CFTC Commissioner Giancarlo Discusses the Perils of Low Liquidity, Rips into FSOC

CFTC Commissioner J. Christopher Giancarlo delivered the keynote address before the Cato Summit on Financial Regulation, focusing on the importance of liquidity to reduce risks in financial markets.

Commissioner Giancarlo stated that liquidity is the “life blood” of successful financial markets. He explained that the risk involved in hedging instruments helps “moderate price, supply and other commercial risks,” which in turn frees up capital to boost economic growth. According to Commissioner Giancarlo, an “inferno of complex derivative products used for unfettered risk taking overseen by feckless regulators” contributed to the financial crisis. He noted, however, that the focus of regulation in the post-financial crisis environment has centered around an “incomplete narrative” of deregulated banks that engaged in excessive trading leverage through derivatives, rather than focusing on mortgages that the Federal government encouraged.

According to Commissioner Giancarlo, after the financial crisis, international regulators focused on rulemakings that sought to control borrowing and to leverage the financial system by prioritizing “capital reserves over investment capital, balance sheet surplus over market making and systemic safety over investment opportunity.” He noted that the CFTC has contributed to decreasing liquidity in the form of its “flawed” swap trading rules, and the “double charging of margin” on certain types of derivatives.

Furthermore, he said that regulators are creating a “piecemeal” international framework that is increasing fragmentation and decreasing liquidity in global markets. Commissioner Giancarlo argued that liquidity acts as a “shock absorber” that creates volatile pricing in markets, suggesting that the regulation that contributes to reduced trading liquidity in markets is contributing to the risk of the next financial crisis (citing to a “veteran” industry commentator at fn. 49).

Commissioner Giancarlo went on to discuss the Financial Stability Oversight Council’s (“FSOC”) “unmitigated failure” as a coordinator of regulatory reform. He stated that FSOC has unwisely spent its time designating financial and insurance firms as “too big to fail,” rather than focusing on the systemic risk posed by “liquidity draining regulations.” Commissioner Giancarlo recommended that FSOC “step up to its statutory duty” to analyze U.S. and cross-border regulations.

Lofchie Comment: This seems a good opportunity to link to the Cabinet’s three most recent stories regarding FSOC: (i) ICI Submits Comment Letters to Regulators and FSB Critical of Potential for G-SIFI Designation (with Lofchie Comment); (ii) SIFMA AMG Urges Regulators to Stop Efforts to Create Systemic Risk Methodology for Asset Managers and Funds (with Lofchie Comment); and (iii) Professors Submit Brief Supporting FSOC’s Authority (with Lofchie Comment and YouTube Selection).

See: Commissioner Giancarlo’s Remarks.