[Senate Hearing 113-83]
[From the U.S. Government Publishing Office]
S. Hrg. 113-83
MITIGATING SYSTEMIC RISK IN FINANCIAL MARKETS THROUGH WALL STREET
REFORMS
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED THIRTEENTH CONGRESS
FIRST SESSION
ON
EXAMINING EFFORTS BY THE SEC AND CFTC TO IMPROVE FINANCIAL STABILITY
AND REDUCE SYSTEMIC RISK IN THE FINANCIAL MARKETS THROUGH
IMPLEMENTATION OF THE DODD-FRANK WALL STREET REFORM ACT AND THE
CONSUMER PROTECTION ACT OF 2010
__________
JULY 30, 2013
__________
Printed for the use of the Committee on Banking, Housing, and Urban
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
TIM JOHNSON, South Dakota, Chairman
JACK REED, Rhode Island MIKE CRAPO, Idaho
CHARLES E. SCHUMER, New York RICHARD C. SHELBY, Alabama
ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee
SHERROD BROWN, Ohio DAVID VITTER, Louisiana
JON TESTER, Montana MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia PATRICK J. TOOMEY, Pennsylvania
JEFF MERKLEY, Oregon MARK KIRK, Illinois
KAY HAGAN, North Carolina JERRY MORAN, Kansas
JOE MANCHIN III, West Virginia TOM COBURN, Oklahoma
ELIZABETH WARREN, Massachusetts DEAN HELLER, Nevada
HEIDI HEITKAMP, North Dakota
Charles Yi, Staff Director
Gregg Richard, Republican Staff Director
Laura Swanson, Deputy Staff Director
Glen Sears, Deputy Policy Director
Jeff Siegel, Senior Counsel
Elisha Tuku, Senior Counsel
William Fields, Legislative Assistant
Brett Hewitt, Legislative Assistant
Greg Dean, Republican Chief Counsel
Hope Jarkowski, Republican SEC Detailee
Dawn Ratliff, Chief Clerk
Kelly Wismer, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
?
C O N T E N T S
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TUESDAY, JULY 30, 2013
Page
Opening statement of Chairman Johnson............................ 1
Opening statements, comments, or prepared statements of:
Senator Crapo................................................ 2
WITNESSES
Mary Jo White, Chair, Securities and Exchange Commission......... 3
Prepared statement........................................... 23
Responses to written questions of:
Chairman Johnson......................................... 49
Senator Crapo............................................ 52
Senator Corker........................................... 55
Senator Johanns.......................................... 56
Gary Gensler, Chairman, Commodity Futures Trading Commission..... 5
Prepared statement........................................... 39
Responses to written questions of:
Chairman Johnson......................................... 57
Senator Crapo............................................ 58
Additional Material Supplied for the Record
United States Conference of Mayors Resolution submitted by
Senator Menendez............................................... 61
(iii)
MITIGATING SYSTEMIC RISK IN FINANCIAL MARKETS THROUGH WALL STREET
REFORMS
----------
TUESDAY, JULY 30, 2013
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:05 a.m., in room SD-538, Dirksen
Senate Office Building, Hon. Tim Johnson, Chairman of the
Committee, presiding.
OPENING STATEMENT OF CHAIRMAN TIM JOHNSON
Chairman Johnson. Good morning. I call this hearing to
order.
Today we welcome Chair White and Chairman Gensler to update
the Committee on important work underway at the SEC and CFTC to
implement the Wall Street Reform Act and reduce systemic risk
in our financial markets. We look forward to hearing about the
progress being made to better oversee the derivatives market,
finalize the Volcker rule, and implement changes to money
market funds and credit rating agencies, among other reforms.
On derivatives, the SEC and CFTC should be proud of the
progress made to date. Important rules governing clearing and
swap data reporting have taken effect, with the majority of
other rules slated to be completed and take effect in the
months ahead. Also, due in no small part to the work of both
agencies, the U.S. has provided the template for how other
Nations should regulate derivatives. This large, global market
demands strong, coordinated regulations to help improve
financial stability, and I commend the recent CFTC agreement
with the EU Commission to establish a framework that relies on
strong cooperation between our two jurisdictions. As you work
to harmonize international swap regulations, the SEC and CFTC
should continue to harmonize your separate rules in a way that
avoids market disruption or fragmentation.
On other reforms, the SEC has made progress to address
areas of systemic risk by proposing rules to implement money
market fund reform. The proposed rules follow earlier reform
measures taken by the SEC, and I hope the considerable work
that has been done in this area will result in a more stable
framework for the money market fund market.
We also look forward to hearing more about the SEC's
efforts to address flaws in the operation and use of credit
ratings that were exposed by the financial crisis. As required
by the Wall Street Reform Act, there has been extensive
examination of this issue, and I look forward to improvements
in the credit rating process.
Last, actions that improve investor protection will restore
confidence in financial markets and bolster financial
stability. To that end, I want to encourage the SEC and CFTC to
continue to use every tool Congress gave them to stop fraud and
protect investors. That is also why I believe the SEC should
move forward with adding sensible safeguards in the private
placement market.
With that, I look forward to hearing today's testimony, and
I now turn to Ranking Member Crapo for his opening remarks.
STATEMENT OF SENATOR MIKE CRAPO
Senator Crapo. Thank you, Mr. Chairman, and I agree with
the concerns and issues that you have raised. Today we will
hear from SEC Chair White and CFTC Chairman Gensler on their
implementation of financial reform, including Dodd-Frank and
the JOBS Act.
Having just passed Dodd-Frank's third anniversary, there is
still considerable work to be done. Among other things, this
hearing provides an opportunity to learn more about the steps
they are taking to fix the lack of coordination and
harmonization of rules among the United States and
international regulators for the cross-border derivatives
market.
The unique role that the securities, futures, and swaps
markets each play has informed the manner in which the SEC and
CFTC regulatory regimes have developed since the 1930s.
Notwithstanding these differences, it is critical that the SEC
and CFTC harmonize their regulatory approaches where sensible,
both domestically and abroad.
True harmonization is not only getting on the same page,
but it is working together to get on the right page. The U.S.
markets are the most liquid in the world and must remain so.
Market participants must not be discouraged from entering a
market that will allow them to allocate their risks, hedge
their investments, and grow their business. The cumulative
regulatory burdens that will flow from a regime that is not
truly harmonized will work against the flow of free capital in
the United States and abroad.
The CFTC has issued an array of interpretive guidance,
exemptive orders, and no-action letters on cross-border issues.
The CFTC's initial proposal for the cross-border implementation
of Title VII received criticism both domestically and in
foreign markets participants and regulators as being confusing,
overexpansive, and harmful.
The final cross-border interpretive guidance announced by
the CFTC on July 12th continues to raise questions both as to
its substance and the process surrounding its issuance.
In the hours leading up to the CFTC's final guidance, the
CFTC and European regulators issued a joint statement regarding
how international coordination of rulemaking should proceed.
This path forward has been characterized as an ``agreement''
when it appears to be a statement of future collaboration.
While this development may prove to be constructive, a number
of questions still remain.
For example, how will conflicts in rules for central
clearinghouses, which will handle the large majority of trades
and collateral posted by swap dealers, be addressed across
borders?
We also need information as to what agreement has been
reached, if any, regarding treatment of margin for end users.
Timelines for implementation remain very much in flux, and
the path forward does not make mention of Canada or various
Asian jurisdictions where swap dealing takes place and where
regulatory reform is progressing.
I look forward to hearing Chairman Gensler's testimony on
what exactly was agreed upon with respect to these and other
issues. With these questions unanswered, it is clear there is a
lot of work to be done on international harmonization.
The SEC proposed its own cross-border rule on May 1st. In
light of the far-reaching significance of this rule, the SEC
also reopened comment periods for many of its previously
proposed security-based swap regulations. The public is now
faced with two marginally similar plans from two agencies
issued through very different processes--the CFTC through
interpretive guidance and examinations, the SEC through notice
and comment rulemaking.
For example, both cross-border schemes contemplate
substituted compliance, which is intended to provide foreign
market participants with a chance to continue to abide by their
own country's requirements if those requirements are deemed
comparable to U.S. requirements. The willingness of each agency
to grant substituted compliance for foreign jurisdictions is
questionable. The details matter.
I look forward to hearing the views of Chair White and
Chairman Gensler on these issues of truly international
significance. Our capital markets are the preferred destination
in the world and cannot be tarnished by virtue of two
regulators that appear to be going in different directions and
not working effectively with each other and their international
counterparts.
If the current lack of coordination persists, it would not
be surprising to me to hear additional calls for merging the
two agencies into a single regulator for the securities,
futures, and swaps markets.
I appreciate, again, your holding this hearing, Mr.
Chairman, and I look forward to hearing from our witnesses.
Chairman Johnson. Thank you, Senator Crapo.
Due to votes scheduled on the floor this morning, opening
statements will be limited to the Chair and Ranking Member. The
record will be open for the next 7 days for opening statements
and any other materials Members would like to submit. Now I
would like to introduce our witnesses.
The Honorable Mary Jo White is the Chair of the Securities
and Exchange Commission. She was confirmed to this position in
April 2013.
The Honorable Gary Gensler is the Chairman of the Commodity
Futures Trading Commission. He was confirmed to this position
in May of 2009.
Chair White, please begin your testimony.
STATEMENT OF MARY JO WHITE, CHAIR, SECURITIES AND EXCHANGE
COMMISSION
Ms. White. Thank you. Chairman Johnson, Ranking Member
Crapo, and Members of the Committee, thank you for inviting me
to testify on behalf of the Securities and Exchange Commission
regarding the steps the agency has taken in an effort to reduce
systemic risk in our capital markets. We recognize the
importance of addressing systemic risk in a manner that
preserves the strengths of our financial system and protects
both investors and taxpayers alike.
There are many ways in which the Commission has sought to
reduce the likelihood of systemic risk, many of which stem from
our efforts to implement the various provisions of the Dodd-
Frank Act. I will highlight several of these in my oral
testimony. Other steps are described in my written testimony.
First, under Title VII of the Dodd-Frank Act, the
Commission, along with the CFTC, has focused on creating a new
oversight regime for the global, multi-trillion-dollar over-
the-counter derivatives market. To put this regime in place,
the Commission has proposed or adopted virtually every rule
required under Title VII. It is a regime aimed directly at
mitigating systemic risk in the financial markets.
In 2012, along with the CFTC, we adopted rules defining key
products and entities. In addition, the SEC proposed important
rules setting capital requirements for security-based swap
dealers and describing how those dealers would have to collect
margin collateral. In the event of a failure, these capital and
margin rules are designed to help protect customers and
counterparties and limit the impact on the capital markets and
the broader economy.
Given the global nature of the derivatives market, the
Commission also has been working with our regulatory
counterparts abroad and the CFTC to coordinate our approach. In
May, we issued a proposal outlining which regulatory
requirements would apply when a security-based swap transaction
occurs in part within and in part outside the United States.
Comments are due on August 21st.
Second, the Commission has been serving as the primary
supervisory agency for four of the eight financial market
utilities designated as systemically important by the Financial
Stability Oversight Council. Under Title VIII of the Dodd-Frank
Act, FSOC is authorized to make such a designation if the
failure or disruption of the financial market utility could
increase the risk of significant liquidity or credit problems
spreading among financial institutions or markets. The SEC
examines each of these utilities annually and reviews all
proposals that affect the level and nature of risk of these
entities in light of their systemic importance.
Third, the Commission adopted rules last year requiring
registered clearing agencies to meet comprehensive standards
with respect to risk management and operations. The
requirements are designed in part to strengthen and promote
consistency in the regulation of clearing organizations,
thereby reducing systemic risk in the financial markets.
A fourth step we have taken under Title IV of Dodd-Frank is
to establish reporting requirements for investor advisers to
private funds on the new Form PF. The information submitted is
intended in part to assist the FSOC in better assessing
systemic risk across the market. The filing requirements for
Form PF are scaled to the size of the adviser.
Last week, the SEC filed its first annual report to
Congress relating to the use of the data collected. In
addition, under Title I of Dodd-Frank, as the Chair of the
Commission, I serve as a voting member of FSOC. Among other
things, FSOC considers whether certain nonbank financial
companies should be deemed ``systemically important'' and
thereby subject to heightened prudential supervision by the
Federal Reserve Board.
The Commission has also taken additional steps intended to
further reduce systemic risk in the operation of our capital
markets. For example, in March of this year, the Commission
proposed Regulation SCI, which stands for systems, compliance,
and integrity. Regulation SCI requires exchanges and clearing
agencies to maintain policies and procedures reasonably
designed to meet certain technology standards, and it would
require appropriate corrective action if problems occur.
The Commission also approved a ``limit up-limit down''
mechanism that will create speed bumps to reduce abrupt market
movements in individual securities, and put in place new
marketwide circuit breakers to provide for brief, coordinated,
cross-market trading halts during sharp declines in the
securities market.
As a final example of the agency's work to reduce systemic
risk, in June the Commission proposed reforms designed to
reduce the susceptibility of money market funds to heavy
redemptions so as to mitigate potential contagion effects and
to increase the transparency of the funds' risks. Comments are
due September 17th, and we look forward to public input on all
aspects of this proposal, including whether the proposal
appropriately addresses systemic risk concerns while
maintaining money market funds as a viable investment product.
The men and women of the SEC have been tasked with expanded
responsibilities to help mitigate systemic risk in the
financial markets. I am proud of what they have accomplished,
and I am confident that we will be able to also complete the
remaining tasks before us.
Thank you very much. I would be happy to answer any of your
questions.
Chairman Johnson. Thank you.
Chairman Gensler.
STATEMENT OF GARY GENSLER, CHAIRMAN, COMMODITY FUTURES TRADING
COMMISSION
Mr. Gensler. Good morning, Chairman Johnson, Ranking Member
Crapo, and Members of the Committee.
Today's hearing comes as market participants are well along
a path implementing the congressionally mandated swaps market
reforms, and the CFTC has nearly completed rule writing to
implement these critical reforms. I am pleased to testify along
with SEC Chair Mary Jo White--the second time we are testifying
together in her now 3 months of tenure. But I am also pleased
to say the CFTC has benefited greatly from the SEC's input and
collaboration. On every step of this journey to bring about
swaps market and securities swaps market reform.
Just as we have commonsense rules on our roads--by that, I
mean traffic lights, stop signs, speed limits, and, yes, cops
on the streets to enforce the rules--the comprehensive swaps
market reforms that are nearly complete include complementary,
robust rules of the road to benefit both those who trade
swaps--those on the roads--and also those who do not, the
bystanders in our society. Americans would never accept a city
or highway system with no rules, no street lights, no traffic
lights, or no cops.
Middle-class Americans paid the price of the financial
crisis with their jobs, their pensions, and their homes. They
were the bystanders that were not even standing on these
complex roads called ``derivatives.'' The crisis cost 8 million
jobs and thousands of businesses, and the swaps market was
right at the center of it.
And now the American public no longer will need to accept a
dark market, that is, the swaps market, lacking commonsense
rules of the road. That is because based on what Congress put
in place and our completed rules, reforms now shine light on a
marketplace that has been opaque for too long. Both the public
and regulators have already benefited from what is called
``real-time reporting.'' This started last December. It has
been phasing in. There are some additional phasing dates in
August and September, but for over 9 months, that full data
set, regulators, like the SEC, like the Federal Reserve, and we
have had access to it, and foreign regulators as well. Further,
markets will shortly benefit from something called ``swap
execution facilities,'' a new trading facility that will bring
greater competition, access, and pretrade transparency along
the way.
Completed reforms also mitigate risk and broaden market
access through something called ``central clearing,'' a key
part of the G20 commitment that the President laid out in
Pittsburgh in September of 2009. The vast majority of interest
rate swaps and credit index swaps are already coming into
central clearing, but, again, key compliance dates go along the
way through October of this year--October 9th will be an
important date for some of the cross-border swaps to come into
clearing.
Nonfinancial end users, as Congress dictated, will have a
choice on central clearing, and consistent with this intent,
the CFTC has proposed that margin for uncleared swaps will not
have to be collected from such end users. To anticipate a
question, we have been actively encouraging the international
community to adopt that same approach. I believe in August we
will publish international standards that will be consistent
with that approach.
Third, completed reforms bring oversight to swap dealers.
We now have 80 that are registered. Many of these were at the
center of the bailout 5 years ago, and they are coming under
business conduct and reporting rules. Completed cross-border
guidance ensures that the far-flung operations of U.S.
financial institutions will be covered by reform, either
directly under Dodd-Frank or through what we call substituted
compliance. That means if there is a guaranteed affiliate
sitting offshore in a jurisdiction that does not have reform,
then it is Dodd-Frank, if it is somewhere where they do have
reform, we might look to those home country rules.
It is critical to the American public, and I am sure in
South Dakota, Idaho, Massachusetts, and in Ohio, your publics
are all saying, ``Do not forget the lessons of AIG and Lehman
Brothers and these other institutions that brought their far-
flung operations risk back home.''
We worked closely with international regulators,
collaborated here and abroad, and most recently we came to
these understandings with the European Union on cross-border
transactions. To anticipate the question, many of these were
included specifically in the guidance or were acted upon that
day by no-action letters. I view those as agreements because
they are embedded in Commission actions today. But there are
some aspirational things that we still need to work on. This
journey is not complete, and it is a multiyear journey with
Europe and with Asia.
We do have work to do moving forward. Most importantly, we
are working with market participants to smooth the transition
to these new reforms. We do also want to work closely with the
international community on the substituted compliance
determinations. Last, there are a handful of rules, including
capital, margin, the Volcker rule, and relooking at the
position limits that need further work. But I thank you, and I
look forward to your questions.
Chairman Johnson. Thank you.
Votes have just been called on the Senate floor, so we will
take a short recess to allow Senators to vote. I ask the
Senators to vote quickly and then return immediately to the
hearing room so that we may resume questioning.
