondition, those
market participants that may benefit from the relief are subject to
numerous other conditions, needless restrictions, and arbitrary
compliance timelines.
A stark example of the inappropriateness of no-action letters to
grant relief is demonstrated by the recent CFTC staff no-action letter
allowing substituted compliance for certain foreign jurisdictions from
the Commission's cross-border swaps guidance.\40\ I am concerned that a
staff letter issued by a single division, with no input or vote from
the Commission, would be used as the vehicle for addressing such a
major issue. This no-action letter is outside the scope of a
forthcoming Commission decision regarding the comparability of European
rules. Further, because the relief is not time-limited, it creates an
effect similar to a rulemaking but does not go through notice-and-
comment procedures. As a result, this indefinite exemption not only
preemptively overrides a Commission decision, but also seems to
conflict with provisions in the cross-border swaps guidance that call
for a re-evaluation of all substituted compliance determinations within
4 years of the initial determination.
---------------------------------------------------------------------------
\40\ No-Action Relief for Registered Swap Dealers and Major Swap
Participants from Certain Requirements under Subpart I of Part 23 of
CFTC regulations in Connection with Uncleared Swaps Subject to Risk
Mitigation Techniques under EMIR, CFTC Letter No. 13-45 (July 11,
2013).
---------------------------------------------------------------------------
Unfortunately, this is not the first time that CFTC staff no-action
letters have been used to set forth Commission policy under Dodd-Frank.
Staff no-action letters are inappropriate because they are not voted on
by the Commission and are not formal Commission action. They are not
binding on the Commission, but affected parties comply with their
conditions despite the lack of legal certainty due to practical
business considerations, even though the Commission may later decide to
pursue enforcement or other prejudicial action. I believe that the
prolific use of no-action relief relating to Dodd-Frank provisions
reflects the ad-hoc and last-minute policy approach that has been far
too prevalent lately at the Commission. The Commission must stop this
approach and get back to issuing policy in a more formal, open and
transparent manner.
The Commission cannot continue with its reactive regulatory
oversight. It must re-visit the rules that have proved to be
unworkable, incorporate indefinite permanent relief into amended rules,
make necessary adjustments, and consistently and fairly apply such
amended rules to all regulated entities.
Violating Notice-and-Comment Requirements
Another serious concern I have with the Commission's rulemaking
process is the lack of notice-and-comment procedures. For example, and
also in connection with its cross-border swaps guidance, the Commission
recently issued an exemptive order that excludes certain foreign
entities from the definition of ``U.S. person'' and, therefore, from
compliance with the CFTC swap regulations. Even though this exemptive
order goes into effect immediately, the Commission has included a post-
hoc 30 day comment period. I am concerned that this final exemptive
order should have complied with notice-and-comment requirements under
the APA that allow parties to be heard before binding rules go into
effect. I am also concerned that the Commission may be inappropriately
using a good-cause exception to the APA to get around notice-and-
comment requirements that are supposed to ensure careful and well-
reasoned decision-making.\41\
---------------------------------------------------------------------------
\41\ Section 553(b)(B) of the APA provides for a good-cause
exception to notice-and-comment requirements: ``Except when notice and
hearing is required by statute, this subsection does not apply . . .
(B) when the agency for good cause finds (and incorporates the finding
and a brief statement of reasons therefore in the rules issued) that
notice and public procedure thereon are impracticable, unnecessary, or
contrary to the public interest.'' 5 U.S.C. 553(b)(B) (emphasis
added). However, section 4(c) of the CEA clearly provides that the
Commission may grant exemptive relief only by ``rule, regulation, or
order after notice and opportunity for hearing'' (emphasis added). 7
U.S.C. 6(c). The APA further provides under section 559 that it does
not ``limit or repeal additional requirements imposed by statute or
otherwise recognized by law.'' 5 U.S.C. 559. The CEA also grants
emergency powers to the Commission under exigent circumstances. See,
e.g., 7 U.S.C. 12a(9). In addition, courts have narrowly construed
the good-cause exception and placed the burden of proof on the agency.
See, Tenn. Gas Pipeline Co. v. Fed. Energy Regulatory Comm'n, 969 F.2d
1141 (D.C. Cir. 1992); Guardian Fed. Sav. & Loan Ass'n v. Fed. Sav. &
Loan Ins. Corp., 589 F.2d 658, 663 (D.C. Cir. 1978).
---------------------------------------------------------------------------
Issuing Interpretive Guidance Versus Rulemaking
I believe that the recent cross-border swaps guidance is also an
example of yet another way the Commission's recent approach to
implementing its policy has minimized public participation, open
engagement, and the deliberative process from our rulemakings. By
issuing interpretive guidance, and then having staff issue no-action
relief that exempts a large class of persons and imposes conditions
without a Commission vote, the Commission evades both APA requirements
and cost-benefit analysis.
I believe that putting the label of ``guidance'' on this document
did not change its content or consequences. The courts have held that
when agency action has the practical effect of binding parties within
its scope, it has the force and effect of law, regardless of the name
it is given.\42\ Legally binding regulations that impose new
obligations on affected parties--``legislative rules''--must conform to
the APA.\43\ As a threshold matter, the cross-border swaps guidance
rests on thin statutory authority, because Congress limited the
extraterritorial application of U.S. swap regulations, and therefore
the CFTC's jurisdiction, to foreign activities that have a ``direct and
significant'' impact on the U.S. economy. Despite the statutory
limitation, the cross-border swaps guidance sets out standards that it
applies to virtually all cross-border activities in the swaps markets,
in a broad manner similar to the application of the swap dealer
definition to market participants. For practical reasons, market
participants cannot afford to ignore detailed regulations imposed upon
their activities that may result in enforcement or other penalizing
action.\44\ Accordingly, I believe that the cross-border swaps guidance
has a practical binding effect on market participants and it should
have been promulgated as a legislative rule under the APA. Similarly, I
cannot support any future interpretive guidance that would be more
properly issued as a notice-and-comment rulemaking.
---------------------------------------------------------------------------
\42\ See Gen. Elec. Co. v. Envtl. Prot. Agency, 290 F.3d 377, 380
(D.C. Cir. 2002) (finding that a guidance document is final agency
action); Appalachian Power Co. v. Envt. Prot. Agency, 208 F.3d 1015,
1020-21 (D.C. Cir. 2000).
\43\ See Chrysler Corp. v. Brown, 441 U.S. 281, 302-03 (1979)
(agency rulemaking with the force and effect of law must be promulgated
pursuant to the procedural requirements of the APA).
\44\ ``A document will have practical binding effect before it is
actually applied if the affected private parties are reasonably led to
believe that failure to conform will bring adverse consequences . . .
.'' Gen. Elec., 290 F.3d at 383 (quoting Anthony, Robert A.,
Interpretive Rules, Policy Statements, Guidances, Manuals, and the
Like--Should Federal Agencies Use Them to Bind the Public?, 41 Duke L.
J. 1311 (1992)) (vacating an agency's guidance document that the court
found to have practical binding effect and where procedures under the
APA were not followed).
---------------------------------------------------------------------------
Avoiding Cost-Benefit Analysis
Further, by issuing interpretive guidance instead of rulemaking,
the Commission has also avoided analyzing the costs and benefits of its
actions pursuant to section 15(a) of the CEA,\45\ because the CEA
requires the Commission to consider costs and benefits only in
connection with its promulgation of regulations and orders. Compliance
with the Commission's swaps regulations entails significant costs for
market participants. Avoiding cost-benefit analysis by labeling the
document as guidance is unacceptable.
---------------------------------------------------------------------------
\45\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------
I have always advocated that the Commission's rulemaking must
include a thorough cost-benefit analysis, both qualitative and
quantitative, to ensure that new rules do not impose unreasonable costs
on the public. Frankly, the Commission's cost-benefit provision in the
CEA does not require the Commission to undertake any quantitative
analyses of its proposed rules. Last year, the CFTC Inspector General
found that the Commission used inadequate cost-benefit methodology for
the adoption of regulations implementing the derivatives provisions of
Dodd-Frank. The study found that the CFTC General Counsel played a
dominant role in the cost-benefit analysis to the derogation of the
CFTC Chief Economist, which has been detrimental to other agency
rulemakings.
Rigorous cost-benefit analysis is simply a common sense tool
designed to ensure that the benefits of any regulation exceed its costs
and that regulators adopt the least burdensome approach to achieve the
desired regulatory outcome. I am pleased to see that the House has
passed a cost-benefit analysis bill amending the CEA and requiring the
Commission to conduct quantitative economic analysis on its rules. In
essence, the United States Court of Appeals for the District of
Columbia Circuit found that the Commission's cost-benefit determination
in connection with its recent commodity pool operator/commodity trading
advisor (``CPO/CTA'') rules, which lacked quantitative analysis, was in
compliance with section 15(a) of the CEA because the statute imposes
few requirements to quantify or estimate the cost of Commission rule
proposals in favor of very high level, theoretical impacts.\46\
---------------------------------------------------------------------------
\46\ Inv. Co. Inst. v. Commodity Futures Trading Comm'n, No. 12-
5413, Slip. Op at 14 (D.C. Cir. June 25, 2013) (stating that ``[t]he
statute only requires the Commission to address costs and benefits''
and that the Commission does not ``need [to] count costs'' because the
statute does not ``mandate'' it).
---------------------------------------------------------------------------
Even though the Commission has nearly completed its rulemaking to
implement the Dodd-Frank Act, I believe it makes sense for Congress to
draft and pass new, more specific cost-benefit analysis requirements
for the Commission to ensure that future regulations undergo a
quantitative and qualitative analysis that is consistent with the cost-
benefit standards applied by other Federal Government agencies in their
rulemaking. I support Chairman Conaway's bill H.R. 1003 as it would
require the Commission to conduct a higher standard of analysis than
has been previously utilized.
Internal Policies and Procedures
One area of concern that I would like to draw to your attention is
the importance of a strong Commission that faithfully adheres to our
principles of democratic government. Each of the five Commissioners is
appointed by the President, with the advice and consent of the Senate,
to carry out the mission of the CFTC to supervise the commodity
markets. I am concerned that we have strayed from faithfully executing
this directive as a Commission that is fully accountable to Congress
and the public.
When I first arrived at the Commission in 2009, fellow Commissioner
Mike Dunn, a distinguished public servant for many years, impressed
upon me the importance of consistency and transparency in order to
achieve good government and policy outcomes. I believe that we have
lost sight of these guiding principles in our rush to implement the
Dodd-Frank Act.
Stronger Commission Oversight of CFTC Staff Action
CFTC regulations ensure that the Commission is made accountable for
all enforcement matters by requiring a Commission order to initiate
investigations by the Division of Enforcement. Just recently, I
dissented on an enforcement matter that involved a radical procedural
shift in the authorization of investigations for potential violations
of the CEA. What I found troubling is that the Division of Enforcement
sought to circumvent the powers of the Commission by proposing to bring
investigations on a summary basis through the use of an ``absent
objection'' process. I was surprised to be advised by the Commission's
Office of General Counsel that the Commission cannot block a staff-
initiated absent objection circulation because this process is not a
Commission ``vote.''
To ensure fairness in terms of true separation of functions,
Congress gave power to the members of the Commission to reconsider CFTC
staff recommendations by independently assessing facts and legal
justifications for initiating various actions. In other words, Congress
intended that any decision to bring an investigation by the CFTC is
reflective of a shared opinion of the majority of the Commissioners,
rather than a unilateral assessment by the Division of Enforcement's
staff. The new absent objection process described by the Office of
General Counsel is a clear abrogation of the Commission's powers and a
violation of Commission rules relating to investigations.\47\
---------------------------------------------------------------------------
\47\ 17 CFR 11.4 (stating that the Commission is authorized to
issue a subpoena) (emphasis added).
---------------------------------------------------------------------------
While I support the Division of Enforcement's efforts to
expeditiously investigate possible fraudulent activity, I also
recognize that the Commission possesses certain responsibilities to
execute its law-enforcement powers and that these responsibilities
should not be brushed off to achieve an ``efficient'' investigative
process.
Stronger Congressional Oversight of Commission Action
Congressional oversight will help to instill discipline in our
internal policies and procedures. I believe the following is necessary:
(1) Congress should demand a full review of the Commission's policies
and procedures for Commission action and interpretation of the CEA and
(2) the Commission should adopt policies and procedures that are
identified to ensure that no-action relief is not abused, restore a
strong Commission with appropriate accountability to the public,
require the basic application of APA notice-and-comment procedures, and
undertake rigorous cost-benefit analysis review. If Congress is
dissatisfied with the Commission's past practices and procedures, I
believe that Congress should enact reforms to the CEA to impose
discipline on the Commission so that it complies with the APA and other
laws.
III. Improving CFTC Utilization of Data and Technology
A critically important component to any solution for the
Commission's approach to its greatly expanded mission is the use of
technology in order to accept, sort, aggregate, and analyze the new
sources of market information provided for under the Dodd-Frank Act.
I'd like to highlight two major challenges in data and technology: (1)
problems faced by market participants in the swap data reporting rules
and (2) problems faced by the Commission in understanding the massive
data flows as a result of our enhanced oversight of the swaps and
futures markets.
Challenges in Swap Data Reporting Rules
I would like to bring the Commission's approach to swap data
reporting to your attention as an illustrative example of the
Commission's rulemaking getting in the way of our mission to oversee
trading activity and mitigate systemic risk. CFTC rules have seriously
impaired the Commission's ability to effectively and immediately
monitor the markets and conduct its expanded oversight
responsibilities.
Under the Dodd-Frank Act, swaps data must be reported in two forms.
First, basic data on swap transactions such as time, price, and
notional size must be reported to a swap data repository (``SDR'') and
must be available to the general public. Second, more detailed and non-
public information on uncleared swap transactions must be sent to SDRs
under Part 45.\48\ This particular swap data would include information
on the counterparties to the swap and other detail that is
significantly greater than what the public would need to know.
---------------------------------------------------------------------------
\48\ 727, 729 of the Dodd-Frank Act.
---------------------------------------------------------------------------
Unfortunately, the Commission failed to follow Dodd-Frank's
directives when it implemented its reporting rules. Instead, the
Commission required that market participants report all swaps, both
cleared and uncleared, to SDRs in order to comply with the Commission's
regulations.\49\ The Commission complicated matters further by failing
to definitively state who--the counterparties to the swap, the SEF or
DCM on which the swap was traded, or the clearinghouse through which
the swap was cleared--had the authority to decide which SDR would
receive the data.\50\
---------------------------------------------------------------------------
\49\ See Part 45 of the Commission's regulations.
\50\ See 45.3 and 45.8 of the Commission's regulations that
provide seemingly contradictory instructions on which market
participants and registered entities have the responsibility for
reporting swap transactions.
---------------------------------------------------------------------------
The lack of clarity in our regulations, just as in the other
examples I previously discussed, has led to both confusion and
litigation. This past spring, the Commission was called upon to decide
who had the authority to determine which SDR would receive the swap
data. CME filed a request for a rule approval that would give them the
authority to send swap data to the SDR of their choice. After
considering the issue for close to 3 months, the Commission approved
CME's new rule.\51\ DTCC, a competing SDR, filed suit soon after and
claimed the Commission's approval was inconsistent with the
Commission's reporting requirements under its swap data reporting
rule.\52\
---------------------------------------------------------------------------
\51\ http://www.cftc.gov/ucm/groups/public/@newsroom/documents/
file/statementofthecommission.pdf.
\52\ http://www.dtcc.com/dtcc.v.cftc.pdf.
---------------------------------------------------------------------------
Although correcting the inconsistencies in the Commission's
rulemaking is something the Commission must address as soon as
possible, there still remains an unresolved issue with respect to
cleared swaps. The Dodd-Frank Act did not specifically address
regulatory reporting of cleared swap data. I believe Congress should
now re-examine the issue and decide if the Commission's current
regulations meet both the letter and the spirit of Dodd-Frank.
Repeal of Swap Data Repository Indemnification Requirement
While on the subject of data reporting, I would like to bring up
one more important issue. The Dodd-Frank Act requires foreign
governments to provide an SDR with an indemnification agreement in
order to have direct access to the swap transaction data for
counterparties that are within the foreign government's
jurisdiction.\53\ Needless to say, foreign governments are either
prohibited or unlikely to provide an SDR with an indemnification
agreement. The Commission cannot require unfettered access to foreign
trade repositories until the law is changed and this imbalance is
corrected. I am pleased to see that the House has passed the bill
addressing the indemnification provision.
---------------------------------------------------------------------------
\53\ See 728 of the Dodd-Frank Act.
---------------------------------------------------------------------------
Challenges in CFTC Data Utilization
However, even if the Commission fixes its swap data reporting
rules, the Commission still lacks the ability to utilize and analyze
the regulatory reporting data it receives from SDRs.
Since the beginning of 2013, certain market participants have been
required to report their interest-rate and credit index swap trades to
a SDR. Unfortunately, the Commission has made very little progress in
analyzing and utilizing the data. With the Commission's current
technology, things are not going well.
For example, the data submitted to SDRs and, in turn, to the
Commission, is not usable in its reported format. Earlier this spring,
the Surveillance staff admitted that they couldn't spot the London
Whale trades in the Commission's current data files.
This problem is caused by the Commission's failure in its swap data
reporting rules to specify the data format that reporting parties must
use when sending their swaps to SDRs. In other words, the Commission
told the industry what information to report, but didn't specify which
language or format to use. As it turned out, reporting parties have
their own internal nomenclature that is used to compile swap data.
Without a Commission regulation identifying a specific nomenclature
that must be used, reporting parties are free to use their own.
The end result is that even when market participants submit the
correct data to SDRs, the language received from each reporting party
is different. In addition, data is being recorded inconsistently from
one dealer to another. Now multiply that number by the number of
different fields the rules require market participants to report.
Further, the abused no-action process has allowed unidentified gaps to
appear in the data without explanation.
Aside from the need to receive more uniform data, the Commission
must significantly improve its own IT capability. The Commission has
failed to make technology investment a top priority. Our ability to
adapt our existing systems to our new data requirements is a major
challenge. Consequently, we don't have the capacity to undertake review
of order book data, which is critical to spotting manipulative trading
schemes.
Solving our data dilemma must be the Commission's top priority. We
must focus our attention to both better protecting the data we have
collected and developing a strategy to understand it. Until such time,
nobody should be under the illusion that promulgation of reporting
rules has enhanced the Commission's surveillance capabilities. As
Chairman of the Commission's Technology Advisory Committee (``TAC''), I
have formed a working group comprised of various market participants,
including SDRs and DCOs, to leverage the expertise of this group to
resolve this problem as soon as possible.
Challenges in Data Privacy
As I mentioned before, the ability of the Commission to access and
analyze transaction data is paramount to the agency's regulatory
oversight responsibilities. Access to data is crucial to developing new
strategies and surveillance tools, but it comes with an enormous burden
of responsibility to protect section 8 data (disclosure of information
by the Commission).\54\ In our cooperation with foreign regulators to
achieve the G20 objectives, the Commission must address access issues
and privacy concerns.
---------------------------------------------------------------------------
\54\ 7 U.S.C. 12(e).
---------------------------------------------------------------------------
Currently the Commission's Inspector General is investigating
whether or not market data was properly controlled by the Office of the
Chief Economist when visiting scholars/contractors were assisting the
Office of the Chief Economist in research efforts. While I support
collaborative study programs that bring in new and innovative thinking,
it is vital that the Commission has policies and procedures in place to
protect against the illegal release of market data. It would not be
unreasonable for the Subcommittee to request a thorough review of the
Commission's data privacy policies and procedures and a subsequent
briefing by the Inspector General when his investigation is complete.
Ensuring that the Commission can fulfill its responsibilities under the
Dodd-Frank Act constitutes appropriate Congressional oversight. It is
also imperative for foreign regulators to have confidence that U.S.
policy will protect the data of their citizens, just as we have every
right to expect that for U.S. citizens.
Technology Plan: A Solution to Challenges in Data Reporting and
Utilization
Given the Commission's expanded regulatory responsibilities, it is
imperative for the Commission to develop a technology plan that can
assist the Commission with meeting its regulatory objective. I believe
the Commission must develop a 5 year strategic plan that is focused on
technology, with annual milestones and budgets. To keep up to speed
with the challenges of enhanced regulatory oversight, this technology
plan would require each CFTC division to develop a technology budget
that reflects the regulatory needs and responsibilities of that
particular division.
As part of developing the CFTC strategic plan, Commission staff is
working with goal teams and divisions to highlight the major technology
initiatives by specific goal. These initiatives will form the basis for
the IT strategic plan. While I am encouraged by the process, I will
wait to review the recommendations before I can say with confidence
that the Commission understands both its own shortcomings and immediate
priorities, and how it intends to oversee the swaps and futures markets
over the next decade.
Like the review of the no-action relief process, this Committee has
every right to expect that the Commission develops and explains its
strategy for deploying technology. The Commission needs to leave behind
its 20th century regulatory ways in order to oversee this modern 21st
century marketplace.
Electronic Monitoring of Customer Fund Balances: Industry Solution
Powered by Technology
I'd like to close my testimony by focusing on a success story: the
Commission's pursuit of enhancements to its oversight ability by
leveraging industry resources. In response to the egregious lack of
regulatory compliance exposed by the failures of MF Global and
Peregrine, there was a positive and immediate industry response that
solved a gaping hole in FCM oversight. Following the Peregrine failure,
which exposed the absence of electronic monitoring of customer fund
balances held by the FCM and custodian banks, I called an emergency
meeting of the TAC. At this meeting, I tasked the National Futures
Association (``NFA'') and CME, which are the Self-Regulatory
Organizations (``SROs'') of the FCMs, to develop a technology solution
to monitor and reconcile the balances held by the FCMs and custodian
banks. I am proud to say that NFA and CME delivered the technology
solution. Since January 2013, an automated system linking FCMs and
custodian banks has been in place to monitor changes in expected
balances to within less than one percent deviation in customer
accounts. The system is being expanded to carrying brokers and
clearinghouses as well. This new technology capability was not mandated
by CFTC regulations and was not paid for by taxpayers. This is a prime
example of having industry solutions that protect customers and augment
the Commission's oversight ability.
Conclusion
The Commission has been given the momentous task of creating a
regulatory environment that increases transparency and improves
stability in the financial markets. The Commission, in implementing
such broad and ambitious goals, was tasked with transforming Dodd-Frank
objectives into a workable regulatory framework. Given the intrinsic
complexities of the financial markets, the Commission must come up with
clear and consistent rules that take into account the global nature of
derivatives trading. Although it is difficult to achieve these goals
without making mistakes along the way, when flaws are uncovered, it is
imperative for the Commission to work with market participants to come
up with better solutions to implementing Dodd-Frank objectives. If the
Commission does not faithfully implement the statute or make the
necessary conforming updates to its rules, this Committee has every
right and responsibility to make the necessary and immediate changes it
sees fit. I am happy to continue to work together to provide any
information the Subcommittee requires to ensure the Commission is
operating as authorized and as mandated by the Dodd-Frank Act.
