[House Hearing, 116 Congress]
[From the U.S. Government Publishing Office]
BREXIT AND OTHER INTERNATIONAL
DEVELOPMENTS AFFECTING U.S.
DERIVATIVES MARKETS
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON COMMODITY EXCHANGES, ENERGY, AND CREDIT
OF THE
COMMITTEE ON AGRICULTURE
HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTEENTH CONGRESS
FIRST SESSION
__________
JUNE 26, 2019
__________
Serial No. 116-14
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
Printed for the use of the Committee on Agriculture
agriculture.house.gov
__________
U.S. GOVERNMENT PUBLISHING OFFICE
37-019 PDF WASHINGTON : 2019
--------------------------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Publishing Office,
http://bookstore.gpo.gov. For more information, contact the GPO Customer Contact Center,
U.S. Government Publishing Office. Phone 202-512-1800, or 866-512-1800 (toll-free).
E-mail, [email protected].
COMMITTEE ON AGRICULTURE
COLLIN C. PETERSON, Minnesota, Chairman
DAVID SCOTT, Georgia K. MICHAEL CONAWAY, Texas, Ranking
JIM COSTA, California Minority Member
MARCIA L. FUDGE, Ohio GLENN THOMPSON, Pennsylvania
JAMES P. McGOVERN, Massachusetts AUSTIN SCOTT, Georgia
FILEMON VELA, Texas ERIC A. ``RICK'' CRAWFORD,
STACEY E. PLASKETT, Virgin Islands Arkansas
ALMA S. ADAMS, North Carolina SCOTT DesJARLAIS, Tennessee
Vice Chair VICKY HARTZLER, Missouri
ABIGAIL DAVIS SPANBERGER, Virginia DOUG LaMALFA, California
JAHANA HAYES, Connecticut RODNEY DAVIS, Illinois
ANTONIO DELGADO, New York TED S. YOHO, Florida
TJ COX, California RICK W. ALLEN, Georgia
ANGIE CRAIG, Minnesota MIKE BOST, Illinois
ANTHONY BRINDISI, New York DAVID ROUZER, North Carolina
JEFFERSON VAN DREW, New Jersey RALPH LEE ABRAHAM, Louisiana
JOSH HARDER, California TRENT KELLY, Mississippi
KIM SCHRIER, Washington JAMES COMER, Kentucky
CHELLIE PINGREE, Maine ROGER W. MARSHALL, Kansas
CHERI BUSTOS, Illinois DON BACON, Nebraska
SEAN PATRICK MALONEY, New York NEAL P. DUNN, Florida
SALUD O. CARBAJAL, California DUSTY JOHNSON, South Dakota
AL LAWSON, Jr., Florida JAMES R. BAIRD, Indiana
TOM O'HALLERAN, Arizona JIM HAGEDORN, Minnesota
JIMMY PANETTA, California
ANN KIRKPATRICK, Arizona
CYNTHIA AXNE, Iowa
______
Anne Simmons, Staff Director
Matthew S. Schertz, Minority Staff Director
______
Subcommittee on Commodity Exchanges, Energy, and Credit
DAVID SCOTT, Georgia, Chairman
JEFFERSON VAN DREW, New Jersey AUSTIN SCOTT, Georgia, Ranking
FILEMON VELA, Texas Minority Member
STACEY E. PLASKETT, Virgin Islands ERIC A. ``RICK'' CRAWFORD,
ABIGAIL DAVIS SPANBERGER, Virginia Arkansas
ANTONIO DELGADO, New York MIKE BOST, Illinois
ANGIE CRAIG, Minnesota DAVID ROUZER, North Carolina
SEAN PATRICK MALONEY, New York ROGER W. MARSHALL, Kansas
ANN KIRKPATRICK, Arizona NEAL P. DUNN, Florida
CYNTHIA AXNE, Iowa DUSTY JOHNSON, South Dakota
JAMES R. BAIRD, Indiana
Ashley Smith, Subcommittee Staff Director
(ii)
C O N T E N T S
----------
Page
Conaway, Hon. K. Michael, a Representative in Congress from
Texas, opening statement....................................... 5
Scott, Hon. Austin, a Representative in Congress from Georgia,
opening statement.............................................. 3
Scott, Hon. David, a Representative in Congress from Georgia,
opening statement.............................................. 1
Prepared statement........................................... 3
Witnesses
Duffy, Hon. Terrence A., Chairman and Chief Executive Officer,
CME Group Inc., Chicago, IL.................................... 7
Prepared statement........................................... 9
Edmonds, Christopher S., Senior Vice President, Financial
Markets, Intercontinental Exchange, Inc., Chicago, IL.......... 12
Prepared statement........................................... 14
Maguire, Daniel J., Chief Executive Officer, LCH Group Limited;
Member, Executive Committee, London Stock Exchange Group PLC,
London, UK..................................................... 17
Prepared statement........................................... 19
Lukken, J.D., Hon. Walter L., President and Chief Executive
Officer, Futures Industry Association, Washington, D.C......... 23
Prepared statement........................................... 24
Berger, Stephen John, Managing Director, Global Head of
Government & Regulatory Policy, Citadel, LLC, New York, NY; on
behalf of Managed Funds Association............................ 38
Prepared statement........................................... 40
Submitted Material
Appendix......................................................... 75
BREXIT AND OTHER INTERNATIONAL
DEVELOPMENTS AFFECTING U.S.
DERIVATIVES MARKETS
----------
WEDNESDAY, JUNE 26, 2019
House of Representatives,
Subcommittee on Commodity Exchanges, Energy, and Credit,
Committee on Agriculture,
Washington, D.C.
The Subcommittee met, pursuant to call, at 10:00 a.m., in
Room 1300 of the Longworth House Office Building, Hon. David
Scott of Georgia [Chairman of the Subcommittee] presiding.
Members present: Representatives David Scott of Georgia,
Van Drew, Spanberger, Delgado, Craig, Maloney, Axne, Austin
Scott of Georgia, Crawford, Bost, Marshall, Dunn, Johnson,
Baird, and Conaway (ex officio).
Staff present: Carlton Bridgeforth, Emily German, Matt
MacKenzie, Ashley Smith, Paul Balzano, Patricia Straughn, Dana
Sandman, and Jennifer Yezak.
OPENING STATEMENT OF HON. DAVID SCOTT, A REPRESENTATIVE IN
CONGRESS FROM GEORGIA
The Chairman. [audio malfunction in hearing room]
Exchanges, Energy, and Credit entitled, Brexit and Other
International Developments Affecting the U.S. Derivatives
Market, will now come to order.
I want to thank everyone for joining us this morning. This
is a very, very important hearing. The very future of our
international cross-border financing is very critical because
of what is happening concerning Brexit.
Today, we really want to examine, and examine it very
thoroughly, so we come to a very succinct understanding with
supreme knowledge as to how this situation involving the
European Union's divorce with Great Britain affects our United
States financial industry.
It is most important that when we leave this hearing today,
we will have one resolve, and that is to make sure what is
happening with Brexit and the European Union does not, will
not, and cannot put our United States financial industry in a
weakened position. It is important that the United States
financial industry remain in its position as the most
significant, most important, most influential financial system
in the world, because the world is depending on that and us
making sure of it.
There are some threats out there with this move in Brexit,
and that is why we in this Committee realize our responsibility
as Members of Congress to hear from you, to hear from our
market participants, for you are the ones that engage in this.
And we have to remember that this is an $843 trillion, not
million, not billion, but trillion dollar, piece of the world's
economy. And let me assure you that the United States financial
system must remain number one in this strengthening position.
Now, there are some very important facts I want to go over
so you can see where we are.
First of all, as we look at Brexit and other international
developments, we know without a doubt that there are 27 members
of the EU that are bracing for Great Britain's exit from the
Union, and the UK approaches a leadership crisis with its Prime
Minister's departure, and she is still at the helm, but there
are so many things that are bubbling up underneath.