The Committee stands in recess.
[Recess.]
Chairman Johnson. The hearing will now return to order, and
we will now resume the questioning of our witnesses. As we
begin questions, I will ask the clerk to put 5 minutes on the
clock for each Member.
Chair White, while I recognize there is a lot on the SEC's
plate and Congress must do its part to appropriately fund your
agency, how soon can we expect Wall Street reform rules to be
completed, especially on derivatives, the Volcker rule, and
QRM? What, if any, barriers are there to completing these
rules?
Ms. White. I share the concern for--and I think I testified
in my confirmation hearing that one of my highest immediate
priorities, is to complete the congressionally rulemakings
under Dodd-Frank and the JOBS Act. I think we have made very
good progress. We are continuing to push extremely hard to
complete those rulemakings.
I cannot give you a precise timetable as to the completion
for all of them, but I think you will see through the summer
and through the fall and throughout this year those rulemakings
coming out. That is my expectation and hope. I am not saying
every single one will be done by year end.
In terms of derivatives, as I think I mentioned in my
testimony, our comment period on the cross-border proposal ends
on August 21st. We did reopen, as Ranking Member Crapo said,
our substantive rules that we proposed in the derivatives
space. That comment period ended July 22nd.
So it is my--obviously, I operate in a commission, but it
is my hope and expectation that we will move into the adoption
phase when those comment periods are completed.
QRM is one that is a joint rulemaking, as you know. We are
working quite hard and quite actively now with our fellow
regulators on that, at both the staff level and the Commission
level. So, you know, it is, again, a hope and expectation that
some action should be taken in the very near term.
On Volcker, I think particularly in the last 2 or 3 months,
obviously an extraordinarily complex rulemaking. We need to get
it right to make sure we are carrying out the statutory
objectives. But we also want to make sure that we are dealing
with the exemptions that occur so that we do not have
unintended consequences there.
We are working quite well in the last 2 or 3 months
particularly with our fellow regulators on that. I think
Governor Tarullo may have testified before this Committee,
maybe more than once, that his at least hope and expectation is
that may be completed by year end. I hope that is correct.
Chairman Johnson. What, if any, barriers are there to
completing these rules?
Ms. White. I think what I would say the barriers are, the
SEC was given, depending on how you count it, over 90--and this
is under Dodd-Frank, alone--92, I think, and if you count
subsets, about 130 rulemakings under Dodd-Frank. So there is a
lot of volume. Many of them have a great deal of complexity.
Some of them are done, as they should be, jointly with other
regulators. I think those would be the factors that I would
point to, and there has been, no question about it, some
backlog at the SEC.
When I arrived there, I tried to make certain that we had
parallel work streams working on both the Dodd-Frank
rulemakings and the JOBS Act rulemakings so that we did not
have the same people at the staff level working on different
rulemakings. So I am hoping to expedite and complete that
process.
Chairman Johnson. Chairman Gensler, consistent with the
CFTC goal to limit regulatory arbitrage, will the CFTC allow
swap trades between non-U.S. customers and foreign branches of
U.S. swap dealers to rely on substituted compliance? In
comparison, how will the CFTC treat swap trades between non-
U.S. customers and foreign affiliates of U.S. swap dealers?
Mr. Gensler. I am pleased to say that we were able to
finalize guidance with a lot of public input, and this issue
was one of those, where the overseas branches and overseas
guaranteed affiliates of U.S. swap dealers are covered by
reform. This is necessary because so much of that risk did come
back in 2008.
Specific to your question, if a branch of a U.S. swap
dealer is dealing overseas, it is part of the U.S. person; it
is part of the legal entity. And we would look to substituted
compliance if there are such rules in place.
We did have a carveout, though, that said that up to 5
percent of their business is in emerging markets, that they
might not have to come in.
For the guaranteed affiliates, if it is truly an offshore
entity operating in London or Toronto or Tokyo and doing a
business with some local insurance company, the transaction
level compliance, we said that is up to the foreign
jurisdiction, not ours. Sort of similar to this 5-percent
exception for the branches.
Chairman Johnson. Senator Crapo.
Senator Crapo. Thank you, Mr. Chairman, and both Chair
White and Chairman Gensler, in my opening statement I mentioned
that there are some discrepancies between the rules and
guidances that the two agencies are engaged in, both in terms
of the substance of how they are being adopted and in terms of
their actual substance. And my question to both of you is: Do
you agree that we need to have as much coordination on these
rules and guidances as possible so that both agencies are, to
the maximum extent reasonably possible, on the same page and on
the right page? And if you agree with that, are you undertaking
actions to coordinate and communicate with each other to
achieve these objectives? Chair White.
Ms. White. I do agree with your statement, Senator Crapo,
very much so. There may be some differences because we have
different markets, different market participants, but for the
most part, I think we need to strive for consistency, avoiding
disruption, avoiding duplication.
The staffs of the agencies have been, before my arrival and
after my arrival, working together with each other sharing
drafts and having discussions. Obviously differences do remain.
One of the things you will see in our proposal where the
comment period ends in August is we specifically tee up that
consistency question. And what I would like to see going
forward--there are open issues to deal with--is even an
increase in the depth of engagement at the principal level as
well as the staff level.
Senator Crapo. Thank you.
Chairman Gensler.
Mr. Gensler. Senator, I do agree. We have been coordinating
and collaborating all the way back to the legislative phase and
to sharing our term sheets. If we send a term sheet or a draft
memo to our Commissioners, we send it to the SEC. We also share
with the Federal Reserve and other U.S. regulators, and
internationally as well. We have gotten tremendous feedback. We
do have some differences, of course, because this is the only
thing we focus on--futures, commodities, and swaps--and the
SEC, frankly, has so many other things. We oversee markets
called the ``interest rate swap markets'' and some other
markets that are so large that they are well over 90 percent of
the swaps markets.
Last, there are some small but very important differences
in the law themselves, a swap, for instance, is not a future, a
securities-based swap is a security. This was embedded in the
laws. It might sound like a small difference, but actually the
lawyers tell me it is a big difference. Also on cross-border,
Congress expressly had direction for the CFTC that was not
included in the SEC. You may have heard these words, but it is
about a direct and significant connection to or effect on U.S.
commerce or activities. If I have the words garbled, I
apologize. That is what we were asked to give some guidance on
and did so.
Senator Crapo. Well, I appreciate your answers and
encourage you to continue to try to coordinate to the maximum
extent reasonably possible.
Chairman Gensler, a number of questions remain regarding
the path forward, and in my introductory comments I indicated I
thought it was more of an agreement to agree or to collaborate
further. But I think in your opening statement you indicated
you felt there was more specificity than I was suggesting.
Could you just explain that a little better and what you
believe the next steps are to implementing the path forward?
Mr. Gensler. Why, thank you. We have worked really on this
journey for 4-plus years with the European Commission and the
various European authorities, and we decided to put in writing
this 10 or 15 pages about a path forward that I thank you for
highlighting.
Many of those pieces were incorporated specifically and
expressly in the Commission guidance, particularly about when
international parties meet on trading platforms. It is in our
guidance. We expressly said that a U.S. person could fulfill
some of their trading requirements under Dodd-Frank even on
foreign boards of trade, so they do not have to do it here in
the U.S. on swap execution facilities. That, too, is expressly
in the guidance that is--everybody can use that.
We took most of that path forward, wherever we could, and
we put it in the guidance or in addition in some things called
``no-action letters.'' Going forward, though, we will be
working with Europe, Japan, Canada, Australia, Hong Kong, and
Switzerland on looking at whether they have comparable rules
overseas, and where we can, particularly on the entity-level
requirements, we hope to do some substituted compliance
determinations before December; and where we cannot, at least
alert market participants to that.
Senator Crapo. Thank you.
Chairman Johnson. Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman. Thank you both
for your testimony.
Chair White, let me ask you, there is a comment period
going on now with the SEC as it relates to proposed money
market fund rules, and I am sure you are already receiving a
lot of responses to that. Money market funds remain an
important financing channel for investors, fund managers, for
companies and local governments who obtain financing through
money market funds. And they have expressed concerns that one
of the SEC's proposals about floating a net asset value could
potentially cause some investors to turn away from money market
funds and thereby increase funding costs for borrowers.
For example, the U.S. Conference of Mayors, an organization
I work with quite closely, having been a former mayor, recently
adopted resolutions--which, Mr. Chairman, I ask consent to
submit for the record.
Chairman Johnson. Without objection.
Senator Menendez. They recently adopted resolutions where
they talk about these concerns, and I think, if I am not
mistaken, it was the SEC itself that in one of its studies said
that the floating net asset value does not in and of itself
solve the concern of solvency issues, might make it, you know,
more understanding of what the potential exists in the
marketplace. There are those who suggest that gating is more
likely to create a safeguard.
Are you going to be considering the consequences in the
marketplace--I know you are not ready to determine here at this
moment on the rule, but are you going to be considering as part
of the equation what happens in the marketplace, what happens
to access, to, for example, public entities like municipalities
across the Nation, as well as other entities in terms of making
this decision on what the rule should look like?
Ms. White. No question about that, Senator. We obviously
did that kind of analysis, aided by our economists, when we
made the proposals we did. There are actually alternative
proposals, one that proposes a floating NAV for prime
institutional funds only, not for Government funds or retail
funds, and another that is a fees and gates proposal. We also
invited comments on combining them. But we are very interested
in the impacts under both proposals, taken separately or
combined, and will be studying all of those comments very
carefully.
Senator Menendez. I appreciate that. I have a feeling that
there is some suggestion or some pressure that exists out
there, at least from my perception, that the Fed wants to see
this happen. You have the jurisdiction here, and having a
merger for the sake of making everybody happy over these two
rules is not--these two elements of the rules, the two options,
is not the optimum result. So I hope you will look at the real
consequences in the marketplace and making sure that what you
ultimately do is to ensure the very safety and soundness of
those funds versus just responding to another entity that may
have their own views.
Ms. White. If I may, Senator, this is a space where the SEC
has the expertise. The SEC has acted. Obviously we take input
from wherever it comes from that is useful, whether it is
fellow regulators or the public or end users. But it is
something we will decide quite independently.
Senator Menendez. During your confirmation hearing, I asked
you on a provision that I included in Dodd-Frank, which was the
issue of having disclosure in annual SEC filings of the amount
of CEO pay to the amount of the median company worker pay and
the ratio of the two. I asked you to look at that as the
Chairperson. There was a Bloomberg report that suggested that
the SEC is moving forward with a proposed rule soon. Is that a
correct report, or is that an incorrect report?
Ms. White. I would not want to comment on specific timing.
I know the report that you are referring to. But we are very
much as a staff and Commission focused on that rulemaking.
Senator Menendez. OK. So while you do not want to commit to
a time, since I have been waiting for several years now--which
precedes you, but heavy is the head that wears the crown. Right
now you have it. Can you give me some time frame here?
Ms. White. It should be in the near future. I do not know
if that is helpful to you or not. We have two new
Commissioners.
Senator Menendez. How do you define ``near future''? Two
months? Three months? Six months? A year?
Ms. White. I would hope that it is completed in the next
month or two. You know, we have two new Commissioners coming on
board, or we are expecting to, so that may affect some of the
projected timetables you may have read about.
Senator Menendez. All right. Thank you very much, Mr.
Chairman.
Chairman Johnson. Senator Toomey.
Senator Toomey. Thank you, Mr. Chairman, and thank you and
welcome to our witnesses today.
Madam Chairman, I just want to follow up--well, let me go
to the question of the rules implementing some of the JOBS Act.
I have got to confess, I continue to be frustrated. It has been
over a year now. Reg A in particular strikes me as a relatively
straightforward, relatively simple change in law that has been
on the books now for over a year, and we still do not have a
rule.
What kind of progress are we making? And what can we expect
there?
Ms. White. I think we are making progress. I think,
Senator, you and I discussed this actually at my confirmation
hearing, too. I think I commented that, from the outside at
least, it would seem to me that with Reg A Plus, as we refer to
it, the regulation should be one that could be done
comparatively faster than others.
One of the reasons it is taking longer, although it is very
much front and center with the staff and the Commission, is to
make sure that it is workable. Reg A itself has not been used,
particularly in recent years.
One of the issues that we are focused on--there was not
sweeping preemption given to that rule--is to make sure that it
actually is used once we adopt the final rules. But it is very
much--I have several things on front burners, but it very much
is one of those.
Senator Toomey. So it is on the front burner.
Ms. White. Along with several others, but, yes, sir.
Senator Toomey. OK. Now, I know how reluctant you are to
put a time frame on this, but I have got to ask you: Do front-
burner things get taken care of this summer? Is that a fall
kind of thing? When do you think we can----
Ms. White. Well, again, I would just comment, I am one
member of a Commission. I have two new Commissioners coming on
board. But I would hope we would certainly reach that by the
fall.
Senator Toomey. OK. All right. Thank you.
Then I would like to follow up on some questions that
Senator Menendez raised. Could you just briefly summarize what
you see as the advantages of the disclosure mandate on floating
NAV, the daily disclosure of a net asset value with greater
precision, which is one of the proposals, as I understand it,
for the nonprime institutional money funds?
Ms. White. We certainly have in the proposal enhanced
disclosures fairly across the board, and as you know, a number
of prime funds have actually voluntarily made disclosure. What
I guess now is referred to as the ``shadow NAV.'' I think the
floating NAV alternative that is the subject of a proposal
would obviously have those disclosure features with it, but
also would actually, change to a market value.
Senator Toomey. So I guess the question is: The argument
that I most frequently heard advocating for a floating NAV was
to provide additional, more precise information to investors.
To the extent that that is provided, why is it necessary to
operationally float the NAV? And, second--well, second, I would
like to discuss the tax implications, but in the first
instance, why is it necessary to operationally do so when the
information is being provided?
Ms. White. Again, those are among the questions that we
have, I think, teed up, with the proposal. But disclosure
itself does not change the transaction value. What this
proposal would add to disclosure is that you basically would be
transacting at a market rate. Simply knowing what the NAV is
does not deal necessarily with the gaming of the one dollar
price. And so the main thrust of additional money market reform
is to deal with what is perceived to be--and obviously we had
our economists study this--the run risk or the possibility of
the run risk. And so it is not just a disclosure proposal,
although that is included.
Senator Toomey. It seems to me that there is always a
first-mover advantage regardless of whether you disclose a net
asset value or whether you operationally impose it. It seems to
me the main argument has always been about transparency and
greater disclosure, and that is achieved by simply disclosure.
As you know, of course, there is a tax consequence if these
minute changes manifest themselves in capital gains and losses
that have to be monitored.
Clearly the SEC has no authority to make that problem go
away or solve that problem, right?
Ms. White. That is correct. We have been working closely
with Treasury and the IRS on those issues. One is whether the
wash sales rules would be, in effect, a problem if, in fact,
the floating NAV proposal was adopted. And the IRS on that tax
aspect has actually recently put out tentative guidance saying
that you would not have that negative tax consequence.
There is another outstanding tax issue which we have not--
the IRS has not concluded on, which is sometimes referred to as
a ``record keeping requirement,'' but it really would allow
netting, which obviously would be very important to this
proposal.
Senator Toomey. I am concerned that the operational
challenges and potential remaining tax consequences of this
would create a huge disincentive for firms, for institutions to
use this very valuable tool, and I hope you will keep that in
mind as you consider finalizing the rule.
Ms. White. We certainly will, Senator. We also--and I think
I have stated it publicly--are concerned about preserving the
viability of the product.
Senator Toomey. All right. Thank you.
Chairman Johnson. Senator Brown.
Senator Brown. Thank you, Mr. Chairman.
Mr. Gensler, manufacturers, as you know, that rely on
aluminum to produce products--beer and soda pop cans and cars
and other things--say that banks are using their metal
warehouses to delay aluminum deliveries, driving up the cost of
aluminum. These warehouses are linked to the London Metal
Exchange. Apparently U.S. and U.K. authorities have said that
neither has oversight over these bank-owned warehouses.
There is a 2000 Memorandum of Understanding with U.K.
market regulators that entitles the CFTC to information
regarding ``the operations and stocks of warehouses,'' and
``the use of warehouses by regulated market members, their
licensees, or customers,'' including warehouses outside the
U.S.
There is a 2001 no-action letter between the CFTC and the
London Metal Exchange, conditioned in part on the fact that
``the law, systems, rules, compliance mechanisms of the U.K.
applicable to the London Metal Exchange will continue to
require LME to maintain fair and orderly markets, prohibit
fraud, abuse, and market manipulation.'' It appears that this
is manipulation, at the very least abuse.
One of the purposes of the Commodity Exchange Act is to
deter and prevent price manipulation or any other disruptions
of market integrity.
Now, I understand from news reports that the CFTC has sent
out notices to at least a couple of banks saying, ``Do not
destroy any emails,'' suggesting there will be an
investigation.
So my question is: Does the CFTC have the legal authority
to interrogate and investigate and address potential market
manipulation occurring at U.S. warehouses that are harming U.S.
companies? If not, how can that be?
Mr. Gensler. Senator, we are a market regulator overseeing
the commodity futures swaps markets and have clear authority to
police these markets for fraud, manipulation, and other abuses,
and we will use those authorities appropriately where we see
abuses and pursue it. That is in the physical commodity markets
as well as the derivative marketplace. We tend to do that when
it is related to derivatives, but the authorities are there.
We also have authorities and Dodd-Frank included
authorities with regard to something called ``foreign boards of
trade,'' and the LME is actually operating under, as you said,
this no-action letter from 12 years ago, has followed along
with I think 18 others to become registered foreign boards of
trade. So we have that in front of us as well.
But, yes, we have authorities to pursue fraud manipulation
and other abuses in the commodity markets.
Senator Brown. So can you tell us what the next step is
after you sent this admonition to these banks?
