Futures Industry Association (“FIA”) President Walt Lukken delivered a speech at the SIFMA Compliance and Legal Seminar discussing the five trends that he believes are affecting the financial services industry and how to proceed with regulation pragmatically.
- The Era of Regulatory Cooperation: President Lukken stated that, since the passage of Dodd-Frank, both the SEC and CFTC have faced a tidal wave of regulatory change in attempting to finalize rule writing. When viewing this in the context of static and tightening budgets, President Lukken said, and the increasing globalization of the markets, it is clear that “regulatory compliance is going to require a cooperative and pragmatic approach across domestic agencies, foreign regulatory authorities, SROs and private sector compliance departments.” To make progress in rebuilding cooperation, President Lukken said, it is important for regulators to seize the opportunity for “mutual recognition,” the concept that one domestic agency with possible legal jurisdiction over a foreign entity is willing to defer to that foreign authority as long as the rules are comparable. President Lukken explained that the United States and Europe are facing a real test of this concept: whether the EU deems U.S. clearinghouses equivalent for EMIR by June.
- The Lines between Securities and Derivatives Markets Are Blurring: President Lukken stated that, despite the differences between the securities and futures worlds, the industries are being pulled together “by the changes in the regulatory environment and the forces of technology.” He stated that a hybrid of these two worlds seems to have been created with the development of new clearing and trading services for swaps. President Lukken recommended that the CFTC write more technical guidance and standards for SEFs in order to avoid the complexity of problems that have arisen in the securities field.
- Regulators Are Focused on Central Counterparty (“CCP”) Risk: According to President Lukken, one of the lessons of the financial crisis was that “clearinghouses worked to mitigate risk.” He explained that there has been an increased focus by regulators on every aspect of the clearing process, and the recent default of a clearing member at the Korean exchange KRX highlighted the risks involved with clearinghouses globally. He stated that it will “benefit both regulators and market participants alike to ensure that global CCPs meet the highest standards of risk management.”
- Regulatory Costs for Clearing Will Begin to Be Realized with Consequences: President Lukken stated that futures commission merchants (“FCMs”) and exchanges have already seen major consolidation in the industry, and that higher capital, in combination with clearing and regulatory costs, will drive further consolidation. He noted that “it is ironic that the rules meant to mitigate risk in our markets may have the unintended impact of concentrating risk and discouraging new entrants.”
- Fixing the Trust Deficit: According to President Lukken, there is a trust deficit with the public that should be fixed. He stated that it is incumbent on trade associations like FIA and SIFMA to play a lead role in this effort.
Lofchie Comment: The need for the industry to reclaim public “trust” is an issue that is raised regularly. Unfortunately, it seems impossible for this to occur so long as the government and regulators find it beneficial to bash the financial industry as a means of engendering political support, and so long as the press finds that this story sells. While I have not yet read Mr. Lewis’s new book (and I do intend to buy it, demonstrating the profitability of industry bashing), the early reviews indicate that it is yet another demonstration of the upside in impugning the industry. This is not a battle that the industry shows any sign of being able to win. Perhaps after another few years of the employment rate’s failing to rise, it will become clear that this bashing of an entire industry is completely destructive (even if it is profitable for the bashers).
Regarding the issue of trust, it also seems that the regulators have their own issues. Now that Chairman Gensler has departed from the CFTC, there is a greater willingness to confront the fact that central clearing is fraught with risks, and there are reasonable arguments that the risks created by central clearing in the swaps market are just as significant as those that central clearing eliminated. Yet for years, Chairman Gensler touted the view (largely unchallenged by other government regulators who knew better) that central clearing was an inherently safe process, as if it were a magical solution to financial risk. Here, for example, is a typical quote from the former Chairman: “For over a century, through good times and bad, central clearing in the futures market has lowered risk to the broader public. Dodd-Frank brings this effective model to the swaps market. Standard swaps between financial firms will move into central clearing, which will significantly lower the risks of the highly interconnected financial system.” Now, the events in Korea make clear what was already known to those who work in financial regulation: that central clearing by increasing interconnectivity may increase risk to the system. So how does the government now address the risks that come with its forced imposition of central clearing without first admitting that the product was oversold?
See: President Lukken’s Speech.