Now, it is important for me to share with you that in 2016,
the CFTC completed, that is the Commodity Futures Trading
Commission, completed a 3 year negotiation for an equivalence
agreement. It is very important to note that prior to this
point, it was the European Union that was our equivalency
partner. And this agreement on the regulatory treatment of
derivatives clearinghouses with the European Union, and this
agreement ensured that both the EU and U.S. clearinghouses
operate at the same high standards, and at a comparable level
of cost to their participants. Last year, as the EU prepared
for the potential impact of Brexit, the EU Parliament passed
the European Market Infrastructure Regulation, EMIR 2.2.
I want to pause there, EMIR 2.2, and we have to examine
EMIR 2.2 thoroughly this morning, because we on this Committee
are convinced that EMIR 2.2 presents a very clear and present
danger to our United States financial industry.
When they passed EMIR 2.2, it unilaterally and
automatically scrapped the 2016 equivalence agreement. EMIR 2.2
increases oversight of the EU and third-country clearinghouses,
and it has significant implications, as I said, for the
industry in the United States.
Some of the most extreme parts of this suggested policy is,
number one, administrative fees charged to clearinghouses in
other countries in exchange for oversight, and we will get back
to that, by the EU. Comparable compliance discounts instead of
grandfathering, which means that even when granted, you will
get a discount of 15, 20, or 35 percent of fees. Also, a very
complex tiering regime where the difference between Tier 1 and
Tier 2 is fees that are as much as seven times higher. Tier 1
is =50,000. Tier 2 is =350,000, seven times higher.
However, the largest concern is a possible relocation
provision requiring that all clearing move to the EU, either by
the letter of the law or by making it so expensive that
companies outside the EU will be priced out of competition. And
everyone in this room knows that financial instruments do not
operate in a vacuum. What happens in the EU and the UK will
ripple through financial markets, just as our decisions here in
our country have ramifications for them.
It is my hope today that with our discussions and
conversations that we will have today, that we can begin to
explore and better understand what Brexit and the associated
geopolitical developments in Europe and elsewhere will mean for
the derivatives market in the United States.
[The prepared statement of Mr. David Scott of Georgia
follows:]
Prepared Statement of Hon. David Scott, a Representative in Congress
from Georgia
Thank you for joining us today as we look at Brexit and other
international developments. This hearing is an important one, and a
timely one, as the 27 members of the EU brace for the UK's exit from
the Union, or ``Brexit'' and the UK approaches a leadership change.
In 2016, the CFTC completed a 3 year negotiation for an equivalence
agreement on the regulatory treatment of derivative clearinghouses with
the European Union. This agreement ensured that both the EU and U.S.
clearinghouses operate at the same high standards and at a comparable
level of cost to their participants.
Last year, as the EU prepared for the potential impact of Brexit,
the EU Parliament passed the European Market Infrastructure Regulation
(EMIR 2.2), which unilaterally scrapped the 2016 equivalence agreement.
EMIR 2.2 increases oversight of EU and third-country
clearinghouses, and it has significant implications for the industry in
the U.S.
Some of the most extreme parts of their suggested policies are:
Administrative fees charged to clearinghouses in other
countries in exchange for oversight by the EU.
Comparable compliance discounts instead of grandfathering
which means that even when deemed comparable the only
difference is a 15, 20 or 35 percent discount on your fees.
A very complex tiering regime where the difference between
Tier 1 and Tier 2 is fees that are as much as seven times
higher.
The largest concern is a possible relocation provision requiring
that all clearing move to the EU either by the letter of the law or by
making it so expensive that companies outside the EU will be priced out
of competition.
Everyone in this room knows that financial instruments do not
operate in a vacuum. What happens in the EU and the UK will ripple
through financial markets just as our decisions here in this country
have ramifications for them. It's my hope that with our conversations
today we can begin to explore and better understand what Brexit and the
associated geopolitical developments in Europe and elsewhere will mean
for the derivatives market in the United States.
With that I would recognize my Ranking Member, the other
distinguished Mr. Scott of Georgia, for 5 minutes.
The Chairman. And with that, I would like to now recognize
my Ranking Member, the other distinguished Mr. Scott from
Georgia, for 5 minutes.
OPENING STATEMENT OF HON. AUSTIN SCOTT, A REPRESENTATIVE IN
CONGRESS FROM GEORGIA
Mr. Austin Scott of Georgia. Thank you, Mr. Chairman, for
convening this hearing. You and I share a deep concern over
what I would refer to as the potential absence of international
harmonization work between the CFTC and their global
counterparts.
The main focus of today's hearing is the impact of Brexit
on U.S. derivatives markets. We can't talk about that without
discussing the European Commission's potential divergence from
what was a hard fought 2016 equivalency agreement. For years,
this Committee has been focused on the importance of
harmonizing our international response to the financial crisis.
And we, when Chairman Gensler sought to impose the U.S. swap
dealer rules around the world, we pushed back because we
rightly believed that overlapping rules would make it more
difficult or impossible for global risk markets to function as
end-users and other market participants need them to.
Today, we are in a similar place, except instead of making
common cause with our European colleagues, we are having to
have another discussion about what I thought were principles
that we had agreed on, principles that were agreed on with
people who share both our interests and our values.
Implementing EMIR 2.2 in a way that would disrupt our
existing equivalency agreement would trample on our previously
shared principles. Just like in 2011 and 2012, regulators are
playing a dangerous game, trying to expand their reach into
places that are already well-regulated. Such an effort, just as
it was going to then, will result in inevitable conflicts,
legal uncertainty, and other challenges for market
participants. When there is uncertainty, there will be less
liquidity, and when there is less liquidity, there is more risk
for those who are driving our economy. We need our regulators
to work together to preserve our open global markets while
building the compatible standards that protect market
participants and encourage financial stability.
Open markets and financial stability should be our goals.
Regulators should seek to implement rules that promote both.
Our U.S. Prudential Regulators could also remember this lesson
from time to time. The capital standard and margin rules that
they have been working on are both out of step with global
norms and do not promote access to clearing or sound hedging
practices. The capital rules treatment of initial margined and
unmargined commodity derivatives both penalize end-users who
will see reductions in access to cleared market intermediaries
and increase the cost for utilizing the right to opt out of the
margin requirements.
Our Prudential Regulators insistence on requiring margin
for internal swaps that transfer risk within the same bank
holding company presents similar problems for end-users.
Ultimately, the cost of moving risks within a bank to the place
that is most economical is the cost of providing a service to a
client. If we make the services more expensive, it won't be the
bank that pays, it will be the bank's client, the end-users who
rely on the services, that pay. They will either pay in money
or they will pay in loss of access. These requirements in both
rules run contrary to the spirit and intent of our Committee's
commitment to end-users when we enacted the law.
I am happy to note the Commission is examining changes that
will improve coordination and harmonization. I hope their
efforts bear fruit, and I hope our European colleagues will
join them.
Mr. Chairman, I will end with this. The first meeting I was
in this morning, a gentleman said, ``Do you want to beat people
or win people?'' What we want in the harmonization with the
regulators is a win-win situation for all of us who have shared
interests and shared values. And if we don't have that, my fear
is that it will be other countries who control the trading who
don't share either our interests or our values.
Thank you, Mr. Chairman for having this hearing.
The Chairman. Well, I certainly agree with you, Ranking
Member.
And now, I would like to recognize our distinguished former
Chairman and our Ranking Member, Mr. Mike Conaway.
OPENING STATEMENT OF HON. K. MICHAEL CONAWAY, A REPRESENTATIVE
IN CONGRESS FROM TEXAS
Mr. Conaway. Thank you, Mr. Chairman, and I agree
wholeheartedly with what you and the Ranking Member both said
during your opening statements. I certainly appreciate that.
I know that you both remember the hearing that we conducted
in 2012 on international regulatory harmonization. It was a
good and informative hearing, and I expect that today's hearing
will build on that work.
I was looking through the transcript of that hearing in
preparation for today, and I would like to share some words of
wisdom submitted by Chairman Steven Maijoor, who was then and
still remains the Chairman of the European Securities and
Market Authority, or ESMA. In written testimony, he summed up
the issues we are talking about today quite well. At the time,
he wrote ``A number of conflicting duplicative and inconsistent
requirements have been identified when analyzing the
simultaneous application of different national regulations.