Mr. Gensler. I think it would be best not to try to
prejudice any matter that we might be--or might not be looking
at. I think it would be better not to try to prejudice anything
that we might be doing.
Senator Brown. OK. This is a question for both Ms. White
and Mr. Gensler. We know, as we heard in a hearing in my
Subcommittee last week, that some banks own oil tankers and
trade oil futures; others own energy transmission rights and
sell energy derivatives; financial institutions in some cases
control fleets of oil tankers and can withhold delivery while
also wagering on the price of oil, or they can speculate on the
price of energy while controlling its supply, as we saw in
today's settlement between FERC and JPMorgan.
In a Reuters story, a commodities expert in 2012 said that
owning physical assets while trading in financial markets gives
you the visibility of the market to make far more successful
proprietary trading decisions in both physical and financial
markets. It is trading with material nonpublic information. The
only difference, this writer pointers out, that this market
experts points out, the difference compared with equity markets
is that it is perfectly legal.
That certainly suggests a conflict of interest. Should the
rules--and that suggests the question to both of you. Should
the rules for commodities markets be updated to prohibit
trading on this kind of, call it ``insider,'' but at least two
judging it, calling it ``nonmarket information.'' Should these
rules be updated? Ms. White, if you would answer that, and then
Mr. Gensler.
Ms. White. It is a subject matter that once it came to my
attention--and that is fairly recently--I have actually asked
the staff to examine that question, those series of questions.
I cannot really respond further at this point other than I am
looking into that and, frankly, the range of possible
disclosure issues that could be involved as well.
Senator Brown. Mr. Gensler.
Mr. Gensler. Based on the Dodd-Frank reforms, we actually
did update our whole regime about fraud and manipulation rules,
and those were finalized about 2 years ago, and Congress
expressly focused on information and deceptive practices.
As it relates to an individual having information, the
commodity markets have been looked at. A grain elevator
operator or farmer or rancher may know something about their
crop and want to hedge that, and we would not want to diminish
the ability of that farmer, rancher, or grain elevator operator
to hedge that risk even though in a sense they might be the
only one to know that their crop is not yielding as well as
they thought or yielding better than they thought.
So there are some differences, but the good news is that
Dodd-Frank did include and we finalized rules that give us a
lot of enhanced protection. But, there is a long history of
allowing the hedgers to really ensure that they can hedge their
risk and not concern themselves that they might know something
about their crop or what is happening on the ground that
somebody else did not know.
Senator Brown. Thank you.
Chairman Johnson. Senator Warner.
Senator Warner. Thank you, Mr. Chairman, and I thank the
witnesses as well. And while I have not followed the issue as
closely as Senator Brown, I think I would simply say, Mr.
Gensler, that there is knowledge in the field on appropriate
hedging, but some of the representations that Senator Brown
made seem to be closer to manipulation than hedging. So I
appreciate the work he is doing.
I want to come back actually, Chairman White, to my
favorite topic, which is the JOBS Act, again, the crowdfunding
issue. I think it is--I know Senator Merkley worked on this
issue as well. I think there is enormous, enormous opportunity
to use this new tool for equity crowdfunding that can really
marry together in a remarkable way, particularly from markets,
rural markets, smaller markets that do not have access to this
early stage capital, this really could be transformative. I
have traveled around Virginia and around the country, and there
is a nascent industry waiting for the regulations to get out,
and let me acknowledge on the front end the nature of this will
be--I do not think the SEC will get it perfect the first time
out, and there will be people who will lose money. But I do
think there will be the ability for the Internet to kind of
self-police a bit and call out bad actors in an appropriate way
and to work with you I think is, again, different than the
analogy that was sometimes made back to the old telephone
boiler room operations where there was a lot of fraud.
So I am not sure you are going to give me the answer I am
looking for, but back to the Senator Toomey analogy, I am
hoping you are going to say this is front burner as well since
it has been more than a year-plus, and we are seeing other
Nations around the world move into this space and take away any
potential first-mover advantage America has. How front-burner
issue within the parameters of what you have been able to say,
what else can you--a lot of folks are waiting for you to get
these regulations out.
Ms. White. I appreciate that, Senator, and I think there
still is, despite the length of time, a great deal of
excitement out there about this.
Again, I seem to be describing multiple front burners to
some degree, but it is certainly--the crowdfunding rulemaking
is certainly on one of those front burners. It has been quite
an undertaking to some degree, although the crowdfunding
legislation does build in a number of investor protections.
Obviously the funding portals, there are some issues there. We
are working very closely with FINRA to make sure that does not
delay us, that we----
Senator Warner. Right. Because once you are done, there is
still a FINRA process as well.
Ms. White. We are trying to land that at the same time, if
we can, so that does not build in other delays any more than it
needs to. So it is among those front-burner rulemakings very
much in----
Senator Warner. Summer front burner? Fall front burner?
Ms. White. We are almost out of summer, right? We are
almost out of summer. Yes, I guess I have defined ``front
burner'' so far to be into the fall, but I do not want to
really--again, what I have said before is, I really have
separated out these work streams. I have prioritized as many as
I possibly can, and I get them done as they are ready to get
done. But it does not take away from what I said that it is
certainly among those very front burners.
Senator Warner. I would acknowledge that this is, you know,
a new space, but I would simply make the editorial comment that
this is one where the perfect could be the enemy of the good,
and, you know, I think there will be mistakes made. I think all
of us who supported the JOBS Act recognize that there were
challenges in this space. But the potential upside in terms of
connecting capital to entrepreneurs that otherwise are not
going to exist--I was in Richmond yesterday where Kiva, which
is the microlending site I know you are familiar with--launched
in Richmond, and, you know, the lending portal is a little
better, you know, less regulatory burdensome than the equity
portal, although the Kiva fellows announced the fact that they
spent about 7 or 8 years being told everything they were doing
was virtually illegal. They have now done close to 900,000
loans and $500 million of lending with a rate of return north
of 98 percent. So, you know, it is a pretty good system that
actually both abroad and now domestically provides a lot of
value. So my hope will be, again, that we keep this front
burner.
I am going to run out of time here. I would simply--I
wanted to get your comment as well on the swap depository--the
swap data repositories, you know, these SDRs, and how you are
working with--whether you are going to have to kind of
reduplicate what your colleague Mr. Gensler has already done.
We need to get these registered as quickly as possible. This is
going to be an important part of transparency in the swaps
market.
Ms. White. I think just briefly on that, the SEC has
actually put out what we call the ``implementation policy,''
and those rulemakings are, I think, in our second category. I
think the first category is to make sure that we get the cross-
border out and adopted. Obviously mandatory clearing decisions
have to be made, but I would not anticipate delay once we are
at that stage.
Senator Warner. Thank you, Mr. Chairman.
Chairman Johnson. Senator Hagan.
Senator Hagan. Thank you, Mr. Chairman, and thank you both
for being here today.
Ms. White, one of the issues that we have talked about over
the past has been the definition of a ``fiduciary,'' and it is
coming--obviously it is here again, this definition.
Now that you have had a few months in office, can you
provide an update on the coordination between the SEC and the
Department of Labor on this issue of the definition of
``fiduciary'' and how you are working.
Ms. White. Yes. Obviously, again, we are independent
agencies, but, I fully take all the points in that space about
the desirability for consistency.
One of the things that we have done--and I think we did
talk about this before at my confirmation hearing, again,
before my arrival--the SEC staff has been working very closely
with the Department of Labor's staff to make certain that they
understand the broker-dealer business model impacts of
rulemaking on those models. Obviously, we, in terms of
considering a fiduciary duty standard, are also told other
things about what we can do and not do. The commission
structure remains, principal trading remains.
What I have done, I think July 5 was when our period of
comment closed on our request for additional information on the
fiduciary duty, so that is fairly recently closed. I have
actually personally met with senior officials at the Department
of Labor and directed the staff to really engage even more
actively than they have in the past to try to coordinate, try
to make certain that the Department of Labor understands our
perspective and we can provide our expertise.
Again, we have our different rules, are different agencies,
but that is really the status.
Senator Hagan. I appreciate you taking that effort. I
appreciate that.
On the asset management study, as you know, the FSOC is
responsible for the designation of systemically important
nonbank institutions. The FSOC has indicated publicly that it
is reviewing what risk, if any, the asset managers pose to the
U.S. financial system. The SEC is the expert agency on asset
management, both from its long-established oversight of the
mutual fund industry, but also more recently with the Dodd-
Frank requirement that advisers to private funds, such as
private equity and hedge funds, register with the SEC as
investment advisers.
My question is: What role is the SEC playing in this FSOC
review? And is the SEC being active here? And if so, is your
expertise being reflected in the study?
Ms. White. The answer is we are very active. The study is
actually with the Office of Financial Research, but my staff is
extremely active in providing comments, again, providing
expertise in connection with that study. I cannot tell you when
it will be completed, but we are quite active in participating
in that process. Again, it is not being led by us--but,
certainly we are being listened to, and we are very focused on
making certain that that level of activity and interface
continues.
Senator Hagan. One other question back on the definition of
``fiduciary,'' and you mentioned that July 5th was the end of
the comment period. What do you see as the time frame going
forward on either the SEC and the DOL setting the actual
definitions?
Ms. White. I cannot speak for the DOL----
Senator Hagan. I did not know if you had heard any comments
through that.
Ms. White. I think that they are considering kind of what
to do next. I mean, what we are focused on as far as they are
concerned is just making sure they have all the expertise and
data.
In terms of, a timetable for what we may do at the SEC,
that is something we are focused on, but we obviously have a
very full plate of mandated rulemakings as well. But it is
not--it is very important to me that we get to wherever we are
going on that as quickly as we can.
Senator Hagan. OK. Thank you, Mr. Chairman.
Chairman Johnson. Senator Warren.
Senator Warren. Thank you, Mr. Chairman.
I want to just start by saying you have really done some
remarkable work, Chairman Gensler, over the last 4 years. You
have taken on important fights for taxpayers, for consumers.
You have shown some real backbone, something that I hope would
act as a model for some of the other leaders of our regulatory
agencies. You have laid out a road map for the CFTC to follow
in the years to come, and you have really done a great job in
identifying priorities, where we should be, what we should do.
But I have a specific follow-up question to what you have
laid out, and that is, as you know, the CFTC has been under
sustained pressure to delay implementing the rules that you
have already worked out. And so my question is: Could you
comment on how important it is to stick to the timetables that
the CFTC has laid out?
Mr. Gensler. Thank you for that question. I think it is
important, one, because 8 million people lost their jobs.
Two, there is still risk in the financial system, and there
will always be risk in the financial system. And if we are
going to truly end too big to fail, we need to cover and finish
off these transparency and risk reduction things.
And then, three, sometimes a deadline just helps people
come into compliance. You were a professor. You know that
sometimes having those deadlines helps people come into
compliance. So we will work with market participants to smooth
the transition and, where appropriate, use our tools to give
them some relief. But stick to the deadlines.
Senator Warren. Good. Thank you very much, Mr. Chairman.
I wanted to ask both of you a question about enforcement.
We have spoken individually about enforcement multiple times,
and recently, Chair White, you announced that the SEC will be
requiring admission of guilt in more cases. I think that is a
powerfully important step. It shows real toughness in your
enforcement strategy and that that will help build leverage,
even when you end up with a settlement.
But when I talk about the importance of being willing to
take large financial institutions to trial, people tell me,
well, it is a real problem because the agencies do not have
enough resources in their Enforcement Divisions, and they would
have a tough time going up against big Wall Street
corporations.
So can each of you discuss whether you have the resources
and the importance of resources in having an effective
enforcement strategy? Chair White, might I start with you?
Ms. White. Yes. There is no question that additional
resources are essential to our successful enforcement strategy,
including the change that you are referencing. One of our
specific requests in the President's budget is for additional
trial attorneys, and we cannot judge at this point how many
additional trials we are going to have, but we already do not
have enough trial resources. We have to be prepared to go to
trial. We are prepared to go to trial. I am really proud of,
frankly, the record that the SEC has had in trials. I think it
is about 80 percent, when you see it from a defendant's point
of view.
One of the things--we need resources across the board for
many other things as well, and our budget situation is we are
budget neutral, deficit neutral, and, I would certainly hope
that we could get that funding. And it really is essential to
that strategy.
Senator Warren. Thank you.
Chairman Gensler.
Mr. Gensler. We have not shied away from bringing cases
against large banks, against exchanges, and sometimes if they
do not settle, going straight into court. We are proud of that.
But I would say our enforcement resources are tiny compared to
the size of the markets, and, you know, the American public put
$180 billion into AIG. That is 600 times what the President
asked for for funding for our agency. Our enforcement folks are
only about 150 of our people. We are trying to make the best
decisions, but often we have to delay justice because we do not
have the right resources.
Senator Warren. That is a very important point. Thank you
very much. It seems clear that if Congress wants to have a
tough watchdog, it needs to make sure that the dog has not been
starved, so I appreciate your comments on this.
I have one more question, and that is for you, Chair White.
One share/one vote has long been a bedrock principle of
corporate governance. In recent years, however, a number of
companies--Facebook, LinkedIn, Groupon--have given special
insiders voting powers that are far greater than those
available to the investing public. This can have short-term
benefits, of course, in some cases, but it undermines the basic
concept of ownership and says, in effect, that some inside
owners can help themselves even if it is at the expense of
other outside owners.
Now, last October, the Council of Institutional Investors
wrote letters to the New York Stock Exchange and Nasdaq
requesting that they prohibit companies seeking an initial
listing from having unequal voting rights. I wrote a follow-up
letter to the exchange last month. I have not gotten a very
encouraging reply.
Chair White, do you support the principle of one share/one
vote? And if so, do you have a position on whether or not the
exchanges should require it?
Ms. White. I think it is a--the voting rights and the
voting rights structure is dictated by State law, actually.
But--and the SEC years ago actually attempted to act in this
space in that direction, but there was an authority issue that
the court overturned the action that the SEC did take.
So if there is to be movement in that direction--and I
cannot prejudge it because I would have to judge it when it
comes in--it would come from the SROs. In terms of the legal
issue, I think, the SEC's possible lack of authority would not
necessarily preclude the SROs. They do have a rule that
prohibits disenfranchisement, but that is different than what
you are talking about.
Senator Warren. No, I understand that, and the question I
was asking is basic support for the idea of one share/one vote.
Ms. White. Well, I certainly support shareholder
franchisement to the degree--to the most significant degree
possible. But it is not an issue where I think the SEC can act
on its own.
Senator Warren. I understand that limitation. I apologize
for going over. Thank you, Mr. Chairman.
Chairman Johnson. Senator Merkley.
Senator Merkley. Thank you very much, Mr. Chair, and thank
you both for testifying. I wanted to return to the topic that
Senator Brown was pursuing.
We have the situation now where we have JPMorgan is in the
process of--an examination is underway by FERC of their trading
in the electricity markets. Some articles say a settlement is
pending, but FERC is talking about eight market manipulation
strategies that were used to crank up prices that are
unacceptable.
We have certainly the situation with the LIBOR rates more
recently. We have the big article in the New York Times over
aluminum warehouses that Goldman holds. We have the public
discussion of the SEC allowing--and, Chair White, correct me if
I am wrong, but basically approving JPMorgan to own a
significant share of the copper assets with the anticipation of
a strategy that might look something like what is happening in
aluminum.
I find it fascinating that we have a variety of regulatory
powers, but essentially despite those powers dispersed among a
number of different agencies, we have a picture of companies,
big banks, that have enormous assets being able to buy vast
quantities of particular commodities and control of the
distribution systems through pipelines, through offshore oil
tankers, through warehouses, not only providing a huge amount
of market information that is very advantageous in trading, but
also in a sense to have a thumb on the scale in terms of supply
and demand and be able to have some influence over the price.
And if you are simultaneously allowed to bet on the price and
you are allowed to have your thumb on the scale reflecting the
price, it is a huge conflict of interest.
So in Dodd-Frank and within the Volcker framework, we have
conflict-of-interest provisions that provide some powers on
this. We certainly have the Fed that has control over commodity
trading assets and a reasonable benefit test that is to be
applied to that. And, Chair Gensler, as you noted, the CFTC has
considerable power regarding market manipulation.
Despite the powers invested in the Fed and the SEC and the
CFTC, it seems like there is a huge amount of conflict of
interest and a huge amount of market manipulation, and it does
not seem like much action. Meanwhile, this is essentially--when
these prices go up, it is a huge tax on the economy, whether it
is in the price of a beer can or aluminum siding or in the
future copper that goes into every electric--the electricity
channel through every house, et cetera. Should we expect more?
Is the regulatory power too dispersed? What needs to be done?
Because essentially the law is written time and time again to
try to say such conflicts of interest, such market
manipulation, such trading in commodities while you are also
betting on the price of commodities is not allowed, and yet
somehow we end up with all of that. How are we to explain this?
And what is to be done? And maybe I will start with you, Chair
Gensler.
Mr. Gensler. Senator, I could not agree more that these
markets matter. And they matter on the dining table at night;
they matter for somebody buying a six-pack of beer; they matter
when we all fill up a tank of gas; and they even matter when we
take out of a mortgage or a student loan. And as you noted
LIBOR. We at the CFTC oversee markets for commodities, and
commodities and their derivatives, futures, and swaps include
even interest rates. We took I think appropriate but tough
action about three banks that were readily and pervasively
rigging interest rates. We will do similar, if we see it, in--
whether it is corn or wheat, whether it is metals, whether it
is energy products. The Federal Reserve has authorities as to
whether bank holding companies are actually in that space, as
you say, that they actually hold those assets. What is critical
is that the CFTC ensure that the markets are free of fraud and
manipulation and other abuses.
I do think Congress gave us strong tools of enforcement. We
need to get the funding behind it, as Senator Warren said. But
I do think we have the strong legal tools to do what we are
supposed to do.