I appreciate the opportunity to testify today and am happy to
answer any of your questions.
Thank you.
The Chairman. Thank you, Scott. Mark?
STATEMENT OF HON. MARK P. WETJEN, COMMISSIONER, U.S. COMMODITY
FUTURES TRADING COMMISSION,
WASHINGTON, D.C.
Mr. Wetjen. Good morning, Chairman Conaway, Ranking Member
Scott, and Members of the Subcommittee. Thank you for inviting
me to testify this morning and share some of my perspectives on
the future of the Commodity Futures Trading Commission. It is a
pleasure to be here.
I want to personally thank Chairman Conaway for his keen
interest in our agency and his open dialogue with me since I
joined the Commission. I have found our discussions to be
useful and hopefully mutually beneficial.
I also want to acknowledge my friend, Commissioner O'Malia,
who is beside me today. I have admired his skills in analyzing
and bringing attention to important issues raised by our rules
or other market developments. I hope you would agree that we
have developed a good working partnership at the agency.
For a host of reasons, now is a very good time for not only
this Subcommittee but all stakeholders in the CFTC to reflect
on what the future might bring for this agency. Allow me to
mention a few.
First, and most obviously, Congress must address the
expiring authorization for the agency, which is the primary
reason for the hearing today and of course will require a
Congressional response. I appreciate the Subcommittee's efforts
to work toward making that response an informed one that seeks
to solve any inadequacies or other problems related to the
Commodity Exchange Act or the work of the Commission.
It is my hope and belief that many of the issues raised by
the CFTC rulemakings in the past 3 years that eventually became
the subject of Congressional legislation have been resolved or
adequately addressed in our final rules or through other relief
granted by the agency. With or without additional direction
from Congress through CFTC reauthorization, it is important
that the agency and its staff continue to find ways to address
problems that are still in need of a solution.
Second, the Commission's implementation of Title VII of
Dodd-Frank is for the most part finished. We have almost 80
swap dealers now registered with the CFTC, clearing mandates in
place for a broad swath of the swap market, and new reporting
obligations for market participants. The Commission also just
completed its cross-border guidance informing market
participants and other regulators how the Commission's rules
will be applied to activities and entities overseas.
Looking ahead through the lens of what already has been
done, the Commission and all stakeholders will need to closely
monitor and, if appropriate, address the inevitable challenges
that will come with implementing the new regulatory framework
under Dodd-Frank.
Third, while most of the Commission's work to implement
Dodd-Frank is complete, there remain important rulemakings and
administrative matters in the months ahead. Perhaps most
importantly, the Commission, along with the Federal Reserve,
the OCC, the FDIC, and the SEC, must finalize its rulemaking on
the so-called Volcker Rule.
The agency also must undertake substituted compliance
determinations under the recently finalized cross-border
guidance. This will involve a review of swap-regulatory regimes
in other nations to determine whether they are comparable and
comprehensive or essentially identical to U.S. law.
The Commission also must finalize its rulemaking on capital
and margin requirements for uncleared swaps and there are two
very important rulemakings related to the international
harmonization of risk management requirements on
clearinghouses, which dovetails with the substituted compliance
determinations.
Another critical rulemaking, albeit not directly related to
Dodd-Frank, is the Commission's customer protection rule that
seeks to improve risk management practices at futures
commission merchants.
Finally, given that the U.S. has nearly delivered on its
G20 commitments to derivatives reform and the European Union is
close behind, all of us can spend more time focusing on the
developing market structure for swaps on a more global scale.
The Commission already has authorized new trading platforms for
swaps and Europe is about to do the same. We anticipate that
with these developments, many swaps will be executed on
regulated and transparent marketplaces located both here and
abroad, facilitating global liquidity formation and risk
management.
Consistent with this result, I believe the Commission's
cross-border guidance reversed a developing trend toward market
and risk management fragmentation that would have been
counterproductive to the goals of Dodd-Frank, as well as the
G20 commitments.
But we all must wait and see to a greater degree what
developments will take shape outside of the U.S. and Europe.
Other jurisdictions that host a substantial market for swap
activity are still working on their reforms and certainly will
be informed by our work. All of us will need to monitor those
developments closely with an eye toward how they could separate
those jurisdictions from the fabric we, along with our European
partners, stitched together in last week's accord.
In other words, the Commission must remain vigilant in
monitoring, identifying, and addressing risk, and continually
prioritize so we are focused on the greatest threats. Indeed,
another threat identified by the Treasury Secretary 2 weeks ago
must be part of this global monitoring: the cybersecurity
threat. As marketplaces and systems continue to rely more and
more on technology, the need to better understand and protect
against cybersecurity threats increases. There are multiple
task forces and coalitions formed of domestic and international
partners that the Commission will need to work with to ensure
success on this front.
Thank you again for inviting me today. I would be happy to
answer any questions.
[The prepared statement of Mr. Wetjen follows:]
Prepared Statement of Hon. Mark P. Wetjen, Commissioner, U.S. Commodity
Futures Trading Commission, Washington, D.C.
Good morning, Chairman Conaway, Ranking Member Scott, and Members
of the Subcommittee. Thank you for inviting me to testify this morning
and share some of my perspectives on the future of the Commodity
Futures Trading Commission. It is a pleasure to be here.
I want to personally thank Chairman Conaway for his open dialogue
with me since I joined the Commission. I have found our discussions to
be useful and hopefully mutually beneficial.
I also want to acknowledge my friend, Commissioner O'Malia, who is
beside me today. I have admired his skills in analyzing and bringing
attention to important issues raised by our rules or other market
developments. I hope he would agree that we have developed a good
working partnership at the agency.
For a host of reasons, now is a very good time for not only this
Subcommittee, but all stakeholders in the CFTC, to reflect on what the
future might bring for this agency. Allow me to mention a few.
First, and most obviously, Congress must address the expiring
authorization for the agency, which is the primary reason for the
hearing today and of course will require a Congressional response. I
appreciate this Subcommittee's efforts to work toward making that
response an informed one that seeks to solve any inadequacies or other
problems related to the Commodity Exchange Act or the work of the
Commission.
It is my hope and belief that many of the issues raised by CFTC
rulemakings in the past 3 years that eventually became the subject of
Congressional legislation have been resolved or adequately addressed in
our final rules or through other relief granted by the agency. With or
without additional direction from Congress through CFTC re-
authorization, it is important that the agency and its staff continue
to find ways to address problems that are still in need of a solution.
Second, the Commission's implementation of Title VII of Dodd-Frank
is for the most part finished. We have almost 80 swap dealers now
registered with the CFTC, clearing mandates in place for a broad swath
of the swap market, and new reporting obligations for market
participants. The Commission also just completed its cross-border
guidance, informing market participants and other regulators how the
Commission's rules will be applied to activities and entities overseas.
Looking ahead through the lens of what already has been done, the
Commission and all stakeholders will need to closely monitor and, if
appropriate, address the inevitable challenges that that will come with
implementing the new regulatory framework under Dodd-Frank.
Third, while most of the Commission's work to implement Dodd-Frank
is complete, there remain important rulemakings and administrative
matters in the months ahead. Perhaps most importantly, the Commission,
along with the Federal Reserve, the OCC, the FDIC, and the SEC, must
finalize its rulemaking on the so-called ``Volcker Rule.''
The agency also must undertake ``substituted compliance''
determinations under the recently finalized cross-border guidance. This
will involve a review of swap-regulatory regimes in other nations to
determine whether they are ``comparable and comprehensive'' or
``essentially identical'' to U.S. law.
The Commission also must finalize its rulemaking on capital-and-
margin requirements for un-cleared swaps. And there are two very
important rulemakings related to the international harmonization of
risk-management requirements on clearing houses, which dovetails with
the substituted-compliance determinations.
Another critical rulemaking, albeit not directly related to Dodd-
Frank, is the Commission's customer-protection rule that seeks to
improve risk-management practices at futures commission merchants.
Finally, given that the U.S. has nearly delivered on its G20
commitments to derivatives reform, and the European Union is close
behind, all of us can spend more time focusing on the developing market
structure for swaps on a more global scale. The Commission already has
authorized new trading platforms for swaps, and Europe is about to do
the same. We anticipate that with these developments many swaps will be
executed on regulated and transparent marketplaces located both here
and abroad, facilitating global liquidity formation and risk
management. Consistent with this result, I believe the Commission's
cross-border guidance reversed a developing trend toward market and
risk-management fragmentation that would have been counterproductive to
the goals of Dodd-Frank as well as the G20 commitments.
But we all must wait and see to a greater degree what developments
will take shape outside of the U.S. and Europe. Other jurisdictions
that host a substantial market for swap activity are still working on
their reforms, and certainly will be informed by our work. All of us
will need to monitor those developments closely, with an eye toward how
they could separate those jurisdictions from the fabric we--along with
our European partners--stitched together in last week's accord.
In other words, the Commission must remain vigilant in monitoring,
identifying, and addressing risk, and continually prioritize so we are
focused on the greatest threats. Indeed, another threat identified by
the Treasury Secretary last week must be part of this global
monitoring: the cyber-security threat. As marketplaces and systems
continue to rely more and more on technology, the need to better
understand and protect against cyber-security threats to the markets
the Commission regulates increases. There are multiple task forces and
coalitions formed of domestic and international partners that the
Commission will need to work with to ensure success on this front.
Thank you again for inviting me today. I would be happy to answer
any questions from the panel.
The Chairman. Thanks, Mark. I appreciate that.
The chair would remind Members that they will be recognized
for questioning in order of seniority for Members who were here
at the start of the hearing. After that, Members will be
recognized in order of arrival, and I appreciate Members'
understanding.
And with that, I would like to recognize the Chairman of
the full Committee, Mr. Lucas, for 5 minutes.
Mr. Lucas. Thank you, Mr. Chairman. I appreciate that, and
I appreciate the efforts of yourself and the Ranking Member as
we proceed through this process. And I want to thank both of
the Commissioners for testifying today.
The topic of CFTC reauthorization is a very important one,
and this is the Committee's second hearing on the issue.
Tomorrow, we will continue the process and hear directly from
end-users. I expect the Committee to move forward with CFTC
reauthorization as the farm bill also progresses.
Now, a couple of issues confronting us; in light of the
confusion surrounding the exemptive order and final guidance
that has been circulated to regulate cross-border transactions,
how can institutions be sure they are correctly interpreting
these policies? And can either of you comment on whether the
Commission will give some degree of deference to American firms
as they implement the hundreds of pages of new guidelines,
gentlemen?
Mr. O'Malia. Thank you for the question, a very good
question, and it is a challenge. So the guidance has been out
less than a week and people are beginning to digest it and I am
trying to understand and make sense of it and understand where
their activities fall. It is complicated depending on your
organizational structure, et cetera. I think we have to give
the appropriate deference to people trying to comply with the
rules. And this is not dissimilar from any of the other complex
rulemakings, including the swap dealer definition. And so we
have always had to have some latitude to provide people the
cooperation and convenience to comply with the rules, and we
have to respond to their questions as quickly as possible.
Mr. Wetjen. Thank you, Mr. Chairman, for the question. I
agree with Commissioner O'Malia. I think what you might be
referring to is a provision that was in the exemptive order
that expired, that was not retained in the new exemptive order,
and it had to do with basically a statement of fact as I see
it, and that was that we expect good-faith compliance at the
agency during this unusual time of implementation of our rules
and initial compliance with our rules.
And so while the new exemptive order did not retain that
provision, as I said, I believe it is a statement of fact. So
we are going to have to continue working with all market
participants. I am sure a number of questions will come up,
some have already materialized in the last week or so and I am
sure others will come up as well. And so we will just have to
keep working with market participants in sorting out some of
these issues.
Mr. Lucas. Commissioner O'Malia, I was pretty troubled
reading your testimony that the Commission staff may now be
initiating enforcement actions outside of the Commission vote
process. Is this a new change in policy or has it been done
before?
Mr. O'Malia. Thank you for the question. It is a relatively
new change. The issue that I raised is that the Commission,
under Dodd-Frank, has issued a number of broad omnibus orders
to initiate oversight or undertake subpoena authority. Now,
these broad authorities don't identify specific practices but
they are seeking approval from the Commission to issue
subpoenas over a scope of law that they believe they have
concerns about.
Now, we have provided these omnibus orders in the past and
they are generally time-limited, and I have had some concerns
about that because the Commission's authority to approve the
rule and to approve the initiation of an omnibus order and
subpoena is a fundamental part of the Commission's
responsibility. It is not something that should be delegated to
staff, and in fact, Commission Regulation 11.4 requires
Commission action to issue these orders.
Now, the recent activity, there are two things that have
occurred. One, they have asked for absent objection by the
Commission, meaning that it is a staff action. When I asked our
General Counsel if the Commission could overrule an absent
objection circulation, he said no, it is not a Commission
action. Therefore, it does not fall within our authority under
11.4 for the Commission to initiate these type of
investigations.
So I believe this is kind of a slippery slope we are headed
down and it is a concern of mine that we not delegate too much
authority to staff, especially with the new authority under
Dodd-Frank. I think there are a lot of areas here that are not
explored. Think about the new manipulation authority. We have a
new recklessness standard. We need to be thinking about these
and how they will be interpreted by the market.
Mr. Lucas. I absolutely agree and I suggest that whatever
we have to do to preserve the check-and-balance system that
Congress envisioned when it created the five-member Commission
is absolutely necessary. The requirement for a vote on key
actions should not be disregarded under some guise of efficient
government, which is a paradox if I have ever heard of one.
I thank you, Mr. Chairman, and I yield back my seconds.
The Chairman. The gentleman yields back 2 seconds. Mr.
Scott, 5 minutes.
Mr. David Scott of Georgia. Thank you, Mr. Chairman.
Let me start with you, Commissioner Wetjen. Do you have
sufficient staff to accomplish the task that you all have been
given?
Mr. Wetjen. Thank you, Congressman Scott, for that
question. I believe the answer is no. As we all know and as we
discussed in our opening statements, the responsibilities of
our agency have increased dramatically in the past 3 years. We
are overseeing a market that we had very, very little oversight
over before. It is a massive market. There are, as I said in my
opening statement, close to 80 registrants now registered as
swap dealers. So there is no doubt our responsibilities have
been magnified and we need the resources to do the job and to
mete out these new responsibilities.
And here is a main reason for it. And it is especially true
now that we are mostly finished with finalizing the rules but
we are at the beginning stage of the implementation process.
And the reason why we need resources, probably the most
important reason in my mind is during this new phase of
implementation--and we have already seen it; we have already
talked about it this morning--a number of questions are going
to continue to come up. Market participants are going to have
multiple interpretive questions. They are going to need
additional guidance from staff, in some cases additional
guidance from the Commission as a whole, and we need staff to
be able to provide that.
And the reason we need to do that is because, again, we
have been in this process now 3 years. The markets need and
deserve certainty, and the way that we provide certainty is by
having the staff in our building that can get answers to market
participants as quickly as possible.
Mr. David Scott of Georgia. And so how much funding do you
need? Your appropriations authorization runs out, as I said, in
about 9 weeks on September the 30th, so this is very important
that we move expeditiously to get you the funding that you
need. Would you tell us how much that is?
Mr. Wetjen. Well, the budget request was a pretty
significant increase over our current budget, as you know, Mr.
Scott. I think the request was around $305 million.
Mr. David Scott of Georgia. And that would be about a 52
percent increase, is that correct?
Mr. Wetjen. I think that sounds right, yes. And here is how
we came up with that number. You know, the Chairman obviously
manages this process, but in terms of the rest of us who have
to decide whether or not to support a big budget request, the
division heads within the agency, they all make their case to
us as to what they believe they need, and after going through
that process and listening directly from them what their
justification was for the request, I feel comfortable
supporting the request. I thought it was justified.
Mr. David Scott of Georgia. Very good. Just before I get to
Mr. O'Malia, I would like to just make mention for the
Committee that back in February, Chairman Gensler said, budget
cuts have caused the CFTC to shelve some potential enforcement
actions. This means cases that should have been investigated
and/or prosecuted were passed over due to a lack of funds.
I think it is very important, Mr. Chairman, that we make
sure the record is clear that this agency needs the funding
that we are asking them to do a job, their workload has been
overloaded, they have had burnout at staff, they have done a
commendable job with the intelligence and the precision and the
commitment and dedication. I think it is very important that we
honor their request, going forward, for this 52 percent
increase, and I for one, I think you will agree, will know that
that is very important. I think I have one more minute here.
Commissioner O'Malia, could I get your opinion on, we just
passed House Resolution 1256. And the two major parts of that
were harmonization between you all and the SEC. I would like to
ask you to comment very briefly on where that is, how that is
coming along. And then the second part, the making sure that
those nine major economies that we have to deal with have
regimes that are equal to ours for enforcement.
Mr. O'Malia. Well, that is a very important and timely
question. The harmonization effort, we have struggled with,
frankly. Our agency has put forward cross-border definitions
that is not consistent with the SEC definition. We are on a
different timeline and we have used a different process. They
have used a regulation. We have relied on guidance. And I have
some very serious concerns about relying on guidance in and of
itself, and when I asked our General Counsel how do we bring
enforcement under guidance, he said it does not have the force
of law provided under regulation.
So I am frustrated with the lack of coordination between
the SEC and the CFTC. I think it is almost comical that we
would have two agencies coming up with a different definition
of a U.S. person. So that is problematic in and of itself.
The question about how we were going to find substituted
compliance with regard to the other nine regulatory regimes is
really what is important and what is the focus of the
Commission's efforts right now. We passed an exemptive order
that provides until end of December, right before Christmas,
relief that will expire and we will be back in the same
situation of being up against an artificial deadline. But in
that time, between now and then, we have to determine and do an
evaluation of all of these different jurisdictions for
comparability and do they match with our regulatory regime. And
that will be a tough situation and it is not easy because there
are a lot of details we are going to have to go through. Our
guidance does say we will consider it on an outcomes basis, but
I am skeptical that that will really be applied in actuality
when the staff goes through and does its evaluation.
Harmonization is vital if we are going to make this work
effectively, and we cannot unilaterally dictate our rules to
the rest of the world.
Mr. David Scott of Georgia. Thank you. And thank you, Mr.
Chairman, for that extra minute.
The Chairman. All right. I recognize myself for 5 minutes.
Commissioner O'Malia, you mentioned in your testimony the
cost-benefit issue and the ongoing controversy that we have had
with the Commission during most of the Dodd-Frank era in terms
of my dissatisfaction with the level of attention that was paid
to that issue. Can you talk to us a little bit about with the
bill that we have passed through the House, if you implemented
it--and Mark, I would like you to weigh in on this, too--if we
implemented that bill itself, would that put the Commission on
a proper footing with respect to how it would have to analyze
the impact that potential regulations had on those who are
regulated and the compliance with that?
Mr. O'Malia. I think that bill would be a vast improvement
over the current standards we have under the CEA in 15(a). I
think in the recent ICI case, the District Court found that the
Commission, where defendants complained that our standard
wasn't very high and the judge affirmed it, it was not a very
high standard, and we do not have to do a quantitative and
qualitative analysis necessity to justify the costs and the
benefits. I think implementation and passage of the cost-
benefit bill that you have sponsored in the House as passed
would be a vast improvement for our Commission and would
require us to do a much more rigorous evaluation of the rules.
The Chairman. Commissioner Wetjen, thoughts?
Mr. Wetjen. Thanks, Mr. Chairman. I just wanted to point
out that Commissioner O'Malia has been a real leader at our
agency on this topic. He has been very effective at keeping the
agency and the agency staff focused on this provision.
In our statute--of course, I am referring to Section 15(a),
which is current requirement that we take into account the
costs and benefits of our provisions in a rulemaking. And I
have to say since I have been at the Commission, it is almost 2
years now, I have seen a real commitment to 15(a) and to making
sure that it is being implemented appropriately.
And Scott mentioned the ICI litigation. That is one view to
take of the litigation, but what was more important to me from
the litigation is the fact that both the District Court and
Appellate Court found that we are again abiding by the current
requirements of the Commodity Exchange Act with respect to
Section 15(a). I am always happy to explore ways to improve.
Mr. Chairman, you and I have had some initial discussions about
that. I happy to continue those, but for now, it is important
to point out that, at least in the time that I have been at the
Commission, we have done, in my judgment, a satisfactory job on
this front.
The Chairman. Well, I appreciate the perspective. I need to
correct the record. The bill was only passed out of Committee
with a voice vote. We still have yet to get across the Floor.
I guess one of the things that we are asking industry is to
look at the effectiveness of the cost-benefit analysis that was
done on many of the Dodd-Frank rules now that they have some
perspective in actually having to implement and how much it is
actually costing them versus what the Commission on the front
end said it would. And so we will hopefully have a bit of
empirical evidence to show that whatever was done--again, this
is a prospective change; we are not going to go back and redo
anything--but whatever impact the costs had on the regulation
that that was chosen by the Commission in order to be put in
place; were those costs rational at the time you were making
your decision? And all of us make better decisions with better
information, so we will hopefully have some empirical evidence
on what the Commission thought it would cost to implement many
of these regulations when you were doing it versus what the
industry and the folks who are having to comply with those have
actually had to invest in making that happen.
And I don't want to run over, but can you talk to us a bit
about the pervasive use of no-action letters and just kind of
walk us through mechanically how that happens? Is there a way
to improve the process so either you need fewer of them or you
can issue them in a more timely basis, and what impact does
that actually have?
Mr. O'Malia. I think no-action is an important tool for the
Commission to provide a very selective, narrowly crafted relief
to either a particular entity or for a certain activity. And we
have relied on it heavily in the past. We have relied on it in
the past to provide these narrow execeptions. Now, what we have
done in moving our rules forward, we relied on it more heavily
in order to provide relief from general time frames and
timelines that are unachievable by the industry.
I think the poster child for the no-action relief was for
the special entity relief for utility special entities. We
called it temporary relief until the Commission reevaluates the
rules. Well, in October it will be a full year. We have no
intention of really going back to revisit that rule, which is
the swap dealer definition. So I suspect we will not reopen
that, so we have offered what fundamentally becomes indefinite
relief. That in fact is a rulemaking. If you are changing the
Commission's policies indefinitely, that turns out to be a
rulemaking, and it did not have the benefit of APA notice and
comment and cost-benefit analysis.
In that instance we really need to go back and really look
at how we are going to use this no-action process. And in my
testimony, I suggest this is an area for the Committee to
really evaluate to understand what our policies and procedures
are and how we are going to be using it.
The Chairman. Okay. Thank you, Scott. Mr. Vargas for 5
minutes.