These requirements, if applied on a cross-border basis to the
same entities and transactions would, in certain cases, impede
a transaction from taking place or might impede an entity from
operating with the United States counterparts. This would have
serious consequences for global market liquidity, and might
even have financial stability consequences. ESMA considers it
to be of fundamental importance to avoid the application of two
or more sets of rules to the same entities or transactions, if
those entities and transactions are subject to appropriate
requirements in their home jurisdiction. Therefore, we urge
U.S. regulators to rely on the maximum extent and equivalent
requirements enshrined in EU law instead of imposing U.S.
requirements when those non-U.S. entities are dealing with U.S.
persons. When a duplicative application of rules cannot be
avoided, we believe it is essential to identify and mitigate
any possible conflict that might arise from that situation.''
As Ranking Member and Mr. Scott mentioned, at that time,
you and I and this whole Committee argued strenuously against
our own U.S. regulators when they sought to push the boundaries
of our regulations too far. We were worried about exactly what
Chairman Maijoor identified, duplicative and inconsistent
requirements harming global liquidity formation and raising
financial stability concerns. Yet today, it is U.S. regulators
who are recalibrating their approach and working to offer
solutions to these thorny cross-border issues, and our European
colleagues who are failing to heed their own advice. If
European regulators persist down this path, we will likely
learn that they were correct in their analysis and find that
their actions have left our global markets in disarray.
Mr. Chairman, before I close, I want to mention my deep
disappointment in comments made by a senior Commission official
at a conference several weeks ago in London. It is particularly
personal to me because you and I so warmly received his
testimony on this topic during that December 2012 hearing. In
their worst light, his comments suggest that the United States
does not have a partner, but a competitor in financial market
regulation, a competitor who is willing to use its regulations
to its strategic advantage. Viewing financial regulations as a
competition would be a grave mistake. But, even in their best
light, his comments betray a smugness that is inappropriate
among friends. Such casual arrogance breeds mistrust,
frustration, and needless friction at a time when we cannot
afford intramural sniping.
I have been struggling to make sense of the complete
reverse on principle from our European friends expressed at
their 2012 hearing. It is comments like these that lend
credence to the argument that our ongoing CCP equivalence
disagreements have nothing to do with systemic risks or safety
and soundness of European institutions, and everything to do
with retribution and competitive regulatory arbitrage. I
certainly hope that is not the case. If it isn't, European
leadership plainly made that clear through their words and
their actions.
With that, I yield back.
The Chairman. Well, Ranking Member Conaway, thank you so
much for that. As you know, I agree with you 100 percent. I
really appreciate you really exposing that to the Committee
this morning.
Mr. Conaway. Thank you, Mr. Chairman.
The Chairman. Thank you very much.
And now, the chair would request that other Members submit
their opening statements for the record so the witnesses may
begin their testimony, and to ensure that there is ample time
for questions.
Let me begin now by welcoming all of our distinguished
panel members and thanking you all for coming, and we are
looking forward to your testimony on this important issue.
First of all, Mr. Terrence Duffy, thank you for coming. Mr.
Duffy is Chairman and CEO of the CME Group, Chicago Mercantile
Exchange in Chicago, Illinois. Thank you for coming, sir.
We also have next Mr. Christopher Edmonds. Mr. Edmonds is
Senior Vice President of Financial Markets for the
Intercontinental Exchange, Chicago, Illinois. Wonderful. Please
give my regards to Mr. Jeff Sprecter, a good friend, and ICE,
as you may know, is headquartered in our wonderful State of
Georgia in Atlanta. Thank you.
And next, we have Mr. Daniel Maguire who is CEO of the LCH
Group, London, United Kingdom. Thank you for coming. We really
appreciate you coming over the pond to deal with this very
important issue that London and Great Britain are grappling
with at this moment. Thank you for bringing this insight to our
Subcommittee hearing.
And next, we have Mr. Walt Lukken, who is the President and
CEO of Futures Industry Association, Washington, D.C. We are
very much looking forward to your comments as well.
And finally, we have Mr. Stephen Berger, Managing Director
and Global Head of Government and Regulatory Policy, Citadel,
LLC, on behalf of Managed Funds Association out of New York,
New York. Good to have you. Thank you. We look forward to your
input as well.
What a distinguished panel. Thank you all very much for
coming.
And now, we will now proceed to hearing from our witnesses.
Each of you will have 5 minutes, and 1 minute is left when the
light turns yellow, signaling time is closely expiring.
However, this is indeed a very critical and important hearing,
and if there is something else that is pressing that you need
to say, the chair will be lenient to make sure your full
thoughts are here, because you are the ones who are out there
day in and day out within this as leaders of our financial
system in this international marketplace. We want to make sure
that we hear from you and your recommendations as to what
recommendations we need to take as a Committee to make sure
your positions at the world market are strengthened, and you
are not weakened on the world financial stage.
All right. We will hear from you first, Mr. Duffy.
STATEMENT OF HON. TERRENCE A. DUFFY, CHAIRMAN AND CHIEF
EXECUTIVE OFFICER, CME GROUP INC., CHICAGO, IL
Mr. Duffy. Well thank you, Chairman Scott, Ranking Member
Scott, and Members of the Committee. I am Terry Duffy, as the
Chairman said. I am the Chairman and Chief Executive Officer of
CME Group.
Before I go into some of my prepared remarks that I wanted
to give to you today, I am absolutely struck by what I heard
here by this Congress, and I want to thank you, Mr. Chairman,
for your leadership, Ranking Member Scott for your leadership
on the comments that I heard. And Mr. Conaway, what you had
said is just so profound to dig back up what people said in
2012. It is just truly amazing that we are sitting here today
in the duplicativeness of what people have said throughout the
time.
I don't think a lot of people understand the importance of
this Committee, what it is doing here today. And so, Mr.
Chairman, I really applaud you, your foresight to bring this
forward because you look at what is going on in the world today
alone, just with the farm community, and not only are they
dealing with very difficult issues as far as trade goes; they
are also dealing with extremely difficult issues with weather.
These are a couple issues that they have no control over.
But to your point, Mr. Conaway, the liquidity--or
Chairman--Ranking Member Scott on the liquidity, this is
critical. This Congress has an opportunity not to impose
another problem for the American farmer, and that is giving
them a place where they don't have any risk management tools
during these very uncertain times. And if you think that there
is nothing else to it but agricultural products, you can talk
about home mortgages. You can talk about fuel for your car. You
can talk about your 401(k). All these different services that
we use in our daily lives need risk management products, and if
you drive the cost up, I think Mr. Conaway said, it will fall
on the consumers. That is where it ultimately goes. Your
foresight to have this Committee hearing is critically
important. It is a lot more than just regulatory arbitrage.
This has a lot to do with the American consumer and the global
consumers. I really applaud your efforts, all of you on this
Committee, for going forward with this.
That being said, I testified before this Subcommittee
almost 3 years ago to the day in June of 2016. After that
hearing, I stated the negotiations between the United States
and the European Union on equivalence were successfully
resolved in February when the European Commission officially
granted the CFTC equivalent status. I encouraged global
regulators to avoid potential market disruption in the future
by implementing long-term solutions. And I warned if this was
not the case, regulation will artificially influence liquidity,
price discovery, and risk management, and competitively
disadvantage individual markets in an increasingly competitive
global marketplace.
Unfortunately, here we are 3 years later again discussing
our regulatory overreach by the European Union that is in
direct challenge to the authority of the United States Congress
and the Commodity Futures Trading Commission to set rules and
to regulate the U.S. futures market. One year after the U.S.
and the European Union reached the equivalence agreement in
2016, in the wake of Brexit, the European Union proposed
legislation creating a sweeping new set of regulations to apply
to clearinghouses operated outside the European Union.
This new law, as the Chairman referred to it as EMIR 2.2,
unilaterally amends the agreement layering significant new
requirements on top of those previously agreed to without
justification. The 2016 agreement was the result of painstaking
comparison of U.S. and European Union clearinghouse
regulations. Its ratification reflected consensus that the U.S.
regulations were comparable and equivalent to those in the
European Union. Yet, just last month, as the Chairman said,
ESMA and the European Union regulatory authority asked--they
were tasked with overseeing the non-European Union
clearinghouses, released its consultations detailing how they
recommend implementing the new EMIR 2.2 requirements.
