CFTC Commissioner Scott O’Malia delivered remarks to the Commodity Markets Council, discussing areas of regulation that he believes the CFTC must address and reform, including technology and data, swap trade execution and the impact of rules on end users.
According to O’Malia, if the CFTC does not invest in and improve its technology, “major oversight functions will be severely impaired.” He stated that the CFTC is making progress towards improving the quality of its data, citing a recent announcement that the CFTC will establish a cross-divisional team to identify data utilization problems and recommend appropriate solutions. Additionally, O’Malia noted that, beginning in March, the CFTC will provide a comment period for market participants to offer suggestions to improve reporting so that the data team can make recommendations to the CFTC in June. He stated that he hopes the CFTC will reengage with various jurisdictions that have trade data repositories in an attempt to find a global solution to data reporting, and noted that the EU reporting rules will become effective on February 12, 2014.
O’Malia went on to discuss the progress of swap trade execution, stating that it is still unknown whether swap execution facilities (“SEFs”) will become the “spitting image” of a designated contract market (“DCM”). O’Malia noted that it is important to remember that Dodd-Frank did not intend for SEFs to look like DCMs, and stated that the CFTC must “resist the temptation to impose a one-size-fits-all approach to SEF platforms.” According to O’Malia, the CFTC should encourage trading on SEF platforms while simultaneously protecting the efficiency of trading various combination products.
Additionally, O’Malia discussed the importance of protecting end users. According to O’Malia, Congress gave the CFTC two “competing” objectives: reducing systemic risk in the derivatives market and protecting end users. O’Malia stated that, while attempting to reduce systemic risk, the CFTC “has neglected to safeguard end-users from costly compliance” with regulations. O’Malia cited the swap dealer rule as one that should be revisited to provide end users with greater clarity – in particular, the de minimis threshold and the “Special Entity” definition. Additionally, O’Malia explained that end users have struggled to determine whether a volumetric option is a forward or a swap, and suggested that volumetric options be redefined to create “reliable and well-defined safe harbors.”
According to O’Malia, the CFTC also failed to consider the impact of a number of rules on end users due to “lack of appropriate cost-benefit analysis,” including Rule 1.35 (“Records of Commodity, Interest and Related Cash or Forward Transactions”) and the position limits re-proposal. O’Malia stated that both of these rules impose unfair burdens on some end users who lack the resources to comply, and the CFTC “must consider revising the rule to offer cost-effective alternatives, not another barrage of reflexive no-action letters.”
Lofchie Comment: The first task of the incoming Chairman of the CFTC must be to clean up the rules. There will only be greater confusion as the agency presses on with further rulemaking on so shaky a foundation. If the CFTC loses its case on whether the “Interpretative Guidance” on cross-border issues was a rule adopted in violation of the Administrative Procedures Act (as it should), the foundation will largely crumble.
Commissioner O’Malia’s comments on SEFs are worthy of serious consideration. While there is a good argument to be made that the whole notion of mandatory SEF trading is entirely misplaced (as SEF trading has nothing to do with systemic risk), it would seem that, given that SEFs are intended to be venues for sophisticated investors to trade, the rules applicable to SEFs should be materially less restrictive than those which are applicable to retail markets. Instead, the CFTC’s rules applicable to SEFs are largely identical to rules applicable to retail markets, raising the following question: what is the point of a separate system of institutional regulation if that system is identical to the retail system?