Mr. Vargas. Thank you, Mr. Chairman, for the opportunity to
speak. And I also want to thank the witnesses here today. You
have already testified a little bit about this and that is the
budget request, and my understanding is that it is in fact a
15.25 percent increase above the current year. I would like to
comment more specifically about the IT factor of this, and it
doesn't matter who goes first, but I think that is an important
factor. Mr. O'Malia, you are chomping at the bit. Why don't you
go first?
Mr. O'Malia. Well, I am because technology and the IT
sector is really a passion of mine and I am very interested.
And since arriving at the Commission I have really put a lot of
focus and attention on it. And my frustration with it is that
it is always kind of a second-tier issue for us. And despite
the kind of promise of investing in technology and making IT a
priority, consistently we underfund it, and for the past 2 or 3
years, we have always taken $10 million out of the technology
budget and shifted it over to staffing needs.
And granted, there is a balancing act here but we are
policing a 21st century market with 20th century surveillance
tools. We need to do much more to invest in technology to
really leverage our staffing needs. We could rely on less
staffing if we are able to automate our surveillance tools.
And under Dodd-Frank we have an enormous task ahead of us.
We have required that everybody report all of their trades and
their data into a swap data repository. Our ability to look
into that and evaluate and do the analysis on it is critically
important if we are going to be an effective regulator. And
then we have to link it back to the futures market. There are
no shortcuts with this. This is not eyeshades and Excel
spreadsheets. This is serious data crunching that we are going
to need automation for it.
So I am very frustrated that we have not invested to our
greatest capacity. One of the areas where we need to focus is
actually developing a budget that selects good priorities, and
one area that I have advocated for is a division-by-division
analysis of what our needs for the next 5 years are for
technology. This is something the Committee should ask for.
Where do you want to be in 5 years as part of your
reauthorization? Technology is a critical element, so how are
we going to get there and what tools are we going to need to
get there? After you have that evaluation, then you and I can
make real serious decisions about funding levels and budget
priorities. And until we develop that budget spend plan for
you, we are in the dark.
Mr. Vargas. Mr. Wetjen, would you care to comment on that
or do you generally agree?
Mr. Wetjen. I do generally agree. This is another area
where Commissioner O'Malia has been very vocal in his advocacy
for additional resources to be targeted at IT investments at
the agency. It is a very noncontroversial position for him to
take. As I said in my opening statement, participation in our
markets are basically driven by technology and through
technology, and so in order to keep up surveillance it is also
going to have to rely heavily on it. There is always going to
be an important component of human interface with the
technology that is being deployed and used, but without a doubt
I agree it is an area of improvement that we need to focus on
at the agency.
Mr. Vargas. I would like to ask one last question and I
only have a minute and 40 seconds. My question would be this,
and that is the issue that a lot of people ask. Is there
overspeculation in the commodities derivatives market in the
sense that you see these radical price swings and market
uncertainty especially with issues of energy, gasoline. And I
would like to know if this is market forces or you said you
need serious data crunching, this technology. If we had this
ability, do you think we could tell the American people that
what you see in the cost of gasoline is in fact market prices
and not some sort of speculation that is inappropriate? Because
that is what Dodd-Frank and all of this is supposed to do. Does
someone care to take a shot?
Mr. Wetjen. Thank you, Congressman. I think that certainly
monitoring the markets we oversee for speculative activity is
important. It is part of what we do now. I would like to point
out that the Commission has a weekly surveillance meeting every
Friday where we review and have the staff present any sorts of
odd activity in the marketplace, any sorts of irregularities
that they might be seeing. And it doesn't focus solely on
energy commodities. It runs the whole range of asset classes.
First and foremost, that is what we need to do. We need to
continue being very, very vigilant in regard to our
surveillance activities. And Scott alluded to this. I just
spoke about it as well. Additional technology investments
should help on that score. But we have done a pretty decent job
of trying to keep tabs on true irregularities and----
Mr. Vargas. Thank you. My time has concluded here but I
appreciate it. Thank you, Mr. Chairman.
The Chairman. Thank you. The other Mr. Scott from Georgia,
5 minutes.
Mr. Austin Scott of Georgia. Thank you, Mr. Chairman.
Commissioner Wetjen, Commissioner O'Malia spoke of the need
to have better coordination with the SEC on just some basic
definitions. Do you agree with him on that?
Mr. Wetjen. I appreciate the question, Mr. Congressman.
There is a provision in Dodd-Frank in Title VII that requires
us to coordinate. Even absent a specific mandate to do a joint
rule, we still have this obligation under the statute to
coordinate as best we can. I think Scott would agree that he
and I don't always see everything that is going on at the
agency because we are just one of five Commissioners, actually
four at the moment. But I do think it is fair to say that there
is a lot more going on behind the scenes than people realize. I
think there are a lot of staff discussions taking place between
the SEC and the CFTC. I think we could probably always do more.
But the one last thing I would add, Congressman, is that in
the weeks leading up to the finalization of the guidance, I can
assure you I was having multiple conversations with SEC
Commissioners, high-level SEC officials. I was having multiple
conversations with members of the European Commission,
conversations with other agencies within the Federal Government
that had an interest in what we were doing with the guidance.
So I felt pretty good about the level of engagement I was able
to get with my counterparts at these different regulatory
bodies.
Mr. Austin Scott of Georgia. That kind of answered my next
question as well, which was do you believe that the SEC shares
that desire to have uniform definitions? And certainly, that
makes it easier from a compliance standpoint for those that are
being regulated, as well as from a regulatory standpoint. If we
can't even get to the agreement on what the definition of a
U.S. person is, then how do we get to the definition of what a
direct and significant impact on U.S. consumers is?
And so that would lead to my next question, which is the
Act says it shall not apply to swap activities that do not have
a direct and significant connection with activities in, or
effect on, commerce in the United States. The definition of
direct and significant, can you give us that?
Mr. Wetjen. So the question was what I think the definition
of a direct and significant impact on U.S. commerce is? Well,
the words obviously are somewhat plain and in many ways speak
for themselves, but I will tell you how I interpret it. To me,
what it meant was when we designed our cross-border policy, we
needed to ensure that the U.S. taxpayer was protected and the
U.S. financial system was protected. The mandate was not to go
too far in that effort, but at a minimum, we needed to be sure
that those two objectives were accomplished. Through the other
provisions of the policy we adopted through the guidance, that
will be the effect of our policy once it is implemented and
once market participants comply with it.
Mr. Austin Scott of Georgia. Well, I know there was some
discussion of latitude to comply with the new rules, but again,
if we don't have a definition of what direct and significant
is, then how can somebody who is being regulated comply with
that rule? And I would hope that direct and significant is
another term that you are able to get a uniform agreement with
the SEC on because, I mean, look, simpler is better from the
regulator standpoint and it is certainly better from the person
who is trying to comply with the rules just to keep up with one
definition instead of multiple.
But you do not have a feel for at what point the
transactions are de minimis so that they would not be subject
it to the new regulations?
Mr. Wetjen. I guess the first way I would answer that
question is under our guidance, if there is an entity, even if
it is offshore but it has the benefit of parental guarantee or
if it is a foreign branch of a U.S. bank, in which case
obviously it would be offshore as well, the guidance provides
that those entities, if they do the requisite level of
specified swap dealing activity, they would need to register as
swap dealers. And the policy behind that is again by virtue of
the parental guarantee or in the case of a foreign branch the
legal structure of the bank, the risk will come back to the
United States to the parent or to the home bank. And for that
reason the Commission decided that it was appropriate to ensure
or to require registration so long as the requisite amount of
activity was actually taking place.
Commissioner O'Malia referred to it earlier. We have this
de minimis threshold and for now you have to deal more than $8
billion of swap dealing activity. In that event, you have to
register but----
Mr. Austin Scott of Georgia. Sorry to interrupt. I am down
to about 5 seconds. I do hope that you will continue to get the
uniform definitions with the SEC and our overseas regulators as
well. It would just make it easier to regulate and for those
other entities to comply with regulations. With that, I yield
back.
The Chairman. The gentleman's time has expired. Mr. Maloney
for 5 minutes.
Mr. Maloney. Well, thank you very much. And I apologize for
being absent for a moment. Thank you both for your service.
Thank you for all the hard work that you have done. I think it
is often overlooked just how much has been going on in the CFTC
and I want to commend you both for that. And thank you for your
appearance here today. My question to either of you, I would be
interested to hear your views, what happens on December 21,
with respect to the interpretive guidance and the exemptive
order if the Europeans aren't ready? Do you expect the
Europeans to be ready and, if not, what happens?
Mr. O'Malia. Thank you for that question. I think it is a
very important question because we faced an artificial deadline
of July 12, 2 weeks ago, and we have created another artificial
deadline. And this one is again backed up right against the
holidays. Of course, everybody will be intently focused on
fixing it, but at the same time, we don't give ourselves much
leeway in terms of being able to resolve it if it goes over. We
were forced into an artificial deadline that created some
flawed policy. We took shortcuts with the Administrative
Procedure Act--which shouldn't be done--with notice and
comment. And I am very concerned that we will not have a
process in place that will give careful evaluation to the
substituted compliance regimes and make that determination and
put in place a new regime to follow on to that.
At our open meeting 2 weeks ago, I asked the staff what is
the process for the substituted compliance determination? When
will we make it? What information will we have about different
regimes and what are the recommendations of staff? The Chairman
actually directed staff at that meeting to provide within 2
weeks, which will be this Friday, a process for the Commission
to evaluate. I think this needs to be fully exposed to
transparency, open meetings, allow for foreign entities to come
defend their applications and talk to us, directly to the
Commissioners, not through a staff no-action, not through
sending e-mails or discussions that are not privy to all four
of us, to have this open discussion and figure out where we
have comparable rules and where we do not have comparable rules
and then how are we going to solve for the differences. So I
look forward to having the process unveiled to us by the staff
and how they are going to make this determination so we can
better figure out if we have enough time so we don't put
ourselves in a situation like we had with July 12.
Mr. Maloney. Mr. Wetjen.
Mr. Wetjen. Thank you, Congressman Maloney. I think the
answer is that, in an ideal world by December 21 the CFTC staff
will have made recommendations to the full Commission regarding
those jurisdictions that have submitted applications for
substituted compliance determinations; that is Canada, the
European Union, Japan, Hong Kong, Australia, and Switzerland.
And as Commissioner O'Malia has said, we will be making full
Commission determinations as to whether substituted compliance
should be allowed.
I can see that is a fairly abbreviated time frame but it is
one that was based on judgments made about how to make sure the
process would be undertaken expeditiously. The date was also
informed by input from these other foreign jurisdictions. And
in some cases they suggest dates in order to keep their own
countries on task and focused on their own finacial reform
efforts. And so that is the reason behind the date. It could
turn out to be that it is overly aggressive but we will have to
wait and see. But it is not a totally irrational date in other
words.
Mr. Maloney. Let me ask you with my remaining time just an
open-ended question to both of you. I am very curious if you
just pull the lens back with all that is going on with the
reauthorization still out there and these other issues, what is
the thing that keeps you up at night? What is your biggest
risk?
Mr. O'Malia. Some of our biggest risks are the lack of
certainty in our rules. I think that is the biggest
complicating factor. And while it keeps me up, I am quite
certain it keeps every commercial end-user, financial entity
out there that are trying to comply with our rules on a regular
basis, trying to do their jobs and to meet the obligations of
these rules. What is frustrating about a swap dealer rule is
you have to look towards position limits rules potentially and
clearing determinations and made available for trade
determinations and figure out where you sit in the queue and
all your responsibilities. It is extraordinarily complex, which
means it makes it extraordinarily expensive to do your job.
We have four or five different hedging definitions
depending on if you are trading as a swap dealer or you are not
trading as a swap dealer, if you are trading on position limits
or you are trading on a different entity. Four rules for
hedging determinations is insane. What is wrong with one? Why
can't we treat it consistently? And that is something that I
would encourage you to consider because this is the basic
premise of what is hedging. And I think that is a very
important thing for the Commission and the Committee to look
at.
Mr. Wetjen. I was going to respond by saying my 3 year old
is what keeps me up most nights.
Mr. Maloney. It doesn't change when they are 12, believe
me.
Mr. Wetjen. Is that true? Well, I am sorry to learn that. I
think the thing that I worry most about is another incident
where, because of gaps or failures in oversight, there is a
failed firm and customer funds are lost. I think we have done a
very good job in many ways responding to that. We have a
proposed rulemaking that we hope to finalize very, very soon.
But there is always this fear that I have that we don't know
what we don't know. And so while the reforms that have been
recommended are going to be very, very good ones, it would be
best to feel like you are going to eliminate all risk as it
relates to the loss of customer funds. And so if there is any
one thing I would identify, it is that.
The other thing is what I mentioned in my statement, Mr.
Congressman, there is this looming cybersecurity threat that
people are trying to get their minds around more in recent
years, and that is something that we are going to have to focus
on more because there is pretty significant vulnerability for
our markets to these threats. And then the other thing is how
the patchwork of global regulatory reforms takes shape and
whether there are any gaps there. Our agency has found that the
European regime is essentially identical, so that is a terrific
first step and that covers most of the swap activity around the
globe. But there are some other jurisdictions where there is
significant activity as well. It is not clear what is going to
happen there.
The Chairman. The gentleman's time has expired.
Mr. Maloney. Thank you, Mr. Chairman.
The Chairman. Mr. LaMalfa, 5 minutes.
Mr. LaMalfa. Thank you, Mr. Chairman.
For Commissioner O'Malia, first of all, thank you,
gentlemen, for being here today. I had a little mini chuckle
with Mr. Maloney's question asking what happens December 21 and
if this was a year ago, we would be worried about the Mayan
calendar. This year I hope it is a lot less of a worry. Anyway,
we have been very attentive to the swap dealer situation and we
wanted to cover again CFTC has had a $25 million special entity
subthreshold which needs to be fixed as it relates to public
power utilities. Even though also the CFTC has provided a no-
action letter increasing the subthreshold for certain
transactions to $800 million, but the effect has been still to
limit the pool of counterparties with which public power
utilities can enter operations-related swaps, in turn,
concentrating the risk to fewer market participants, so fewer
participants. Because of these concerns, as also expressed by
public utilities in my own district and throughout the whole
country, myself and three of my colleagues, Mr. Denham, Mr.
Costa, and Mr. Garamendi, as well as many other cosponsors, we
introduced H.R. 1038, the Public Power Risk Management Act.
Also Mr. Luetkemeyer, who sits on the House Banking Committee,
was an original cosponsor as well.
The bill's purpose is to put public power utilities back on
an even playing field with the other utilities in hedging their
risks, this by exempting the operation and related swaps from
their $25 million low subthreshold but giving them the same
power to the general $8 billion threshold. So our Act, our bill
was approved by this Committee unanimously--thanking the
Members--as well as passed on the House Floor by 423 to 0 on
June 12.
First, Mr. O'Malia, do you think this is the right approach
that we have taken so far since this is maybe the first chance
to talk to you about it? And second, is this an approach the
CFTC would like to emulate itself and would it take place
anytime soon? Or does the Congress need to move forward full
speed ahead with this bill that we have already moved out of
the House?
Mr. O'Malia. That is a great question and a great issue. I
fully support your legislation so thank you for that. And I
hope the Senate will pass it so we can achieve the reform that
I think is appropriate. I think this issue in and of itself--
and here is the staff no-action letter right here. It says,
``temporary relief.'' Temporary is only based on the fact that
it promises that the Commission is going to review this and
make changes. I don't see that happening anytime soon, if at
all. So----
Mr. LaMalfa. Aspirin provides temporary relief. We need
something more certain.
Mr. O'Malia. I would agree with that. And it really goes
into saying that the reason we provided the relief is because
these entities, and the utilities are more sophisticated than
the general special entity for one, and second, that there is a
concern that at the $25 million, which is the same concern we
have at the $800 million, that we have provided the relief to
because you do not have counterparties for these energy
companies that are trading in regional markets. And we lay out
in our first justification for providing the relief that there
are not adequate counterparties and therefore they are left to
and still hostage to Wall Street banks.
Mr. LaMalfa. Let me jump to the second line here on this
question here. So have any entities registered with CFTC as a
swap dealer for having exceeded the $25 million subthreshold?
Has anybody even taken part in that?
Mr. O'Malia. Not that I am aware of.
Mr. LaMalfa. Yes. Yes.
Mr. O'Malia. Nor at the $800 million that I am aware of.
Mr. LaMalfa. So do you think anymore will be coming into
play under this $25 million rather than the $8 billion
threshold?
Mr. O'Malia. I don't know. I would go back to the staff and
try to provide you some information----
Mr. LaMalfa. Well, if you had to prognosticate how things
have been going on that and what do you think would happen?
Mr. O'Malia. I doubt it. I think they are fleeing this
market to avoid this very issue of becoming registered as a
swap dealer for trading with a special entity.
Mr. LaMalfa. So the effects are on public power then that
means less options for people that are public power users?
Mr. O'Malia. That is correct.
Mr. LaMalfa. All right. Quickly, I will try to get to a
final line here. We were talking about technology a little bit
ago, too. Does CFTC currently have the necessary technology to
monitor massive amounts? It sounded like no but at the
beginning of the year, press reports indicated that an academic
data sharing program run by the former Chief Economist may have
resulted in proprietary data being disclosed in published
academic papers. So with all this going on with NSA and other
issues out there, we have very grave concerns of how are
people's data being treated and what is the security of that?
Please answer briefly on that.
Mr. O'Malia. We have an IG investigation ongoing right now
to uncover what happened and what went missing, but it is
critical that we have policies and procedures, especially with
regard to our markets as well as the international coordination
to make sure that we protect all market data.
Mr. LaMalfa. Perhaps maybe too much data is being retrieved
that can't possibly be managed. I will yield back. Thank you,
Mr. Chairman.
The Chairman. The gentleman yields back. Mrs. Negrete
McLeod, 5 minutes. No questions? Mr. Neugebauer, you are it. No
questions? Mrs. Noem for 5 minutes.
Mrs. Noem. Thank you, Mr. Chairman. I want to thank both
the Commissioners for coming today. I wanted to thank you for
your clarification on the hedging definitions because that has
been a burr under our saddle for a while. And I am curious,
that is what I understand to be under the Commission's
authority to come up with the uniformity in those definitions.
Are you taking action in that manner?
Mr. O'Malia. Not in the manner and process that I am
satisfied with.
Mrs. Noem. Okay. Well, if we on this Committee can be
helpful on that, that would certainly be a priority for me.
Do you have a secure method that you both believe in on
protecting integrity of consumer and customer funds?
Mr. O'Malia. One of the important things that we were made
aware of following the bankruptcy of both Peregrine and MF
Global was there was not a technology solution in place that
would surveil on a daily basis what the status of customer
funds was where they were and how they were being treated. We
used the Technology Advisory Committee to respond immediately
to that and we actually tasked the industry to come up with an
industry-led and industry-funded solution. It didn't require a
rulemaking. No taxpayer dollars had been expended for this.
But the industry quickly responded, and as of January this
year, they have integrated a technology solution to double-
check the accounts held at an FCM and double-check them against
the custodian bank. And they have automated thresholds so that
any deviation from that specific threshold will send a red
flag.
So we will know when and if customer funds are being moved
unexpectedly or illegally, and then we will be able to respond
to that more quickly. That was not in place. It is in place
today and we are continuing to build that out to include not
only the FCM and the custodian bank but also carrying brokers
and CCPs, the clearinghouses. So we will have an electronic net
that can really identify when and if customer funds are moving.
We have also made some changes in our rules that we call
the Corzine rule, for example, that requires the CEO to sign
off on any time they move a certain amount of money, which is a
very important reform. And we will be addressing the proposed
customer protection reforms coming up regarding FCM management.
And we haven't seen that final rule yet so we will wait on
that.
Mrs. Noem. Okay. Commissioner Wetjen, did you have anything
to add to that? Do you think it is an adequate safety net out
there and available technology-wise?
Mr. Wetjen. Well, I appreciate the question. As
Commissioner O'Malia has said, a lot of changes have been made
already on the part of the industry, and some of those new
practices are going to be reflected in our customer protection
rule once it is finalized. The system and the safeguards have
improved even without our finalization of the customer
protection rule.
The one other thing we did right after I joined the
Commission was a rulemaking that limited the types of risky
investments that FCMs could invest in or could invest customer
funds in. And so I thought that was an appropriate reform at
the time. We do have one rule that has actually been finalized
in response to some of the shortcomings in our previous
regulatory structure. We need to get the rest of the way by
finalizing the customer protections rule. As I said earlier in
response to Congressman Maloney's question, once we finalize
the rule, we will be in pretty good shape, but I would continue
to worry that we don't know what we don't know, and so we will
just have to continue monitoring the practices of the FCMs.
That is going to be much easier to do with some of the new
requirements under the final rulemaking, first and foremost,
the daily reporting of balances to the SRO and to the
Commission. I think that will be very important.
Mrs. Noem. On another topic, is an insurance product a
viable option for customers of futures trading?
Mr. Wetjen. That is a proposal that has been recommended by
some. I think it is certainly worthy of consideration and
exploration. One of the things we have heard from some is that
the folks need to get a handle on what the expense of providing
the insurance would be. One of the trade associations has
undertaken a study on that front and so it would be important
to understand what the costs would be. And it would be
important because what we don't want to do is somehow saddle
the FCMs with additional cost in a way that makes it more
difficult for those who actually need to use our markets to
hedge. We don't want to make it prohibitively expensive for
them. So that would be counterproductive. That would be the
issue to watch for when examining whether an insurance program
has any viability.
Mr. O'Malia. We want to make sure that we instill the right
corporate culture in the management of not only the FCM but
sometimes the larger entity, the family parent, and making sure
that the CEO and the financial officers all have customer
interests first and foremost in mind. And I know one of the
concerns with the insurance fund is that, don't worry about it;
it is insured. We want corporate cultures to make sure that
they protect customers, not rely on an insurance fund as a
backup strategy. So I look forward to reviewing the study on
the customer protection issue.
I also want to pursue, and I put in my testimony, different
bankruptcy reforms that would really improve the customer's
chances of being fully refunded if there is ever a bankruptcy
or a hole in the funds, to take that all the way up through the
corporate structure and really make management totally
accountable for customer protection.
Mrs. Noem. I appreciate that. Thank you. With that, Mr.
Chairman, I yield back.
The Chairman. The gentlelady yields back. Mr. Hudson for 5
minutes.
Mr. Hudson. Thank you, Mr. Chairman.
Commissioner O'Malia, I am trying to understand the CFTC's
final rulemaking on the de minimis level of swap dealing. Am I
correct in reading that the level is set to automatically drop
over 60 percent in 5 years without any public notice or
comment?
Mr. O'Malia. Correct.
Mr. Hudson. Would you agree that such a drastic change
should warrant some time for public comment?
Mr. O'Malia. That is a frustration. We have provided for a
number of automatic changes. Block rules, for example, required
for swaps automatically rises from 50 percent to 67 percent. I
proposed an amendment that, at the least, the Commission should
evaluate and look at the data before we make any decision. My
frustration lies with the de minimis rule as well. Making these
automatic changes totally devoid of any data makes no sense to
me.
