While both President Obama and Congress have proposed a boost in funding for the Commodity Futures Trading Commission (CFTC) in fiscal year (FY) 2011, CFTC Chairman Gary Gensler said more funds beyond the increase would be needed for his agency to implement sweeping Wall Street reforms, which exponentially increase the number of exchanges and clearinghouses that the CFTC will have to regulate.
In February Obama proposed a budget for the CFTC of $261 million for FY 2011 — a 55% hike ($93 million) over the budget of $168.8 million in FY 2010 (see NGI, Feb. 8). The Senate Appropriations subcommittee with jurisdiction over the CFTC boosted the amount to $286 million for FY 2011, which began Friday for the federal government.
Senate Banking Committee Chairman Christopher Dodd (D-CT) and Rep. Barney Frank, chairman of the House Financial Services Committee, co-wrote and shepherded the financial regulatory reform legislation through Congress. It was signed into law by Obama in July (see NGI, July 26).
“Though we have the resources to write the rules required by Dodd-Frank, we need more staff to implement and enforce them in the years to come,” Gensler told the Senate Banking Committee Thursday. “We will need significant more resources [in] about a year from now to actually implement these” new rules, he said.
“The next year of rule writing will test the very talented staff of the CFTC. Our staff has significant expertise regulating the on-exchange derivatives markets that will translate well into regulating the over-the-counter [OTC] swaps markets. Still, we need significant new resources,” Gensler said.
Gensler told the committee that the CFTC will be busy writing regulations to implement the Dodd-Frank legislation through mid-December. The CFTC has established 30 teams to write the rules and is working with other regulators, such as the Securities and Exchange Commission (SEC).
Sen. Jack Reed (D-RI) said the collaboration between Gensler and SEC Chairman May Schapiro was “very recent but commendable.” The two federal agencies have had a long history of not working well together. Schapiro said the cooperation from Gensler has been unlike anything she’s seen in all her years in government.
Dodd said it was important that the close relationship between the two agencies continue, even after Gensler and Schapiro leave office. “Anything you can do to institutionalize that so the people don’t drift away…will be very, very helpful,” he told Gensler. Gensler said he was dedicated to that effort.
Gensler said a priority of the CFTC in the months ahead is to designate some clearinghouses as systemically relevant.
Sen. Richard Shelby of Alabama, the ranking Republican on the Senate banking panel, questioned Gensler about the steps he was taking to “ensure that your personal aversion to end-user exemption does not interfere with your agency’s mandate to carry out the Dodd-Frank [act].” The new law regulates OTC transactions for the first time by requiring them to be traded on regulated exchanges, much like stocks, and to be cleared in a clearinghouse in order to limit excessive speculation in markets.
However, it grants an exemption to end-users that use derivatives to legitimately hedge their commercial risk rather than for speculative purposes. Gensler was opposed to any kind of exemption while the bill was being drafted in Congress.
“We’re going to adopt exactly what you have” in the legislation, Gensler told Shelby. “There’s a clear end-user exception for anyone who is hedging or mitigating commercial risk…That’s completely what we’re going to do, is comply.”
Of the 30 rule-writing teams at the CFTC, Gensler said six teams are focused specifically on rules regulating the swaps marketplace. “One team is working jointly with the SEC on defining key terms, such as ‘swap dealer’ and ‘major swap participant.’ Another team is working on registration requirements for dealers. We also have teams working on business conduct standards, capital and margin requirements and rules for segregating customer funds,” he said.
Gensler said the CFTC expects as many as 200 entities to register with the agency as swap dealers. These would include about 80 global and regional banks currently known to offer swaps in the United States; about 60 affiliates of existing swap dealers; approximately 40 non-bank swap dealers currently offering commodity and other swaps; and about 20 potential new market makers that wish to become swap dealers.
The CFTC will also regulate major swap participants because, while they are not swap dealers, their “participation in the swaps market is substantial enough to significantly affect or present system risks to the economy or the financial system as a whole,” Gensler said in his testimony.
The Dodd-Frank bill requires standardized swaps to trade on either exchanges or swap execution facilities (SEF). “It is anticipated that as many as 30 new entities will register as SEFs or DCMs [designated contract markets]. That is in addition to the 16 futures exchanges that we already regulate,” Gensler said.
“At the CFTC we have six teams focused on rules related to clearing, including determining which contracts will be subject to the mandatory clearing requirement. Though we do not yet know the total number of contracts that will be submitted for clearing, and the Commission may be able to group many by class, the largest swaps clearinghouse currently clears nearly one million unique contracts,” he told the committee.
“It is anticipated that the number of registered derivatives clearing organizations will increase from 14 to around 20 as a result of the Dodd-Frank act.”
And the legislation requires that rules establishing position limits be completed within 180 days from the date of enactment for energy and metals, according to Gensler.
In a related development, a major natural gas group called on the CFTC to clarify the “ambiguity” between the definitions of a swap dealer and major swap participant when crafting regulations to implement reforms called for in the Dodd-Frank legislation.
“We are committed to a liquid, well functioning market that protects natural gas consumers and encourages capital investment in the natural gas industry. Through the [Dodd-Frank] financial reform debate, we have emphasized that our companies primarily use derivatives to reduce commercial risk to the benefit of natural gas consumers,” said Jenny Fordham, vice president of markets for the Natural Gas Supply Association (NGSA).
“Consequently we urge the CFTC to adopt regulations that resolve the ambiguity around the terms ‘swap dealer’ and ‘major swap participant’ and protect physical market participants from increased costs that would divert capital from productive uses, particularly where the capital diversion would not further the goal of protecting consumers,” she said.
In addition, the NGSA recommended that the de minimis exclusion from the definition of swap dealer be based on the percentage of an entity’s swap transactions with customers relative to total swap transactions.
Capital and margin requirements for nonbank dealers should take into consideration a market participant’s overall risk profile, including physical assets, balance sheet strength and parent company support, NGSA suggested. Low-risk profiles should face lower capital and margin requirements, it noted.
The NGSA also recommended that the liquidity test for identifying swaps subject to mandatory clearing should be based on the full term of the swap agreement, rather than a portion of the term. If the liquidity test cannot be satisfied for the full term of the agreement, the swap must not be subject to mandatory clearing.
And the Commission must avoid establishing rigid classifications for the kinds of transactions and positions that qualify as bona fide hedges, the producer group said. It noted that the exemption must be applied by the CFTC using the forward-looking, situation-specific perspectives of individual swap participants.
For example, “consider a natural gas supplier hedging against predictions of a disruptive hurricane season in the Gulf of Mexico. In the event that the hurricane season is significantly less disruptive than predicted, the position the supplier took to hedge its perceived risk, as perceived at the time it entered into the subject transaction(s), should not be second-guessed in hindsight by the regulator as ‘speculation’ on hurricane activity. Such second-guessing would effectively undermine swap participants’ confidence in…the bona fide hedge exemption,” the NGSA said.
In a related development CFTC Chairman Gary Gensler and European Commissioner Michel Barnier met Tuesday to discuss many of the upcoming reforms to the over-the-counter (OTC) derivatives market, which includes comprehensive regulation of the multi-billion-dollar market for the very first time. Both Gensler and Barnier committed themselves to working across borders to achieve the goals set forth by G-20 leaders with respect to strengthening OTC derivatives regulation.
“I am confident that we will bring strong and consistent regulation to both the European and U.S. swaps markets,” Gensler said. “We have proven on OTC derivatives regulation that close transatlantic cooperation can work. It’s essential — across the board on all financial regulation — that the United States and Europe move in parallel [direction] and that we don’t create new space for regulatory arbitrage.”
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