The consultations proposed to needlessly require a line-by-
line comparison of U.S. and European Union laws, ignoring the
principles of deference and substituted compliance that the two
jurisdictions agreed to just a few years ago.
ESMA proposed to classify U.S. clearinghouses according to
their systemic relevance to the European Union through a set of
subjective criteria that in many cases have no nexus to the
European Union, and are inappropriate tests of whether a U.S.
clearinghouse has systemic importance to the Union.
ESMA further proposes to override U.S. law and the 2016
agreement by rejecting substituted compliance for U.S.
clearinghouses that they deemed systemically important to the
European Union. ESMA's proposal would demand strict compliance
with the majority of the European Union rulebook, effectively
making ESMA, instead of the United States Congress and the
CFTC, the standard setter for U.S. clearinghouses.
ESMA would also give European Union regulators authority
over clearinghouses' corporate governance. This is in direct
conflict with U.S. law, and imposes fees on U.S. clearinghouses
to fund the European Union's expansion of its regulatory
apparatus.
This wholesale regulatory takeover by the European Union is
inconsistent with the needs of global financial markets.
Without deference and cooperation, global markets will face
regulatory fragmentation resulting in, as we said earlier,
decreased liquidity, increased volatility, and higher prices
for all market participants, and ultimately, consumers. It will
place a higher cost on farmers, end-users, and producers that
use U.S. markets to hedge risk. If this European Union
legislation were to be enacted, it will weaken the stability of
the U.S. financial system, in addition to the global financial
marketplace.
Our U.S. regulators have longstanding experience overseeing
complex markets, ensuring robust risk management, and assessing
systemic risk. Rather than attempting to override this capable
and vigilant regulatory regime, the European Union regulators
should work with the U.S. to build a coordinated global
regulatory framework.
Mr. Chairman, Members of the Committee, I thank you for
giving me the extra time to give my comments today. I look
forward to answering any questions you may have.
[The prepared statement of Mr. Duffy follows:]
Prepared Statement of Hon. Terrence A. Duffy, Chairman and Chief
Executive Officer, CME Group Inc., Chicago, IL
Hearing To Review U.S. CCP Equivalence in the EU
Chairman Scott, Ranking Member Scott, and Members of the
Subcommittee, I am Terry Duffy, Chairman and CEO of CME Group Inc.
(``CME Group'').\1\ Thank you for the opportunity to testify today
regarding U.S. central counterparty (``CCP'') equivalence in the
European Union (``EU'') and the potential implications for the U.S.
futures markets. We appreciate your interest in addressing the EU's
recent legislation on non-EU CCPs, which could have a drastic impact on
Congress's and the Commodity Futures Trading Commission's (``CFTC'')
authority over U.S. domiciled derivatives clearing organizations
(``DCO''). Congress now has the opportunity to positively influence the
EU to move towards an approach of regulatory deference before the full
package of revised legal and regulatory requirements for non-EU CCPs is
finalized by the EU. We expand on our views on how Congress can reduce
the likelihood of EU overreach in our concluding remarks and believe
that active Congressional engagement is a prerequisite to a positive
result.
---------------------------------------------------------------------------
\1\ CME Group Inc. (``CME Group'') is the parent of the Chicago
Mercantile Exchange Inc. (``CME''). CME is registered with the
Commodity Futures Trading Commission (``CFTC'') as a derivatives
clearing organization (``DCO'') and is one of the largest central
counterparty (``CCP'') clearing services in the world. CME's clearing
house division offers clearing and settlement services for exchange-
traded futures and options on futures contracts, as well as over-the-
counter (``OTC'') derivatives transactions, including interest rate
swaps (``IRS'') products. On July 18, 2012, the Financial Stability
Oversight Council designated CME as a systemically important financial
market utility under Title VIII of the Dodd-Frank Wall Street Reform
and Consumer Protection Act (``Dodd-Frank Act'') based on its U.S.
exposures, among other things. See, Minutes of the Financial Stability
Oversight Council, pg. 5 (July 18, 2012), available at https://
www.treasury.gov/initiatives/fsoc/Documents/
July%2018%20FSOC%20Meeting%20Minutes.pdf.
---------------------------------------------------------------------------
Background on EU CCP Equivalence
In March of 2016, the CFTC and the EU entered into an equivalence
agreement following years of negotiations.\2\ This agreement was soon
followed by the recognition of individual DCOs in the U.S., like
Chicago Mercantile Exchange Inc. (``CME''), which allowed EU persons to
efficiently access U.S. futures markets for their hedging needs.
---------------------------------------------------------------------------
\2\ Commission Implementing Decision (EU) 2016/377 of 15 March 2016
on the equivalence of the regulatory framework of the United States of
America for central counterparties that are authorised and supervised
by the Commodity Futures Trading Commission to the requirements of
Regulation (EU) No 648/2012 of the European Parliament and of the
Council, available at https://eur-lex.europa.eu/legal-content/EN/TXT/
PDF/?uri=CELEX:32016D0377&from=EN.
---------------------------------------------------------------------------
On June 23, 2016, the United Kingdom (``UK'') voted to depart from
the EU. To ensure ongoing oversight of the Euro currency and financial
markets denominated in Euros, the European Commission proposed new
legislation in June of 2017 (hereafter, ``EMIR 2.2'').\3\ But rather
than focus on Euro denominated products and EU risks,\4\ this
legislation instead proposed a broad test to determine whether non-EU
CCPs are of systemic importance to the EU. As drafted, the legislation
may have captured non-EU CCPs with an extremely limited nexus to the
Euro and/or limited exposures to EU financial institutions. As expanded
upon below, this approach potentially captures U.S. DCOs such as CME,
which have limited exposures to the Euro and EU clearing members.
Consequently, under these very broad standards, U.S. DCOs that are
found to be of systemic importance to the EU would be subject to direct
EU regulation and supervision, contrary to the original equivalence
agreement reached in March of 2016.
---------------------------------------------------------------------------
\3\ European Commission, Proposal for a Regulation of the European
Parliament and of the Council amending Regulation (EU) No 1095/2010
establishing a European Supervisory Authority (European Securities and
Markets Authority) and amending Regulation (EU) No 648/2012 as regards
the procedures and authorities involved for the authorisation of CCPs
and requirements for the recognition of third-country CCPs (June 2017),
available at https://eur-lex.europa.eu/
resource.html?uri=cellar:80b1cafa-50fe-11e7-a5ca-01aa75ed71a1.0001.02/
DOC_1&format=PDF.
\4\ Id. at pg. 6 (noting, ``[m]oreover, a substantial volume of
euro-denominated derivatives transactions (and other transactions
subject to the EU clearing obligation) is currently cleared in CCPs
located in the United Kingdom. When the United Kingdom exits the EU,
there will therefore be a distinct shift in the proportion of such
transactions being cleared in CCPs outside the EU's jurisdiction,
exacerbating the concerns outlined above. This implies significant
challenges for safeguarding financial stability in the EU that need to
be addressed. In light of these considerations, the Commission adopted
a Communication on 4 May 2017 on responding to challenges for critical
financial market infrastructures and further developing the Capital
Markets Union 22. The Communication indicated that `further changes [to
EMIR] will be necessary to improve the current framework that ensures
financial stability and supports the further development and deepening
of the Capital Markets Union (CMU)'.'').
---------------------------------------------------------------------------
Despite efforts by the CFTC to encourage EU policy makers to
incorporate cross-border deference into EMIR 2.2, political agreement
was reached among the European Commission, European Parliament and
European Council in March of 2019 on a version of EMIR 2.2 that
provides for a test for systemic importance that does not require that
a non-EU CCP have a nexus to the EU.\5\ Thus, U.S. DCOs such as CME
could be designated systemically important in the EU, despite CME's
limited exposures in EU denominated products and to EU clearing
members. A DCO that is so designated would be directly regulated and
supervised by the European Securities and Markets Authority (``ESMA'').
Last month, ESMA issued technical advice consultations on EMIR 2.2
(hereafter, ``ESMA Consultations'').\6\ The ESMA Consultations propose
text for regulations that are required to be adopted by the European
Commission to implement EMIR 2.2.