Mr. Hudson. Well, how exactly does the CFTC plan to
evaluate what the de minimis level ought to be in 5 years? I
mean what is the process there?
Mr. O'Malia. Well, there is no requirement obviously. The
swap dealer rule is an automatic change. Mind you, the SEC,
even though we are supposed to do a joint rulemaking, they did
not have an automatic reduction in their standard.
You know, we are going to benefit from having all of the
reported swap data repository. It is really incumbent upon the
Commission to aggregate, understand, and analyze that data,
make its findings, and then make decisions based on that. To
skip that step doesn't make sense to me.
Mr. Hudson. Well, and my understanding is based on notional
value, but that may work for interest rate swaps, but my
concern is the commodities markets, the rising energy prices
could push entities over the threshold without a needed change
in their trading. In fact, the entities might be forced to
limit trading when faced with rising prices, reducing liquidity
at exactly the wrong time. And is the Commission even taking
that into consideration?
Mr. O'Malia. Not under this rule it hasn't. Those are very
important questions and concerns you raise. One of the real
frustrations with the swap dealer rule is the four-part test
that provides for what is swap dealing, in that the Commission
did not define it, and we use the facts and circumstances test.
So there is a lot of uncertainty as to whether end-users fall
within the dealing definition.
Congress gave us the tools in section 1a(49)(C) of the Act
to provide for an exemption for people who are not doing swap
dealing as a part of their regular business. We completely
ignored that and did not provide that coverage to end-users. So
they are left with this de minimis solution as their only
protection against being a swap dealer, and that is
unfortunate, especially in light of the fact that the number
drops from $8 billion to $3 billion and all of a sudden what
was acceptable the day before could be found to be dealing the
next day and many people have to register. So we have some
time, obviously, before that so I hope the Commission will
revisit it. It ought to revisit the special entity threshold.
So there are a couple of reasons why we ought to reopen the
swap dealer definition.
Mr. Hudson. I thank you for that. And I guess building on
what my colleague Mr. LaMalfa was talking about assuming the
$800 million de minimis threshold actually reduced the number
of parties the special entity may deal with, I mean, what
regulatory benefit is gained by this limitation on a special
entity's ability to offset risk? And I will open it up to both
of you, Mr. O'Malia, if you want to start.
Mr. O'Malia. Well, the promise we made in offering the
exemptive relief or the staff no-action was because at $25
million they weren't going to have enough counterparties. We
raised it to $800 million, or the staff raised it to $800
million, they are still in the same problem. So we just
provided a solution that doesn't solve the problem. So either
that number has to go up and I don't know why we would want to
treat them any differently than any other end-user for the
purposes of a de minimis or Congress ought to step in and
change it.
Mr. Hudson. Mr. Wetjen, if you would like to respond, I
have a minute left.
Mr. Wetjen. Sure, Congressman. Thanks for the question. I
think that experience has shown us that with regard to the
special entity de minimis, the level was set too low. The level
that it is currently set at through the no-action letter, $800
million, as you alluded to, was the number suggested by market
participants. I think it is informed by the petition that was
submitted by one of the trade groups that is seeking to change
the definition. And the no-action letter does hinge on
Commission action on that petition, so in the meanwhile the no-
action is effective.
I am not aware of any particular reason why the no-action
letter has not done the job in terms of providing the relief
sought. There obviously is a difference between no-action
relief and a full Commission exemptive order or a Commission
rulemaking. I certainly can see that point. But I am not aware
that there is something peculiar about the fact that the relief
has come through a no-action letter, that it hasn't provided
the relief sought. And so I would have to learn more from the
market participants who sought the relief to understand that
better.
But as far as where the level is set, again, as informed by
those impacted by the de minimis threshold in the first place,
so if it needs to be a different number, we need to be open to
that. It was set based on information that was provided to us.
And I agree with Commissioner O'Malia. Whenever we can, we
should always take Commission action. And again, in this
instance, no-action relief was provided because it was somewhat
targeted in the sense that it was specific to a subset of these
special entity groups. But I agree. If it can have the effect
long-term of effectuating an entirely different policy than
what was in the swap dealer rule, that is something the
Commission should reexamine.
Mr. Hudson. Well, our time has expired. I appreciate it.
Mr. Chairman, we definitely need to provide more certainty than
a no-action letter, and so I hope this Committee will work
towards that working with the Commission. And I yield back.
The Chairman. The gentleman's time expired previously but
he yields back anyway. Mrs. Hartzler for 5 minutes.
Mrs. Hartzler. Thank you, Mr. Chairman, and thank you,
gentlemen.
I am hearing a lot about an issue that directly impacts the
folks back home with some of the rules that are being proposed.
We have heard from farmers and ranchers and small- to medium-
sized futures commission merchants strongly opposing the CFTC's
proposed rules that were supposedly designed to improve
customer protections. Instead, many of them say the new
proposals would profoundly increase their costs and potentially
threaten their existence. If the proposed rules are implemented
as currently drafted, FCMs must hold enough of their own funds
to cover all customer positions at all times of the day, in
addition to the farmers and ranchers now having to meet just a
1 day margin call. So if this happens, what will happen to the
agriculture segment of the futures markets both from the FCM
and from the customer standpoint?
Mr. Wetjen. Congresswoman, I appreciate the question. You
are referring to the residual interest provision in our
customer protection rulemaking that has not been finalized, and
it is true that the proposal would have had an effect
consistent with what you said. The staff is preparing a draft
and will recommend a different approach on this particular
issue as I understand it, based on our internal dialogues.
I think, again, we have to find a balance. You know, the
statute does require that customer seg funds should be
protected at all times and shouldn't be covered by some other
customer's funds. And so that is an important principle we need
to have reflected in our rulemakings. But by the same token,
what was originally proposed is such a dramatic change from the
current practice. We started to hear the same concern that you
just raised, which was that many FCMs wouldn't be able to
handle that additional expense and might very well go out of
business, and these tend to be the ones that provide services
to the hedgers back in places like Iowa where I am from and
back in your district. So I am eager to take a look at what the
staff recommends and to ensure that it finds the right balance.
Mr. O'Malia. I share your concerns. I think I share the
same concerns that Commissioner Wetjen does. It is a balance
and we have to be very careful as we do not want to put these
FCMs in a position that they can't serve their customers and
the customers can't afford to hedge their risk. So I haven't
received the same staff briefing and with the commitment that
they are coming up with a different approach, so I will
carefully evaluate it when it comes before the Commission. But
this is a top priority for that rule so thank you for the
question.
Mrs. Hartzler. You bet. I am from Missouri in a mainly
rural district and so this is important to us so I am just
curious about the draft. Now, was it dealing with the FCM's
requirements or was it dealing with the farmers' 1-day margin
or both?
Mr. O'Malia. Well, the rule changes the way FCMs hold the
money and therefore the commitments--it changes the
interpretation of what we had historically been relying on in
the past and that would change how much farmers and ranchers
would have to put up to meet that demand and it reduces the
FCM's flexibility to extend the credit to their customers.
Mr. Wetjen. Yes, I would agree with that and say it just a
little bit differently. You know, where we land will have to be
informed by how quickly the FCM can actually collect additional
margin from a customer and how quickly margin is provided by
some users is different from how much time it takes with
others. And again, we will have to make sure the balance is
struck in the final rule.
Mrs. Hartzler. I am encouraged to hear that you are
listening and trying to wait because the average farmer relies
on their local FCM, and I would hate to see the rule so onerous
that it puts them out of business or makes it too difficult for
the local farmer to be able to hedge their risk because that is
a very big part of their marketing plan. So thank you for your
response and I yield back.
The Chairman. The gentlelady yields back. I will recognize
myself. We will have a second round since we have a little bit
of time left to do that.
Playing off of what we were just talking about, the
Agricultural Advisory Committee meets tomorrow for the first
time in 2\1/2\ years, a pretty tumultuous time during the
Commission's existence, and I am concerned that the ag
community not having had access to the Commission directly,
during that time frame, has missed an opportunity to hear some
of these concerns that Vicki and I hear from the folks.
So what is your expectation as to what the Agricultural
Advisory Committee can do with respect to advising the
Commission on the impact that the proposed rulemaking will
have? Mark, do you want to start off?
Mr. Wetjen. Mr. Chairman, oftentimes, we might hear more
often from certain segments of the marketplace than others, and
so the main importance of this Agriculture Advisory Committee
is to make sure that the Commission is being informed by the
perspective of that community when we adopt policies at the
agency. I think through our rulemakings under Dodd-Frank, for
example, we have received literally tens of thousands of
comment letters, and a lot of those have come from groups
representing the ag interests. So I do feel like we have
received a lot of input, valuable input from that community,
but this would be a good forum to make sure that we are
especially focused on their interests.
Mr. O'Malia. Obviously, the Advisory Committee has the
potential to be a very useful tool for the Commission to
discuss issues that are not immediately before it and think
about different issues affecting that industry, so I remain
optimistic. We have used the Technology Advisory Committee
quite effectively to talk about customer protection, talk about
high-frequency trading, talk about risk mitigation tools. So
they are important tools. I just hope that this is as effective
as that.
The Chairman. Speaking of that advice, it seems to me that
the self-regulatory agencies who drove the daily bank
confirmation process really got to the heart of the customer
protection issue. Will that effort be reflected in the final
rulemaking with respect to customer protection? Because if in
fact your new rule drives greater customer balances at the FCM,
aren't you exposing them to greater risks for loss of those
dollars? How much is enough? I am hopeful that you will be able
to fold all that in.
You both have spoken about how data collection plays a
great role in the regulatory scheme and how that should be able
to ferret out all kinds of stuff. Can you talk to us about why
that didn't work in the J.P. Morgan ``London Whale'' deal from
last summer and why we have not been able to ferret that out at
this point? Why did the data collection oversight potential not
work?
Mr. O'Malia. Data requires very rigorous and disciplined
rules and kinds of policies. We have to be very prescriptive
with requiring what data to be reported and when, and we
weren't adequately prescriptive. Ironically, I am talking about
how the Commission failed to be prescriptive, which is
generally not the case with most of its rules. But in terms of
data, it is a very granular requirement. You have to be very
specific about how people report. Right now, we are not getting
the consistency and uniformity that allows us to do the
essential aggregation. If you can't line up the columns and you
are not looking at the same data from the same people
consistently, you won't get the right answers.
The Chairman. Well, doesn't that strike to the heart of
most of what we are trying to do? Isn't that why we want all of
this data collected through swap data repositories throughout
the system; in order to be able to ``see'' where the bad actor
is, and where the potential systemic risks to the financial
system would lie? Are we no closer to making that happen?
Mr. O'Malia. Well, we are making marginal progress but we
are making steady progress, and we have convened a working
group to really address this. And we are going back to first-
order fundamentals to make sure that we work with the SDRs to
identify this.
The other thing that is causing some problems with the data
is actually the no-action process. When there is a gap in the
data when somebody doesn't have to report for an entity or an
activity that we have exempted, we won't be able to see that in
the data.
The Chairman. Scott, with a relook at data collection
requirements, will you have the potential to shed certain data
you have been collecting in the past? Is it useful as you look
at what you should be collecting in order to monitor the
market?
Mr. O'Malia. Well, we have taken a more prioritized
approach. I still think we have a ``we want it all, we want it
now'' attitude. But we are beginning to figure out that in
order to swallow this issue, we are going to have to take it in
bites. And we are starting to focus on getting elements right
and building from there. But it is going to take a very long
time--
The Chairman. Right.
Mr. O'Malia.--to get this completely correct.
The Chairman. Mr. Scott, for an additional 5 minutes?
Mr. David Scott of Georgia. Yes, thank you very much, Mr.
Chairman.
Let me go back to my line of questioning because, after
all, one of the major purposes of this hearing is for the
reauthorization and your budget and appropriations. I want to
follow up on the House Appropriations Committee reported an
appropriation bill that reduces your funding for the CFTC by
more than $10 million, below what we talked about earlier that
you needed. Chairman Gensler was at that meeting and he
testified. Mr. O'Malia, you were there as well, that even at
current spending levels, that sequestration, that the CFTC
would likely face furloughs, would very likely face reductions.
And all that we talked about here at this meeting shows this
increased load. So do you believe that this cut by the
Appropriations Committee is justified, and if so, which areas
of the CFTC would you assign for furloughs?
Mr. O'Malia. That is a very good question and it is a
difficult one obviously because it strikes at the heart of kind
of how we function. But the House level is where we are today
and so while it is off of the 2013 appropriated level, it is at
our current operating level of the sequestration. Now, we had
the opportunity to use carryover balances. The Appropriations
Committee was kind to give us 2 year money, which is essential,
because that gives us some flexibility to husband resources as
necessary to take and work through some of the difficult times.
We were able to use a $6 million carryover balance this year
alone to make sure that we did not have furloughs or layoffs at
all. So we have yet been unaffected, but as time goes by, we
may not have those carryover balances. We need to be very
prudent with the management of our funds to make sure and
protect our staff resources that we have today and not get into
a position that we have furloughs in the future.
I had to dissent against a spend plan recently that would
set that out, and in that document it did say that there is a
chance that we would have some furloughs as a result of the
budget.
Mr. David Scott of Georgia. Going forward, in Europe in
which you will be playing a far more intricate role, over in
Europe there is talk about what they refer to as transaction
taxes you may be familiar with. And some here in the United
States, in view of these budget shortfalls, if you are not able
to get the money that you need, have called for some kind of
user fee or transaction fee to help finance the Commission's
activities. What are your thoughts on that proposal and would
they be any different at all from what Europe is offering? And
quite honestly, should we go that way? I mean we are the leader
here of the world. I value that. I think it is very important
for us to sustain that. So I am concerned very much about your
funding capacity. What would it mean if you are forced to have
to go the way that these Europeans are talking about when it
comes to transaction fees if we here in Congress don't give you
the level of money you need?
Mr. O'Malia. I think that is a great question. I think it
is a very contested issue in Europe right now, as you correctly
point out. It is very controversial. This year in the
President's budget, OMB proposed a fee to be collected but it
had no specifics as to how the fee would be assessed on our
industry to recover these costs. I believe it says it is a full
recovery of cost but I know OMB has not provided it to you in
terms of requesting authorization to impose a fee. So they
proposed a budget. It did not assume it in its baseline but it
did talk about their desire to have one. You should receive
that information. I have not seen information. I don't know how
they were going to propose to collect this information or the
funds. I don't know who it is going to be assessed on, and I
would want to make sure that we understand what the
ramifications of this are before we implement it and I don't
have a position on it because I don't know what the proposal
says.
Mr. David Scott of Georgia. Yes.
Mr. O'Malia. We do rely to some extent, a very small
amount, on the National Futures Association. They recover cost
through their member registrations that are under our
jurisdiction and they provide a very valuable resource to the
Commission. Their challenge has been to take taxing a futures
trade versus a swaps trade but they handle that at 2 per side.
It amounts to roughly 20 percent of the futures trades due to
several exemptions in there, and then swap dealers are assessed
a membership fee and the largest members pay $1 million, the
smallest members pay as low as $150,000. So there is a range
and we are using that. And members actually receive direct
benefit from that. They receive the recovery of those costs in
those services.
Mr. David Scott of Georgia. Thank you very much, Mr.
Chairman.
The Chairman. Mr. Costa, 5 minutes.
Mr. Costa. Thank you very much, Mr. Chairman.
This hearing today of which I missed the earlier part of
it, but it is the continuation of other hearings that we have
had, and the overall descriptive for me is that this continues
to be a work in progress as we deal with the implementation of
the efforts that are assigned under your responsibility.
Tell me, as you look down the road here over the next 5
years, what your expectations are in terms of the
implementation and the regulatory process under the most
optimistic scenario and what are your greatest fears under a
most difficult 5 year journey in terms of what you wake up in
the middle the night wondering, under what set of scenarios,
i.e., a repeat of the 2008 crash and how you might respond?
Mr. Wetjen. Congressman, I appreciate the question. First,
I would answer by saying we do have a little bit of work left
to do, as you know.
Mr. Costa. That is my description, a work in progress.
Mr. Wetjen. I think one of the key areas of focus for the
agency will be on these substituted compliance determinations
where we take a look at regulatory regimes in other nations and
determine whether they are comparable and comprehensive or
essentially identical.
Mr. Costa. To that end, are you working with our European
allies?
Mr. Wetjen. Yes, in fact, certain determinations have
effectively been made with regard to Europe. There was an
agreement struck 2 weeks ago reflecting that. But the key will
be looking at some of these other jurisdictions like Australia,
Switzerland, Hong Kong, Japan. And then some of the other
jurisdictions where----
Mr. Costa. Do you believe the transparency is there with
those other countries?
Mr. Wetjen. I am sorry?
Mr. Costa. Do you believe the transparency is there with
those other countries?
Mr. Wetjen. Well, the ones I mentioned, those are the ones
that we expect to find to be closest.
Mr. Costa. All right.
Mr. Wetjen. But again, there is swap activity taking place
outside of those jurisdictions as well.
Mr. Costa. Clearly.
Mr. Wetjen. And so we have taken an approach in our
guidance to deal with those other jurisdictions, but we need to
make sure that we are collecting data and understanding what is
happening in those jurisdictions as well. So that is probably
the one area of focus for the Commission over the next 3 to 5
years in addition to just finishing the other remaining
rulemakings under Title VII.
Mr. O'Malia. I think the way Commissioner Wetjen answered,
over the next 5 years, that will be the substituted compliance
determinations, and coordination internationally will be
paramount, and we are going to spend a lot more time dealing
internationally to make sure that we have good rules that
harmonize our rules and don't create a competitive imbalance.
And one of the areas we need to be very focused on is in the
transaction space. Our requirements for rules----
Mr. Costa. And the transaction space, is that where you
think you have to monitor in a way to not create a competitive
disadvantage?
Mr. O'Malia. Well, I don't know at this point. I think that
is where we have probably the greatest differences in
regulatory structures internationally. That is an area where
trades can move easiest internationally. They can move trades
to different platforms----
Mr. Costa. Obviously the clearinghouses in Europe----
Mr. O'Malia. I think we have very close comparability in
terms of clearinghouses and recognizing the European
clearinghouses, Asian clearinghouses, we are much closer in
those regard. We have done a lot of work through IOSCO, and the
international regulatory and Prudential Regulators have ensured
that we do have systemically relevant entities that are going
to be closely harmonized. The transaction space is going to be
a little more Wild West and there is going to be a variety of
different trading venues, platforms, and requirements, and that
is going to be something that we need to focus on.
Mr. Costa. With that thought in mind, I am going to give
you the proverbial softball down the middle of the plate. So
what do you think is the appropriate role for oversight for the
Congress as you are trying to do your job?
Mr. O'Malia. I would encourage careful and immediate
oversight actually and really bring closer evaluation to how
our rules are being implemented. I think you can start with
some of the definitional rules, certainly entity rules like the
swap dealer definition. We have had a lot of discussion about
how our end-users are faring under this. There are some real
examples of how this is making a lot of entities' life a
challenge, hedging definitions, et cetera, that I raised
earlier.
And I also think that Congress should really focus on
expanding and changing some of the bankruptcy rules to really
help in terms of protecting customer funds.
Mr. Costa. Thank you. My time has expired.
The Chairman. The gentleman yields back. Mr. LaMalfa for 5
minutes.
Mr. LaMalfa. Thank you again, Mr. Chairman.
I wanted to come back to the no-action letters and some of
the frustration among market participants about how they come
about and their timing, et cetera, as we talked about earlier a
little bit. We can come at the 11th hour while people are
tracking maybe two entirely different tracks anticipating
scenarios with or without one. Could you explain, please, how
the Commission standards work for issuing a no-action letter
and who determines what entity or activity might receive such
relief and whether or not the Commission itself is the one that
votes on approving its issuance?
Mr. O'Malia. Well, the no-action process, since I have been
here has been an evolving one. I think historically the
Commission has had a greater say and there has been some sort
of--they would circulate the no-action relief, which is
really--generally, an entity petitions the Commission and says
we have a unique situation. We would like some very narrow
relief. And we have used that over the years to provide that
narrow relief to specific entities. And the staff will evaluate
it and make its recommendation and then provide the no-action
letter, circulate it to the Commission for review, but as we
now know, that is not a Commission action and it is a staff
action. So the Commission does not have a vote on that.
And therefore, it is a challenge because if you use it
broadly--and we have used it and abused it frankly in kind of
covering some of our faults in Dodd-Frank rulemaking, and if
you use it indefinitely, it becomes a de facto rulemaking,
which is certainly the purview of the Commission, and they are
now substituting staff decisions for Commission decisions
without the benefit of notice and comment, without having it be
put in the Federal Register for everybody to review. It is a
letter sent and it just generally appears on our website. And
it is not added to the Code of Federal Regulations that we have
so you can't go to one spot to figure out if you are in
compliance or not because you have to check our website to see
if there is any no-action relief on it.
Mr. LaMalfa. How many no-action letters do you think over
the last year have been issued, do you think?
Mr. O'Malia. I think in relation to Dodd-Frank, I tried
counting them and we are a little over 100, and 24 of those, it
is my understanding, we have provided indefinite relief meaning
unlimited or permanent.
Mr. LaMalfa. And so you mentioned, too, it is kind of de
facto for Commission rulemaking. What would be a better system
for replacing that so that the Commission actually is doing the
rulemaking instead of this gray zone we have, this really
unpredictable situation you have, especially 11th hour
decisions? How can we make that better?
Mr. O'Malia. Well, and certainly no-action relief is a
vital tool for us to provide that targeted relief, and we
should use it for specific entities and on a limited basis.
When we have an issue where we are considering permanent
indefinite relief or something like that, then the Commission
should revisit the rule. We should open up the rule and say we
have an issue here that needs to be corrected, go through the
proper process to make those rule changes. And we are beginning
to rack up a few proposals where it is now appropriate to come
back and reevaluate the rule. If I had a nickel for every time
we have said at an open meeting we are going to come back and
fix these rules if they are broken, I would be a rich man
because we have always committed to that, yet we have never
done it. And that is my frustration----
Mr. LaMalfa. You are probably starting to build a pattern
of very often requests for a particular type of relief, right?
So this would be a rule that you might put at the top of the
list to come back on?
Mr. O'Malia. The issue is that special entity issue. The
headline of that no-action relief is temporary relief. What is
temporary about it? It says the Commission is reviewing the
petition. Nothing is happening at the Commission to review that
petition. I don't see any action happening to fix the rule to
fix this problem. And the no-action solution has turned into a
no-fix of the problem, and that doesn't make sense to me
either.
Mr. LaMalfa. Does Congress need to have a greater role,
kind of dovetailing what Mr. Costa was asking, in oversight or
even legislatively?
Mr. O'Malia. You have the exact same role you did when
Dodd-Frank was formed. You don't need any additional authority
but I would suggest to you if we are not going to fix it, you
should.
