CFTC Acting Chair Giancarlo Appoints Chief Innovation Officer

CFTC Acting Chair Christopher J. Giancarlo named Daniel Gorfine as Chief Innovation Officer and Director of the LabCFTC initiative (see previous coverage). Mr. Gorfine will be responsible for coordinating with U.S. regulators and international regulatory bodies as the CFTC develops digital regulatory frameworks and strives to “promote market-enhancing FinTech innovation and incorporate emerging regulatory technologies.”
Most recently, Mr. Gorfine served as director of financial markets policy and legal counsel at the Milken Institute think tank.

OCC Releases Semiannual Risk Report

The Office of the Comptroller of the Currency (“OCC”) described the principal risks facing national banks and federal savings associations in its Semiannual Risk Perspective for Spring 2017 (the “Report”).

In the Report, the OCC identified the following key risk themes:

  • strategic risk due to a changing regulatory climate, low interest rates and competition from nonfinancial firms, including fintech companies;
  • increased credit risk and relaxed underwriting standards due to strong risk appetite and competitive pressures;
  • elevated operational risk as a result of increased reliance on third-party service providers and attendant cybersecurity risks; and
  • high compliance risk as banks navigate money laundering risks and new consumer protection requirements.

OCC supervisory priorities for the next 12 months will remain broadly the same as in 2016 and will include the objective of identifying and assigning regulatory ratings and risk assessments. The OCC also pledged a continued commitment to monitoring and evaluating risks presented by third-party service providers.

In remarks on the Report, Acting Comptroller of the Currency Keith A. Noreika stated:

“The OCC employs a risk-focused approach to supervision, and tailors examination strategies to the individual risks of each of its supervised institutions and will pay close attention to these key risk areas over the next six months.”


Lofchie Comment: A material portion of the “risk” that banks face, according to the report, is regulatory risk. The Comptroller’s remark that “[m]ultiple new or amended regulations are posing challenges” to banks and the financial system also echoes the comment made by the SEC’s Investor Advocate in his recent report to Congress that he would “encourage Congress to consider giving the [SEC] a respite from statutory mandates” (at 3). It is clear that the very rate and extent of regulatory change has itself become a threat to the financial system.

CFTC Acting Chair Giancarlo to Move Past Dodd-Frank and Focus on How CFTC “Applies Reforms”

In the June 23, 2017 issue of The Risk Desk, editor John Sodergreen offered his take on CFTC Acting Chair J. Christopher Giancarlo’s efforts to work on regulatory reform.

Mr. Sodergreen noted a sharp distinction between the friendly reception Mr. Giancarlo received at recent congressional hearings with that of his predecessors, who, he said, “often managed to draw fire from Republicans and Democrats alike.” Mr. Sodergreen emphasized how little controversy was generated at Mr. Giancarlo’s budget hearing, stating:

“[U]p and down the line, Republican and Democrat alike seemed to praise the acting chairman for submitting a budget request that exceeds the president’s number by over $30 million. We sensed no pushback at all, which had to be some sort of first.”

Mr. Sodergreen was also taken by how Mr. Giancarlo was endorsed at his nomination hearing before the Senate Agriculture Committee. Mr. Sodergreen called it “a slam-dunk, a fan-fest almost,” and added: “[i]t was the fastest confirmation hearing we had ever seen and we covered them all since Jim Newsome’s hearing.”

Mr. Sodergreen highlighted Mr. Giancarlo’s non-confrontational approach to regulatory reform, as reflected in these congressional appearances. Concerning Dodd-Frank, Mr. Sodergreen (i) stated that Mr. Giancarlo “didn’t see the value in debating whether Dodd-Frank is good or bad” and (ii) explained that Mr. Giancarlo chose to focus on high-frequency trading and cyberattacks, which are two “massive” areas of concern for the CFTC. In this regard, Mr. Sodergreen pointed out that Mr. Giancarlo is calling for a forward-looking agenda. Mr. Sodergreen further highlighted Mr. Giancarlo’s explanation of the Project KISS (“Keep It Simple, Stupid”) initiative, which Giancarlo described as focused on how reforms are applied rather than repeal or rollback (see previous coverage).