---------------------------------------------------------------------------
\5\ Council of the European Union, Regulation of the European
Parliament and of the Council amending Regulation (EU) No 648/2012 as
regards the procedures and authorities involved for authorisation of
CCPs and requirements for recognition of third-country CCPs--
Confirmation of the final compromise text with a view to agreement
(March 2019), available at https://data.consilium.europa.eu/doc/
document/ST-7621-2019-ADD-1/en/pdf.
\6\ European Securities and Markets Authority, Consultation Paper,
Draft technical advice on criteria for tiering under Article 25(2a) of
EMIR 2.2 (May 2019), available at https://www.esma.europa.eu/sites/
default/files/library/esma70-151-2138_cp_ta_on_tiering_criteria.pdf;
European Securities and Markets Authority, Consultation Report,
Technical Advice on Comparable Compliance under article 25a of EMIR
(May 2019), available at https://www.esma.europa.eu/sites/default/
files/library/esma70-151-2179_cp_ta_on_comparable_com
pliance.pdf; European Securities and Markets Authority, Consultation
Paper, ESMA fees for Third-Country CCPs under EMIR 2.2 (May 2019),
available at https://www.esma.europa.eu/sites/default/files/library/
esma70-151-1663_cp_on_emir_2_2_ccp_fees.pdf.
---------------------------------------------------------------------------
Although EMIR 2.2 provides a mechanism based on comparable
regulation that could potentially avoid the application of EU laws and
regulations directly to U.S. DCOs, fulsome comparable compliance is not
permitted by the proposed ESMA Consultations. Instead, the ESMA
Consultations require that U.S. DCOs designated as systemically
important in the EU must comply with the majority of laws and
regulations adopted for EU CCPs. As a result, ESMA would exercise
primary supervisory powers over such U.S. DCOs such as CME. This
approach fails to recognize the comprehensive legal and regulatory
framework adopted by Congress and implemented by the CFTC for U.S. DCOs
generally and those designated as systemically important in the U.S.
particularly.\7\ Congress adopted this framework as the exclusive form
of regulation for such U.S. DCOs.
---------------------------------------------------------------------------
\7\ U.S. DCOs that have been designated as systemically important
in the U.S. are subject to heightened regulatory standards along with
direct oversight and annual examinations by the CFTC and the Board of
Governors of the Federal Reserve System.
---------------------------------------------------------------------------
In effect, EMIR 2.2 and the ESMA Consultations propose, in many
cases, to supersede not only U.S. laws but also CFTC regulations that
were subject to a robust notice and comment process. Instead of those
Congressional and CFTC mandates, U.S. DCOs would be subjected to
recently developed EU laws and regulations on risk management and
governance which were drafted with EU financial markets in mind. It is
notable that ESMA does not, and will not under EMIR 2.2 or the ESMA
Consultations, supervise any EU CCPs. In fact, the EU policy-makers
specifically considered giving ESMA supervisory powers over EU CCPs as
part of the legislative process and decided to continue to defer to the
local regulators in the EU member states.
The U.S. approach to supervision and oversight of foreign futures
markets stands in stark contrast to EMIR 2.2 and the ESMA
Consultations. CCPs outside of the U.S. can clear foreign futures for
U.S. persons without being subject to any supervision or oversight from
the CFTC due to exemptive relief offered by the CFTC under Part 30 of
its regulations, which has been in place for decades.
CME Does Not Pose A Systemic Risk to the EU
CME does not pose a systemic risk to the EU and is subject to the
robust regulatory oversight of the CFTC under a framework designed for
U.S. financial markets by this Committee and Congress. Notwithstanding
CME's lack of systemic importance to the EU based on its financial
exposures and products cleared, the ESMA Consultations are designed to
capture CME as systemically important. If so captured, CME would be
subject to EU supervision and regulation, which would have negative
implications for the U.S. economy and regulatory sovereignty, as
further discussed in the next section.
CME has long provided a wide variety of U.S. Dollar denominated
futures products to its market participants. While these products are
used to hedge business risk on a global basis due to the role of the
U.S. Dollar as the world's reserve currency, the vast majority of the
risks that CME manages stem from U.S. domiciled clearing members. In
fact, EU domiciled entities clear less than 2% of the risks that CME
manages. The de minimis nature of CME's exposures to EU domiciled
clearing members is consistent with the limited products that CME
clears denominated in EU currencies. These products represent
significantly less than 5% of CME's volume and exposure and an even
smaller portion of the overall Euro denominated futures markets.
Potential Impacts of EU Superseding U.S. Law
The powers proposed under EMIR 2.2 and the ESMA Consultations are
far reaching. They present negative implications for U.S. sovereignty
over its financial markets. Ultimately, the EU's imposition of its laws
and regulations risk weakening the stability of the U.S. and global
financial systems and fragmenting U.S. futures markets, while
potentially undermining the central role the U.S. has played in the
global commodities markets.\8\ As just one example of the wide ranging
regulations imposed, the combination of EMIR 2.2 and the ESMA
Consultations would allow ESMA to remove members of the board of
directors of a U.S. DCO designated systemically important in the EU.
That power directly conflicts with well-established corporate law
principles in the U.S. and exceeds the authority afforded to the CFTC
under U.S. law. The ability to dictate board representation has
consequences beyond corporate governance since the board is the
ultimate decision-making power on all manner of major strategic issues,
including U.S. DCO's risk management.
---------------------------------------------------------------------------
\8\ European Commission, Communication from the Commission to the
European Parliament, the European Council (Euro Summit), the Council,
the European Central Bank, the European Economic and Social Committee
and the Committee of the Regions--Towards a stronger international role
of the euro (Dec. 2018) (noting, recently, the European Commission laid
out a vision for a future state where the Euro replaces the U.S. Dollar
as the currency of choice when transacting in commodities markets. That
vision, if realized, will have broader deleterious effects on the U.S.
economy and mainstream consumers. Historically, most commodities have
been priced in U.S. Dollars due to the central role of the U.S. Dollar
in the global economy and the pre-eminence of the U.S. financial
markets.), available at https://eur-lex.europa.eu/legal-content/EN/TXT/
PDF/?uri=CELEX:52018DC0796&from=en.
---------------------------------------------------------------------------
EMIR 2.2 and the ESMA Consultations would supplant U.S. regulatory
standards for U.S. DCOs' risk management, even though the EU standards
were drafted by policy-makers unfamiliar with the nuances of the U.S.
futures markets. The application of foreign regulation to U.S. futures
markets has the potential to create systemic risk through increased
regulatory complexity and conflict. Risk management best practices
originated in the U.S. futures markets and have served as a template
for global financial reform due to the robust performance of U.S. DCOs
during the financial crisis. Congress and the CFTC have expanded upon
these best practices by applying their well-earned expertise to develop
a robust set of principles-based regulations that are designed to
ensure financial stability while taking into account the unique
characteristics of the deeply liquid U.S. cleared futures markets used
by farmers, end-users and producers for price discovery and hedging
purposes.
Next Steps for Congress and the CFTC
The ESMA Consultations are currently open for comment with the
period closing on July 29, 2019. It is expected that the ESMA
Consultations would then be finalized by the end of 2019 with the new
EU powers going into effect in early 2020. We respectfully urge
Congress and the CFTC to act now to ensure that the implementation of
EMIR 2.2 respects U.S. sovereignty and expertise over its financial
markets.
This Committee and Congress have since 1974 provided the exclusive
regulatory framework for U.S. futures markets to be administered by the
CFTC. Ensuring the continuation of that framework is critical. In the
event that regulatory deference is not offered by its foreign
regulatory peers, the CFTC has powers under the Commodity Exchange Act
and Part 30 of its regulations to take actions to support U.S.
financial markets' stability and the broader role played by U.S.
financial markets in the global financial system. We encourage Congress
and the CFTC to use their powers as necessary while also considering
whether any additional statutory or regulatory tools are necessary to
address regulatory overreach by policy-makers outside of the U.S.,
including the EU.
Thank you. I look forward to answering your questions.
The Chairman. Thank you very much, Mr. Duffy. That was very
informative.
And now, I recognize Mr. Edmonds.