Senator Merkley. Chair Gensler, a number of articles have
said what FERC is doing in terms of being an aggressive
regulator in manipulation of the electric markets needs to be
replicated, if you will, in the metals market. Is that a model
that you are looking to as you think about where the agency
goes down the road here?
Mr. Gensler. We have good collaboration with FERC. They
take the primary lead in the electricity markets, as you know,
as Congress has dictated. And we have some involvement if it is
in the futures or swaps on electricity. We principally have
used our authorities with regard to those derivatives
marketplaces, and I think we will continue to do so. But as I
said, and as you pointed out, these are important markets to
all Americans.
Senator Merkley. Is there such an inherent conflict in
owning commodities and the tools that control the flow of those
commodities--warehouses, pipelines, et cetera--should it simply
be a situation where, if you are in the business of betting on
the price, you cannot engage in those commercial activities?
Mr. Gensler. I think, Senator, the challenge we have is
that hedgers, whether you are a farmer, a rancher, thinking
about----
Senator Merkley. But we are not talking about farmers or
ranchers. Those are very small players. We are only talking
about a situation where people can own vast shares of a
commodity market.
Mr. Gensler. You are absolutely right. I was just saying
there are speculators in the marketplace, and there have been
for centuries. The tools Congress gave us are to set
appropriate levels, call it ``position limits.'' I think we do
need to move forward. That was a rule we finalized. A court
vacated it. Two trade associations challenged it in court, and
though we are appealing, I think we do need to move forward and
finalize those rules.
We do have some interesting provisions in Dodd-Frank that
conflicts at large banks, that they have to separate out their
research--let us say they are doing research on oil and gas and
so forth, and they are trading. So there are conflict-of-
interest provisions that we also had. But ultimately it is the
Federal Reserve that would decide whether they are in that
space at all.
Senator Merkley. My time is up, and so, Chair White, I am
sorry I do not have time to get your insights. Thank you.
Chairman Johnson. I would like to thank Chair White and
Chairman Gensler for being here with us today. The
implementation of Wall Street reform continues to be a high
priority for this Committee, and we appreciate your hard work.
This hearing is adjourned.
[Whereupon, at 11:41 a.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF MARY JO WHITE
Chair, Securities and Exchange Commission
July 30, 2013
Chairman Johnson, Ranking Member Crapo, and Members of the
Committee, thank you for inviting me to testify on behalf of the
Securities and Exchange Commission regarding steps taken by the SEC to
reduce systemic risk in our capital markets. In particular, you
requested that I discuss the Commission's responsibilities with respect
to those aspects of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (``Dodd-Frank Act'' or the ``Act'') designed to mitigate
systemic risk.
The Commission, of course, recognizes the importance of addressing
systemic risk and promoting financial stability. The Dodd-Frank Act
gave the SEC significant new responsibilities for, among other things,
over-the-counter derivatives, hedge fund and other private fund
advisers, municipal advisors, and clearing agencies. The SEC has
proposed or adopted rules for over 80 percent of the more than 90 Dodd-
Frank Act provisions that require SEC rulemaking, and completing this
rulemaking--and the rulemaking called for under the Jumpstart Our
Business Startups Act (JOBS Act)--remains a top and immediate priority.
It is critical that we execute our responsibilities under both the
Dodd-Frank Act and JOBS Act in as timely and smart a way as possible.
Among the Dodd-Frank Act's goals was to decrease the likelihood
that an entity's failure will cause a cascading failure across the
financial system as a whole. Many of the core provisions of the Act
that seek to reduce systemic risks are within the sole jurisdiction of
the Federal banking regulators, but other provisions are within the
SEC's jurisdiction, either solely or as shared with other regulators.
For example, the Act:
Established a regulatory regime for over-the-counter
derivatives transactions, including security-based swaps;
Enhanced oversight and standards for systemically important
financial market utilities, including designated clearing
agencies supervised by the Commission;
Required advisers to many private funds to report data, on
a confidential basis, for use in monitoring systemic risk and
also supporting the SEC's mission;
Prohibited banks and their affiliates generally from
engaging in proprietary trading, or sponsoring or investing in
a hedge fund or private equity fund;
Altered the regulation of credit rating agencies;
Prohibited entities that create and distribute asset-backed
securities from engaging in certain transactions;
Established a new orderly liquidation authority for
systemically important broker-dealers and other financial
entities; and
Created the Financial Stability Oversight Council (FSOC) to
provide a formal structure for coordination among the heads of
various financial regulators to monitor systemic risk and to
promote financial stability across our Nation's financial
system.
Beyond the actions taken in connection with the Dodd-Frank Act, the
SEC has tried to diminish systemic risk in the securities markets by,
among other things, providing additional safeguards for money market
mutual funds.
Below is an overview of the steps the SEC has undertaken to try to
mitigate systemic risk in our securities markets, with an emphasis on
those actions mandated by the Dodd-Frank Act. \1\
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\1\ A list of the rulemaking provisions in the Dodd-Frank Act
applicable to the SEC is attached as Appendix A.
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Over-the-Counter Derivatives
Among the key provisions of the Dodd-Frank Act are those that
establish a new oversight regime for the over-the-counter (OTC)
derivatives marketplace. Title VII of the Dodd-Frank Act (Title VII)
requires the Commission to regulate ``security-based swaps'' and to
write rules that address, among other things: mandatory clearing; trade
reporting and trade execution; the operation of clearing agencies,
trade data repositories, and trade execution facilities; capital and
margin requirements and business conduct standards for dealers and
major market participants; and public transparency for transactional
information. Such rules are intended to achieve a number of goals,
including:
Facilitating the centralized clearing of swaps, with the
intent of reducing counterparty and systemic risk;
Increasing market transparency for regulators and market
participants;
Increasing security-based swap transaction disclosure; and
Addressing potential conflict of interest issues relating
to security-based swaps.
To date, the Commission has: proposed substantially all of the core
rules required by Title VII; adopted a number of final rules and
interpretations; provided a ``roadmap'' to implement Title VII and to
inform market participants of the sequence in which the new
requirements will become effective and how the proposed rules would
apply in a cross border context; and taken other actions to provide
legal certainty to market participants during the implementation
process. In advancing its regulatory initiatives, the Commission also
takes into account the potential disruption and cost to the market. The
Commission's more recent Title VII initiatives are discussed below in
more detail.
Proposal of Rules Regarding the Application of Title VII in the Cross-
Border Context
Given the global nature of the derivatives market, the Commission
has been working with its counterparts abroad and the Commodity Futures
Trading Commission (CFTC) to coordinate an approach to the regulation
of derivatives. In May, the Commission proposed rules and interpretive
guidance regarding the application of Title VII to cross-border
security-based swap transactions. \2\ The proposal includes rules and
interpretive guidance that, among other things, would inform parties to
a security-based swap transaction about which regulatory requirements
apply when their transaction occurs in part within and in part outside
the U.S. In addition, the proposal would provide interpretive guidance
regarding when a trading platform or clearing agency is required to
register with the Commission.
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\2\ See, Release No. 34-69490, Cross-Border Security-Based Swap
Activities; Re-Proposal of Regulation SBSR and Certain Rules and Forms
Relating to the Registration of Security-Based Swap Dealers and Major
Security-Based Swap Participants (May 1, 2013), http://sec.gov/rules/
proposed/2012/34-68071.pdf.
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The proposal generally would subject security-based swap
transactions to the requirements of Title VII if they are entered into
with a U.S. person or otherwise conducted within the United States. In
addition, foreign affiliates whose security-based swap transactions are
guaranteed by U.S. persons would be subject to certain requirements
under Title VII, based on the risk such guaranteed transactions might
pose to the U.S. financial system.
Under the proposal, a party may have the ability to comply with
Commission requirements by complying instead with some or all of the
requirements of a foreign regulatory regime, provided that those
requirements have been determined by the Commission to achieve
comparable regulatory outcomes. The Commission's proposal refers to
this approach as ``substituted compliance.'' Under substituted
compliance, a foreign market participant would be permitted to comply
with the requirements imposed by its own home country, so long as those
requirements achieve regulatory outcomes comparable with the regulatory
outcomes of the relevant provisions of Title VII. If the home country
does not have any requirements that achieve comparable regulatory
outcomes, substituted compliance would not be permitted and the foreign
entity would be required to comply with the applicable U.S.
requirements. The 60-day reopening of the comment period for certain
Title VII rulemaking releases and the policy statement ended July 22,
2013, and the comment period for our proposal on cross-border security-
based swap transactions ends August 21, 2013. We are actively reviewing
public input on the proposals, as well as the final guidance approved
by the CFTC on July 12, 2013.
The Commission has been, and continues to be, strongly supportive
of coordination of regulatory reforms to meet the G20 Leaders'
commitments to central clearing, trading, and reporting of OTC
derivatives. The Commission has been actively engaged in ongoing
discussions with foreign regulators regarding the direction of
international derivatives regulation and the Commission's efforts to
implement the requirements of Title VII, including participation in the
Financial Stability Board and the International Organization of
Securities Commissions (IOSCO), and engaging in regulatory dialogues
with other countries about our respective regulatory reform efforts.
Requirements for Security-Based Swap Dealers and Major Security-Based
Swap Participants
In July 2012, the Commission adopted final rules and
interpretations jointly with the CFTC regarding key product definitions
under Title VII, such as the meaning of ``swap'' and ``security-based
swap.'' \3\ This effort followed the joint adoption of entity
definitions by the Commission and the CFTC in April 2012, which further
defined the key terms ``swap dealer'' and ``security-based swap
dealer,'' provided guidance as to what constitutes dealing activity,
and implemented the Dodd-Frank Act's ``major security-based swap
participant'' definition. \4\
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\3\ See, Release No. 33-9338, Further Definition of ``Swap,''
``Security-Based Swap,'' and ``Security-Based Swap Agreement''; Mixed
Swaps; Security-Based Swap Agreement Recordkeeping (July 18, 2012),
http://www.sec.gov/rules/final/2012/33-9338.pdf.
\4\ See, Release No. 34-66868, Further Definition of ``Swap
Dealer,'' ``Security-Based Swap Dealer,'' ``Major Swap Participant,''
``Major Security-Based Swap Participant,'' and ``Eligible Contract
Participant'' (April 27, 2012), http://www.sec.gov/rules/final/2012/34-
66868.pdf.
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In October 2012, the Commission proposed rules that would, among
other things, prescribe how much capital security-based swap dealers
would need to maintain, when and how these dealers would need to
collect margin collateral to protect against counterparty losses, and
how these dealers would need to segregate and protect customer funds
and securities. \5\ The proposal also would establish capital and
margin collateral requirements for major security-based swap
participants and raise capital requirements for certain large broker-
dealers that use internal models in computing capital. The proposal
would further require those large broker-dealers and security-based
swap dealers to compute capital utilizing internal models, perform a
liquidity stress test at least monthly, and maintain liquidity reserves
sufficient to address potential funding needs during a stress event.
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\5\ See, Release No. 34-68071, Capital, Margin, and Segregation
Requirements for Security-Based Swap Dealers and Major Security-Based
Swap Participants and Capital Requirements for Broker-Dealers (Oct. 18,
2012), http://www.sec.gov/rules/proposed/2012/34-68071.pdf.
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Taken together, the goal of these rules is to help ensure that
market participants remain highly liquid and well capitalized so that
they can meet their obligations to customers and counterparties without
creating unnecessary burdens that impede liquidity and efficient
capital formation. In addition, in the event of a failure, enhanced
capital, margin, and customer segregation rules should help ensure that
customers and counterparties will be protected, thus limiting systemic
effects in the capital markets and the broader economy.
Requirements for Security-Based Swap Clearing Activity
Title VII of the Dodd-Frank Act requires that an entity acting as a
clearing agency with respect to security-based swaps register with the
Commission and that the Commission adopt rules with respect to clearing
agencies that clear security-based swaps. As described below, in
October 2012, the Commission adopted a rule that establishes
operational and risk management standards for clearing agencies,
including clearing agencies that clear security-based swaps. In June
2012, the Commission adopted rules that establish procedures for its
review of certain actions undertaken by clearing agencies. These rules
include provisions detailing how clearing agencies will provide
information to the Commission about the security-based swaps the
clearing agencies plan to accept for clearing, which will then be used
by the Commission to aid in determining whether those security-based
swaps are required to be cleared.
Financial Market Utilities
Title VIII of the Dodd-Frank Act (Title VIII) aims to mitigate
systemic risk in the financial system and promote financial stability
by providing for increased regulation of financial market utilities \6\
(FMUs) and financial institutions engaging in payment, clearing, and
settlement activities that are designated as systemically important.
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\6\ Section 803(6) of the Dodd-Frank Act defines a financial
market utility as ``any person that manages or operates a multilateral
system for the purpose of transferring, clearing, or settling payments,
securities, or other financial transactions among financial
institutions or between financial institutions and the person.''
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Enhanced Standards for Systemically Important Financial Market
Utilities
Under Title VIII, FSOC is authorized to designate an FMU as
systemically important if the failure, or a disruption to the
functioning, of the FMU could create or increase the risk of
significant liquidity or credit problems spreading among financial
institutions or markets, thereby threatening the stability of the U.S.
financial system. FSOC established an interagency FMU designations
committee to develop a framework for the designation of systemically
important FMUs. In July 2012, FSOC designated eight FMUs as
systemically important under Title VIII (DFMUs), and the Commission
acts as primary supervisory agency for four of these: the Depository
Trust Company, Fixed Income Clearing Corporation, National Securities
Clearing Corporation, and The Options Clearing Corporation. \7\
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\7\ Two other clearing agencies registered with the Commission are
designated systemically important for which the CFTC is the primary
supervisory agency: Chicago Mercantile Exchange, Inc. and ICE Clear
Credit LLC. The Federal Reserve Board acts as primary supervisory
agency for two payment systems that were designated as systemically
important FMUs: CLS Bank International and the Clearing House
International Payments System.
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Title VIII provides a framework for an enhanced supervisory regime
for DFMUs, including oversight in consultation with the Federal Reserve
Board (Federal Reserve) and FSOC. It permits the Commission to
prescribe regulations for risk management and operations, and also
directs the Commission to take into consideration relevant
international standards and existing prudential requirements for the
DFMUs it supervises. \8\ The Commission is also required to examine
such DFMUs annually.
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\8\ See, 805(a)(2) of the Dodd-Frank Act. Commission staff also
worked jointly with the staffs of the CFTC and the Federal Reserve to
submit a required report to Congress in July 2011 discussing
recommendations regarding risk management supervision of clearing
entities that are DFMUs. Risk Management Supervision of Designated
Clearing Entities, Report by the Commission, Board and CFTC to the
Senate Committees on Banking, Housing, and Urban Affairs and
Agriculture in fulfillment of Section 813 of Title VIII of the Dodd-
Frank Act (July 2011), http://www.sec.gov/news/studies/2011/
813study.pdf. The report discussed several recommendations, including
finalizing rulemakings to establish enhanced risk management for such
clearing entities, formalizing the process for ongoing consultations
and information sharing regarding such clearing entities and systemic
risk, and enhancing clearing entity examinations.
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Title VIII also establishes a process for a DFMU to submit to the
Commission, with a copy to the Federal Reserve, advance notices
identifying changes to its rules, procedures, or operations that could
materially affect the nature or level of risk presented by the FMU. \9\
In June 2012, the Commission adopted rules that establish procedures
for how it will address these advance notices, \10\ and it has since
considered a significant number of such notices. \11\
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\9\ See, 806(e)(4) of the Dodd-Frank Act.
\10\ See, Release No. 34-67286, Process for Submissions for Review
of Security-Based Swaps for Mandatory Clearing and Notice Filing
Requirements for Clearing Agencies; Technical Amendments to Rule 19b-4
and Form 19b-4 Applicable to All Self-Regulatory Organizations (June
28, 2012), http://www.sec.gov/rules/final/2012/34-67286.pdf.
\11\ Advance notices are published on the Commission Web site at
http://www.sec.gov/rules/sro.shtml.
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Adoption of Clearing Agency Standards
Clearing agencies play a critical role in financial markets by
ensuring that transactions settle on time and on agreed-upon terms. To
enhance the integrity of clearing agency operations and governance, the
Commission adopted rules in October 2012 requiring all registered
clearing agencies--including, as noted above, clearing agencies that
clear security-based swaps--to maintain certain standards with respect
to risk management and operations. \12\ The rules contain specific
requirements for clearing agencies that perform central counterparty
services, including, for example, written policies and procedures
addressing measuring credit exposures, use margin requirements,
maintaining financial resources sufficient to withstand defaults, and
fair and reasonable membership opportunities for persons who are not
dealers or security-based swap dealers. The requirements are designed
to strengthen the Commission's oversight of securities clearing
agencies and promote consistency in the regulation of clearing
organizations generally, thereby helping to ensure that clearing agency
regulation reduces systemic risk in the financial markets.
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\12\ See, Release No. 34-68080, Clearing Agency Standards (October
22, 2012), http://www.sec.gov/rules/final/2012/34-68080.pdf.
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Form PF: Systemic Risk Reporting by Advisers to Private Funds
Title IV of the Dodd-Frank Act directed the Commission to establish
reporting requirements for investment advisers to private funds as
necessary and appropriate in the public interest and for the protection
of investors or for the assessment of systemic risk by the FSOC. \13\
The Dodd-Frank Act specifies that such reporting must include certain
information about private funds, including but not limited to the
amount of assets under management, use of leverage, counterparty credit
risk exposure, and trading practices for each private fund managed by
the adviser. \14\ The Commission implemented this provision of the
Dodd-Frank Act when it adopted Form PF in October 2011, a systemic risk
reporting form for advisers to private funds. \15\ As required by the
Dodd-Frank Act, Form PF was designed in consultation with FSOC. To
date, approximately 2,300 investment advisers managing over $7 trillion
in private fund assets have filed approximately 4,000 reports on Form
PF concerning approximately 6,700 hedge funds, 66 liquidity funds and
5,900 private equity funds.