Based on these hearings, Mr. Sodergreen predicted an easy confirmation. “[We]’d bet the farm Giancarlo sails through,” he said.

Lofchie Comment: On the one hand, there is a good amount of Dodd-Frank that should be repealed or rolled back, particularly in the commodities world. On the other hand, there is something to be said for avoiding partisan disputes.

FRB Governor Powell Examines Liquidity Risks in Central Clearing

At the Federal Reserve Bank of Chicago Symposium on Central Clearing, Board of Governors of the Federal Reserve System (“FRB”) Governor Jerome H. Powell detailed the risks faced by central counterparties (“CCPs”) and their members.

Because they advocated for central clearing, Mr. Powell noted, global authorities (i) have a responsibility to make sure that CCPs do not become a point of failure in the system and (ii) must ensure that bank capital rules do not discourage central clearing.

Regarding bank capital, Mr. Powell argued that the supplementary leverage ratio for U.S. global systemically important banks fails to account for the relatively low risk of central clearing, as compared to riskier activities, and could discourage central clearing. He explained that the Basel Committee on Banking Supervision is considering a “risk-sensitive” approach to evaluating counterparty credit risk for certain centrally cleared derivatives, which could help to encourage central clearing. He also noted that the FRB is considering implementing a “settlement-to-market” approach for some cleared derivatives that would treat daily variation margin as a settlement payment, which means that banks would not have to hold capital against it.

On the subject of liquidity, Mr. Powell outlined the risks associated with central clearing. He noted the challenges that CCPs face with regard to outgoing and incoming payment flows. In the event of a member default, for instance, CCPs would need to be able to convert large amounts of non-cash collateral into cash in order to make payments to non-defaulting parties. For that reason, they must have lines of credit and ready access to the repurchase market. Mr. Powell’s example of a payment flow challenge led him to consider where CCPs should store their available cash. He mentioned central bank deposits as a safe and flexible option.

Mr. Powell also described the risks associated with incoming payment flows. Market volatility can trigger events that lead to an abnormal number of margin calls, which, in the first instance, requires liquidity on the part of clearing members to meet the margin call. It also requires a series of payments to be made simultaneously, so that the CCPs can obtain funds from the settlement bank quickly to meet margin requirements for its members. (In most instances, clearing members have an hour to meet intraday margin calls.) By way of example, Mr. Powell noted that data from the CFTC suggests that the top five CCPs requested $27 billion in additional margin over the two days following the Brexit referendum, which is about five times the average amount. Fortunately, members and CCPs were prepared in that instance, and were able to make the necessary payments.

In order to manage liquidity risk, Mr. Powell suggested, regulators should conduct expanded stress tests for CCPs:

“Conducting supervisory stress tests on CCPs that take liquidity risks into account would help authorities better assess the resilience of the financial system. A stress test focused on cross-CCP liquidity risks could help to identify assumptions that are not mutually consistent; for example, if each CCP’s plans involve liquidating Treasuries, is it realistic to believe that every CCP could do so simultaneously?”

He also urged regulators to (i) facilitate innovations that help to reduce liquidity risks, such as exploring the utilization of distributed ledger technology, (ii) make Federal Reserve bank accounts available to major CCPs, and (iii) take global market implications into account when developing solutions for managing liquidity risk for CCPs.

Lofchie Comment: The CFTC and the banking industry have long argued that the Basel III capital rules that require banks to reserve against collateral posted to a central clearing agency are mistaken. Governor Powell is coming around belatedly to that view. The existence of central clearing parties does not decentralize risk; it concentrates it. Yet a further risk of clearing emphasized in Governor Powell’s remarks is the power that the clearing agencies have to suck tremendous amounts of liquidity out of the market: $27 billion of additional margin in the two days following Brexit. (What this means is that, in demanding more margin to protect their own liquidity in a financial crisis, clearing agencies may bring down everyone else.)

It is certainly time for a full review of the benefits and risks of central clearing. Many of the concerns raised by clearing skeptics are being proved valid.