STATEMENT OF CHRISTOPHER S. EDMONDS, SENIOR VICE PRESIDENT,
FINANCIAL MARKETS, INTERCONTINENTAL
EXCHANGE, INC., CHICAGO, IL
Mr. Edmonds. Chairman Scott, Ranking Member Scott, and
Members of the Subcommittee, I am Chris Edmonds, Senior Vice
President for Financial Markets, Intercontinental Exchange, or
ICE. I appreciate this opportunity to appear before you today
as this Committee looks at Brexit and EMIR 2.2, and related
cross-border issues.
Central counterparties play a critical role in the
financial markets serving the needs of market participants
around the globe. Policy makers across the world, including
this Committee, have an interest in safe and efficient markets.
Since launching an electronic marketplace for energy in
2000 in Atlanta, Georgia, ICE has expanded in both the U.S. and
internationally. We have acquired or founded derivatives
exchanges and clearinghouses in the U.S., Europe, Singapore,
and Canada. Today, ICE owns and operates six geographically
diverse clearinghouses that serve global markets and customers
across North America, Europe, and Asia. Each of these
clearinghouses is subject to direct oversight by local national
regulators, and subject to regulations reflective of the G20
reforms and IOSCO principles. Our assets are regulated by the
CFTC, the SEC, the Federal Reserve System, the Bank of England,
the UK Financial Conduct Authority, The European Securities
Market Authority, the Monetary Authority of Singapore, among
others.
Over the last decade, we have become familiar and work
closely with global regulators to understand their unique
perspectives.
Clearing has consistently proven to be a fundamentally safe
and sound process for managing systemic risk. Observers
frequently point to non-cleared derivative contracts as a
significant factor in the broad reach and complexity of the
2008 financial crisis, while noting the relative stability of
cleared markets. Regulators and market participants also
understand these are global markets, and to realize the goals
of the G20 reforms, it is essential regulators share
information and continue to cooperate with each other,
consistent with agreed upon international frameworks.
As an example, ICE supports the ongoing dialogue between
the European and U.S. policy makers where there have been
notable success. The 2016 agreement between the European
Commission and CFTC established a common approach to
supervision of cross-border CCPs. This agreement promotes
regulatory deference as well as prioritizes provisions
supporting robust global derivatives markets. Continued
regulatory cooperation is imperative, as issues such as Brexit,
which should have no bearing on these efforts, are determined
by other political bodies and agendas.
Differences and unsubstantiated changes in financial sector
reforms can lead to overlapping and conflicting requirements.
This is in no one's best interest, and it has been clearly
articulated here today in previous comments. This spirit of
cooperation should guide our ongoing discussion on critical
cross-border issues, including EMIR 2.2 implementation and
potential Brexit responses.
The proposed EMIR 2.2 text contemplates that with respect
to non-European Union domiciled CCPs determined to be
systemically important, ESMA could rely on comparable
compliance with the CCP local regulatory regime. However, the
text also contemplates that ESMA be able to recommend and the
Commission be able to adopt after agreement with the ECB, an
act requiring a clearinghouse to relocate in the EU if the
central counterparty or some of its clearing services are of
such systemic importance.
A better outcome would be to continue the development and
reliance on the model of supervisory cooperation, enabling EU
supervisors to exercise appropriate and proportionate oversight
of central counterparties.
The European Commission policy goals to ensure appropriate
supervision of non-EU domiciled CCPs that are deemed
systemically important, are completely understandable. ICE
believes these goals can be achieved by ESMA employing
mechanisms based on international standards such as CPMI-IOSCO.
Each national regulator should consider the interest of other
relevant authorities and interested parties when managing a
crisis. However, there should be no ambiguity in the ultimate
decision-making authority for the avoidance of doubt. The
industry cannot afford any regulatory confusion in a time of
stress.
ICE believes the cross-border oversight and regulatory
deference to home country regulators are essential to well-
functioning markets. They are the foundation of healthy global
markets. The CFTC's recent publication and Chairman Giancarlo's
description of his vision for future CFTC rule proposals are,
in ICE's view, positive steps towards implementing relevant
laws, standards, and policies that further the goal for
financial stability and resilience while minimizing supervisory
duplication and conflict.
ICE has always been, and remains a strong proponent of open
and competitive markets with appropriate regulatory oversight.
To that end, we have, and we will continue to work closely with
this Committee and all regulatory authorities to ensure access
to all relevant information available.
Mr. Chairman, thank you for the opportunity to share our
views with you. I would be happy to answer any questions you or
Members of the Subcommittee have today.
[The prepared statement of Mr. Edmonds follows:]
Prepared Statement of Christopher S. Edmonds, Senior Vice President,
Financial Markets, Intercontinental Exchange, Inc., Chicago, IL
Introduction
Chairman Scott, Ranking Member Scott, I am Chris Edmonds, Senior
Vice President, Financial Markets for Intercontinental Exchange, or
ICE. I appreciate the opportunity to appear before you today, as this
Committee looks at Brexit, the European Commission's recent reforms to
its legislation governing the regulation and supervision of CCPs,
called the European Market Infrastructure Regulation (or EMIR 2.2), and
related cross-border issues.
Central counterparties (or CCPs) play a critical role in the
financial markets that serve the needs of market participants around
the globe. Policy makers across the world, including this Committee,
have an interest in safe and efficient markets. To further the common
interest of well-functioning markets and well-regulated CCPs, we
appreciate the opportunity to participate in this hearing as it
examines the cross-border supervision of CCPs.
Background
Since launching an electronic over-the-counter (OTC) energy
marketplace in 2000 in Atlanta, Georgia, ICE has expanded both in the
U.S. and internationally. Over the past seventeen years, we have
acquired or founded derivatives exchanges and clearing houses in the
U.S., Europe, Singapore and Canada. In 2013, ICE acquired the New York
Stock Exchange, which added equity and equity options exchanges to our
business. Through our global operations, ICE's exchanges and clearing
houses are directly regulated by the U.S. Commodity Futures Trading
Commission (CFTC), the Securities and Exchange Commission (SEC), the
Bank of England, the UK Financial Conduct Authority (FCA), the European
Securities and Markets Authority (ESMA) and the Monetary Authority of
Singapore, among others.
ICE has a successful and innovative history of clearing exchange
traded and OTC derivatives across a spectrum of asset classes,
including energy, agriculture and financial products. Today, ICE owns
and operates six geographically diverse clearing houses that serve
global markets and customers across North America, Europe and Asia.
Each of these clearing houses is subject to direct oversight by local
national regulators, often in close coordination and communication with
other regulatory authorities with important interests, and subject to
regulations reflective of the G20 reforms and IOSCO principles.
ICE acquired its first clearing house, ICE Clear U.S., as a part of
the 2007 purchase of the New York Board of Trade. ICE Clear U.S. is
primarily regulated by the CFTC and is recognized by ESMA and clears a
variety of agricultural and financial derivatives. In 2008, ICE
launched ICE Clear Europe, the first new clearing house in the UK in
over a century. ICE Clear Europe clears derivatives in several asset
classes, including energy, interest rates, equity and credit
derivatives, and is primarily supervised by the Bank of England, in
close cooperation with the CFTC, the SEC and ESMA. ICE Clear Credit was
established as a trust company in 2009 under the supervision of the
Federal Reserve Board and the New York State Banking Department and
converted to a derivatives clearing organization (DCO) following
implementation of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act). ICE Clear Credit is primarily
regulated by the CFTC and SEC and also recognized by ESMA and clears a
global set of credit default swaps on indices, single names and
sovereigns. ICE also operates ICE Clear Netherlands under the
regulatory supervision of De Nederlandsche Bank, Autoriteit Financiele
Markten and ESMA and ICE Clear Singapore which is overseen by the
Monetary Authority of Singapore.
CCPs Vital Role in the Derivatives Market
The risk reducing benefits of central clearing have long been
recognized by users of exchange-traded derivatives (futures) and the
pre-existing regulatory framework and efficacy of the clearing model
throughout even the most challenging financial situations made it the
natural foundation of the financial reforms put forward over the past
decade. Clearing has consistently proven to be a fundamentally safe and
sound process for managing systemic risk. Observers frequently point to
non-cleared derivative contracts as a significant factor in the broad
reach and complexity of the 2008 financial crisis, while noting the
relative stability of cleared markets.