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\13\ Section 404 of the Dodd-Frank Act (codified at Section 204(b)
of the Investment Advisers Act of 1940, as amended).
\14\ Section 404 of the Dodd-Frank Act.
\15\ See, Release No. IA-3308, Reporting by Investment Advisers to
Private Funds and Certain Commodity Pool Operators and Commodity
Trading Advisors on Form PF (Oct. 31, 2011), http://www.sec.gov/rules/
final/2011/ia-3308.pdf.
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The requirement to file Form PF applies to investment advisers
registered with the Commission that advise one or more private funds
and have at least $150 million in private fund assets under management
at the end of the adviser's most recently completed fiscal year. The
filing requirements of Form PF vary depending on the size of the
adviser. Both the amount of information required to be reported and the
frequency with which Form PF must be filed depend on the amount of the
adviser's assets under management and the types of funds it advises.
\16\ Most advisers are required to file Form PF once a year, and report
basic information regarding the private funds they advise, such as the
types of private funds that an adviser advises, and information
relating to such funds' size, leverage, types of investors, liquidity,
and performance. Advisers managing hedge funds must also report
information about fund strategy, counterparty credit risk, and the use
of trading and clearing mechanisms.
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\16\ Large private fund advisers must provide more detailed
information than smaller private fund advisers. The content and
frequency of this more detailed reporting is different depending on the
type of private fund the large adviser manages. For example, advisers
with $1.5 billion or more in hedge fund assets under management must
report on risk metrics, financing information, and fund exposure for
each hedge fund managed that has a net asset value of at least $500
million.
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To comply with enhanced confidentiality provisions established
under the Dodd-Frank Act with respect to Form PF, Commission staff has
been developing a secure filing environment for Form PF to protect the
information when and after it is filed, including controls and systems
to handle the data across the agency and to deliver the data
electronically to the Office of Financial Research (OFR) within the
Department of the Treasury. As of May 1, 2013, the Commission received
a complete set of initial Form PF filings from those investment
advisers required to file. Commission staff has started to use the data
in carrying out the Commission's regulatory mission, including
examinations, investigations, and investor protection efforts.
The Volcker Rule
Section 619 of the Dodd-Frank Act (known as the ``Volcker Rule'')
generally prohibits and restricts banks, bank affiliates, and certain
nonbank financial companies from engaging in proprietary trading, or
sponsoring, investing, or having certain interests or relationships
with a hedge fund or private equity fund. The statute provides
exceptions to these prohibitions for certain customer-service oriented
activities, such as market making, underwriting, and, subject to
certain limitations, organizing and offering hedge funds and private
equity funds as part of bona fide trust, fiduciary, or investment
advisory services provided to a bank's customers.
In October 2011, the Federal banking agencies and SEC jointly
proposed rules to implement the Volcker Rule. \17\ In January 2012, the
CFTC issued a substantially similar proposal. To date, we have received
nearly 19,000 comment letters in response to the proposal. SEC staff
has carefully reviewed these comments and continues to engage in
regular and active consultation with the staffs at our fellow Federal
financial regulators to develop recommendations for implementing the
Volcker Rule in ways that advance the goals of Section 619 while also
limiting the potential for unintended market impacts.
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\17\ See, Release No. 34-65545, Prohibitions and Restrictions on
Proprietary Trading and Certain Interests in, and Relationships With,
Hedge Funds and Private Equity Funds (October 12, 2011), http://
www.sec.gov/rules/proposed/2011/34-65545.pdf.
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Credit Rating Agencies
The Dodd-Frank Act required the Commission to undertake a number of
rulemakings related to credit rating agencies registered as nationally
recognized statistical rating organizations, or ``NRSROs.'' The
Commission has proposed a series of rules intended to strengthen the
integrity of credit ratings by, among other things, improving the
transparency of ratings methodologies and performance. \18\
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\18\ Release No. 34-64514, Proposed Rules for Nationally
Recognized Statistical Rating Organizations (May 18, 2011), http://
www.sec.gov/rules/proposed/2011/34-64514.pdf.
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Additionally, the Dodd-Frank Act required each Federal agency, to
the extent applicable, to review its regulations that require use of
credit ratings as an assessment of the creditworthiness of a security,
remove these references, and replace them with appropriate standards of
creditworthiness. The Commission has proposed and, in some cases,
adopted amendments to a number of its rules to remove references to
credit ratings. \19\ The Commission plans to take further action in the
near term to complete implementation of these mandates.
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\19\ See, Release No. IC-No. 30268, Purchase of Certain Debt
Securities by Business Development Companies Relying on an Investment
Company Act Exemption (Nov. 19, 2012), http://www.sec.gov/rules/final/
2012/ic-30268.pdf; Release No. 34-67448, Commission Guidance Regarding
Definitions of Mortgage Related Security and Small Business Related
Security (Jul. 17, 2012), http://www.sec.gov/rules/interp/2012/34-
67448.pdf; Release No. 34-9245, Security Ratings (Jul. 27, 2011),
http://www.sec.gov/rules/final/2011/33-9245fr.pdf; Release No. 34-9244,
Re-proposal of Shelf Eligibility Conditions for Asset-Backed Securities
and Other Additional Requests for Comment (Jul. 26, 2011), http://
www.sec.gov/rules/proposed/2011/33-9244fr.pdf; Release No. 34-64352,
Removal of Certain References to Credit Ratings under the Securities
Exchange Act of 1934 (Apr. 27, 2011), http://www.sec.gov/rules/
proposed/2011/34-64352.pdf; Release No. IC-9193, References to Credit
Ratings in Certain Investment Company Act Rules and Forms (Mar. 3,
2011), http://www.sec.gov/rules/proposed/2011/33-9193fr.pdf.
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The Dodd-Frank Act also required the Commission to study the credit
rating process for structured products and the conflicts of interest
associated with the issuer-pay and subscriber-pay rating agency models,
and to examine the feasibility of establishing an assigned ratings
system or alternative means for compensating NRSROs. In December 2012,
the Commission submitted a required report to Congress containing the
findings of the study and recommendations for regulatory or statutory
changes that should be made to implement the findings of the study.
\20\ In May 2013, the Commission held a roundtable dedicated to these
topics.
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\20\ See, Report to Congress on Assigned Credit Ratings (December
2012), http://www.sec.gov/news/studies/2012/assigned-credit-ratings-
study.pdf.
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Prohibition Against Conflicts of Interest in Certain Securitizations
In September 2011, the Commission proposed a rule to implement
Section 621 of the Dodd-Frank Act, which prohibits entities that create
and distribute asset-backed securities from engaging in transactions
that involve or result in material conflicts of interest with respect
to the investors in such asset-backed securities. \21\ The proposed
rule would prohibit underwriters, placement agents, initial purchasers,
and sponsors of an asset-backed security, among others, from engaging
in any transaction that would involve or result in any material
conflicts of interest with respect to any investor in the relevant
asset-backed security.
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\21\ See, Release No. 34-65355, Prohibition Against Conflicts of
Interest in Certain Securitizations (September 19, 2011), http://
www.sec.gov/rules/proposed/2011/34-65355.pdf.
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The Commission received a number of comment letters discussing a
range of complex issues, including the ability of portfolio managers to
hedge the credit risk that a bank holds on its balance sheet through
synthetic securitizations. Commission staff is carefully considering
each of the issues and concerns raised in the comment letters.
Orderly Liquidation Authority
Title II of the Dodd-Frank Act created a new process, modeled on
the receivership process used for failed banks, pursuant to which the
Federal Deposit Insurance Corporation (FDIC) may serve as receiver for
certain large financial companies, including broker-dealers, whose
failure poses a significant risk to financial stability in the United
States. Under Title II, the Commission and the FDIC are required to
develop joint rules governing the orderly liquidation of broker-
dealers, and the Commission staff is working to prepare a
recommendation for the Commission's consideration. The rules should
provide greater certainty and transparency regarding the process the
FDIC would follow during the orderly liquidation of a systemically
important broker-dealer.
Other Commission Actions Addressing Potential Systemic Risks
Beyond actions taken in connection with the implementation of the
Dodd-Frank Act, the Commission has taken additional steps to further
reduced systemic risk in our securities markets.
Enhancing Operational Integrity
Nearly all trading in the equity and options markets today depends
on the reliable performance of highly automated systems, as reliance on
technology has enabled the markets to achieve extraordinary levels of
speed and efficiency. When technology systems do not work as intended,
however, the failures can harm not only the operator of the system, but
also a wide range of other market participants.
In November 2010, the Commission adopted a new Market Access Rule
to require broker-dealers with market access to put in place risk
management controls and supervisory procedures on a pretrade basis.
Among other things, the rule requires any broker using or providing
access to trading on the securities markets to implement pretrade
controls reasonably designed to manage the financial, regulatory, and
other risks of such access.
In March of this year, the Commission proposed Regulation Systems
Compliance and Integrity (Regulation SCI), \22\ which would require
exchanges, certain alternative trading systems, clearing agencies, and
plan processors to maintain policies and procedures reasonably designed
to meet certain technology standards, and take appropriate corrective
action if problems do occur. The comment period for proposed Regulation
SCI closed on July 8, and Commission staff is currently in the process
of reviewing the comment letters.
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\22\ See, Release No. 34-69077, Regulation Systems Compliance and
Integrity (March 8, 2013), http://www.sec.gov/rules/proposed/2013/34-
69077.pdf.
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Addressing Significant Market Volatility
The Commission also recently approved a National Market System
(NMS) Plan to implement a ``limit up-limit down'' mechanism to create
``speed bumps'' to limit abrupt market movements in individual
securities, \23\ and amendments to the marketwide circuit breakers to
provide for brief, coordinated, cross-market trading halts during a
sharp decline in the securities market. \24\ The marketwide circuit
breakers and phase I of the NMS Plan relating to the limit up-limit
down mechanism were implemented on April 8, 2013. \25\
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\23\ See, Release No. 67091, Order Approving, on a Pilot Basis,
the National Market System Plan To Address Extraordinary Market
Volatility by BATS Exchange, Inc., BATS Y-Exchange, Inc., Chicago Board
Options Exchange, Incorporated, Chicago Stock Exchange, Inc., EDGA
Exchange, Inc., EDGX Exchange, Inc., Financial Industry Regulatory
Authority, Inc., NASDAQ OMX BX, Inc., NASDAQ OMX PHLX LLC, The Nasdaq
Stock Market LLC, National Stock Exchange, Inc., New York Stock
Exchange LLC, NYSE MKT LLC, and NYSE Arca, Inc. (May 31, 2012), http://
www.sec.gov/rules/sro/nms/2012/34-67091.pdf; Release No. 34-68953,
Notice of Filing and Immediate Effectiveness of the Second Amendment to
the Limit Up-Limit Down Plan (February 20, 2013), http://www.sec.gov/
rules/sro/nms/2013/34-68953.pdf; Release No. 34-69287, Order Approving
the Third Amendment to the Limit Up-Limit Down Plan (April 3, 2013),
http://www.sec.gov/rules/sro/nms/2013/34-69287.pdf.
\24\ See, Release No. 34-67090, Notice of Filing of Amendments No.
1 and Order Granting Accelerated Approval of Proposed Rule Changes as
Modified by Amendments No. 1, Relating to Trading Halts Due to
Extraordinary Market Volatility (May 31, 2012), http://www.sec.gov/
rules/sro/bats/2012/34-67090.pdf. The operative date of the revised
circuit breakers was delayed from February 4, 2013, to April 8, 2013.
See, e.g., Release No. 34-68784, Notice of Filing and Immediate
Effectiveness of Proposed Rule Change Delaying the Operative Date of a
Rule Change to NYSE Rule 80B, Which Provides for Methodology for
Determining When To Halt Trading in All Stocks Due to Extraordinary
Market Volatility, From the Date of February 4, 2013, Until April 8,
2013 (January 31, 2013), http://www.sec.gov/rules/sro/nyse/2013/34-
68784.pdf.
\25\ Phase I applies the limit up-limit down mechanism to stocks
in the S&P 500, the Russell 1000, and to select exchange-traded
products. Phase II, currently scheduled for implementation in November
2013, will apply to all remaining exchange-traded equity securities,
and will be implemented 6 months following the implementation of Phase
I.
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Money Market Funds
While there are many possible explanations for the redemptions from
money market funds during the 2007-2008 financial crisis, regardless of
the cause or causes, money market funds' experience in the 2007-2008
financial crisis demonstrates the harm that can result from rapid heavy
redemptions in money market funds. Since that time, the Commission and
its staff have reexamined the Commission's regulation of money market
funds. This effort began with the Commission's 2010 reforms to money
market fund regulation, followed by a 2011 Commission roundtable on
money market funds and systemic risk, a new and detailed study in 2012
by SEC economists, and most recently a June 2013 proposal requesting
public comment on additional reforms to the Commission's regulation of
money market funds. \26\ The staff also has used data collected from
money market funds on Form N-MFP to monitor trends and risks in this
area, which was particularly useful during the Eurozone sovereign debt
crisis.
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\26\ See, Release No. IC-30551, Money Market Fund Reform;
Amendments to Form PF (Jun. 5, 2013), http://www.sec.gov/rules/
proposed/2013/33-9408.pdf; Response to Questions Posed by Commissioners
Aguilar, Paredes, and Gallagher, a report by staff of the Division of
Risk, Strategy, and Financial Innovation (Nov. 30, 2012), http://
www.sec.gov/news/studies/2012/money-market-funds-memo-2012.pdf; U.S.
Securities and Exchange Commission, Roundtable on Money Market Funds
and Systemic Risk, unofficial transcript (May 10, 2011), http://
www.sec.gov/spotlight/mmf-risk/mmf-risk-transcript-051011.htm; Release
No. IC-29132, Money Market Fund Reform (Feb. 23, 2010), http://
www.sec.gov/rules/final/2010/ic-29132.pdf.
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The Commission's recent proposal requests comment on a variety of
reforms designed to reduce money market funds' susceptibility to heavy
redemptions, to mitigate potential contagion effects from heavy
redemptions, and to increase the transparency of their risks, while
preserving the benefits of this product to both retail and
institutional investors to the extent possible. There are two principal
reform proposals--which could be adopted separately or in combination.
The first--would require that all prime institutional money market
funds operate with a floating net asset value. The second would require
that all non-Government money market funds impose a 2 percent liquidity
fee if the fund's level of weekly liquid assets fell below 15 percent
of its total assets, unless the fund's board determined that it was not
in the best interest of the fund. The second reform alternative also
would permit the fund's board of directors to temporarily suspend
redemptions in the fund for up to 30 days if it crossed that liquidity
threshold. With respect to both alternatives, the proposed reforms also
would tighten diversification requirements, enhance disclosure
requirements, improve data reporting on both registered and
unregistered money market funds, and strengthen fund stress testing. We
look forward to receiving public input on the proposal and whether it
strikes the right balance between addressing systemic risk concerns
while also maintaining money market funds as a viable investment
product. The 90-day comment period ends in mid-September.
Financial Stability Oversight Council
Title I of the Dodd-Frank Act provides that the Chairman of the
Commission shall serve as a voting member of FSOC. \27\ Pursuant to the
Dodd-Frank Act, the purposes of the Council are:
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\27\ Dodd-Frank Act 111(b)(1).
Identifying risks to the financial stability of the United
States that could arise from the material financial distress or
failure--or ongoing activities--of large, interconnected bank
holding companies or nonbank financial holding companies, or
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that could arise outside the financial services marketplace;
Promoting market discipline by eliminating expectations on
the part of shareholders, creditors, and counterparties of such
companies that the Government will shield them from losses in
the event of failure; and
Responding to emerging threats to the stability of the
United States financial system. \28\
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\28\ Dodd-Frank Act 112(a)(1)(E).
In addition, FSOC provides a formal structure for coordination
among the various financial regulators. As Chairman of the SEC, I
participate in the activities of the Council, including consideration
of designation of certain nonbank financial companies as systemically
important financial institutions (SIFIs) subject to heightened
prudential supervision by the Board of Governors of the Federal Reserve
System (Federal Reserve Board). \29\
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\29\ See, Dodd-Frank Act 112(a)(2)(H) and 113. See also,
``Financial Stability Oversight Council Makes First Nonbank Financial
Company Designations To Address Potential Threats to Financial
Stability'' (Jul. 9, 2013), http://www.treasury.gov/press-center/press-
releases/Pages/jl2004.aspx.
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Conclusion
The Commission recognizes the importance of limiting systemic risk
in our financial markets and is committed to taking appropriate steps
to address systemic threats to our financial system in a balanced
manner that preserves the strengths of the system and protects
investors. Thank you for inviting me to testify today. I would be happy
to answer any questions you may have.
APPENDIX A
PREPARED STATEMENT OF GARY GENSLER
Chairman, Commodity Futures Trading Commission
July 30, 2013
Good morning Chairman Johnson, Ranking Member Crapo, and Members of
the Committee. Thank you for inviting me to today's hearing. I am
pleased to testify along with Securities and Exchange Commission (SEC)
Chair Mary Jo White.
Today's hearing comes at an historic moment in the CFTC's effort to
implement the much-needed reforms of the Dodd-Frank Wall Street Reform
and Consumer Protection Act (Dodd-Frank Act). Now, 3 years since
passage of the Dodd-Frank Act, I am pleased to report that we have
nearly completed all of the necessary rule writing. Market participants
are well along the path of implementing these reforms.
These reforms for the first time shine a light on a marketplace
that has been opaque for far too long. These reforms mitigate risk and
broaden market access through central clearing of standardized
derivatives. These reforms for the first time bring oversight to swap
dealers and major swap participants--some of whom were at the center of
the bailouts of the financial crisis 5 years ago. I thank my fellow
commissioners and the staff of the Commodity Futures Trading Commission
(CFTC) for all of their hard work, dedication, and collaboration in
bringing oversight to the swaps marketplace.