Mr. LaMalfa. Yes. Thank you. I yield back.
The Chairman. The gentleman yields back.
I brought up the issue a while ago of self-regulatory
organizations. Is there a way for the Commission to offload
some of its responsibility? Given the budgetary concerns that
my colleagues have talked about, could some of that regulation
be delegated to the SROs with the Commission then maintaining a
role of supervising that or making sure the SROs did it
correctly?
Mr. O'Malia. This goes directly to Mr. Scott's concerns
about budgeting. We do have a useful tool, as we talked about.
The NFA, for example, charges its participants. Its budget is
$74 million in 2014, so it is viable to do a lot of the
registration responsibilities. They are going to play a vital
role in our self-regulation. These are the swap execution
facilities, these transactions. They are testing, reviewing the
order book, and looking at all of the SEFs for compliance to
make sure that they do their market surveillance tool, great
opportunity to leverage our resources with that. And they have
been a great resource for us in the past.
The swap dealer rule in and of itself--so far the NFA has
received 168,000 pages of swap dealer submissions. It makes no
sense to me for them to go through all of the swap dealer rules
and all of these 168,000 pages of submissions and then have the
Commission do the exact same review. We need to work together.
We need to do a sampling. We need to figure out what their
responsibilities and our responsibilities are because we
certainly can't afford to do both.
The Chairman. You could see an opportunity for the SRO to
do it first and then you come back in and pick the ones that
present the most risks, or some sort of random deal and go
through that. Depending on what you discover there, go with
what the SRO did or go further, rather than a duplicative
effort, isn't that a better way to go?
Mr. O'Malia. I fully support that concept and we really
need to figure out how we are going to leverage that as a tool,
not duplicate it.
The Chairman. Yes. I do think there is a role there. The
SROs are more nimble, as you have seen with their really
elegant fix on customer funds protection by going right to the
banks and having that happen. That went a lot quicker than I
suspect the Commission could have done it, and it is actually
very effective, and to me, may be effective enough that you can
look at your proposed fixes on customer protection and maybe
leverage that one better.
On the path forward what the CFTC and the European
Commission agreed to, you say we are going to agree to agree,
yet you didn't agree on margins for exchange-traded
derivatives. If at the end of the day you decide U.S. has one
margin level, and the EU has a different margin level, what
impact does that have on customers?
Mr. Wetjen. Thanks for the question, Mr. Chairman. I do
think that at the end of the day even though you are right in
the document that was released the document addressed this
issue that effectively punted on it, I expect that the
Europeans will find our clearing regime comparable to theirs. I
would imagine that we will do the same although we do have most
of the European clearinghouses either registered with us or in
the process of registering with us. So that solves a lot of the
problem there. Once comparability is determined, then we have
to leave it up to the market participants to decide even if it
means that in one clearinghouse there is larger, more
additional margin requirements vis-a-vis another.
What we have to keep an eye out for is why we want
participants to have choice in that way, or we want to make
sure that there aren't the sorts of arbitrage taking place that
would invite risk to our system, because in this case we
actually have a smaller margin requirement. So we would want to
keep an eye out for that, but based on initial dialogues
between ESMA and Europe and the staff at the CFTC, it feels to
me like we are trending towards a conclusion where equivalency
or substituted compliance is going to be found.
The Chairman. All right. Anyone else have another question?
Mr. Vargas, 5 minutes.
Mr. Vargas. Thank you very much, Mr. Chairman. I appreciate
it. I appreciate again the witnesses being here. You know, the
question was asked by Mr. Maloney what keeps you up at night?
And you said your 3 year old. If your 3 year old is keeping you
up, you are doing something wrong, but only by 1 year, and then
after that, they shouldn't be keeping you up. I have two girls;
I can tell you.
But anyway, Mr. Costa said what worries you in the middle
of the night and I guess I thought about that. And from my
district it is an interesting district because about \2/3\ of
the district is a very urban area in San Diego and the other
part of my district is a very rural farming community. And for
them it is the issue of manipulation of some commodities like
gasoline. In California back in the early 2000s we had
manipulation of the electrical system there, and our prices
spiked two, three times what they were regularly and I went
back and took a look at the price of gasoline here. And this is
the weekly U.S. conventional gasoline retail prices since 2000.
In 2000 both premium and regular was under $1.50, and today,
they are $3.82 and $3.50 for premium/regular.
That is one of the things that worries people in my
district. You know, what has happened to the price of gas? And
there are economists and academics that are saying it is
manipulation and speculative manipulation, very similar to
that. I don't know that that is true. Now, you said that there
is this process that you go through but how would you find
that? When you are having these meetings, how would you
determine that there is manipulation through speculation?
Because really that is what Dodd-Frank ultimately is supposed
to do. It is where the rubber hits the road is where the
regular American is saying, ``Wait a minute, I am getting
ripped off here. I am paying way too much and this is not
market forces. This is manipulation. This is speculation. This
is something that is wrong and fraudulent.'' How in fact do you
find it there because I know that that is an issue that comes
up in California, the price of gas and these radical increases
that we have seen?
Mr. O'Malia. This is an issue that we are very attuned to
based on the California energy crisis and obviously in 2007 a
lot of commodities saw their prices spike and fall in 2007. And
they have remained more moderate but we have to be vigilant,
absolutely have to be vigilant on this point. We have to work
with our surveillance teams, which are really growing in
capacity, and I am very impressed. One area that I think we are
really improving in is our ability to analyze the data. It is
not so much the new data but it is that we are really expanding
our capacity. And I give a lot of credit to our new office
surveillance director, Matt Hunter, for his efforts to retool
our teams to really become more data-intensive and to do a lot
more modeling. We are making huge improvements there.
We also work with EIA, the Energy Information Agency, which
really looks at physical stores and making sure we understand
how the physical markets are behaving, storage issues, supply
and demand, and those are vital issues to make sure that when
we look at something, are we looking at a supply-and-demand
issue or are we looking at a manipulation issue?
And then some of the other things we work on with the FTC,
Federal Trade Commission, things like gasoline prices, they
have investigated gasoline issues over the years on and off and
tried to figure out why the price of gasoline, why does it go
up faster than it comes down, for example. So we work with all
of these entities, including FERC, by the way, in electricity
issues as well.
So we put that together. Our mandate is to make sure that
we don't have fraud or manipulation in our markets and we
figure out if there is somebody doing that, how do we go about
it? In Dodd-Frank, we have new manipulation authority that
really makes our job easier in terms of pursuing a suspected
manipulation case. In pursuing a case, Congress gave us the
recklessness standard which effectively lowers the bar for us
in terms of proving manipulation.
Recently, we have also had new disruptive trade practices
authority and we recently prosecuted the other day, or at least
came to a settlement with, a high-frequency trader who is using
spoofing. That was the first time we ever used our spoofing
authority that was given to us under Dodd-Frank. In addition to
the farm bill in 2009, I believe, we also raised the penalty
for manipulation to $1 million per violation.
So we have a number of tools in our toolbox today. Congress
has given us easier authority to prosecute these things. And
then the other big issue is going to be data. We are now going
to have the ability eventually to look at the swaps data so we
can work with our physical partners to look at physical market
data, EIA, supply-and-demand data. We are going to have swaps
data. So that market is no longer going to be dark to the
Commission. We need to make sure that we understand how the
physical market trades and the interaction between financial
markets.
Mr. Vargas. Thank you. Thank you, Mr. Chairman.
The Chairman. The gentleman yields back. Mr. Scott for a
closing statement.
Mr. David Scott of Georgia. Well, this has been a very
informative session, and you both handled your testimony in a
very intelligent, knowledgeable way. It has provided us with
tremendous insight. You do an extraordinary job. You have taken
on an extraordinary situation. And, as I mentioned before, it
is important to note a great commendation to your staff who has
had to work overtime, as I said. You have not had a
reauthorization since before Dodd-Frank, since before the
financial crisis. A lot has been thrown at you. It is very
important that you have the staffing, as I have reiterated in
my line of questioning. Thank you for your testimony, and thank
you for the great service that you are providing to our nation.
The Chairman. Thank you, Mr. Scott. And I would echo those
compliments. Thank you both for being here. In the boxing
world, it doesn't appear we laid a glove on either one of you
in this morning's exchanges. Thank you very much for what you
do. Thank you for your staff and their hard work and we berate
you when something goes wrong; we don't brag on you enough when
you get it right. I appreciate both of you, and your very open
attitudes toward exchanging ideas. I hope we were as adept at
listening to you as well.
Under the rules of the Committee, the record of today's
hearing will remain open for 10 calendar days to receive
additional material, and supplementary written responses from
the witnesses to any question posed by a Member.
This hearing on the Subcommittee on General Farm
Commodities and Risk Management is adjourned.
[Whereupon, at 11:52 a.m., the Subcommittee was adjourned.]
[Material submitted for inclusion in the record follows:]
Submitted Questions
Response from Hon. Scott D. O'Malia, Commissioner, U.S. Commodity
Futures Trading Commission
Questions Submitted By Hon. K. Michael Conaway, a Representative in
Congress from Texas
General Commission Operations
Question 1. Are there any programs or divisions of the Commission
that should be cut or consolidated?
Answer. First, in order to determine whether certain programs or
divisions of the Commission should be cut or consolidated, the
Commission must do a better job at identifying its mission and budget
priorities, particularly in light of the fiscal challenges facing the
nation. For example, the Commission has failed to establish a clear
business plan by division that incorporates the specific technology
requirements each division will need over the next 5 years. Without
such a strategy, ambitious goals to integrate technology into the
mission of each division are easily forgotten--especially when there
are no specific goals or timetables for deploying technology to
modernize the Commission into a 21st century regulator.
Second, the Commission must clarify how to coordinate new
registration oversight and compliance responsibilities with the Self-
Regulatory Organizations (SROs) so that limited resources are maximized
and efficiently used. For example, it doesn't make sense for the
Commission to duplicate the role of the National Futures Association
(NFA) by reviewing each and every swap dealer submission and 168,000
pages of swap dealer documentation for registration compliance. It is
unclear how the 50% funding increase for the Division of Swap Dealer
and Intermediary Oversight (DSIO) that is in the Commission's fiscal
year 2014 budget request will be utilized, and how the Commission will
rely on the NFA to execute this mission.
Finally, it must be a priority of the Commission to develop a
cross-divisional team of staff to focus on resolving the challenges
surrounding our data reporting and data utilization efforts because the
Commission's efficient operation is dependent on the effective use of
data. This will allow staff, especially the Division of Enforcement
(DOE) and the Division of Market Oversight (DMO), to conduct
surveillance of the markets and fulfill their mission in a reliable and
expedient manner. The Commission is struggling to accept, interpret,
and aggregate data from the three temporarily-registered swap data
repositories (SDRs), and this problem will be compounded with the
additional data received from international sources. I believe that
only through a dedicated effort can the Commission address our most
pressing market oversight challenge--data. I am committed to working
with the members of the Technology Advisory Committee (TAC), which I
chair, to support the standardization of data.
Question 2. Can you please explain what ``absent objection''
currently means in the context of the issuance of a CFTC staff ``no
action'' letter, or other Commission action, and how it is used?
Answer. It is important to recognize that the ``absent objection''
process is not defined in the Commodity Exchange Act (CEA) or in
Commission regulations. The lack of official procedure has led to
confusion and misunderstanding regarding the exact role of the
Commission with respect to staff action, and whether absent objection
circulation by the staff to the Commission constitutes a Commission
vote. While the Office of the General Counsel (OGC) has provided some
context for the absent objection process, none of the procedures
described below by OGC are included in Commission regulations.
As a practical matter, the current absent objection process is to
put into circulation a matter (such as a staff no-action letter to
provide relief from Commission rules) and notify the office of each
Commissioner that ``absent objection by the majority of the
Commission,'' the staff action will proceed and any referenced
document(s) will be released. Notably, the Secretariat always contacts
each Commissioner's Office to see if there is any objection to staff
action.
Due to the lack of formal procedure, I received two conflicting
views about the role of the Commissioners' vote (i.e., whether or not
to object) in the absent objection process. Initially, I was informed
by the Secretariat that three votes are required to stop staff action
from going forward, although this standard has never been applied. But
later on, I was informed by the General Counsel in an e-mail dated July
12, 2013, that the Commission cannot block staff action because an
absent objection circulation is not a vote.
Now, in connection with these Supplemental Questions for the
Record, I have received the following advice from OGC regarding absent
objection:
In order to explain the ``absent objection'' process at the
Commission, it is helpful to understand how business is
conducted generally at the Commission. As is the case with
other independent agencies in the federal government, the
operations of the Commission and its staff are governed by
Congressional mandate. The Commodity Exchange Act (``CEA'')
distinguishes among actions taken by the Chairman, Commission
action, and staff action.
Under CEA 2(a)(6)(A), the executive and administrative
functions of the Commission are exercised solely by the
Chairman. In carrying out these functions, the Chairman is
governed by general policies, plans, priorities, and budgets
approved by the Commission, and by such regulatory decisions,
findings, and determinations as the Commission has made. See
CEA 2(a)(6)(B).
Staff action occurs under the authority of Section 2(a)(6)
and under authority specifically delegated by the Commission.
See, e.g., 17 CFR 140.14, 140.20, 140.72-140.97 (2013). The
staff's issuance of no-action letters, interpretive letters,
and exemptive letters is authorized by Rule 140.99, 17 CFR
140.99 (2013).
Commission action is accomplished by a majority vote of the
Commissioners. See FTC v. Flotill Prods., Inc., 389 U.S. 179,
183-84 (1967) (absent a specific statutory requirement, federal
agencies follow the common law `majority of a quorum' rule).
Such action occurs in two ways: through votes held at formal
meetings, or through seriatim consideration under Rule 140.12.
See 17 CFR 140.12.
With that background, the term, absent objection, can arise
in two contexts. It usually refers to an informational
circulation to the Commission to describe action to be taken by
Commission staff. Although conducted through the Office of the
Secretariat, the process does not call for a Commission vote.
It is intended to keep the Commissioners apprised of the
staff's activities that are taking place under the Chairman's
supervision.
In addition, business may proceed on an ``absent objection''
basis at Commission meetings. If a Commissioner objects, the
matter is decided by majority vote.
As indicated above, the Commission also conducts business
through seriatim votes without holding a formal meeting. If a
Commissioner objects to seriatim consideration, the matter is
withdrawn from seriatim consideration, and is scheduled for
disposition at a Commission meeting. See 17 CFR 140.12(b).
It is still unclear from the advice provided by OGC what is the
appropriate use of the absent objection process, and whether a majority
of the Commission or a single Commissioner may object to staff action
and request reconsideration of a matter before it is released.
In light of the recently expanded universe of matters that now
proceed by absent objection circulation and their far-reaching
consequences, such as the extension of subpoena authority under omnibus
orders of investigation and the issuance of indefinite relief from
Commission rules via staff no-action letters, the Commission or
Congress should define the appropriate use of the absent objection
process. Historically, absent objection circulation was utilized for
matters like NFA rule amendments or limited no-action relief for a
single entity, not a broad class of persons or products.
Finally, I would draw the Committee's attention to the advice
provided by OGC regarding the Chairman's authority under CEA
2(a)(6)(A), which limits the Chairman's executive authority to
executive and administrative functions. This authority does not appear
to give the Chairman unilateral power over policy decisions of the
Commission or changes to Commission rules or regulations. In
particular, I am seriously concerned that, at the Chairman's direction,
the staff has been issuing indefinite no-action relief from existing
rules--which, in essence, amounts to de facto rulemaking--without a
Commission vote. At the very least, there must be an opportunity for
one Commissioner to object to the proposed staff action and have the
matter considered further.
Question 3. Is there an official legal procedure for utilizing an
``absent objection'' motion at the CFTC? Has there been a change in the
legal interpretation of what ``absent objection'' means between past
and current usage of this procedural motion for Commission business?
Answer. There are currently no Commission regulations that govern
the ``absent objection'' process. I would welcome a review of the
Commission's policies and procedures and recommendations to establish
clear process for staff action and Commission action.
I received the following advice from OGC on procedure and its legal
interpretation of past and current usage of ``absent objection'':
As explained above, Commission action may be taken on a
matter during formal meetings of the Commission by majority
vote or by an ``absent objection'' process. Regardless of which
way it is proceeding, each matter is considered by the
Commission pursuant to a motion made by one of the
Commissioners. Each matter typically includes a staff
memorandum to the Commission explaining the proposal under
consideration. If objection is heard to a matter presented by
an ``absent objection'' motion, the matter becomes subject to
disposition by majority vote.
With respect to staff business that proceeds on an ``absent
objection'' basis, as described in response to Question 2
above, the procedure is to circulate informational memoranda so
that the Commissioners may be informed of a staff action and
the Chairman may be informed of any Commissioner's objection to
the planned staff action. If there are such objections, the
Chairman may choose to withhold such staff action.
The CFTC and its Office of the General Counsel have
consistently interpreted these terms in this way.
Now, based on OGC's current opinion, the Chairman has the
discretion to withhold an absent objection circulation if one
Commissioner objects. It appears that, yet again, OGC is revisiting its
interpretation of this process.
Moreover, as I noted in my response to Question 2, the Secretariat
is operating on a completely different basis: the ``absent objection''
process means ``absent objection by a majority of the Commission''
(emphasis added).
The Secretariat's practice blurs the line between staff action and
Commission action. By requiring a majority to object in order to stop
staff action from going forward, the process seems to call for a
Commission vote. Such a vote would make an ``absent objection''
circulation not opposed by a majority of the Commission more similar to
ratification by the Commission of staff action. This reinterpretation
of ``absent objection'' appears to have no foundation in the common
law, parliamentary procedure, or past practice at the CFTC and other
agencies.
I question whether this reinterpretation of the ``absent
objection'' process means (1) that staff action, absent the objection
of a majority of the Commission, becomes ratified agency action that is
reviewable by the courts under the APA, and (2) to the extent that
staff action is deemed ratified by the Commission and has a practical
binding effect on the rights and obligations of parties, or a binding
legal effect, then it is a rulemaking done without notice and comment
as required by the APA.
Question 4. Procedurally, I understand that a 2-2 Commission vote
prevents an order from being issued, yet a 3-1 vote is required to stop
an ``absent objection'' motion? Why?
Answer. As you will see from the advice provided by OGC below,
there is no explanation why a 3-1 vote is required to stop an ``absent
objection'' circulation. Because it is more difficult to obtain a 3-1
vote than a 2-2 vote, I believe that a 3-1 vote makes it more difficult
to stop staff action from going forward, than a 2-2 vote which is not
enough to pass a Commission order. This produces a nonsensical result.
I received this advice from OGC on the number of votes required to
stop an ``absent objection'' circulation:
With respect to an ``absent objection'' motion at a formal
meeting, if an objection is heard, the matter becomes subject
to disposition by majority vote.
With respect to staff action circulated ``absent objection,''
unless a statute or prior Commission order requires otherwise,
the Chairman's prerogative as staff director controls, and he
may, in his discretion, direct a different course preferred by
fellow Commissioners.
As mentioned above, Commission action is accomplished by a
majority vote of the Commissioners. See FTC v. Flotill Prods.,
Inc., 389 U.S. 179, 183-84 (1967). A 2-2 vote is sufficient to
stop such action.
Question 5. Do you think it is appropriate for CFTC staff to be
given the power to unilaterally initiate investigations, without the
opportunity for the CFTC Commissioners to provide a check on that
power?
Answer. It is appropriate for DOE to initiate informal
investigations with voluntary compliance by subject parties, which was
delegated to DOE under Rule 11.2 in Commission regulations. However,
Rule 11.4 explicitly reserves the authority to initiate formal
investigations to the Commission. Formal investigations permit the use
of subpoena authority to compel compliance by subject parties. Only an
order by the Commission can authorize the issuance of a subpoena.
For some reason, as evidenced below, OGC does not distinguish
between these two types of enforcement actions, even though subpoena
power drastically affects the rights of subject parties.
With respect to the Commission's subpoena authority, it is not
appropriate for the Commission to delegate subpoena power to DOE for an
extended period of time without the opportunity for a Commission vote.
This subpoena power must reside with the Commission, pursuant to Rule
11.4.
Recently, the Commission approved two omnibus orders of
investigation that authorize DOE to extend the duration of subpoena
power without a Commission vote because the language in these omnibus
orders would allow their continuous renewal, ``absent objection by the
Commission.'' Since OGC has determined that the absent objection
process does not constitute a Commission vote, it is not appropriate
for the Commission to use this process to extend the delegation of the
Commission's subpoena authority.
Below is the advice that I received from OGC on investigations:
Yes, I believe that the Commission's current procedure and
practice for investigations promotes the efficient and
effective use of Commission resources, while including measures
to safeguard the Commission's oversight responsibility.
The Commission's authority to conduct investigations is
broad. The Supreme Court has held that administrative agencies
have the authority to ``[i]nvestigate merely on suspicion that
the law is being violated, or even just because it wants
assurance that it is not.'' United States v. Morton Salt Co.,
338 U.S. 632, 642-43 (1950); see CFTC v. McGraw-Hill Cos., 390
F. Supp. 2d 27, 33 (D.D.C. 2005) (same).
In 1976 the Commission delegated to the Director of its
Division of Enforcement, and to the Directors of the
Commission's other operating divisions, the authority to
conduct investigations and make recommendations to the
Commission therefrom. CFTC Rules Relating to Investigations, 41
Fed. Reg. 29798 (July 19, 1976) (adopting Part 11 to the
Commission's Rules, including Rule 11.2 (Authority to conduct
investigations)). The purpose of an enforcement investigation
is to discover the facts so that the Commission may determine
whether it is necessary or appropriate to institute an
enforcement action or take other preventive, remedial or
punitive action. Id.
Over the past 4 fiscal years, the Commission's Division of
Enforcement has opened more than 1,500 investigations of
potential violations of the Commodity Exchange Act or
Commission Regulations. Requiring Commission review and
approval for each investigation would reverse a nearly 40-year-
old Commission delegation that has worked well, cause an undue
burden on the Commission's resources and stifle the
effectiveness of its enforcement program.
The Division of Enforcement provides the Commissioners with
regular briefings regarding the status of significant
investigations. Further, Commissioners regularly request and
receive updates from the Division of Enforcement regarding the
status of investigations of particular interest. In the course
of an investigation, the Division of Enforcement may seek
authorization from the Commission to compel production of
records and or testimony through Commission order authorizing
issuance of subpoenas.
Also, while the Division of Enforcement may make a
recommendation based upon its investigation, the Commission has
the sole authority to make the determination as to whether or
not to file an enforcement action.
Question 6. Per Commission regulations, what is an ``omnibus
order''? What is the permissible scope of an ``omnibus order'' granting
subpoena power to CFTC staff, and how long should such an order be
effective? If the order has an indefinite duration, would it be binding
on a future Commission?