The disciplined and transparent risk management practices of
regulated clearing houses serve to reduce systemic risk. A clearing
house, by acting as a central counterparty, to clearing members'
transactions, eliminates the bilateral counterparty credit risk and
imposes on clearing members a transparent set of rules and prudent risk
management practices, such as margin requirements, to minimize risks
managed by the clearing house. Over the past 100 years, clearing house
risk management practices have been repeatedly tested and proven in
resolving clearing member defaults including large bankruptcy
proceedings, such as Lehman Brothers and MF Global. The recent
introduction of mandated clearing obligations for certain swaps has
sensibly extended the significant benefits of clearing to a broader
array of financial instruments.
Regulatory Cooperation
Following the 2008 financial crisis, global regulators were tasked
with implementing the G20 reforms to achieve the goals of increased
financial stability, resilience and transparency in the global OTC
derivatives market. Over the last decade, ICE has worked with global
regulators as they implement reforms designed to foster financial
stability, facilitate robust, liquid and transparent markets, and
protect the geographically diverse users of those global markets.
It is well understood by regulators and market participants that
the derivatives markets are global markets, as participants in those
markets trade across venues and jurisdictions to meet their unique
business needs. To realize the goals of the G20 reforms, it is
essential that regulators share information and continue to cooperate
with each other, consistent with agreed upon global frameworks. It is
important that regulators carefully implement regulatory requirements
to minimize the fragmentation of markets and liquidity, which can
reduce the efficacy of commercial firms' risk management efforts and
undermine the goals of financial stability and resilience. To this end,
constructive relationships among regulators are critical to building
the confidence and trust essential for effective cross-border
regulatory frameworks and that are consistent with globally agreed to
principles. This effort to work together is in all of our best
interests, just as the prevention of market fragmentation should be.
Such deference and cooperation can enhance liquid, well-functioning
markets and minimize confusion and inefficient, duplicative oversight.
ICE supports the ongoing dialogue between European and U.S. policy
makers where there have been notable successes. The 2016 agreement
between the European Commission (EC) and the CFTC established a common
approach to the regulation and supervision of cross-border CCPs (CCP
Agreement).\1\ The CCP Agreement promotes regulatory deference as well
as prioritizes provisions supporting robust global derivatives markets.
In addition, the CFTC, Bank of England and the Financial Conduct
Authority recently issued a joint statement providing assurances to
market participants on the continuity of derivatives trading and
clearing activities between the UK and U.S. regardless of the outcome
of the UK's withdrawal process from the EU. Similarly, the EU announced
its intention to continue to recognize UK-based clearing firms after
the UK's withdrawal process from the EU. Together, these authorities
took cooperative measures to avoid regulatory uncertainty about the
continuation of the global derivatives market regardless of their
location; such an important step achieved through communication,
coordination and local regulatory frameworks established based upon
global principles. These measures give confidence to market
participants about their continued ability to trade and manage their
global risks on a cross-border basis.
---------------------------------------------------------------------------
\1\ Joint Statement from CFTC Chairman Timothy Massad and European
Commissioner Jonathan Hill, CFTC and the European Commission: Common
approach for transatlantic CCPs (February 10, 2016), https://
www.cftc.gov/PressRoom/PressReleases/pr7342-16.
---------------------------------------------------------------------------
Continued regulatory cooperation is imperative, as issues such as
Brexit, which should have no bearing on these efforts, are determined
by other political bodies. ICE has a long history of working with U.S.
and global regulators on mutually beneficial supervisory outcomes.
Differences and unsubstantiated changes in financial sector reforms can
lead to overlapping or conflicting requirements. By working together
across the globe, regulators can avoid this harmful and
counterproductive outcome and promote a more resilient financial
system. This spirit of cooperation should guide our ongoing discussions
on critical cross-border issues, including EMIR 2.2 implementation and
potential Brexit responses.
EMIR 2.2
Recently, the European Parliament and EU-Member States reached an
agreement on reforms to EMIR 2.2, legislation governing the regulation
and supervision of CCPs. Prior to this announcement, the EU's approach
to supervising non-EU CCPs was based on equivalence and deference to
the 2016 CCP Agreement. EMIR 2.2 expands the regulatory and supervisory
authority of ESMA over third-country CCPs, i.e., non-EU domiciled CCPs,
if those CCPs are determined to be systemically important for the
financial stability of the EU. EMIR 2.2 contemplates that, with respect
to non-EU domiciled CCPs determined to be systemically important, ESMA
could rely on comparable compliance with the CCP's local regulatory
regime. EMIR 2.2 also contemplates that ESMA be able to recommend, and
the Commission be able to adopt, after agreement from the ECB, an act
that requires a clearing house to relocate to the EU if the CCP or some
of its clearing services are deemed to be of such systemic importance.
We agree with the final agreement of the European Parliament and
Council that such an act should be a measure of last resort, as such a
requirement would increase costs considerably for banks and their
customers, because the current portfolio efficiencies would be
unavailable if the euro-denominated portion were disaggregated. A
better outcome would be to continue the development and reliance on a
model of supervisory cooperation that enables EU supervisors to
exercise appropriate and proportionate oversight of CCPs that provide
clearing services in the EU.
ESMA recently published two consultations on the implementation of
the new EMIR 2.2 regime for non-EU domiciled CCPs. Specifically, ESMA
is currently seeking public consultation on the criteria for assessing
the systemic importance of non-EU domiciled CCPs. ESMA is also
consulting on the detailed rules regarding ESMA's approach to
comparable compliance. ICE is evaluating ESMA's recently published
consultations and will be commenting. ICE supports the EMIR 2.2 goal to
establish appropriate supervision of non-EU domiciled CCPs that are
determined to be systemically important for the financial stability of
the EU and looks forward to contributing to the dialogue on
implementation of EMIR 2.2.
The European Commission's policy goals to ensure appropriate
supervision of non-EU domiciled CCPs that are deemed systemically
important to the EU are understandable. ICE believes that these goals
can be achieved by ESMA employing mechanisms based on international
standards such as CPMI-IOSCO, together with continued cooperation and
information-sharing agreements among CCP supervisory authorities. These
mechanisms can provide ESMA with the information and oversight they
require, while leaving the final decision-making in the hands of
national regulators to prevent overlapping or conflicting requirements,
which is particularly critical in a time of crisis. ESMA, in any effort
to enhance oversight of non-EU CCPs, should consider strong and
effective supervisory cooperation between the relevant authorities.
This approach will enable EU supervisors to exercise appropriate and
proportionate oversight of non-EU CCPs.
A global approach to supervision brings significant benefits.
Especially in a crisis situation, the market needs clarity that the
national regulator can take the lead in managing a default and have the
ultimate decision making authority. The national regulator should
consider the interests of other relevant authorities and interested
parties when managing a crisis, however there should be no ambiguity in
the ultimate decision making authority.
CFTC Cross-Border Regulation
In 2018, the CFTC indicated its desire to reassess the current
cross-border application of its swaps regime with a rule-based
framework based on regulatory deference to third-country regulatory
jurisdictions that have adopted the G20 swaps reforms.\2\ The CFTC has
stated that, as global regulators continue to implement swaps reforms
in their markets, it is critical to ensure CFTC rules do not conflict
and fragment the global marketplace. The CFTC has proposed to move to a
flexible, outcomes-based approach for cross-border equivalence and
substituted compliance and to employ deference to overseas regulators.
To this end, Chairman Giancarlo has recently described a new approach
to supervising certain foreign derivatives clearing organizations
(DCOs). This approach would introduce an alternative compliance
regulatory framework for those foreign DCOs that do not pose a
substantial risk to the U.S. financial system and would rely on the
DCOs' home country rules to a large extent. ICE supports this type of
approach and hopes the CFTC will publish the proposal for comment
shortly.
---------------------------------------------------------------------------
\2\ ``Chairman Giancarlo Releases Cross-Border White Paper'',
October 1, 2018 at: https://www.cftc.gov/PressRoom/PressReleases/7817-
18.