Introduction
The public and the economy benefit from swap market reforms, just
as the public benefited from the historic reforms in the securities and
futures markets since the 1930s. For the first time, we have in place a
legal and regulatory foundation for the vast swaps markets that brings
transparency and lowers risk for the American public. This new
comprehensive regulatory regime includes robust rules of the road to
benefit those who trade swaps as well as those who have never even
heard of them.
In 2008, we witnessed widespread failure throughout the financial
system and financial regulatory system. The lack of important oversight
in the swaps market--oversight that we've had for decades in the
securities and futures markets--allowed for risk to accumulate and be
passed on to the public in the form of taxpayer-funded bailouts.
Taxpayers sent $182 billion to AIG alone. And AIG was just one part of
the larger financial crisis that nearly took down the U.S. and global
economies.
Middle class Americans paid the price of the 2008 financial crisis
with their jobs, their pensions and their homes. The crisis cost eight
million jobs and thousands of businesses, and the swaps market was
right at the center. Americans are remarkably resilient, but they do
expect us to learn from the lessons of the crisis and to do everything
possible to prevent this from happening again. That is why Congress
passed the Dodd-Frank Act and why the hard working staff of the CFTC
have worked so diligently to implement its reforms.
These rules are complementary pieces of an interconnected
foundation on which the swaps market will operate in a transparent,
open and competitive manner. Further, just as we have complementary
commonsense rules for our roads--traffic lights, stop signs, and speed
limits, and cops on the streets to enforce all these rules--we need
commonsense rules of the road for the swaps markets. In 2008, we had
AIG recklessly driving toward failure, and it, along with other failing
financial institutions, were so big that they injured millions of
bystanders.
Americans would never accept a city or highway system with no
rules, no streetlights, no traffic lights, and no cops.
And now, with the near-completion of swaps market reforms, the
American public no longer will need to accept a dark swaps market
lacking commonsense rules of the road.
Credit should be shared for this reform with the SEC. We have
worked collaboratively with the SEC, sharing our internal memos, term
sheets, and draft regulations and seeking advice and counsel every step
of the way. In addition to the consultation, Congress tasked the CFTC
and SEC with jointly completing a number of critical, foundational
rules further defining swap dealers and swaps, among other terms. It is
only with this close work and collaboration that reform came to life.
We also significantly benefited from collaboration with other U.S. and
international regulators.
We have completed this reform sensitive, as Congress was, that
nonfinancial firms, responsible for 94 percent of private sector jobs
in this country, only make up approximately 10 percent of the swaps
market. Congress directed that these nonfinancial end users have a
choice about central clearing, and our rules reflect that. Consistent
with Congress's direction related to clearing, the CFTC has proposed
that margin for uncleared swaps does not have to be collected from
nonfinancial end users. We also have ensured that treasury affiliates
of nonfinancial end users will have a choice about central clearing.
Further, we granted relief for inter-affiliate clearing and reporting
as long as outward-facing transactions are cleared and reported.
I now will walk you through the three key areas of completed
reforms: transparency, central clearing, and oversight of swap dealers
and other intermediaries.
Transparency and Access--Lowering Cost and Increasing Liquidity,
Efficiency, and Competition
A key benefit of swaps reform is providing critical transparency
and access to businesses and other end users that use the swaps market
to lock in a price or hedge a risk. Transparency and access--
longstanding hallmarks of the futures market, both before and after the
trade--lower costs for investors, consumers, and businesses.
When light shines on a market, the economy and public benefit.
Transparency increases liquidity, efficiency, and competition. It is
the nonfinancial part of our economy that provides 94 percent of
private sector jobs in the United States and will most benefit from
transparency and access to markets. Even amongst financial entities,
pension funds, community banks, insurance companies, and other
nondealers will significantly benefit as they manage the savings and
security of Americans.
Based upon completed reforms, the public and regulators already are
benefiting from significant new transparency. Starting late last year,
financial regulators have been able to look at swaps transactions that
are now being reported to swap data repositories. The phased
implementation of these reporting requirements is nearly complete, with
just one remaining group of U.S. transactions coming into data
repositories August 19. Additional reporting from offshore swap dealers
will phase in later this fall.
We now have pricing, transactional, counterparty and valuation
information in the data repositories for more than $360 trillion in
outstanding swaps. This covers all the different asset classes,
including interest rate swaps, credit index swaps, foreign currency
swaps, energy swaps, metals swaps, and agriculture swaps. We already
are benefiting at the CFTC, reviewing this data for purposes of our
oversight and surveillance.
Congress knew, though that transparency to the regulators is not
enough. Markets work best when the public benefits from seeing the
price and volume of transactions after they have been executed.
Beginning this past January, the public can now see the prices and
volume of transactions on a time delayed basis (and in a way that masks
counterparties), similar to a modern-day ticker tape, free of charge
and available on the Internet. Further, starting today, July 30, a
significant portion of the smaller-size transactions will no longer be
reported on a time-delayed basis. This fulfills Congress's mandate that
transactions below a block size be publicly reported ``as soon as
technologically practicable.''
As the Commission recently finalized block rules for swaps, it will
shortly turn to consider staff recommendations for a proposal on a
futures block rule.
In addition, for the first time, all swaps trading facilities will
have to register, completing the task of closing what had come to be
known as the ``Enron loophole.'' We accomplished this through
finalizing rules relating to swap execution facilities (SEFs), which
are trading facilities for the transaction of swaps. SEFs already have
started to register, and some are likely to be operating by August 5.
Others will need to register and include the minimum trading functions,
such as an order book, by October 2. All market participants shortly
will have the ability to compete by making bids and offers to each
other through an order book. They also benefit by seeing the prices of
such orders prior to making a decision on a transaction.
Thus, market participants, whether they be pension funds, asset
managers, community banks or other end users, shortly will be able to
go onto a centralized market structure--a designated contract market
(DCM) or a SEF--and execute their swaps transactions in a competitive
marketplace, while in the past they were primarily only able to do this
directly with dealers. This is a critical benefit to our overall
economy. When transparency and competition come to a marketplace, costs
go down.
Further, standardized swaps (swaps that are subject to the clearing
requirement and made available for trading) will be subject to a trade
execution requirement likely starting by early next year. A significant
portion of interest rate and credit derivative index swaps will be in
full view to the marketplace before transactions occur. Trading
platforms also can elect to offer other types of swaps for transparent
trading. This is a significant shift toward market transparency from
the way it used to be.
As Congress made clear in the law, trades will be required to be
executed on SEFs or DCMs only when financial institutions transact with
financial institutions. Nonfinancial commercial companies and other end
users will benefit from access to the information on these platforms,
but will not be required to use them. Further, companies will be able
to continue relying on customized transactions--those not required to
be cleared--to meet their particular needs, as well as to enter into
large block trades.
Beyond these reforms, new CFTC rules brought additional
transparency earlier this year, as customers can now see the valuation
of their positions on a daily basis--either as reported by the
clearinghouse or by their swap dealers as required by business conduct
rules.
With these transparency reforms, the public and regulators now have
their first full window into the swaps marketplace. These reforms build
upon the democratization of the swaps market that is coming with the
clearing of standardized swaps.
Central Clearing--Mitigating Risk and Promoting Access
Transparency is but one critical rule of the road in the swaps
markets. It provides the street lamps that light the roads, but we also
must ensure that the streets are safe for driving and that drivers have
easy access to the highways.
Clearinghouses have operated in the futures markets since the late
19th century to lower risk and improve access for market participants.
Clearinghouses reduce the risk that one entity's failure could spread
to the public by standing between the parties and maintaining resources
to cover defaults. They value every position daily and require the
parties to post adequate margin on a regular basis. Clearing also
fosters access for the broad market as it ensures that each participant
no longer has to individually worry about its counterparty's credit
characteristics.
The CFTC has implemented the two principal reforms of the Dodd-
Frank Act relating to clearing.
First, consistent with the direction of the statute, the Commission
in the fall of 2011 adopted a comprehensive set of rules for the risk
management of clearinghouses. These final rules provided a strong set
of protections for customer money posted to clearinghouses, including
for the first time a requirement for gross margining as well as
segregation of customer money at the clearinghouse.
These final rules were consistent with international standards as
of the time that our rules were published. Subsequently, new
international standards have been adopted--the Principles for Financial
Market Infrastructures. Though the Commission's clearinghouse risk
management rules cover the vast majority of these new international
standards, CFTC staff is working expeditiously to recommend the
necessary steps to implement the remaining items that should be
incorporated in our rules. Most importantly, Commissioners currently
are considering finalizing a rule requiring systemically important
clearinghouses to have prefunded default resources sufficient to cover
the default of the two clearing members that would cause the greatest
loss (after margin) in extreme but plausible circumstances.
Second, the CFTC adopted rules to implement the Dodd-Frank Act's
requirement that standardized swaps be cleared. The Commission approved
the first clearing requirement last November, following through on the
U.S. commitment at the 2009 G20 meeting that standardized swaps be
cleared by the end of 2012. The Commission has determined that swaps in
four interest rate swap classes (U.S. Dollar, Euro, Sterling, and Yen)
and in two credit index swap classes (CDX and iTraxx) are subject to
the clearing requirement. These asset classes account for the vast
majority of interest rate and credit default index swaps.
We reached a key milestone in March when the clearing requirement
for swap dealers and the largest hedge funds went into effect.
Additional financial entities began clearing June 10. Compliance will
continue to be phased in throughout this year. Accounts managed by
third party investment managers and ERISA pension plans have until
September 9. As we phase in compliance with the recently completed
cross-border interpretive guidance, collective investment vehicles,
including hedge funds, whose principal place of business is in the U.S.
but may have incorporated offshore (for instance, in the Cayman
Islands) will have to comply with the clearing requirements by October
10. Further, guaranteed affiliates of U.S. persons will have to begin
complying with the clearing requirement on October 10 as well. The CFTC
also fulfilled Congress's direction to exempt nonfinancial end users
from the clearing requirement.
Oversight of Swap Dealers and Other Intermediaries
The third critical piece of swaps market reform is oversight of
swap dealers and investment funds operating in the swaps market. To
extend the highway metaphor, we require that drivers have licenses and
know the rules of the road. Though Congress did not suggest this for
all market participants, they were clear that the dealers themselves
had to be registered and be brought under new reforms. Furthermore,
Congress directed that swaps reforms extend to investment vehicles that
invest in swaps.
The foundational joint rules of the CFTC and SEC further defining
swap dealers and swaps went into effect last October. By last December,
swap dealers began to provisionally register. We now have had 80 swap
dealers and two major swap participants provisionally register with the
CFTC. This group includes the largest domestic and international
financial institutions dealing in swaps, including the 16 institutions
commonly referred to as the G16 dealers. We expect additional entities
to register as swap dealers as the recently completed cross-border
interpretive guidance becomes effective later this year.
Since the beginning of this year, swap dealers have had to report
their trades to both regulators and the public. They also have had to
comply with various business conduct standards that lower risk and
increase market integrity. These include promoting the timely
confirmation of trades and documentation of the trading relationship.
Swap dealers also have been required since earlier this year to
implement sales practice standards that prohibit fraud, require fair
treatment of customers, and improve transparency.
Cross-Border Derivatives Reform
Congress was clear that the far-flung operations of U.S.
enterprises are to be covered by reform. Recognizing the lessons of the
crisis and modern finance, Congress was clear in section 722(d) of the
Dodd-Frank Act that swaps reform does apply to activities outside our
borders with ``a direct and significant connection with activities in,
or effect on, commerce of the United States.''
The largest banks and institutions are global in nature, and when a
run starts on any part of an overseas affiliate or branch of a modern
financial institution, risk comes crashing right back to our shores.
The nature of modern finance is that financial institutions commonly
set up hundreds, or even thousands, of legal entities around the globe.
In fact, the U.S.'s largest banks each have somewhere between 2,000 and
3,000 legal entities. AIG nearly brought down the U.S. economy because
it guaranteed the losses of a Mayfair Branch operating under a French
bank license in London. Lehman Brothers had 3,300 legal entities,
including a London affiliate that was guaranteed here in the U.S., and
it had 130,000 outstanding swap transactions. Citigroup had structured
investment vehicles that were set up in the Cayman Islands, run out of
London, and yet were central to not one, but two bailouts of that
institution. Bear Stearns, in 2007 had two sinking hedge funds
organized in the Cayman Islands that had to be bailed out by the parent
entity. A decade earlier, the same was true for Long-Term Capital
Management.
After receiving public input and coordinating with the SEC and
other regulators, working with international regulators, we issued
guidance and an exemptive order to provide clarity to the market that
our new rules apply to cross-border derivative activities. The CFTC
interprets the cross-border provisions to cover swaps between non-U.S.
swap dealers and guaranteed affiliates of U.S. persons as well as swaps
between two guaranteed affiliates. The guidance does recognize and
embrace the concept of substituted compliances where there are
comparable and comprehensive rules abroad. Further, the interpretive
guidance captures offshore hedge funds and collective investment
vehicles that have their principal place of business here in the U.S.
or that are majority owned by U.S. persons.
We published the proposed guidance for public comment in June of
last year and then sought additional comment in December. On July 12,
we gave swap dealers organized in each of six jurisdictions (Australia,
Canada, the European Union, Hong Kong, Japan, and Switzerland) 5
additional months to come into compliance with certain swaps reforms as
we assess the submissions from those jurisdictions regarding
substituted compliance.
Investment Funds
Furthermore, Consistent with Congress's direction that swaps
reforms extend to investment vehicles investing in swaps, the
Commission approved final rules 18 months ago that increase
transparency to regulators of commodity pool operators (CPOs) and
commodity trading advisors (CTAs) acting in the derivatives
marketplace--both futures and swaps. The rulemaking also rescinded
prior exemptions from CPO registration that had been used by many hedge
funds. As a result, CPOs of registered investment companies and hedge
funds were required to register by December 31, 2012, and, to date,
more than 500 funds and registered investment companies have done so.
Pooled investment vehicles, including registered investment companies
that trade more than a de minimis amount in commodities or market
themselves as commodity funds now will be subject to CFTC oversight.
These rules enhance transparency and increase customer protections
through amendments to the compliance obligations for CPOs and CTAs. The
Commission currently is considering staff recommendations to finalize a
rule that seeks to harmonize with the securities laws, to the extent
possible, requirements for CPOs of registered investment companies.
Looking Forward on Swaps Market Reform
Now that we have successfully completed the bulk of the rulemaking,
and the market is largely implementing those reforms, the CFTC is
focusing on three principal areas.
Compliance, Registration, Surveillance, and Enforcement
First, with most of the new reforms' compliance dates behind us,
the CFTC is increasingly shifting toward reviewing registration
applications of various entities and reviewing those entities and
transactions for compliance through the agency's surveillance,
examination, and enforcement functions.
The CFTC will continue to work with market participants as they
phase in compliance with these completed reforms. The CFTC embraced
phasing in compliance to smooth the transition to a new regulatory
regime and to ensure that reform is actively implemented. Market
participants began phasing in compliance last October. As I have
reviewed, much already has been accomplished, but, looking ahead, there
are critical compliance dates through the rest of this year and into
2014.
International Harmonization
Second, we are going to continue to work with regulators around the
globe to promote reform and harmonize where we can. For example, we are
working closely with our international counterparts to ensure that all
U.S. persons and their guaranteed affiliates are covered by reform--
either the Dodd-Frank Act reforms or through compliance with comparable
and comprehensive rules of another jurisdiction.
Earlier this month, we took a significant step when the European
Union and we announced a path forward regarding joint understandings
for the regulation of cross-border derivatives. This was a significant
step forward in harmonizing and giving clarity to the markets,
particularly when there might be jurisdictional overlaps with regard to
our respective reforms.
The CFTC over the next 5 months will be reviewing submissions from
the six jurisdictions (Australia, Canada, the European Union, Hong
Kong, Japan, and Switzerland) to assess their regulatory regimes with
regard to possible substituted compliance determinations.
We also are working with foreign regulators on memoranda of
understanding to ensure that we will be able to exercise our respective
supervisory responsibilities in an efficient, coordinated manner.
Dodd-Frank Rulemakings
Third, we do have a handful of rules to finalize, including capital
and margin for swap dealers, the Volcker Rule and position limits.
The CFTC is collaborating closely domestically and internationally
on a global approach to margin requirements for uncleared swaps. We
have been working along with the Federal Reserve, the other U.S.
banking regulators, the SEC and our international counterparts on a
final set of standards to be published by the Basel Committee on
Banking Supervision and the International Organization of Securities
Commissions (IOSCO). The CFTC's proposed margin rules exclude
nonfinancial end users from margin requirements for uncleared swaps. We
have been advocating with global regulators for an approach consistent
with that of the CFTC. I now anticipate that the final set of
international standards, which are nearing completion, will not call
for margin for nonsystemic, nonfinancial entities. After the
international standards are published, the CFTC will further propose
margin rules likely later this year and seek to finalize those rules in
the first half of 2014.
Following Congress' mandate, the CFTC is working with our fellow
domestic financial regulators to complete the Volcker Rule. In adopting
the Volcker Rule, Congress prohibited banking entities from proprietary
trading, an activity that may put taxpayers at risk. At the same time,
Congress permitted banking entities to engage in certain activities,
such as market making and risk mitigating hedging. One of the
challenges in finalizing a rule is achieving these multiple objectives.
In the Dodd-Frank Act, Congress directed the Commission to impose
limits on speculative positions in physical commodity futures and
options contracts and economically equivalent swaps. The agency
finalized a rule in October 2011 that addressed Congress's direction to
prevent any single trader from obtaining too large a share of the
market to ensure that derivatives markets remain fair and competitive.
Last fall, a Federal court vacated the rule, and we currently are in
the process of appealing that decision. Concurrently, we are working on
developing a new proposed rulemaking to address position limits. It is
critically important that these position limits be established as
Congress required.