Answer. Commission regulations relating to investigative powers of
the Commission do not reference omnibus orders. Further, Commission
regulations do not define an omnibus order, nor do Commission
regulations describe the permissible scope and duration of an omnibus
order. I find this troubling, because the process by which the
Commission initiates and issues subpoenas is the foundation of any
enforcement action.
Because omnibus orders are not in Commission regulations, I have to
rely on existing rules related to the issuance of an individual
subpoena by the Commission under Rule 11.4 and on informal OGC advice
to determine whether a particular omnibus order meets the necessary
legal requirements--not a clear standard set forth in Commission
regulations.
For example, I received this advice from OGC regarding omnibus
orders of investigation:
Authorization to issue subpoenas directed at a particular
subject area is commonly referred to as an omnibus formal
order.
OGC further explained that the content of a subpoena should, among
other things:
[The subpoena should] provide a general description of the
scope of the investigation, the authority under which the
investigation is being conducted, and designate the individuals
authorized to issue subpoenas. The scope of the investigation
subject to such an order may be directed at compelling
information and testimony concerning a particular entity's
course of conduct or to a particular subject matter area.
(emphasis added).
Unfortunately, a handful of requests that landed on my desk from
DOE for issuance of an omnibus order of investigation fall short of
these minimum standards. The orders simply mention categories of
registrants, not a specific entity or entities, and refer to potential
violations of the CEA that may be committed at some point in the future
by these categories of registrants. The lack of any specific
information or particularity in these omnibus orders allows DOE to
issue subpoenas without having the Commission review and vote on each
subpoena based on the facts and circumstances of each investigation.
OGC also advised me that omnibus orders are essential for
conducting effective enforcement programs. OGC states:
At times, CFTC investigations require quick enforcement
action to freeze assets belonging to customers, preserve books
and records and, sometimes, coordinate the expedited filing of
related actions in cooperation with other civil or criminal
authorities.
It is not clear to me how a broad omnibus order, which does not
even mention a specific entity that is subject to an investigation, can
help DOE freeze assets and preserve books and records of a specific
company on an expedited basis.
Such ``quick enforcement action'' can only be achieved when DOE,
after obtaining the necessary authorization from the Commission, files
a complaint and a motion for preliminary injunction in a federal
district court requesting that the court issue a restraining order
allowing the Commission to freeze assets and ordering the defendants to
preserve books and records.
Regarding the duration of omnibus orders, I believe that omnibus
orders should be confined to a limited time period. I also believe that
the Commission must retain the power to grant an extension of omnibus
orders through Commission action (i.e., a vote by the Commission).
Congress intended that a decision to bring or extend an investigation
is reflective of a shared opinion of the majority of the Commissioners,
rather than a unilateral ruling of DOE staff.
As I stated before, I support the robust use of the Commission's
enforcement authority to thwart fraud, manipulation, and abuse in CFTC-
regulated markets. Accordingly, I support the use of omnibus orders,
but only if the scope, duration, and permissible use of such orders is
clearly defined in Commission regulations. I welcome Congressional
action to amend the CEA to define the appropriate use of omnibus orders
as well.
Question 7. What is the legal justification for the Commission
issuing a final ``exemptive order'' without prior notice-and-comment
periods? Does this place Commission actions on questionable legal
ground from a compliance standpoint with the Administrative Procedures
Act?
Answer. I received the following advice from OGC:
The APA empowers an agency to proceed without notice and
comment for good cause. See 5 U.S.C. 553. The Commission has
interpreted CEA Section 4(c), which authorizes the Commission
to grant exemptive relief, to incorporate the APA's
requirements, including the good cause exception. The
Commission's view is that Congress did not intend that the
Commission can impose requirements on market participants
without notice and comment when there is good cause, but may
not exempt market participants when the public interest
dictates, or other good cause exists, without first allowing a
comment period.
Recently, the Commission issued an Exemptive Order from the cross-
border swaps guidance without prior notice and comment by utilizing the
good-cause exception in the APA. It is my understanding that courts
have narrowly construed the good-cause exception from notice-and-
comment and placed the burden of proof on the agency to demonstrate
exigent circumstances. See Tenn. Gas Pipeline Co. v. Fed. Energy
Regulatory Comm'n, 969 F.2d 1141 (D.C. Cir. 1992); Guardian Fed. Sav. &
Loan Ass'n v. Fed. Sav. & Loan Ins. Corp., 589 F.2d 658, 663 (D.C. Cir.
1978).
I find it troubling that, notwithstanding the case law, the recent
Exemptive Order stated the deadline of July 12, 2013 (which was
arbitrarily set by the Commission) as the basis for an ``emergency''
necessitating the abrogation of the public's right to participate in
rulemaking. Further, the Exemptive Order's inclusion of a post-hoc
comment period does not, in and of itself, satisfy APA notice-and-
comment requirements because the public must have the opportunity to
comment before any rulemaking becomes final.
Question 8. After the ``post hoc'' comment period has closed for
some exemptive orders, will the Commission allow revisions to be made
based on issues raised by the public comments?
Answer. I received this advice from OGC:
In its informed discretion, the Commission may vote to allow
such revisions.
Notably, only the Chairman can schedule a meeting to consider
amending exemptive orders or other rulemaking.
Question 9. Are there written rules or policy guidelines on how the
CFTC is to use the ``no action'' letter process? If not, does the
Administrative Procedures Act govern the use or issuance of staff ``no
action'' letters?
Answer. Section 140.99 of Commission regulations sets forth
procedures for requesting no-action relief. In addition, Section 140.99
plainly states that a no-action letter does not bind the Commission, it
does not bind other Commission staff besides the issuing Division, and
it cannot be relied upon by the public to govern their market
activities.
I strongly believe that the Commission misused no-action relief by
setting forth significant Commission policy that affects large swaths
of market participants and engaging in rulemaking that implements the
Dodd-Frank Act.
This is starkly illustrated by the fact that of the over 100 no-
action letters granted to date under our new rules and regulations
implementing Dodd-Frank, at least 23 no-action letters have no
expiration date. This ad hoc process of issuing no-action relief is
confusing and inconsistent, and in the case of indefinite relief, a de
facto rule change.
Again, I am concerned that a no-action letter that is effective for
an indefinite period of time essentially amounts to a rulemaking, but
does not adhere to APA safeguards that ensure public participation and
transparency.
As is consistent with historical practice and other agencies'
practice, no-action relief should be used sparingly, for specific
entities based on a particular set of facts and circumstances, and on a
time-limited basis. Any shortcomings in a final rule issued by the
Commission must be resolved through rulemaking under the APA to
properly amend the rule.
I welcome Congressional oversight of the Commission's use of no-
action relief to determine whether the Commission is in compliance with
the APA.
Regarding the current procedure for no-action relief, I received
the following advice from OGC:
CFTC Rule 140.99 sets forth the parameters. It states that a
CFTC staff no-action letter is ``a written statement by the
staff of a Division of the Commission or of the Office of the
General Counsel that it will not recommend enforcement action
to the Commission for failure to comply with a specific
provision of the [CEA] or of a Commission rule, regulation or
order if a proposed transaction is completed or a proposed
activity is conducted by'' the beneficiary of the letter. The
Rule states that the no-action letter represents the views of
the Division that issued it or the Office of General Counsel
and does not bind the Commission--it binds only the issuing
staff and not the Commission or other Commission staff. It
states that only the beneficiary may rely on the letter. See 17
CFR 140.99(a)(2).
The Rule also sets forth a host of requirements, including
that the letter will be issued in response to proposed
transactions only, and not completed transactions unless there
are extraordinary circumstances. Id. 140.99(b)(3). Staff also
will not respond to no-action requests posing hypothetical
questions. Id. The proposed beneficiary must be identified, id.
140.99(b)(4), and additional specified information must be
provided, id. 140.99(c). For the complete set of
requirements, see 17 CFR 140.99(c)-(d); see also id.
140.99(e) (concerning the form of a staff response).
Customer Protection
Question 10. Is the Commission's ability to perform adequate market
surveillance critical to protecting futures and swaps customers? Should
the CFTC's ``Customer Protection'' fund be utilized to make needed
improvements to the Commission's technological capabilities? Why or why
not?
Answer. Yes, the Commission's ability to perform adequate market
surveillance is critical to protecting futures and swaps customers, and
the effective use of technology is an essential element of adequate
market surveillance. I do not believe that the Commission has made the
necessary investments in technology to keep up with our expanded
oversight mission under the Dodd-Frank Act. The need for investments in
technology is especially highlighted by Dodd-Frank because its
provisions bring the swaps market under surveillance and regulation for
the first time.
Regarding the Customer Protection Fund, under the Dodd-Frank Act,
Congress authorized the Commission to utilize the $100 million balance
in the Customer Protection Fund for two purposes: (1) to pay
whistleblowers and (2) to educate customers. To date, we have not paid
any whistleblowers and we have spent just 1% of the fund, annually, on
customer education. Of that amount, the bulk has been spent on salary
and benefits for the Whistleblower Office and the Office of Consumer
Outreach. The next largest line item for the fund is a consultant to
identify customers that require education and training, followed by an
audit of the fund's financial statements.
Customer protection has been neglected and this area is ripe for
additional investment. I suspect that Congress had a better vision for
the Commission's customer protection efforts than what has been done
thus far.
It is clear that the Commission's capacity to use technology to
perform improved market surveillance, monitor risk, and implement tools
to enhance customer protections could be enhanced. One of the most
critical aspects of the CFTC's mission is to protect market
participants and the public from fraud, manipulation, abusive practices
and systemic risk. In order to fulfill its mission, the Commission must
have the ability to effectively conduct surveillance of the swaps and
futures markets.
The Commission is projected to return over $1.2 billion in civil
monetary penalties to the U.S. Treasury to offset the deficit since the
inception of the Fund. That $1.2 billion would have otherwise been
eligible for transfer into the Customer Protection Fund, and could have
been spent on technology investments to improve our market
surveillance.
I would encourage Congress to carefully consider if there are other
purposes for these funds that will help the Commission in its mission
to protect market users, while still maintaining adequate resources to
compensate whistleblowers.
Question 11. In light of the automated account verification system
recently implemented by NFA and CME, does the CFTC still need read-only
access to all Futures Commission Merchant customer fund accounts?
Answer. There are serious concerns in providing the Commission with
access to all FCM customer fund accounts. It is also important to keep
in mind that NFA and the Chicago Mercantile Exchange (CME) have
implemented an automated account verification system that checks the
balances in customer accounts daily, thus eliminating the need for the
Commission to duplicate this function.
The draft customer protection rule contained a proposed requirement
that all banks holding customer funds (``custodian banks'') provide the
Commission with direct access to customer account information. This
direct, read-only access to every customer account used by FCMs would
involve the sharing of all relevant account information and passwords
for each account, and new passwords every time an account password is
changed.
I have serious concerns with this requirement for two practical
reasons. First, we don't have the staffing necessary to perform the
manual checks needed to make this system an effective deterrent.
Instead, both the Commission and customers would be better served by
relying on the current, automated system implemented by NFA and CME
that provides daily verification of segregated balances at the FCM and
custodian bank.
Second, creating direct access to these accounts poses a higher
cybersecurity threat relative to ``push'' technologies currently being
utilized. This concern was raised at a TAC meeting. Moreover,
maintaining and securing all the variable passwords and account
information for every bank, FCM, and customer account would be a
daunting task.
A better approach would be to utilize the current automated system
implemented by NFA and CME and amend our regulations to require all
FCMs to only use custodian banks that agree to immediately provide
customer account information to the Commission upon request. By using
this two-pronged approach of daily automated account verification,
combined with the ability of the Commission to contact custodian banks
directly and obtain account information in an emergency, the Commission
will be able to protect customer funds in an efficient and expedient
manner.
Question 12. Is reliance on the automated verification system
utilized by CME and NFA a more secure method of accomplishing the same
ultimate goal of protecting the integrity of customer funds?
Answer. I believe the automated system established and paid for by
the market participants is a cost-effective early warning system that
can identify unexpected changes in customer account balances. If
account values change beyond a specific threshold from one day to
another, the SROs and the Commission will be alerted and will be able
to take immediate action to investigate.
Question 13. Do you think an exemption or some other form of
protection should be made for small to medium-sized futures commission
merchants pertaining to the level of excess margin required to be held
under the CFTC's proposed customer protection rule?
Answer. The residual interest proposal in the rule has caused
widespread concern within the industry. The practical effect of this
rule would require FCMs to maintain a level of excess margin so that
one customer's excess margin is never used to fund the margin shortfall
of another customer. This increased capital contribution by the FCM
will most likely be passed on to customers. Large institutional clients
are not significantly burdened by this pass-through of costs. However,
this pass-through of costs would impose serious financial constraints
on the business operations of farmers and other end-users.
The Commission needs to reconsider the residual interest proposal
to identify a process that adheres to the requirements of the CEA, yet
places the least financial burden on end-users and the smaller FCMs
that service them. It is imperative that we follow Congress' mandate
and impose the least regulatory burden on end-users as we implement the
Dodd-Frank Act.
Question 14. I find it fascinating that with all of the publicity
over the cross-border rules and Chairman Gensler's warnings about how a
failure to regulate entities in other countries would ``blow a hole in
Title VII''--that the accounts of the small farmer, farm cooperatives,
and the public municipalities were not protected. Why did any guidance
on cross-border regulation not include a solution related to how
customer accounts should be treated when a multi-national FCM, like MF
Global Inc., goes bankrupt? Or do you need a legislative solution?
Answer. I would welcome a Congressional solution to ensure that
customer accounts are protected when a multinational FCM goes bankrupt.
Without a doubt, customer protection--especially in bankruptcy--is a
major factor in cross-border regulation. Both the still-ongoing Lehman
Brothers' bankruptcy proceedings and the MF Global bankruptcy
proceedings have taken years to resolve, delaying the recovery of U.S.
customer funds. While the Dodd-Frank Act and financial reforms in other
countries were intended to reduce the likelihood of future bailouts or
failures, little has changed in the area of bankruptcy law.
Since over 90% of customer assets that are held in FCMs are held by
jointly registered and regulated broker-dealers/FCMs, I would support
increasing the authority of the CFTC in the bankruptcy proceedings for
these jointly-regulated entities. For example, in the case of MF
Global, the Securities Investor Protection Corporation (SIPC) placed
the firm into bankruptcy, with SIPC as its trustee and with the
exclusive mandate to protect securities customers. Since the interests
of futures customers may not align with securities investors, it makes
sense for the Commission to have the power to appoint its own trustee
who is familiar with the CEA.
Also, I believe Congress should pursue granting new authority to
the Commission in the U.S. Bankruptcy Code to ensure that customers are
first in order of priority in any distribution of assets of the estate
by the bankruptcy trustee--a ``super-lien'' so customers are always
first in line.
Finally, I believe Congress should carefully consider the pro-rata
distribution rules in bankruptcy proceedings, including creating the
opportunity for market participants to have the ability to establish
third-party segregation accounts that will not be comingled in
bankruptcy proceedings, as long as those market participants are
willing to pay for the costs of third-party segregation. Currently, if
there is a shortfall in segregation, customers share the loss
proportionally. This is the law, whether customer funds are held in one
account (comingled), or in a separate individual account. The
Commission has explored various options, but has been unable to change
the pro-rata requirements without statutory amendments.
End-User Issues
Question 15. In passing the Dodd-Frank Act, Congress made clear its
intent to exempt end-users from bearing the additional financial and
regulatory burdens brought on by the legislation. Keeping that intent
in mind, why has the CFTC used such a low swap dealing threshold for
Special Entities?
Answer. As I described in my testimony, I believe the Commission
failed to provide certainty to end-users because it did not faithfully
interpret both the letter and the spirit of the law to carry out
Congress' intent to exclude end-users from the swap provisions of the
Dodd-Frank Act. The Commission implemented vague rules that
inadvertently brought end-users under the swap dealer definition, which
creates uncertainty for end-users in their risk mitigation practices.
For example, it is not clear to me why only $25 million was set as
the de minimis threshold for swap dealing with Special Entities. This
low threshold has resulted in few counterparties that are willing to
trade with municipal utilities because of the concern that the
counterparties will exceed the $25 million amount and thus be forced to
register as swap dealers. Fewer potential counterparties means less
competition for business, which in turn would mean widened bid-ask
spreads. These widened spreads consequently mean greater costs for
energy end-users.
The end result would be that these increased costs are passed on to
the final energy consumers-the general public.
Question 16. Why do you think the Commission failed to completely
exclude commercial end-users from regulation even after Congress made
clear its intentions were not to regulate end-users who use swaps to
hedge or mitigate risks from their business?
Answer. As I mentioned above, the main reason why the Commission
has not excluded end-users from regulation is that it has ignored
express Congressional directives to do so. The Commission has
promulgated rules under the Dodd-Frank Act that are so broad and far-
reaching that they require end-users to comply with virtually all of
the new regulations.
In response to the outcry by end-users and Members of Congress, the
Commission has issued a series of no-action letters and exemptive
relief to alleviate some of the enormous regulatory burdens that now
face end-users. However, this patchwork of regulatory relief is
insufficient and fails to provide end-users and the market generally
with clear guidance on their regulatory obligations and the current
state of the law.
Because the Commission has failed to address this issue properly,
Congress must now correct the Commission's error and specifically
exclude end-users from the numerous regulatory burdens now imposed on
them as a result of the Commission's implementation of Dodd-Frank.
Question 17. Do you agree that forward contracts containing terms
providing some form of flexibility in delivered commodity volumes--
otherwise known as ``volumetric optionality''--should fall underneath
the scope of the forward-contract exclusion? Why or why not?
Answer. Forward contracts with volumetric optionality should be
included in the forward-contract exclusion. If the Commission fails to
do so, then Congress should amend the CEA to specifically include
volumetric options in the forward-contract exclusion from the swap
definition.
In the final swap definition rule, the Commission left open the
question whether contracts for the delivery of commodities with
variability in the delivery amount fall within the definition of a
forward contract. To determine whether a contract would qualify for the
forward-contract exclusion, the Commission set forth a complicated
seven-part test in the final rule that would call on market
participants to establish each of the seven factors in order for their
volumetric contracts to be classified as forwards.
However, the seventh factor caused a lot of anxiety among end-
users. The Commission interpreted this factor as requiring market
participants to determine whether their exercise or non-exercise of
volumetric optionality is based on factors outside their control--not
on the economics of the option itself. Quite often, one counterparty
will enter into multiple volumetric option contracts in the hopes of
securing both supply of needed resources and the best possible price.
By prohibiting counterparties from exercising these options because
they offer the best price, the Commission limits their ability to
operate their business efficiently and restrains competition in the
market place.
The Commission should amend the swap definition rule to include
volumetric options within the forward exclusion if the first six parts
of the test are met. Satisfaction of the seventh factor is not
necessary and should not be a requirement for classification as a
forward contract.
Question 18. The definition of ``financial entity'' in the
Commodity Exchange Act cross-references the banking laws and depends on
whether someone is engaged in activity that is ``financial in nature.''
In short, this definition has the potential to treat many end-users
like hedge funds in certain circumstances. Has the CFTC provided any
guidance for how the banking definition of activities that are
``financial in nature'' applies in the context of Title VII for end-
users? Is this something that Congress should address legislatively?
Answer. The Commission has addressed the conflict between the
definition of ``financial in nature'' under the banking laws and risk
management practices common to end-users in the futures and swaps
markets, such as the use of treasury affiliates, by issuing indefinite
no-action relief from the clearing requirement for swaps. This
indefinite relief, which is essentially a clearing exemption, applies
to swaps entered into solely by entities that meet the definition of
``financial in nature'' under the banking laws. The relief from the
clearing requirement has no expiration date.
This is a prime example of a final rule with unforeseen
consequences that adversely impacts end-users, but has been addressed
through indefinite no-action relief--de facto rulemaking--instead of
properly engaging in notice-and-comment rulemaking under the APA to
amend the rule.
I would encourage Congress to clarify the definition of ``financial
entity'' under the CEA and avoid any further shortcuts taken by the
Commission. Using the definition of ``financial in nature'' under the
banking laws applies unnecessary restrictions to certain end-users and
interferes with their business operations. The definition also
interferes with the Commission's mandate to ensure that the commodity
markets are liquid and promote hedging and price discovery.
As an alternative solution, section 102(a)(6) of the Dodd-Frank Act
sets forth a predominance test to determine whether or not a firm is a
``nonbank financial company.'' Title I of Dodd-Frank applies an 85%
standard for gross revenue from financial activity to determine if a
company is predominantly engaged in financial activities, and
ultimately, is a nonbank financial company. One could assume from this
test that a de minimis amount is, therefore, less than 15% of gross
revenue from non-financial activity.
Accordingly, I wonder whether the Commission should apply a similar
85/15 test as part of our de minimis exception in order to provide a
bright-line test for end-users (both commercial and non-bank financial)
to demarcate themselves from swap dealers.
Question 19. Non-deliverable forwards (NDFs) were not included when
the Treasury exempted foreign exchange swaps and forwards, under its
authority under the Dodd-Frank Act, resulting in unnecessary and costly
regulation. Do you believe the CFTC has the authority to address this
unintended consequence by issuing an exemption providing that NDFs be
treated the same as foreign exchange swaps and forwards? Should
Congress clarify its intent to include NDFs in the definition of
``foreign exchange forward''?
Answer. Due to the specific characteristics of NDFs, they remain
characterized as swaps despite their similarity to foreign exchange
forward contracts. Since the publication of the CFTC's and SEC's final
rule defining swap contracts, I have heard from numerous market
participants about the need for exemptive relief for NDF contracts.
NDFs are used by market participants as a means of mitigating
commercial and financial risk in operating in emerging markets. The
classification of NDFs as swaps creates numerous regulatory obligations
such as centralized trading, clearing, and reporting. All this adds to
the costs associated with trading contracts that are necessary for risk
mitigation purposes. At present, there are no plans by the Commission
to provide any relief for NDFs from compliance with the CEA and
Commission regulations. In light of the Commission's inaction, Congress
may be the only source of relief for market participants.
Question 20. The CFTC requirement to record phone conversations at
grain elevators that occasionally take orders from farmers who want to
hedge in the futures market has been an issue of concerned raised by
numerous commercial end-users. Based on your understanding, was this
requirement called for by the Dodd-Frank Act? If not, why did the CFTC
propose such a measure? What level of data should be collected at grain
elevators, if any? How could this data collection be required in a
manner that is not overly burdensome and costly to this sector of the
marketplace?
Answer. The Dodd-Frank Act does not require FCMs to record
telephone conversations with customers. Even though Congress did not
direct the Commission to implement such a requirement, the Commission
promulgated it at the request of DOE in order to aid in the prosecution
of future enforcement actions.
As a result of these changes, a grain elevator that also acts as an
FCM to assist its customers in risk mitigation must now integrate new
systems that will record telephone conversations with customers that
lead to the execution of a futures transaction. This requirement is
applicable, regardless of the amount of futures business conducted by
the grain elevator, and is extremely burdensome and expensive for a
small grain elevator with a very limited futures trading operation.
