Speaking at the CME Group’s Financial Leadership Conference, Chair Massad devoted most of his remarks to the appropriate regulation of the clearing system. He also made a number of implicit concessions to critics and expressed his equally implicit worries about clearing.
Perhaps most notably, Chair Massad seemed to concede that at least some of the clearinghouses were too big to fail. In that vein, Chair Massad touched on what would happen if a clearinghouse did fail, how the markets and regulators would respond, and what might be done to alleviate the effects of that scenario:
“Some have suggested that a potential solution is to have more than one clearinghouse for each product. This idea is attractive in theory, but it may be difficult to achieve. . . . “
Chair Massad also expressed concern about the unintended consequences of regulation:
I started my speech by talking about the challenge regulators face in having to look backward and address the problems of the past, but still create a framework that works going forward. Our actions affect how markets evolve, and a challenge is to avoid unintended consequences. And I think we need to be mindful of that as we address these very important issues pertaining not only to clearinghouse resiliency but to financial stability generally.
Let me conclude on this note: I have described what I believe will be an intensive focus on clearinghouses over the next year or so.
His concerns notwithstanding, Chair Massad stated his belief that the “[central clearing] model remains sound,” and that “central clearing and clearinghouses will continue to play the vital role in the development of our markets.”
Moving from policy statements to specifics, Chair Massad described the CFTC’s domestic work in clearing, which he said includes strengthening the requirements in risk management and transparency, as well as focusing on recovery and resolution planning. He also provided information about the CFTC’s work abroad with other organizations, including the Committee on Payments and Market Infrastructures and IOSCO, which involves looking at the margin methodologies and resources available to clearinghouses in the event of a default. He asserted that these efforts are a means to work through the concerns and questions he raised.
As clearinghouse regulation continues to progress, he said, it is important to keep the following in mind: (i) daily risk management, (ii) continuity of function in the event of a default and (iii) the importance of a robust clearing member industry. He assured his audience that defining these aspects as pivotal to clearinghouse regulation will lead to the establishment of laws that are resilient and supportive of innovation.
Lofchie Comment: Chair Massad is to be applauded for acknowledging the risks created by central clearing, including the huge concentration of risk to the financial system that results from clearing. In light of various regulators’ belated realization that central clearing creates significant systemic risk and may, in Chair Massad’s words, have “unintended consequences” (see the related news stories below), it would be prudent for the CFTC to declare a moratorium on any further imposition of a mandatory clearing requirement until those regulators are able to demonstrate by reasonable argument that central clearing reduces systemic risk – notwithstanding the fact that it also increases concentration and interconnectedness, arguably decreases the ability of firms to net against their customers, and poses a material risk of creating a liquidity drain if the central clearinghouses demand more initial margin during a market crisis. If the various regulators are uncomfortable making such a demonstration – and their recent statements indicate that they are not – then it would be imprudent for them to continue down this path.