Looking Forward on Other Critical Reforms
In addition to the ongoing work on swaps market reform, the CFTC
also is pursuing a number of other critical initiatives. I will
highlight three such initiatives in this testimony.
Customer Protection
First, the Commission is continuing its work to enhance the
protection of customer funds in both the futures and swaps markets.
We have completed amendments to rule 1.25 regarding the investment
of customer funds to benefit both futures and swaps customers in
December 2011. The CFTC's gross margining rules for futures and swaps
customers, which went into effect last November, require clearinghouses
to collect margin on a gross basis. Futures Commission Merchants (FCMs)
are no longer able to offset one customer's collateral against another
or to send only the net to the clearinghouse. Swaps customers further
benefit from the new so-called ``LSOC'' (legal segregation with
operational comingling) rules, which also became effective last year
and ensure funds are protected individually all the way to the
clearinghouse.
The Commission also worked closely with market participants on new
customer protection rules adopted by the self-regulatory organization
(SRO), the NFA. These include requiring FCMs to hold sufficient funds
for U.S. foreign futures and options customers trading on foreign
contract markets (in Part 30 secured accounts). Starting last year,
FCMs must meet their total obligations to customers trading on foreign
markets under the net liquidating equity method. In addition,
withdrawals of 25 percent or more of excess segregated funds would
necessitate pre-approval in writing by senior management and must be
reported to the designated SRO and the CFTC.
Building upon these reforms, in the fall of 2012, the Commission
sought public comment on a proposal that would further strengthen the
controls around customer funds at FCMs. It would set new regulatory
accounting requirements and would raise minimum standards for
independent public accountants who audit FCMs. And it would provide
regulators with daily direct electronic access to the FCMs' bank and
custodial accounts for customer funds.
The proposal includes a provision on residual interest to ensure
that the assets of one customer are not used to cover the positions of
another customer. We are considering the many comments we have received
on this, consistent with the specific provisions of the Commodity
Exchange Act and the overall goal of protecting customers. The
Commissioners shortly will receive final staff recommendations on this
rule. I think it is critical that we complete these reforms this fall.
Benchmark Interest Rates
Second, the CFTC is continuing its work with domestic and
international regulators to ensure the market integrity of benchmark
interest rates. Benchmark interest rates, such as the London Interbank
Offered Rate (LIBOR) are very important to the American public. LIBOR
is the reference rate for 70 percent of the U.S. futures market and
more than half of our swaps market. It is the reference rate for more
than $300 trillion in derivatives and more than $10 trillion in loans.
We need to ensure that these benchmark interest rates have market
integrity and that they are based on fact, not fiction.
The interbank unsecured market that the benchmarks are intended to
measure, however, essentially no longer exists, particularly for longer
tenors.
Furthermore, our enforcement actions against three global banks,
along with those of the Financial Conduct Authority, the Justice
Department and others, have shown that LIBOR, EURIBOR, and similar
rates have been readily and pervasively rigged. The CFTC initiated an
investigation in 2008 related to LIBOR. Barclays, UBS, and RBS paid
fines of approximately $2.5 billion for manipulative conduct relating
to these rates as a result of multiple agencies' enforcement and
criminal actions.
Given these vulnerabilities and the real risk that they will
remain, to ensure market integrity and support financial stability, the
Financial Stability Oversight Council recommended in its annual report
that U.S. regulators work with foreign regulators, international
bodies, and market participants to promptly identify alternative
interest rate benchmarks that are anchored in observable transactions
and are supported by appropriate governance structures, and to develop
a plan to accomplish a transition to new benchmarks while such
alternative benchmarks are being identified. The Council further
recommended that steps be taken to plan for and promote a smooth and
orderly transition to alternative benchmarks, with consideration given
to issues of stability and to mitigation of short-term market
disruptions.
An IOSCO task force took an important step in bringing reform to
benchmark interest rates in announcing new principles earlier this
month. Given the known problems with LIBOR, EURIBOR, and other
significant market benchmarks, I am pleased that the IOSCO Principles
require that benchmarks be anchored by observable transactions and
subject to robust governance processes that address potential conflicts
of interest. This report establishes new international standards.
The Financial Stability Board (FSB) is building upon the work of
IOSCO by initiating a review of alternatives to existing benchmark
interest rates as well as considering any potential transition issues.
The FSB has established an Official Sector Steering Group of regulators
and central banks and will convene and guide the work of a Market
Participants Group.
Direct Market Access
Third, Commission staff currently is developing a concept release
for public comment concerning the testing of systems and supervision of
market participants with direct electronic market access. These
concepts will be designed to address potential risks that high
frequency traders and others who have direct market access may cause.
Working with other regulators, we hope to hear from the public on this
issue soon.
Resources
Traffic laws are only as good and as valuable as the cops assigned
to enforce them. While the reforms of the Dodd-Frank Act are essential
to promoting transparency and lowering risk in the marketplace, they
will not be sufficient to protect the public unless we have the cops on
the beat to enforce them. To do so, the CFTC must be adequately funded.
The agency currently is operating on a budget of $195 million after
sequestration and has a staff of 685. That is only 8 percent more staff
than we had 20 years ago. Yet since that time, the futures market has
grown five-fold, driven by rapid advances in technology. The swaps
market is eight times larger than the futures market.
Imagine telling the South Dakota Highway Patrol or the Idaho Patrol
that, instead of just patrolling the streets of South Dakota or Idaho,
they are now responsible for policing a vast portion of the country's
highway system, but they can only hire 8 percent more officers.
That is basically the challenge we now face at the CFTC. Making the
challenge even harder is that the new highway system we have been
tasked with overseeing is much more complex. Not only do we need
resources to have enough cops on the beat, but we need to make sure
that our cops have the tools necessary to police the highways and
protect the public.
We are not asking for eight times our current funding, but
investments in both technology and people are needed for effective
oversight of these markets by regulators.
Though data has started to be reported to the public and to
regulators, we need the staff and technology to access, review, and
analyze the data. With 80 entities having registered as new swap
dealers, as well as new swap data repositories, swap execution
facilities, and clearinghouses, we need people to review registrations
and to run examinations to ensure compliance and ensure market
integrity. Furthermore, as market participants expand their
technological sophistication, CFTC technology upgrades are critical for
market surveillance and to enhance customer fund protection programs.
The U.S. Government is facing a strained budget environment, but
adequately funding the CFTC is a good investment for the American
public. The $182 billion AIG bailout was nearly 600 times more than the
CFTC's budget request of $315 million. Without sufficient funding for
the CFTC, the Nation cannot be assured that this agency can effectively
enforce essential rules that promote transparency and lower risk to the
economy. Without sufficient funding for the CFTC, the Nation cannot be
assured this agency can closely monitor for the protection of customer
funds and utilize our enforcement arm to its fullest potential to go
after bad actors in the futures and swaps markets.
Conclusion
Today's hearing comes as many of the swaps market reforms that this
Committee worked to include in the Dodd-Frank Act have already begun to
benefit the American public. The CFTC, having completed 59 final rules,
orders and guidances, has nearly completed the rule set, and market
participants are coming into compliance with these reforms.
Clearinghouses have begun clearing the majority of interest rate and
credit index derivatives, and the biggest swap dealers have
provisionally registered with the CFTC. The public and regulators are
benefiting from transparency, as real time and regulatory reporting is
already a reality. SEFs will be up and running soon.
Our staff has worked tirelessly to complete this reform that is so
important to the American public. We will continue to work with
domestic and international regulators on these critical reforms and to
ensure compliance.
I am pleased to tell you that the swaps market, which once was an
unregulated highway, now has streetlights and traffic laws. The dealers
now have to have drivers' licenses. Though there is still critical work
to be done, the swaps marketplace will no longer be dark and will now
have safer roads. Still, our traffic laws will not be fully effective
without a sufficient number of cops patrolling the highways and back
roads.
Thank you again for inviting me today, and I look forward to your
questions.
RESPONSES TO WRITTEN QUESTIONS OF
CHAIRMAN JOHNSON FROM MARY JO WHITE
Q.1. Identifying New Systemic Risks--What steps are the SEC and
CFTC taking to identify other potential systemic risks in the
markets each of you regulate?
A.1. Since the financial crisis, the SEC staff and their
colleagues from other regulators have been collaborating with
greater frequency and intensity to identify and appropriately
address potential systemic risks. SEC staff participates in a
number of working groups with other federal financial
regulators relating to the supervision of certain large
financial companies with subsidiaries or affiliates that are
registered U.S. broker-dealers, where such risks may arise. In
addition, SEC staff serves on the Financial Stability Oversight
Council (FSOC or the Council) Systemic Risk Committee, which
plays a role in monitoring systemic risk in the financial
markets. As systemic risks often are global in nature, SEC
staff also serves on international regulatory groups, such as
Financial Stability Board committees, that seek to identify and
develop coordinated initiatives to mitigate systemic risks, and
I personally serve on the Financial Stability Board Steering
Committee. These groups are designed to enhance regulatory
cooperation and oversight, including crisis management and
planning. Participation enhances the agency's ability to
effectively supervise market participants by giving it greater
insights into the full range of their activities, as well as
providing a forum for regulators to discuss any emerging issues
of potential concern with respect to those activities.
Commission staff also is active in (1) leading the
regulatory oversight of four registered clearing agencies
designated as systemically important by the FSOC for which we
act as supervisory agency under Title VIII of the Dodd-Frank
Act and (2) contributing to the oversight of two other clearing
agencies for which the CFTC is the named supervisory agency.
Among the activities undertaken in the past year are the
examinations required by Title VIII, in which staff from the
Federal Reserve Board participates, as well as ad hoc reviews
by Commission supervisory staff focused on governance and risk
management. These examinations and reviews include attention to
a clearing agency's compliance processes; internal audit
findings and resolution; board of directors' interaction; and
risk management framework, including new product reviews and
approvals, margin methodology, back-testing and stress-testing
procedures, risk monitoring practices, model governance
practices, and sizing and allocation of financial resources.
Findings from such examinations and reviews are used by
Commission staff both to define specific remediation actions,
and to inform discussions of systemic risk issues more
generally with the Federal Reserve Board and the CFTC, as well
as with other financial regulators through the Financial Market
Utilities Committee of the FSOC.
In addition, as a member of FSOC, I personally participate
in the Council's work to identify risks to the financial
stability of the United States and to respond to emerging
threats to the stability of the U.S. financial system. As part
of this work, particular emphasis is placed on identifying and
follow-on monitoring of potential threats discussed in the
FSOC's annual report, which most recently was published in
April 2013 and is available at which most recently was
published in April 2013 and is available at which most recently
was published in April 2013 and is available at http://
www.treasury.gov/initiatives/fsoc/Documents/
FSOC%202013%20Annual%20Report.pdf. Among other issues, that
report discussed issues related to vulnerabilities to sudden
spikes in fixed income yields, foreign economic and financial
developments, and operational risk. These are issues the SEC
staff continues to monitor both in conjunction with FSOC
reviews and in our own oversight of the financial entities the
SEC regulates.
Q.2. CFTC-SEC Harmonization--What are the differences between
how your agencies plan to regulate cross-border swaps, and what
steps are you taking to better harmonize the two approaches?
A.2. There are many similarities, as well as some differences,
in how the SEC and CFTC plan to regulate cross-border swaps.
Both agencies have proposed, and the CFTC has now adopted, a
robust set of measures for regulating cross-border swap
activity, including a ``results-based'' substituted compliance
framework. The principal differences between the SEC's proposed
cross-border approach and the CFTC's final guidance involve the
scope of the term ``U.S. person,'' the treatment of guaranteed
affiliates, and the approach to substituted compliance for
``true'' cross-border transactions. In addition, the agencies'
approaches differ in the application of margin requirements
and, potentially, the application of the Dodd-Frank Act to
conduct in the United States by counterparties booking
transactions outside the United States.
First, with respect to the definition of ``U.S. person,''
the SEC's proposed rules define the term in a more limited and
territorial manner than the CFTC. A key difference is the
CFTC's focus on foreign-organized investment vehicles, such as
hedge funds, that are majority-owned by U.S. persons. The SEC
did not propose to take into account majority-ownership in
determining the U.S. person status of investment vehicles.
Instead, the SEC's proposed definition focuses on the place of
organization of those investment vehicles.
Second, unlike the CFTC's final guidance, the Commission's
proposal does not require a non-U.S. person that receives a
guarantee from a U.S. person to register as a security-based
swap dealer so long as it limits its dealing activities to non-
U.S. persons and conducts those activities outside the United
States. Further, the Commission's proposal does not require a
non-U.S. person that is not guaranteed by a U.S. person to
register as a dealer if it limits its activities to non-U.S.
persons, regardless of whether those non-U.S. persons receive a
guarantee from a U.S. person. The Commission's proposal,
however, does address these risks with more targeted regulatory
measures to address the activities of guaranteed non-U.S.
persons.
Third, the SEC's proposal would permit broad substituted
compliance for ``true'' cross-border transactions, that is,
those transactions involving a U.S. person and a non-U.S.
counterparty (the so-called ``New Jersey Transaction''). The
CFTC's guidance limits the use of substituted compliance in
these circumstances, but holds out the possibility of allowing
compliance with foreign law in these circumstances if it
determines that the foreign requirements are ``essentially
identical'' to the requirements of the Dodd-Frank Act.
In addition, the SEC's proposal would treat margin as an
``entity-level'' requirement, requiring foreign dealers to
collect margin from both non-U.S. and U.S. counterparties,
whereas the CFTC's final guidance would not require foreign
dealers to collect margin from non-U.S, counterparties. On
conduct in the United States, the SEC's proposal would apply
certain Title VII requirements to a transaction conducted in
the United States, but booked outside of the United States. The
CFTC's final guidance appears to focus on conduct in the United
States solely in the context of dealing activity by a non-U.S.
dealer through a U.S. branch.
As the SEC moves toward adoption of final cross-border
rules, we are continuing to consider whether there are ways to
bring our cross-border framework closer together with the CFTC
framework. In addition to reviewing the comments we received on
our proposal, we are carefully considering the approach taken
by the CFTC in its final cross-border guidance. We are also
engaging in discussions with CFTC on various cross-border
issues with an eye toward finding ways, given the differences
in our statutory frameworks, and in our products, markets and
participants, to achieve more consistency at adoption.
Q.3. Credit Rating Agencies--What lessons have been learned in
the credit rating market since the financial crisis? What has
been learned considering the possible solutions, including the
Franken Amendment? As the credit rating process is revised, do
you think that the market can become less dependent on explicit
ratings? Do you believe that the quality of ratings can
improve?
A.3. The Credit Rating Agency Reform Act of 2006 provided the
Commission with explicit oversight authority over credit rating
agencies registered as nationally recognized statistical rating
organizations, or NRSROs. This oversight authority was expanded
with the enactment of the Dodd-Frank Act. Through the enhanced
examinations of NRSROs that have been conducted since the
financial crisis, as required by the Dodd-Frank Act and
documented in our annual reports to Congress, we have seen the
NRSROs strengthen their governance structure and their
controls, increase transparency, and enhance the integrity of
the ratings process. Other important issues have been addressed
in a suite of recent Commission studies on credit rating
standardization, reliance on credit ratings, and assigned
credit ratings.
The staff also is working to finalize the suite of new
rules required under the Dodd-Frank Act that are applicable to
NRSROs, and the Commission continues to focus on removing
references to credit ratings in its rules and regulations. We
expect that both of these efforts will contribute significantly
to industry reform. Pursuant to the authority provided to the
Commission under the Dodd-Frank Act, the staff will continue to
examine the NRSROs' compliance with applicable rules and may
develop further recommendations to be presented to the
Commission in the future.
In particular, in December 2012, Commission staff issued a
Report to Congress on Assigned Credit Ratings, as required by
Section 939F of the Dodd-Frank Act. The staff recommended that
the Commission, as a next step, convene a roundtable to discuss
the potential courses of action presented in the report. The
Commission held this Credit Ratings Roundtable in May 2013 with
broad representation from a range of interested constituencies.
The staff considered the various viewpoints presented during
discussion at the roundtable, as well as in the related public
comment letters, and will be presenting to the Commission a
recommendation for its consideration. Any such staff
recommendation will be designed to increase transparency,
foster competition, mitigate conflicts of interest associated
with the issuer-pay business model, and may consider removing
certain impediments in the rules to encourage the issuance of
unsolicited credit ratings for structured finance products.
In terms of whether the market can become less dependent on
ratings, increased transparency with respect to credit ratings
and the credit ratings process is designed to promote less
mechanistic reliance on credit ratings. The Commission's
continued focus on removing references to credit ratings in its
rules and regulations will further the efforts to reduce market
dependence on ratings.
The notion of quality of ratings would include integrity in
the ratings process, governance and controls around determining
and disseminating ratings, and ongoing surveillance of ratings.
Consistent with the authority provided to the Commission, the
staff's examinations are designed to test, assess and, where
deficient, make recommendations for improving, the ratings
process. This oversight should ultimately lead to improvement
in the quality of ratings. It is important to note, however,
that quality of ratings is distinct from accuracy of ratings.
Market participants need to judge for themselves the quality of
ratings and whether to use those ratings as an input in their
decision making.
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
FROM MARY JO WHITE
Q.1. By regulations enacted in December 2011, both the SEC and
CFTC collect information on private funds (hedge funds, private
equity, and liquidity funds). The SEC has been collecting data
on Form PF for over a year, and the CFTC on its Form PQR more
recently (starting with March 31, 2013, data). What plans does
your agency have for the review and use of this data?