Unfortunately, this is another example of the Commission's failure
to heed Congress' directive to exclude end-users from the new
regulatory requirements of Dodd-Frank.
Swap Dealer Definition
Question 21. Would excluding SEF-executed trades from the de
minimis calculation help achieve Dodd-Frank's goals of encouraging
trading on SEF's and requiring clearing?
Answer. As I discussed in my testimony, excluding SEF-executed and
cleared trades from the de minimis calculation will help end-users by
providing regulatory certainty regarding the swap dealer definition and
mitigates counterparty risk.
Position Limits
Question 22. As you know, a properly functioning positions limit
regime is not only dependent on a clear understanding of deliverable
supply for a particular commodity, but also on a workable hedge
exemption process. In a stark change from historical practice, the
CFTC's approach in its since-vacated position limits rule was to limit
the availability of the bona fide hedge exemption to only a few
specific types of transactions. The result was a hedge exemption that
was nearly unworkable. Why did the Commission deviate from the
Commission's well-functioning historical approach, and does the
Commission plan on providing a more flexible hedge exemption in its
forthcoming proposed rule?
Answer. I believe that any hedge exemption must be flexible and do
a better job of understanding and acknowledging hedging activities in
today's markets. Hedging is the foundation of the swaps and futures
markets and a cornerstone of the way commercial firms run their
businesses. Because of its importance, any action the Commission takes
or considers taking must avoid hindering the hedging activities of
commercial firms.
The vacated position limits rule failed to take such risk
mitigation practices into account because its definition of hedging was
too narrow and not workable. Under the vacated rule, many commonly
understood and historically accepted hedging practices would not
qualify for the rule's hedge exemption. In order to comply with the
position limits set forth in the rule, commercial firms would have had
to potentially curtail risk-reducing transactions that are necessary
for them to run their businesses effectively. I do not believe that
this was Congress' intent.
My belief is underscored by the fact that the Commission's position
limits rule was struck down last year by the United States District
Court for the District of Columbia. The court held that before setting
position limits, the Commission is required by statute to determine
whether position limits are ``necessary and appropriate'' to prevent
excessive speculation in the commodity markets. Unfortunately, the
Commission ignored the district court order to undertake the required
analysis and is defending the position limits rule in the United States
Court of Appeals for the District of Columbia Circuit. Concurrently
with its appeal, the Commission is drafting a new rule all over again,
instead of simply evaluating the necessity for position limits, which
it should have done in the first place.
Question 23. Should Congress be more explicit in defining what
exactly constitutes a ``bona fide hedge''?
Answer. I would welcome Congressional action to clarify the
definition of a ``bona fide hedge,'' including the scope and level of
permissible hedging activity. For purposes of both simplicity and
consistency, the Commission must adopt one uniform definition of
hedging activity, and the same definition should be applied to both
swap dealers and major swap participants. Instead of providing a
bright-line test for market participants, different Commission
regulations include different definitions that apply depending on the
circumstances.
I believe Congressional action is necessary if the Commission's
upcoming position limit proposal fails again in providing a flexible
hedge exemption that allows end-users to continue to use the futures
and swaps markets to mitigate risk and effectively manage their
operations.
Question Submitted By Hon. Doug LaMalfa, a Representative in Congress
from California
Question. Some have suggested that the way to ``fix'' the special
entity sub-threshold is for the CFTC to lower the de minimis
registration threshold for the entire energy swaps marketplace to $25
million. What damage would be done to end-users, consumers, and the
marketplace by lowering the registration threshold for all energy swaps
to $25 million?
Answer. I believe that lowering the de minimis threshold for all
energy swaps to $25 million would negate the explicit Congressional
directive to exclude end-users from the new regulatory requirements of
the Dodd-Frank Act. Lowering the threshold for all energy swaps could
create additional costs and regulatory burdens for end-users.
For example, as we have seen with utility special entities, fewer
counterparties may be willing to trade energy swaps out of concern that
they will surpass the $25 million amount and be forced to register as
swap dealers. Due to the reduction of available counterparties, end-
users that trade energy swaps might pay more in bid-ask spreads and
pass the costs on to the general public.
Response from Hon. Mark P. Wetjen, Commissioner, U.S. Commodity Futures
Trading Commission
Questions Submitted By Hon. K. Michael Conaway, a Representative in
Congress from Texas
General Commission Operations
Question 1. Are there any programs or divisions of the Commission
that should be cut or consolidated?
Answer. Given the long-term fiscal challenges our country faces, it
is important that every agency of the U.S. Government, including the
U.S. Commodity Futures Trading Commission (``CFTC'' or ``Commission''),
consider ways to streamline or otherwise eliminate unnecessary costs to
the U.S. taxpayer. Although there will always be differences in opinion
based on priorities and other considerations, I believe that the
President's Budget and Performance Plan for the CFTC appropriately
takes into account our nation's fiscal challenges while seeking the
appropriate amount of resources--as well as their allocation within the
agency--for the CFTC to pursue the mission given to it by Congress.
Please see the attached ``Commodity Futures Trading Commission,
President's Budget and Performance Plan for Fiscal Year 2014,'' *
submitted to the Appropriations Committees in the U.S. House of
Representatives and U.S. Senate in April 2013. Note that the attached
Budget and Performance Plan highlights the CFTC's budgetary priorities
and recommended allocations of staff and resources for the upcoming
fiscal year.
---------------------------------------------------------------------------
* The document referred to is retained in Committee file, and can
be accessed on the CFTC's website at: http://www.cftc.gov/ssLINK/
cftcbudget2014.
Question 2. Can you please explain what ``absent objection''
currently means in the context of the issuance of a CFTC staff ``no
action'' letter, or other Commission action, and how it is used?
Answer. Please see the following description of the ``absent
objection'' process prepared by the CFTC's Office of General Counsel:
In order to explain the ``absent objection'' process at the
Commission, it is helpful to understand how business is
conducted generally at the Commission. As is the case with
other independent agencies in the federal government, the
operations of the Commission and its staff are governed by
Congressional mandate. The Commodity Exchange Act (``CEA'')
distinguishes among actions taken by the Chairman, Commission
action, and staff action.
Under CEA 2(a)(6)(A), the executive and administrative
functions of the Commission are exercised solely by the
Chairman. In carrying out these functions, the Chairman is
governed by general policies, plans, priorities, and budgets
approved by the Commission, and by such regulatory decisions,
findings, and determinations as the Commission has made. See
CEA 2(a)(6)(B).
Staff action occurs under the authority of Section 2(a)(6)
and under authority specifically delegated by the Commission.
See, e.g., 17 CFR 140.14, 140.20, 140.72-140.97 (2013). The
staff's issuance of no-action letters, interpretive letters,
and exemptive letters is authorized by Rule 140.99, 17 CFR
140.99 (2013).
Commission action is accomplished by a majority vote of the
Commissioners. See FTC v. Flotill Prods., Inc., 389 U.S. 179,
183-84 (1967) (absent a specific statutory requirement, federal
agencies follow the common law `majority of a quorum' rule).
Such action occurs in two ways: through votes held at formal
meetings, or through seriatim consideration under Rule 140.12.
See 17 CFR 140.12.
With that background, the term, absent objection, can arise
in two contexts. It usually refers to an informational
circulation to the Commission to describe action to be taken by
Commission staff. Although conducted through the Office of the
Secretariat, the process does not call for a Commission vote.
It is intended to keep the Commissioners apprised of the
staff's activities that are taking place under the Chairman's
supervision.
In addition, business may proceed on an ``absent objection''
basis at Commission meetings. If a Commissioner objects, the
matter is decided by majority vote.
As indicated above, the Commission also conducts business
through seriatim votes without holding a formal meeting. If a
Commissioner objects to seriatim consideration, the matter is
withdrawn from seriatim consideration, and is scheduled for
disposition at a Commission meeting. See 17 CFR 140.12(b).
Question 3. Is there an official legal procedure for utilizing an
``absent objection'' motion at the CFTC? Has there been a change in the
legal interpretation of what ``absent objection'' means between past
and current usage of this procedural motion for Commission business?
Answer. Please see the following description of the ``absent
objection'' process prepared by the CFTC's Office of General Counsel:
As explained above, Commission action may be taken on a
matter during formal meetings of the Commission by majority
vote or by an ``absent objection'' process. Regardless of which
way it is proceeding, each matter is considered by the
Commission pursuant to a motion made by one of the
Commissioners. Each matter typically includes a staff
memorandum to the Commission explaining the proposal under
consideration. If objection is heard to a matter presented by
an ``absent objection'' motion, the matter becomes subject to
disposition by majority vote.
With respect to staff business that proceeds on an ``absent
objection'' basis, as described in response to Question 2
above, the procedure is to circulate informational memoranda so
that the Commissioners may be informed of a staff action and
the Chairman may be informed of any Commissioner's objection to
the planned staff action. If there are such objections, the
Chairman may choose to withhold such staff action.
The CFTC and its Office of the General Counsel have
consistently interpreted these terms in this way.
Question 4. Procedurally, I understand that a 2-2 Commission vote
prevents an order from being issued, yet a 3-1 vote is required to stop
an ``absent objection'' motion? Why?
Answer. Please see the following description of the ``absent
objection'' process prepared by the CFTC's Office of General Counsel:
With respect to an ``absent objection'' motion at a formal
meeting, if an objection is heard, the matter becomes subject
to disposition by majority vote.
With respect to staff action circulated ``absent objection,''
unless a statute or prior Commission order requires otherwise,
the Chairman's prerogative as staff director controls, and he
may, in his discretion, direct a different course preferred by
fellow Commissioners.
As mentioned above, Commission action is accomplished by a
majority vote of the Commissioners. See FTC v. Flotill Prods.,
Inc., 389 U.S. 179, 183-84 (1967). A 2-2 vote is sufficient to
stop such action.
Question 5. Do you think it is appropriate for CFTC staff to be
given the power to unilaterally initiate investigations, without the
opportunity for the CFTC Commissioners to provide a check on that
power?
Answer. In answering this question, it is important to distinguish
between (1) the power of CFTC staff to initiate investigations and (2)
the power of CFTC staff to compel testimony or the production of
documents as part of an investigation. The CFTC's Division of
Enforcement has broad, delegated authority to initiate investigations
and obtain certain evidence through voluntary statements and
submissions. See CFTC Rule 11.2(a). However, CFTC Rules 11.2(a) and
11.4(a) require that any exercise of delegated subpoena power by the
CFTC's staff be granted by a formal order of the Commission. Given the
importance of the CFTC's enforcement mission to protect the public,
this longstanding investigatory authority delegated to staff is
appropriate so long as the checks on that authority remain in place.
For additional information, please see the following description of
the CFTC's investigative authority prepared by the CFTC's Office of
General Counsel in consultation with the CFTC's Division of
Enforcement:
[T]he Commission's current procedure and practice for
investigations promotes the efficient and effective use of
Commission resources, while including measures to safeguard the
Commission's oversight responsibility.
The Commission's authority to conduct investigations is
broad. The Supreme Court has held that administrative agencies
have the authority to ``[i]nvestigate merely on suspicion that
the law is being violated, or even just because it wants
assurance that it is not.'' United States v. Morton Salt Co.,
338 U.S. 632, 642-43 (1950); see CFTC v. McGraw-Hill Cos., 390
F.Supp.2d 27, 33 (D.D.C. 2005)(same).
In 1976 the Commission delegated to the Director of its
Division of Enforcement, and to the Directors of the
Commission's other operating divisions, the authority to
conduct investigations and make recommendations to the
Commission therefrom. CFTC Rules Relating to Investigations, 41
Fed. Reg. 29798 (July 19, 1976) (adopting Part 11 to the
Commission's Rules, including Rule 11.2 (Authority to conduct
investigations)). The purpose of an enforcement investigation
is to discover the facts so that the Commission may determine
whether it is necessary or appropriate to institute an
enforcement action or take other preventive, remedial or
punitive action. Id.
Over the past 4 fiscal years, the Commission's Division of
Enforcement has opened more than 1,500 investigations of
potential violations of the Commodity Exchange Act or
Commission Regulations. Requiring Commission review and
approval for each investigation would reverse a nearly 40-year-
old Commission delegation that has worked well, cause an undue
burden on the Commission's resources and stifle the
effectiveness of its enforcement program.
The Division of Enforcement provides the Commissioners with
regular briefings regarding the status of significant
investigations. Further, Commissioners regularly request and
receive updates from the Division of Enforcement regarding the
status of investigations of particular interest. In the course
of an investigation, the Division of Enforcement may seek
authorization from the Commission to compel production of
records and or testimony through Commission order authorizing
issuance of subpoenas.
Also, while the Division of Enforcement may make a
recommendation based upon its investigation, the Commission has
the sole authority to make the determination as to whether or
not to file an enforcement action.
Question 6. Per Commission regulations, what is an ``omnibus
order''? What is the permissible scope of an ``omnibus order'' granting
subpoena power to CFTC staff, and how long should such an order be
effective? If the order has an indefinite duration, would it be binding
on a future Commission?
Answer. The authorization to issue subpoenas directed at a number
of persons within a particular subject matter area, as opposed to a
particular person, is commonly referred to as an ``omnibus'' order. The
primary difference between an ``ordinary'' investigative order and an
omnibus order is that the latter is not limited in scope to a
particular person; it is, however, normally time-limited (although some
have been re-extended). CFTC Rule 11.4(b) requires any CFTC order
authorizing staff to issue subpoenas in the course of a particular
investigation to include (1) a general description of the scope of the
investigation; (2) the authority under which the investigation is being
conducted; and (3) a designation of the members of the Commission or of
its staff authorized by the Commission to issue subpoenas.
The CFTC has issued omnibus orders to investigate the proliferation
of fraud in particular areas for over a decade. For example, on
December 13, 1999, the CFTC issued an omnibus order to investigate
certain entities suspected of engaging in the fraudulent marketing and
promotion of Internet-based commodity trading advisory systems and
services. Similarly, on January 21, 2001, the CFTC approved an omnibus
order to investigate suspected fraud in retail foreign currency
exchange (``forex'') transactions following enactment of the Commodity
Futures Modernization Act of 2000, which expanded the CFTC's
jurisdiction over the forex market. Following these two orders, the
CFTC issued an omnibus order on September 22, 2008 as part of its
National Crude Oil investigation.
The CFTC's Division of Enforcement continues to rely upon targeted
and time-limited omnibus orders in appropriate cases, and these orders
are generally consistent with prior CFTC practice. For example, in
January 2009, the CFTC issued an omnibus order to investigate a number
of suspected Ponzi-schemes and other types of fraud relating to pooled
and managed investment vehicles. That order was initially approved for
a 3 month period, and the CFTC subsequently re-issued it for several
additional 6 month periods of time.
Following enactment of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (``Dodd-Frank Act''), the CFTC unanimously
approved a 6 month omnibus order on November 15, 2011 covering unlawful
retail commodity transactions in response to a proliferation of
precious metals-related schemes. The CFTC has periodically and
unanimously re-issued that order for 6 month periods of time. In
response to patterns of illegal activity in certain areas, the CFTC
also has approved time-limited omnibus orders to investigate, among
other things, deceptive advertising related to forex accounts, customer
segregation and minimum net capital requirements, and exchanges-for-
related-positions.
Since I joined the CFTC in October 2011, the CFTC has approved five
omnibus orders through ten individual votes to either initially issue
or re-issue existing omnibus orders. Of those votes, only one did not
enjoy bipartisan support, and only two were not unanimous votes of the
Commission. During that same timeframe, dozens of formal orders of
investigation have been approved in response to requests by the CFTC's
Division of Enforcement.
The policy rationale for authorizing omnibus orders in limited
circumstances is the need for the CFTC's staff to respond rapidly to
suspected fraud and market abuses. In certain circumstances, for
example in cases involving fraud on retail customers, evidence might be
particularly prone to disappear quickly. Moreover, as noted in the
excerpted response below, omnibus orders often permit the CFTC's
Division of Enforcement to freeze assets belonging to customers,
preserve books and records, or coordinate the expedited filing of
related actions in cooperation with other civil or criminal
authorities.
But there remain important limits on the authority provided by an
omnibus order. The CFTC's orders authorizing the issuance of subpoenas
can be used only during the course of the subject investigation. The
CFTC's staff may issue subpoenas in a matter ``covered'' by an approved
CFTC order until the Division of Enforcement concludes the
investigation, and the CFTC may amend or withdraw an omnibus order at
any time prior to the approved expiration of the order.
Please also see the following description of the CFTC's
investigative authority prepared by the CFTC's Office of General
Counsel in consultation with the CFTC's Division of Enforcement:
The Commission's Division of Enforcement has the delegated
authority to conduct investigations of suspected or alleged
violations of the Commodity Exchange Act and Commission
Regulations. The Division of Enforcement has broad powers to
conduct such investigations. These investigative powers include
obtaining evidence through voluntary statements and
submissions, and inspections of boards of trade, reporting
traders, and persons required by law to register with the
Commission. If enforcement staff believes that it is necessary
to compel testimony or the production of documents, it may
request, pursuant to Commission regulation 11.4, that the
Commission issue an order authorizing issuance of subpoenas,
which provides staff with the authority to issue administrative
subpoenas to compel production of records and/or testimony.
These Commission orders are generally referred to as formal
orders of investigation.
Commission orders authorizing issuance of subpoenas provide a
general description of the scope of the investigation, the
authority under which the investigation is being conducted, and
designates the individuals authorized to issue subpoenas. The
scope of the investigation subject to such an order may be
directed at compelling information and testimony concerning a
particular entity's course of conduct or to a particular
subject matter area.
Authorization to issue subpoenas directed at a particular
subject area is commonly referred to as an omnibus formal
order. For example, the Commission has issued omnibus orders in
response to the number of swindles targeting the retail public
through the use of Ponzi schemes. At times, CFTC investigations
require quick enforcement action to freeze assets belonging to
customers, preserve books and records and, sometimes,
coordinate the expedited filing of related actions in
cooperation with other civil or criminal authorities. The
Commission's omnibus formal orders have been instrumental in
meeting these compressed timelines, particularly in cases
involving ongoing fraud. Similarly, in other cases, access to
omnibus subpoena authority has allowed the Division to
expeditiously proceed with investigations and conserve
resources by eliminating the need to draft and submit for
Commission approval separate formal orders for each entity
subject to investigation of the same subject matter. The
omnibus order will be attached to new matters (``covered
matters'') that involve the same subject matter or violation.
With respect to permissible time periods, Commission orders
authorizing issuance of subpoenas can be used during the course
of the subject investigation. What this means is that once an
order is approved by the Commission, including so-called
omnibus orders, staff may issue subpoenas in the covered matter
until the Division concludes the investigation, unless
otherwise ordered by the Commission. Separately, in certain
omnibus orders the Commission has specified a time period
during which the Division of Enforcement can attach new covered
matters. Those omnibus orders have also required that the
Division of identify and report to the Commission with
specificity all of the covered matters attached to the omnibus
order.
In comparison to the Commission's approach of using targeted
and time-limited omnibus formal orders, several other agencies
have made complete, unencumbered delegations of subpoena
authority to their staff. Such delegations of authority have
been made by the: U.S. Securities and Exchange Commission;
Civil Divisions of the Department of Justice and U.S. Attorneys
offices; Federal Trade Commission; and United States Department
of Agriculture, Packers and Stockyards Division.
Question 7. What is the legal justification for the Commission
issuing a final ``exemptive order'' without prior notice-and-comment
periods? Does this place Commission actions on questionable legal
ground from a compliance standpoint with the Administrative Procedures
Act?
Answer. The legal justification for issuing a final exemptive order
without prior notice and comment provided by the CFTC's Office of
General Counsel is as follows:
The APA empowers an agency to proceed without notice and
comment for good cause. See 5 U.S.C. 553. The Commission has
interpreted CEA Section 4(c), which authorizes the Commission
to grant exemptive relief, to incorporate the APA's
requirements, including the good cause exception. The
Commission's view is that Congress did not intend that the
Commission can impose requirements on market participants
without notice and comment when there is good cause, but may
not exempt market participants when the public interest
dictates, or other good cause exists, without first allowing a
comment period.
In addition, the preambles of CFTC rules and orders provide the
legal rationale for the CFTC's regulatory actions and, where
appropriate, how those actions comply with the APA. For example, since
joining the CFTC, I have supported two CFTC actions that became
effective prior to the completion of the notice-and-comment periods set
forth in the interim final rule and order, respectively. In both cases,
the CFTC provided a legal rationale and sought to address exigent
circumstances that it believed presented considerable challenges for
certain market participants seeking to comply with applicable law. The
CFTC was advised in each case that it was acting consistent with
statutory requirements under the CEA and APA.
For these reasons, and because relief was being provided through
the CFTC action (rather than new or additional compliance burdens), I
voted in favor of these interim actions.
Question 8. After the ``post hoc'' comment period has closed for
some exemptive orders, will the Commission allow revisions to be made
based on issues raised by the public comments?
Answer. The CFTC is carefully considering public comments and
remains open to revisions, as appropriate. The CFTC's Office of General
Counsel advises that ``[i]n its informed discretion, the Commission may
vote to allow such revisions.''
Question 9. Are there written rules or policy guidelines on how the
CFTC is to use the ``no action'' letter process? If not, does the
Administrative Procedures Act govern the use or issuance of staff ``no
action'' letters?
Answer. Please see the following response prepared by the CFTC's
Office of General Counsel:
CFTC Rule 140.99 sets forth the parameters. It states that a
CFTC staff no-action letter is ``a written statement by the
staff of a Division of the Commission or of the Office of the
General Counsel that it will not recommend enforcement action
to the Commission for failure to comply with a specific
provision of the [CEA] or of a Commission rule, regulation or
order if a proposed transaction is completed or a proposed
activity is conducted by'' the beneficiary of the letter. The
Rule states that the no-action letter represents the views of
the Division that issued it or the Office of General Counsel
and does not bind the Commission--it binds only the issuing
staff and not the Commission or other Commission staff. It
states that only the beneficiary may rely on the letter. See 17
CFR 140.99(a)(2).
The Rule also sets forth a host of requirements, including
that the letter will be issued in response to proposed
transactions only, and not completed transactions unless there
are extraordinary circumstances. Id. 140.99(b)(3). Staff also
will not respond to no-action requests posing hypothetical
questions. Id. The proposed beneficiary must be identified, id.
140.99(b)(4), and additional specified information must be
provided, id. 140.99(c). For the complete set of
requirements, see 17 CFR 140.99(c)-(d); see also id.
140.99(e) (concerning the form of a staff response).
Customer Protection
Question 10a. Is the Commission's ability to perform adequate
market surveillance critical to protecting futures and swaps customers?