A.1. While data collected on Form PF is intended primarily for
use by the Financial Stability Oversight Council's (FSOC) in
monitoring systemic risk, the Commission also may use the
information collected on Form PF in its regulatory programs,
including examinations, investigations, and investor protection
efforts relating to private fund advisers. As detailed in an
annual report provided to Congress on July 25, 2013, Commission
staff has begun to assess the quality of the Form PF data
collected, including evaluating the consistency of filer
responses and differences in approaches or assumptions made by
filers. Commission staff has established a working group with
the Office of Financial Research--the group within the
Department of Treasury responsible for performing FSOC's
systemic risk analyses--to coordinate how potential data
quality concerns are addressed. In addition, a number of uses
of the information have been identified across various
Commission Divisions and Offices. For example, Commission staff
has incorporated Form PF data into proprietary analytical tools
and will develop data analytics incorporating Form PF data.
Also, Commission staff anticipates using the information
collected on Form PF as part of their pre-examination due
diligence and in risk identification.
Q.2. The SEC is on a good trajectory toward embracing economic
analysis. While I applaud its achievements, there is more to be
done and it is too early to declare victory. Chair White, do
you remain committed to complete implementation of the
Commission's economic guidance?
A.2. I continue to believe that robust and transparent economic
analysis is key to developing strong and effective regulations.
The 2012 Current Guidance on Economic Analysis in SEC
Rulemaking has enhanced the economic analysis in rulemaking at
the Commission, and I remain committed to its ongoing
application. Indeed, I am always seeking ways to further
improve our consideration of the potential economic impacts of
Commission rules and will continue those efforts.
Q.3. The SEC's Money Market Fund rulemaking proposes to float
the NAV for prime institutional funds. I have concerns
regarding the interaction of tax issues and the proposal. Chair
White, in addition to considering the IRS's guidance on wash
sales, is the SEC coordinating with the IRS to address tax
issues associated with a potential floating NAV?
A.3. Commission staff is engaged in dialogue with staff at the
Internal Revenue Service and the U.S. Department of the
Treasury about the tax implications associated with a floating
NAV reform alternative, as well as administrative relief that
the IRS and Treasury Department are currently considering that
could reduce tax reporting-related burdens and costs to
shareholders. The reporting relief that Commission staff
understands the IRS and Treasury Department are considering
would allow for net information reporting by funds of realized
gains and losses for sales of fund shares, as well as summary
income tax reporting by shareholders (rather than requiring
funds and shareholders to report the details of each
transaction separately). In addition, Commission staff is
working with staff at the IRS and Treasury Department to
address issues relating to ``wash sale'' rules that apply when
shareholders sell securities at a loss and, within 30 days
before or after the sale, buy substantially identical
securities. As you note, the IRS recently proposed guidance on
the wash sale rules, under which redemptions of floating NAV
money market fund shares that generate losses below a certain
threshold would not be subject to these rules. The June 2013
money market fund reform proposal describes the tax
implications relating to the floating NAV alternative
generally, as well as potential IRS and Treasury Department
relief that would affect these implications. I, along with
Commission staff, currently are reviewing comment letters
submitted in response to the proposal, including comments
requesting that greater tax relief be provided in connection
with any floating NAV requirement in order to minimize
operational burdens on fund groups and their intermediaries and
shareholders. These comments certainly will inform any money
market fund reforms that the Commission ultimately adopts, and
I have directed SEC staff to continue working with the IRS and
Treasury Department to minimize any tax-related burdens
associated with money market fund reforms to the maximum extent
possible.
Q.4. Chairman Gensler suggested in his hearing testimony that
the CFTC and SEC coordinated closely in the issuance of the
CFTC's final cross-border guidance and exemptive order. What is
your view regarding the extent to which SEC's comments are
incorporated into the CFTC's final guidance? Do you think that
more could have been done to move the CFTC's and SEC's
framework closer together?
A.4. The Dodd-Frank Act requires the SEC and CFTC to consult
and coordinate regularly for the purposes of assuring
regulatory consistency and comparability, to the extent
possible. To that end, SEC and CFTC staff exchanged draft
documents relating to our respective cross-border efforts, and
engaged in conversations on various cross-border issues, over
the months leading up to the issuance of our cross-border
proposal and the CFTC's final guidance. These efforts helped us
better understand the CFTC's thinking on various cross-border
issues, and, similarly, we believe they helped shape the CFTC
guidance in some respects. For example, the CFTC's final
guidance addresses foreign banks conducting dealing activity
out of their U.S. branches with foreign customers, an issue
that was not addressed in the CFTC's proposed guidance, but was
addressed in the SEC's cross-border proposal.
I believe there is much that can and should be done going
forward to ensure close consultation and collaboration on
regulatory and interpretive questions affecting these markets
that the two agencies jointly regulate, and our staff has
continued to engage in useful and productive discussions with
CFTC staff in that regard. In addition, as I indicated at the
hearing, I am committed to having discussions at the principal
level to enhance coordination with the CFTC on cross-border
issues.
Q.5. As you know, the FSOC is responsible for the designation
of nonbank systemically important financial institutions
(SIFIs), and has publicly indicated that it is reviewing what
risk, if any, asset managers pose to the U.S. financial system.
The SEC is the expert agency on asset management, both from its
long-established oversight of the mutual fund industry. What
role is the SEC playing in this FSOC review? Is the SEC's
expertise being reflected in the study?
A.5. I agree that, as the primary regulator of the asset
management industry, the SEC possesses unique expertise in this
area. I directed relevant SEC staff to engage with the Office
of Financial Research (OFR) in the preparation of its study and
to provide our staff's input. Ultimately, however, the study is
the work product of the OFR. The OFR published this study in
September 2013, and the SEC has invited public feedback on the
study (see, http://www.sec.gov/News/PressRelease/Detail/
PressRelease/1370539852635). We have received approximately 25
letters in response to this invitation for public feedback. In
addition, I would expect that the SEC, as the primary regulator
of the asset management industry, would be involved in any
follow-on work as a result of the study.
Q.6. The Federal Reserve currently has under consideration a
proposal that would require foreign banks to hold their U.S.
broker-dealer operations through a U.S. intermediate holding
company. Concerns have been expressed regarding the impact the
application of bank capital rules at that holding company
level--especially the leverage requirement--would have on the
broker-dealer. Is the SEC concerned about the implications of
the Fed's proposal for broker-dealers, and is the SEC working
with the Fed to address them?
A.6. The SEC has a net capital rule for broker-dealers that is
designed to ensure that customers and other market participants
are fully protected in the event a broker-dealer fails by
requiring a broker-dealer to hold an amount of liquid assets
that is greater than its liabilities. The rule and related
financial responsibility requirements are aimed at both
protecting customer assets and limiting damage to the financial
system that may result from the failure of a broker-dealer.
Aspects of the Fed's proposal, particularly the bank
leverage requirements, potentially could affect the operations
of certain broker-dealers by, for example, requiring the
allocation of additional capital to the broker-dealer. Such a
result could in turn limit the ability of the broker-dealer to
engage in some businesses, including by increasing the
financing costs associated with a repurchase agreement or
securities lending activities.
The Commission staff is focused on these potential effects
and is continuing to consult with Federal Reserve staff to
fully define their extent and consequences, identify any
potential changes to the proposal that may be appropriate, and
help ensure that the impact on broker-dealers is fully
considered and factored into adoption of any final rules in
this area.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR CORKER
FROM MARY JO WHITE
Q.1. I know there is discussion around having the SEC pick a
rating agency for every deal that gets done. While I support
increased regulation of the use of these ratings and the rating
agencies themselves, I have to say that instituting a mandatory
rotation rule managed by the SEC seems like a cumbersome way to
solve a problem. Is having the SEC play the role of selecting
the rating agency on every deal even logistically possible? I
understand that reforms to the way in which we use ratings is
warranted, and I know that we have made some reforms already,
such as not allowing ratings to be used by regulators as the
primary tool for assessing a bank's asset quality. But forcing
the SEC to assign a rating agency to every deal seems like
overkill. Where do we stand with that issue?
A.1. As you know, in December 2012, Commission staff issued a
Report to Congress on Assigned Credit Ratings, as required by
Section 939F of the Dodd-Frank Act. The staff recommended that
the Commission, as a next step, convene a roundtable to discuss
the potential courses of action presented in the report. The
Commission held this Credit Ratings Roundtable in May 2013 with
broad representation from a range of interested constituencies.
The staff considered the various viewpoints presented
during discussion at the roundtable, as well as in the related
public comment letters, and will be presenting to the
Commission a recommendation for its consideration. Any such
staff recommendation will be designed to increase transparency,
foster competition, mitigate conflicts of interest associated
with the issuer-pay business model, and may consider removing
certain impediments in the rules to encourage the issuance of
unsolicited credit ratings for structured finance products. Any
reforms considered also will be focused on efficient,
noncumbersome solutions.
The staff is also working to finalize the suite of new
rules required under the Dodd-Frank Act that are applicable to
nationally recognized statistical rating organizations, or
NRSROs, and the Commission continues to focus on removing
references to credit ratings in its rules and regulations. We
expect that both of these efforts will contribute significantly
to industry reform. Pursuant to the authority provided to the
Commission under the Dodd-Frank Act, the staff will continue to
examine the NRSROs' compliance with applicable rules and may
develop further recommendations to be presented to the
Commission in the future.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR JOHANNS
FROM MARY JO WHITE
Q.1. I understand this hearing is about systemic risk and that
has been the focus of Congress and the regulators for the last
5 years. However, in focusing so much time and resources on
systemic risk, is it possible we are hindering innovation and
opportunities for investors? I am aware of hundreds of ETF
applications and innovations that have been pending at the SEC
for years--some as many as 5 years. Very few businesses can
wait for Government approvals for 5 years.
Press reports indicate that the Division of Investment
Management (DIM) is considering streamlining the ETF approval
process. Is this accurate?
Can you tell me the timeline for when we should see
something on this from DIM, and what you expect the parameters
to be for streamlined review? Is it your expectation that all
equity ETFs with no leverage and no synthetic instruments will
be eligible for this streamlined approval process?
A.1. Prior to offering any securities to the public, Exchange
Traded Funds (ETFs) seeking to operate as investment companies
under the Investment Company Act of 1940 must receive exemptive
relief from various provisions of that Act. In order to receive
the Commission's exemptive relief, an ETF must be listed and
traded on a national securities exchange, and an ETF must be
able to meet the requirements for listing standards prior to
being listed and traded on a national securities exchange.
The Commission's Division of Investment Management has
significantly streamlined its internal review process for ETF
applications. It has instituted deadlines for the staff's
review and developed generally standardized terms and
conditions for these applications. In addition, the staff
redesigned the Commission's Web site so that ``model'' ETF
applications are now easily available to applicants for review
and guidance, a step that has been applauded by the industry.
Applicants that use these models for ``plain vanilla'' ETFs--
i.e., ETFs that seek to achieve the performance of a
securities-based index or ETFs whose investment advisers
actively manage fund investments, including synthetic
instruments, to achieve a stated investment objective--receive
expedited treatment of their applications.
In order for a national securities exchange to list the
shares of an ETF for trading, the ETF must either fit within
the exchange's existing ``generic'' listing standards, which
have been approved by the Commission and require no further
regulatory action, or the exchange must file a proposed rule
change with the Commission pursuant to the Exchange Act to list
and trade the new ETF, which the Commission must approve before
the exchange can list or trade the ETF. The Exchange Act sets
out the timing for Commission review of--and action on--the
proposed rule changes. If the Commission fails to meet any of
the statutory deadlines, the exchange's filing is deemed
approved. The exchange makes the decision as to when to file
its proposal and thereby trigger the statutory time frames.
Staff in the Commission's Division of Trading and Markets,
which oversees proposed rules changes and other requests for
relief relating to the listing and trading of all exchange-
traded investment products (ETPs), including ETFs, on national
securities exchanges, has been evaluating market issues
relating to the listing and trading of ETPs on national
securities exchanges.
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RESPONSES TO WRITTEN QUESTIONS OF
CHAIRMAN JOHNSON FROM GARY GENSLER
Q.1. CFTC-SEC Harmonization--What are the differences between
how your agencies plan to regulate cross-border swaps, and what
steps are you taking to better harmonize the two approaches?
A.1. The staffs of the CFTC and SEC have closely consulted in
an effort to increase understanding of each other's regulatory
approaches and to harmonize the cross-border approaches of the
two agencies to the greatest extent possible, consistent with
their respective statutory mandates. The Commissions recognize
the value of harmonizing their cross-border policies to the
fullest extent possible. The staffs of the two Commissions have
participated in numerous meetings to work jointly toward this
objective. The Commissions expect that this consultative
process will continue as each agency works towards implementing
its respective cross-border policy.
Two months before publication of the CFTC's cross-border
guidance, the SEC published for public comment proposed rules
and interpretive guidance to address the application of the
provisions of the Commodity Exchange Act, added by Subtitle B
of Title VII of the Dodd-Frank Act, that relate to cross-border
security-based swap activities. The CFTC considered the SEC's
cross-border proposal and took it into account in the process
of preparing the CFTC's final interpretive guidance.
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
FROM GARY GENSLER
Q.1. By regulations enacted in December 2011, both the SEC and
CFTC collect information on private funds (hedge funds, private
equity, and liquidity funds). The SEC has been collecting data
on Form PF for over a year, and the CFTC on its Form PQR more
recently (starting with March 31, 2013, data). What plans does
your agency have for the review and use of this data?
A.1. The data will be used to check disclosures that are made
to commodity pool participants and to assist in the review of
annual financial statements and footnote disclosures. The data
also will be used to support examinations of futures commission
merchants (FCMs), including for assessing contagion pathways in
the event of a failure of either an FCM or a commodity pool.
Q.2. The CFTC's cross-border guidance was done outside the
formal notice and comment process that the Administrative
Procedure Act provides. Therefore, there was no opportunity for
the public and stakeholders to formally comment on the final
guidance prior to its release. Chairman Gensler, given the
global significance of the cross-border issue, please explain
why you found it acceptable to proceed without transparent
formal notice and comment rulemaking?
A.2. Congress was clear that the far-flung operations of U.S.
enterprises are to be covered by reform. Recognizing the
lessons of the crisis and modern finance, Congress provided in
section 722(d) of the Dodd-Frank Act that swaps reform applies
to activities outside our borders with ``a direct and
significant connection with activities in, or effect on,
commerce of the United States.'' To respond to industry
questions regarding the interpretation of that provision, the
Commission on June 29, 2012, voted to propose for public
comment interpretive guidance on the manner in which it would
apply Title VII's swaps provisions to cross-border activities.
The CFTC received approximately 290 comment letters on the
proposed guidance from a variety of interested parties,
including major U.S. and non-U.S. banks and financial
institutions that conduct global swap business, trade
associations, clearing organizations, law firms, Congressional
offices, public interest organizations, and foreign regulators.
While considering the proposed guidance, including the public
comments, the CFTC determined that further consideration of
public comments regarding the CFTC's proposed interpretation of
the term ``U.S. person,'' and its proposed guidance regarding
aggregation for purposes of swap dealer registration would be
helpful. On January 7, 2013, the CFTC published further
proposed guidance on these points. The CFTC received
approximately 24 comment letters on the further proposed
guidance. The CFTC's final cross-border guidance discusses the
significant issues raised by the commenters on the proposed
guidance, and how the CFTC addressed the points that they made.
In addition to these comment letters, Commission personnel
held over 50 meetings regarding cross-border issues with
various market participants and others with an interest in the
guidance. The CFTC consulted closely throughout the process
with the SEC, other U.S. regulators, and international
regulators in developing the cross-border guidance.
The comment letters, meetings, and other information
provided were crucial to the Commission's effort in finalizing
the interpretive guidance.
Q.3. The CFTC does not yet have a permanent Chief Economist.
This is a critical role to be filled in order for the CFTC to
understand the economic consequences of the regulatory choices
it makes.
Chairman Gensler, what is the status of the CFTC's search
for a permanent Chief Economist?
A.3. The Commission continues in its efforts to appoint a
permanent Chief Economist. Scott Mixon currently serves as
Acting Chief Economist. Dr. Mixon is a financial economist with
over 15 years of industry experience implementing and
communicating quantitative and empirical analysis.
OCE staff economists play an integral role in cost and
benefit considerations, as well as other aspects of agency
rulemakings. OCE staff consists of both Ph.D. and pre-Ph.D.
economists trained in conducting policy analysis, economic
research, expert testimony, education, and training.
Q.4. While the CFTC and SEC coordinated private fund reporting
in principle, the CFTC is now requiring those private funds
that report on Form PF to also file certain information on the
CFTC's Form PQR. Both forms differ in how the same data is
presented and filed with the agencies (e.g, list of
investments)--this means that OFR is not receiving comparable
information. This is an unnecessary burden on industry. Are you
aware of this disconnect? What can the CFTC do to provide
consistency here?
A.4. Dually registered investment advisers to private funds
that file Form PF only have to file Schedule A of Form CPO-PQR
with the Commission. This information is largely demographic in
nature and represents a small subset of the solicited data.
With respect to the schedule of investments, for example, the
adviser to the private fund would only report that information
on Form PF. With respect to the information that OFR is
receiving from the SEC and CFTC, OFR will not receive
duplicative or inconsistent data as a result of these advisers
filing Form PF and Schedule A of Form CPO-PQR.
Q.5. Based on statements of CFTC Commissioners, we understand
transmitting swaps data that is collected in swap data
repositories (SDR) to the CFTC has caused the CFTC's computers
to crash. The CFTC is also collecting private fund reporting
data, which is information is filed through the National
Futures Association (NFA) system and then transmitted to the
CFTC. Please explain the technological problems the CFTC has
encountered in the transmission of the SDR and NFA data to the
CFTC system.
A.5. The Commission currently receives and processes more than
half a billion rows of data every day from regulated entities
and has the capability to use SDR-provided facilities to access
swaps reporting data and receives sub-sets of that information
as necessary. An instance when CFTC personnel attempted to open
a very large file from an SDR with malformed data caused a
temporary disruption. The SDR corrected the data and the
problem was resolved.
Additional Material Supplied for the Record