Answer. Yes. The primary mission of the CFTC is to protect market
users, consumers and the public at large from (1) fraud, manipulation,
and other abusive practices, and (2) systemic risk, related derivatives
that are subject to the Commodity Exchange Act, as well as foster open,
transparent, competitive, and financially sound markets. Congress
established the CFTC for these purposes, among others, in 1974. The
CFTC's market-surveillance program is crucial to accomplishing that
mission.
For additional information, please see the attached ``Commodity
Futures Trading Commission, President's Budget and Performance Plan for
Fiscal Year 2014,'' * submitted to the Appropriations Committees in the
U.S. House of Representatives and U.S. Senate in April 2013 for a
further description of the CFTC's surveillance program and resource
allocations.
---------------------------------------------------------------------------
* The document referred to is retained in Committee file, and can
be accessed on the CFTC's website at: http://www.cftc.gov/ssLINK/
cftcbudget2014.
Question 10b. Should the CFTC's ``Customer Protection'' fund be
utilized to make needed improvements to the Commission's technological
capabilities? Why or why not?
Answer. The CFTC continues to evaluate the funds necessary to
support the whistleblower and investor education programs based upon,
among other things, the actual number of tips received and resulting
investigations. The CFTC anticipates a number of claims will be paid to
eligible whistleblowers in the upcoming fiscal year, providing a basis
for estimating future spending on such programs.
Please see a recent balance of the CFTC's Customer Protection Fund,
below:
------------------------------------------------------------------------
FY 2013
Projected Actual FY 2014 Estimate FY 2015 Estimate
$000 $000 $000
------------------------------------------------------------------------
Budget 100,040 100,000 100,000
Authority--Pri
or Year
Budget 1,210 12,250 13,750
Authority--New
Year
--------------------------------------------------------
Total Budget 101,250 112,250 113,750
Authority
--------------------------------------------------------
Whistleblower 750 750 750
Program
Whistleblower -- 10,000 10,000
Awards
Customer 500 1,500 3,000
Education
Program
--------------------------------------------------------
Total Planned 1,250 12,250 13,750
Expenditures
========================================================
Unobligated 100,000 100,000 100,000
Balance
------------------------------------------------------------------------
Although the present unobligated balance in the CFTC Customer
Protection Fund could be sufficient to cover anticipated whistleblower
complaints and investor outreach efforts, the present statutory and
regulatory obligations relating to whistleblower compensation
potentially could require the CFTC to seek to transfer or re-program
monies to cover any shortfalls resulting from reallocation of such
funds to technology spending.
For additional information, please see the attached ``Commodity
Futures Trading Commission, President's Budget and Performance Plan for
Fiscal Year 2014,'' * submitted to the Appropriations Committees in the
U.S. House of Representatives and U.S. Senate in April 2013.
Question 11. In light of the automated account verification system
recently implemented by NFA and CME, does the CFTC still need read-only
access to all Futures Commission Merchant customer fund accounts?
Answer. The CFTC continues to consider whether read-only access is
necessary in light of recent NFA and CME customer-protection
initiatives and the CFTC's recent proposed rulemaking. See 77 Fed. Reg.
67866, Enhancing Protections Afforded Customers and Customer Funds Held
by Futures Commission Merchants and Derivatives Clearing Organizations;
Proposed Rule (Nov. 14, 2012) (seeking comment on the following
questions concerning read-only access: What technology issues are
raised by the Commission's proposal? How can the Commission adequately
address such technology issues? What account information can
depositories currently provide to the Commission and to DSROs via the
Internet on a read-only basis? Do all depositories (e.g., banks, trust
companies, derivatives clearing organizations, or other FCMs) have the
capability of using the Internet to provide account access to the
Commission and DSROs? Are there other options for depositories to
provide read-only access to FCM accounts other than the Internet? How
should the Commission implement this requirement? What timeframe would
be appropriate to make the requirement effective?). The CFTC is
carefully considering public comments on read-only access to FCM
accounts and remains open to revising the customer protection proposal,
as appropriate.
Question 12. Is reliance on the automated verification system
utilized by CME and NFA a more secure method of accomplishing the same
ultimate goal of protecting the integrity of customer funds?
Answer. The automated verification system utilized by CME and NFA
is operated and maintained by a third-party with whom the CFTC does not
have a contractual relationship. The CFTC is carefully considering
public comments on read-only access to FCM accounts, as noted above,
and remains open to revising its customer protection proposal, as
appropriate. Depending on revisions to the final rules, the automated
verification system could be a complementary or alternative means of
protecting customers and ensuring compliance with applicable customer
funds regulations.
Question 13. Do you think an exemption or some other form of
protection should be made for small to medium-sized futures commission
merchants pertaining to the level of excess margin required to be held
under the CFTC's proposed customer protection rule?
Answer. The CFTC is carefully considering public comments on its
excess margin requirements and remains open to revisions to its
customer protection proposal, as appropriate. Any determination related
to futures commission merchant margin requirements should take into
account the competing interests of providing the appropriate
protections for FCM customers and maintaining cost-effective access to
the markets for those customers.
Question 14. I find it fascinating that with all of the publicity
over the cross-border rules and Chairman Gensler's warnings about how a
failure to regulate entities in other countries would ``blow a hole in
Title VII''--that the accounts of the small farmer, farm cooperatives,
and the public municipalities were not protected. Why did any guidance
on cross-border regulation not include a solution related to how
customer accounts should be treated when a multi-national FCM, like MF
Global Inc., goes bankrupt? Or do you need a legislative solution?
Answer. The CFTC's proposed customer protection rule is intended to
provide greater protection to customers who trade on foreign markets
through FCMs. First, the proposal would require an FCM to hold
sufficient funds in segregated accounts to repay the full account
balances of every customer trading on foreign markets (this would
provide the customers with comparable protections to customers trading
on CFTC designated contract markets). Second, the proposal would limit
the amount of customer funds that an FCM may deposit with foreign
depositories for trading on foreign markets to the amount of margin
required on such foreign positions plus a 20 percent cushion. The 20
percent cushion is intended to provide a margin buffer to better ensure
that an FCM has sufficient funds to meet daily margin obligations at
foreign brokers and clearing organizations and acknowledges the time-
zone differences that would prevent an FCM from doing real-time funding
of foreign trading.
The CFTC is carefully considering public comments on its customer
protections proposal and remains open to revisions, as appropriate.
End-User Issues
Question 15. In passing the Dodd-Frank Act, Congress made clear its
intent to exempt end-users from bearing the additional financial and
regulatory burdens brought on by the legislation. Keeping that intent
in mind, why has the CFTC used such a low swap dealing threshold for
Special Entities?
Answer. The CFTC sought to address Congressional concerns that
pension plans, governmental investors, and charitable endowments were
provided insufficient disclosures with respect to certain swaps and
security-based swaps entered into with more sophisticated market
participants. See Senate Congressional Record on July 15, 2010 at
S5903-04. The Dodd-Frank Act, in fact, provided certain ``special
entities,'' defined in the Act, with additional protections from market
practices that were viewed by some in Congress as increasing the risks
faced by these entities in using swaps to manage financial risks.
Accordingly, under the CFTC's final rules, persons dealing swaps to
``special entities'' must register as swap dealers if their dealing
activities individually exceed a sub-threshold of $25 million of
aggregate gross notional value in a particular 1 year period.
Currently, the Commission is considering a petition from certain
electric public utility providers seeking to be excluded from the
special entity de minimis threshold based upon liquidity and other
concerns. In the interim, the CFTC's staff has issued no-action relief
increasing the registration threshold for entities dealing to utility
special entities, subject to certain conditions. However, please note
that the term ``special entity'' is defined in Section 4s(h)(2)(C) of
the Commodity Exchange Act as a Federal agency; a State, State agency,
city, county, municipality, or other political subdivision of a State;
an employee benefit plan; a governmental plan; or an endowment,
including an endowment. See 77 Fed. Reg. 30708 (May 23, 2012).
Question 16. Why do you think the Commission failed to completely
exclude commercial end-users from regulation even after Congress made
clear its intentions were not to regulate end-users who use swaps to
hedge or mitigate risks from their business?
Answer. It is clear that in the Dodd-Frank Act, Congress intended
to protect the risk-management activities of commercial firms. Since I
joined the CFTC, the CFTC has proposed or finalized rules that, among
other things, exempt agricultural and other end-users from the Dodd-
Frank Act's clearing mandate, prevent certain inter-affiliate swaps
from having to be cleared, and exclude non-financial end-users from
having to post margin on uncleared swaps. See, e.g., End-User Exception
to the Clearing Requirement for Swaps, 77 Fed. Reg. 42559 (July 19,
2012); Clearing Exemption for Swaps Between Certain Affiliated
Entities, 78 Fed. Reg. 21749 (Apr. 11, 2013); Margin Requirements for
Uncleared Swaps for Swap Dealers and Major Swap Participants: Proposed
Rule, 76 Fed. Reg. 23732 (Apr. 28, 2011). In addition, the entities
definitions rule in appropriate cases excludes hedging from those
activities that could trigger registration, and the product definitions
rule excludes from the term ``swap'' a number of instruments used and
relied upon by the end-user community to manage risk. See Further
Definition of ``Swap Dealer,'' ``Security-Based Swap Dealer,'' ``Major
Swap Participant,'' ``Major Security-Based Swap Participant,'' and
``Eligible Contract Participant,'' 77 Fed. Reg. 30596 (May 23, 2012);
see also Further Definition of ``Swap,'' ``Security-Based Swap,'' and
``Security-Based Swap Agreement''; Mixed Swaps; Security-Based Swap
Agreement record-keeping, 77 Fed. Reg. 48207 (August 13, 2012).
Rulemaking, like legislating, requires balancing competing
interests. On occasion, there is tension between the regulatory
interests embodied in the Dodd-Frank Act itself, such as when steps to
reduce the overall risk in the financial system may decrease liquidity
and thus make it more difficult for some commercial end-users to manage
their risks. Other times, the legitimate interests of different types
of market participants are in conflict.
It is incumbent upon the CFTC to consider thoughtfully the
interests affected by, and the consequences of, the policies that we
adopt. Since I joined the commission, I believe the CFTC's rules have
been informed by an ongoing dialogue with members of the end-user
community, some of whom have issues that are relatively new to the CFTC
and its staff. As a result, the CFTC must, and I intend to, continue to
constructively engage with end-users to gain a sufficient understanding
of how their trading activities are impacted by the CFTC's rules.
Question 17. Do you agree that forward contracts containing terms
providing some form of flexibility in delivered commodity volumes--
otherwise known as ``volumetric optionality''--should fall underneath
the scope of the forward-contract exclusion? Why or why not?
Answer. Forward contracts with embedded volumetric optionality
serve an important risk-management function for commercial end-users.
On July 10, 2012, the CFTC adopted an interim-final rule defining
``swap'' that provided further guidance concerning forwards with
embedded volumetric optionality. Under the CFTC's interpretation,
volumetric options meeting a seven-part test may qualify for the
forward contract exclusion from the term ``swap.''
During consideration of this rule, I expressed concerns that the
seven-factor test could unnecessarily complicate commercial practices
that Congress did not intend to bring under the umbrella of the Dodd-
Frank Act. In response to my concerns, the interim-final rule sought
additional public comment on the seven-part-test. The CFTC is presently
considering public comments and assessing whether changes to the CFTC's
guidance should be proposed in the near future.
Question 18. The definition of ``financial entity'' in the
Commodity Exchange Act cross-references the banking laws and depends on
whether someone is engaged in activity that is ``financial in nature.''
In short, this definition has the potential to treat many end-users
like hedge funds in certain circumstances. Has the CFTC provided any
guidance for how the banking definition of activities that are
``financial in nature'' applies in the context of Title VII for end-
users? Is this something that Congress should address legislatively?
Answer. Congress defined ``financial entity'' in CEA section
2(h)(7)(C) in part by referring to two provisions that appear in the
banking laws. Specifically, the definition refers to ``a person
predominantly engaged in activities that are in the business of
banking,'' a term of art found in the National Bank Act that is within
the jurisdiction of the Office of the Comptroller of the Currency
(``OCC''), ``or in activities that are financial in nature, as defined
in Section 4(k) of the Bank Holding Company Act of 1956,'' which is
within the jurisdiction of the Board of Governors of the Federal
Reserve System (``Federal Reserve'').
As noted in the CFTC's final rule regarding the End-User Exception
to the Clearing Requirement for Swaps, 77 Fed. Reg. 42559 (July 19,
2012), these provisions are subject to interpretation by the OCC and
the Federal Reserve, respectively. Indeed, the CFTC referred to such an
interpretation in footnote 12 of CFTC Letter No. 13-22 dated June 4,
2013, stating that for the purpose of such letter, market participants
may look to the Federal Reserve's final rule defining ``Predominantly
Engaged In Financial Activities,'' 78 Fed. Reg. 20756 (Apr. 5, 2013),
in determining whether they are ``predominantly engaged in financial
activities.'' As with any request from the public for guidance, the
CFTC should thoughtfully consider and respond where appropriate to any
request from a market participant who seeks guidance on whether they
fall under the definition of ``financial entity.''
Question 19. Non-deliverable forwards (NDFs) were not included when
the Treasury exempted foreign exchange swaps and forwards, under its
authority under the Dodd-Frank Act, resulting in unnecessary and costly
regulation. Do you believe the CFTC has the authority to address this
unintended consequence by issuing an exemption providing that NDFs be
treated the same as foreign exchange swaps and forwards? Should
Congress clarify its intent to include NDFs in the definition of
``foreign exchange forward''?
Answer. The CEA, as amended by Title VII of the Dodd-Frank Act,
authorizes the Secretary of the U.S. Department of the Treasury to
issue a written determination that foreign exchange swaps, foreign
exchange forwards, or both, should not be regulated as ``swaps'' under
the CEA. Pursuant to that authority, the Secretary issued a final
determination that exempts both foreign exchange swaps and foreign
exchange forwards from certain regulations applicable to ``swaps.'' See
Determination of Foreign Exchange Swaps and Foreign Exchange Forwards
Under the Commodity Exchange Act, Final Determination, 77 Fed. Reg. 224
(Nov. 20, 2012). The Secretary's final determination acknowledged that
this authority was constrained by the CEA's definition of foreign
exchange swaps and forwards, which by statute must involve the
``exchange of 2 different currencies.''
In addition, on August 13, 2012, the CFTC published the final rule
providing guidance on the scope of and further defining the term
``swap.'' See Further Definition of ``Swap,'' ``Security-Based Swap,''
and ``Security-Based Swap Agreement''; Mixed Swaps; Security-Based Swap
Agreement record-keeping, 77 Fed. Reg. 48207 (Aug. 13, 2012). In that
release, the CFTC stated the following:
NDFs are not expressly enumerated in the swap definition, but
. . . they satisfy clause (A)(iii) of the swap definition
because they provide for a future (executory) payment based on
an exchange rate, which is an ``interest or other rate[]''
within the meaning of clause (A)(iii). Each party to an NDF
transfers to its counterparty the risk of the exchange rate
moving against the counterparty, thus satisfying the
requirement that there be a transfer of financial risk
associated with a future change in rate. This financial risk
transfer in the context of an NDF is not accompanied by a
transfer of an ownership interest in any asset or liability.
Thus, an NDF is a swap under clause (A)(iii) of the swap
definition.
Id at 48254-55. The CFTC also noted that ``at least some market
participants view NDFs as swaps today, and thus NDFs also may fall
within clause (A)(iv) of the swap definition as `an agreement,
contract, or transaction that is, or in the future becomes, commonly
known to the trade as a swap.'' Id. See also CEA section 1a(47)(A)(iv)
of the CEA, 7 U.S.C. 1a(47)(A)(iv).
The CFTC has not to date, however, subjected NDFs to a mandatory
clearing determination. As such, market participants that utilize NDFs
are not subject to certain regulatory obligations that otherwise would
accompany a mandatory clearing determination.
In its final rulemaking, the CFTC also noted that one ``commenter's
request that the CFTC exempt NDFs from the swap definition using its
exemptive authority under section 4(c) of the CEA, 7 U.S.C. 6(c) . . .
with respect to NDFs, is beyond the scope of this rulemaking.'' Id. at
48256. Based on CEA section 4(c), which provides the CFTC with
exemptive authority, it is unclear whether the CFTC has the authority
to issue an exemption providing that NDFs be treated the same as
foreign exchange swaps and forwards.
Question 20. The CFTC requirement to record phone conversations at
grain elevators that occasionally take orders from farmers who want to
hedge in the futures market has been an issue of concerned raised by
numerous commercial end-users. Based on your understanding, was this
requirement called for by the Dodd-Frank Act? If not, why did the CFTC
propose such a measure? What level of data should be collected at grain
elevators, if any? How could this data collection be required in a
manner that is not overly burdensome and costly to this sector of the
marketplace?
Answer. There is no specific CFTC requirement for telephone
conversations to be recorded at grain elevators that occasionally take
orders from farmers who want to hedge in the futures market. CFTC Rule
1.35(a), as proposed, would have required members of a designated
contract market (``DCM'') or swap execution facility (``SEF'') to
record all oral communications that lead to the execution of a
transaction in a cash commodity. The CFTC received numerous comments
about the effect of such a requirement on members of the agricultural
community that trade in cash commodities and are not required to be
registered with the CFTC other than, in some cases, as floor traders.
In response to those comments, the CFTC adopted modifications designed
to preserve the rule's purpose without adversely affecting the
agricultural community.
Accordingly, only those oral communications that lead to a
transaction in a commodity interest (i.e., a commodity futures
contract, commodity option contract, foreign exchange contract, or
swap) will have to be recorded. Furthermore, only futures commission
merchants, certain introducing brokers, retail foreign exchange
dealers, and those members of a DCM or SEF who are registered or
required to be registered with the CFTC (except for floor traders,
commodity pool operators, swap dealers, major swap participants, and
floor brokers who trade for themselves) will have to record oral
communications. To the extent a grain elevator is required to record
its oral communications, that requirement only arises because of its
registration status and the type of transactions it is entering into,
namely commodity-interest transactions. CFTC Rule 1.35(a) was amended
in this way to conform it to the record-keeping requirements for swap
dealers and major swap participants that were required under new
Section 4s of the Commodity Exchange Act and Part 23 of the
Commission's Regulations.
Swap Dealer Definition
Question 21. Would excluding SEF-executed trades from the de
minimis calculation help achieve Dodd-Frank's goals of encouraging
trading on SEF's and requiring clearing?
Answer. Excluding SEF-executed trades from the de minimis
calculation would seem to incentivize market participants to trade on
SEFs, absent other countervailing market or commercial considerations.
However, in its rulemaking defining ``swap dealers,'' the CFTC
determined that exempting all such trading activity would be
potentially inconsistent with Congress' intent in requiring
registration and regulation of persons engaging more than a de minimis
amount of swap dealing activity. The inclusion of a particular trade in
the de minimis calculation for purposes of determining whether a person
must register as a ``swap dealer'' depends not on the venue in which
the transaction occurs but on the nature of the activity. Trading,
speculative, and hedging activities in many cases do not count towards
the de minimis calculation whether or not they are conducted on a
regulated platform.
Position Limits
Question 22. As you know, a properly functioning positions limit
regime is not only dependent on a clear understanding of deliverable
supply for a particular commodity, but also on a workable hedge
exemption process. In a stark change from historical practice, the
CFTC's approach in its since-vacated position limits rule was to limit
the availability of the bona fide hedge exemption to only a few
specific types of transactions. The result was a hedge exemption that
was nearly unworkable. Why did the Commission deviate from the
Commission's well-functioning historical approach, and does the
Commission plan on providing a more flexible hedge exemption in its
forthcoming proposed rule?
Answer. The referenced CFTC final rule and interim final rule for
``Position Limits on Futures and Swaps,'' 76 Fed. Reg. 71626 (Nov. 18,
2011), was adopted by the CFTC prior to my confirmation. The CFTC is
presently considering a re-proposal of that final rule and is seeking
comment on all aspects of the re-proposal, including the scope and
availability of enumerated and non-enumerated hedge exemptions.
The CFTC will carefully consider public comments on this aspect of
the re-proposal with the goal of adopting a workable position limits
regime that protects legitimate hedging activities and prevents
excessive speculation in subject commodities.
Question 23. Should Congress be more explicit in defining what
exactly constitutes a ``bona fide hedge''?
Answer. Definitions of ``hedging'' and ``bona fide hedging'' must
be tailored to their particular regulatory purposes. A single statutory
definition of ``hedging'' or ``bona fide'' hedging could be over-
inclusive for certain purposes and under-inclusive for others. In the
context of the end-user exception, for example, the CFTC gave effect to
Congressional intent by merely requiring that swaps be ``economically
appropriate'' to the reduction of commercial risk, which is broadly
defined as including the risk of the potential change in value of
assets, liabilities, or services, including change resulting from a
change in interest rates, currency or FX movements, and including
anticipated assets and liabilities. ``Hedging or mitigating commercial
risk'' therefore broadly includes ``bona fide hedging'' and any
position that counts as a hedge for accounting purposes, for example.
However, in the position limits context, this conceptualization and
broad definition of ``hedging'' could actually undermine Congressional
objectives to curb excessive speculation in energy markets. The CFTC
has previously stated its view that Congress intended the use of the
term ``bona fide hedging'' in this context to set forth a relatively
narrow exclusion from ``speculative'' positions that generally
contemplates a substitute for transactions or positions (interpreted as
physical positions) taken or intended to be taken in the future.
Question Submitted By Hon. Doug LaMalfa, a Representative in Congress
from California
Question. Some have suggested that the way to ``fix'' the special
entity sub-threshold is for the CFTC to lower the de minimis
registration threshold for the entire energy swaps marketplace to $25
million. What damage would be done to end-users, consumers, and the
marketplace by lowering the registration threshold for all energy swaps
to $25 million?
Answer. As discussed in response to Question 15, above, the CFTC
sought to address Congressional concerns that pension plans,
governmental investors, and charitable endowments were provided
insufficient disclosures with respect to certain swaps and security-
based swaps entered into with more sophisticated market participants.
See Senate Congressional Record on July 15, 2010 at S5903-04. The Dodd-
Frank Act, in fact, provided certain ``special entities,'' defined in
the Act, with additional protections from market practices that were
viewed by some in Congress as increasing the risks faced by these
entities in using swaps to manage financial risks. Accordingly, under
the CFTC's final rules, persons dealing swaps to ``special entities''
must register as swap dealers if their dealing activities individually
exceed a sub-threshold of $25 million of aggregate gross notional value
in a particular 1 year period.
These regulatory interests, and the Congressional intent behind
creation of the ``special entities'' category, may not be applicable to
other types of entities operating in or relying upon the swaps market.
However, in determining the appropriate de minimis threshold for all
dealing entities, and in setting forth guidance on the types of trading
activities that constitute dealing activities in the first instance,
the CFTC balanced the needs of commercial end-users and energy firms
against the regulatory objectives achieved through registration and
regulation of dealing entities.