---------------------------------------------------------------------------
ICE believes that the cross-border oversight and regulatory
deference to home country regulators is essential to well-functioning
markets. The [CFTC's] recent publications and Chairman Giancarlo's
description of his vision for future CFTC rule proposals are, in ICE's
view, positive steps towards implementing relevant laws, standards, and
policies that further the goal of financial stability and resilience,
while minimizing supervisory duplication and conflict.
Conclusion
ICE has always been, and remains, a strong proponent of open and
competitive markets with appropriate regulatory oversight. As an
operator of global futures and derivatives markets, ICE understands the
importance of ensuring the utmost confidence in its markets and we take
seriously our obligations to mitigate systemic risk. To that end, we
have worked closely with regulatory authorities in the U.S. and abroad
in order to ensure they have access to all relevant information
available to ICE regarding trade execution and clearing activity on our
markets. We look forward to continuing to work closely with governments
and regulators at home and abroad to address the evolving regulatory
challenges presented by derivatives markets and to expand the use of
demonstrably beneficial clearing services that underpin the best and
safest marketplaces possible.
Mr. Chairman, thank you for the opportunity to share our views with
you. I would be happy to answer any questions you and Members of the
Subcommittee may have.
The Chairman. Yes, thank you very much, Mr. Edmonds. I
appreciate that.
And now, Mr. Daniel Maguire.
STATEMENT OF DANIEL J. MAGUIRE, CHIEF EXECUTIVE
OFFICER, LCH GROUP LIMITED; MEMBER, EXECUTIVE
COMMITTEE, LONDON STOCK EXCHANGE GROUP PLC,
LONDON, UK
Mr. Maguire. Chairman Scott, Ranking Member Scott, Members
of the Committee, thank you for your warm welcome and the
opportunity to appear before the Committee today to discuss the
evolving global dialogue on cross-border regulation of
clearinghouses, as well as Brexit and its potential
ramifications and impact on the wider markets.
Some context: I am Daniel Maguire. I serve as Chief
Executive Officer of LCH Group, and I am a member of the
Executive Committee of the London Stock Exchange Group, a
global financial market infrastructure business which comprises
of 4,500 employees globally, of which over 700 are here based
in the United States. I have been with the firm for 20 years,
including several years based in New York during the formative
years of Dodd-Frank implementation, during which time I spent a
substantive amount of time here in Washington working with the
regulators on the swaps rules that were developed and
implemented.
LCH operates the world's largest clearinghouse for swaps.
It is domiciled in the UK, and it is a global business serving
global clients. It covers 60+ jurisdictions in terms of
clients, 26 currencies, and has regulatory oversight and direct
licenses in ten jurisdictions. Our home country regulator is
the Bank of England; however, LCH has also been registered as a
derivatives clearing organization, a DCO, with the CFTC since
2001, for over 18 years now, long before the crisis in 2008 and
the Dodd-Frank Act.
LCH's interest rate swap clearing service, SwapClear,
clears 90 percent of the global cleared interest rate market.
Really, just to give some context, just as farmers and
ranchers may use commodity derivatives to manage their risk of
exposure to commodity price fluctuations, it is fair to say
U.S. corporations, asset managers, and other end-users in the
U.S. utilize interest rate swaps to manage their risk exposure
to interest rate fluctuations.
The interest rate swap market is one of the largest global
financial markets, and I am pleased to provide our perspective
on this important piece of the Committee's jurisdiction. My
remarks today will focus on three topics.
First, with respect to Brexit, I am pleased to say that
temporary measures have been put in place to avoid disruption
for the interest rate swap markets, regardless of political
outcome. Three years ago, the UK voted to leave the EU. To
date, no agreement has been reached for their orderly exit from
the EU, and if no agreement is reached by the end of October
2019, no extension of the current deadline provided, the UK
will leave the EU without the transitional arrangements in
place, commonly known as a hard Brexit.
To mitigate the significant market disruption and financial
stability risks, in the event of a hard Brexit, the European
Commission and the UK Government collaborated to install
temporary contingency measures that would allow EU participants
to continue to have access to UK clearinghouses and their
global liquidity in the event of a hard Brexit.
However, regardless of if there is a hard Brexit scenario
or not, LCH will therefore be able to continue offering all of
these clearing services. We welcome these proposals and actions
by the European Commission and ESMA, as has been referred to by
others, which provided great clarity and certainty to market
participants in the EU and outside of the EU, too.
As a systemically important global institution, our main
priority continues to ensure the orderly functioning of the
markets, continuity of service to our customers, and most
importantly, supporting financial stability, regardless of the
Brexit outcomes.
My second point really comes to the evolving framework
regarding large global international clearinghouses. The future
architecture of global derivatives markets must, at all costs,
avoid unnecessary fragmentation, and therefore, must support a
form of regulatory supervisory cooperation and deference
mentioned by my other colleagues today.
Following the financial crisis in 2008, the G20 agreement
in 2009, the U.S. passed derivative reforms in 2010, and Europe
the same in 2012. In 2016, the Brexit vote was shortly followed
thereafter by the EU proposed amendments to EMIR that would
redefine how clearinghouses outside of the EU would be
regulated. It is commonly known as EMIR 2.2. Under EMIR 2.2, in
the event of the UK departure from the EU, the UK will be
treated similar, if not the same, to the U.S. and other non-EU
jurisdictions, known as third countries in the EU regulatory
context.
Regulating global markets requires different jurisdictions
to agree on the mechanisms to allow national regulatory
frameworks to interact on an international level to avoid
fragmentation into smaller localized markets, which increases
risk and increases costs for the U.S. and their users.
My third and final point, systemically important DCOs
should be able to deposit their U.S. dollar cash margin in a
U.S. central bank account, regardless of their domicile.
Although LCH does have access to central bank accounts in many
of the G20 jurisdictions, it does not currently have that
facility here in the U.S. with the Federal Reserve.
As the discussion over the cross-border clearinghouse
regulation progresses, we believe that is absolutely imperative
for central banks to require clearinghouses that manage
substantial risks in their jurisdiction to maintain a deposit
account for their currency. To be clear, this is deposit
accounts for safekeeping of customer margin. This is not and
should not be confused with the Fed providing emergency lending
in the event of a crisis, often known as a discount window
access.
Central bank deposit accounts are widely agreed by the
industry and regulation community as the safest option for
clearinghouses. To put this in context, LCH's daily U.S. dollar
cash balances for U.S. customers is in the region of $30 to $40
billion.
It is important to note that we operate an extensive global
collateral management function to ensure safety of margin that
it receives. Having access to a central bank account would only
enhance that.
So, in line with the recommendations from the U.S. Treasury
Department and others, we would urge this Committee and the
relevant U.S. financial regulators to further evaluate the
important financial stability role that central bank deposit
accounts could make and could play for systemically important
DCOs, such as LCH and others that are here today.
Chairman Scott, Ranking Member Scott, and Members of the
Committee, I would like to thank you again for this
opportunity. I apologize for running over. I appreciate the
opportunity to finish, and I look forward to answering any
questions you may have.
[The prepared statement of Mr. Maguire follows:]
Prepared Statement of Daniel J. Maguire, Chief Executive Officer, LCH
Group Limited; Member, Executive Committee, London Stock Exchange Group
PLC, London, UK
Introduction
Chairman Scott, Ranking Member Scott, and Members of the Committee,
I appreciate the opportunity to appear before you today to discuss
Brexit, its impact on the markets and the evolving international
dialogue on cross-border regulation of clearing houses.
I am Daniel Maguire and I serve as Chief Executive Officer of LCH
Group Limited (``LCH'') and as a Member of the Executive Committee of
London Stock Exchange Group (``LSEG''), a global financial market
infrastructure business.\1\ LSEG has approximately 4,500 employees
around the world, over 700 of which are employed in the U.S. across
offices in five states. LCH and FTSE Russell, one of the world's
largest index providers, which is also part of LSEG, are important
components of the U.S. financial markets.
---------------------------------------------------------------------------
\1\ LSEG holds an 82.6% stake in LCH Group, the remaining share is
held by a consortium of banks.
---------------------------------------------------------------------------
LCH operates the world's largest swaps clearing house, LCH Ltd.,
which is domiciled in the UK.\2\ LCH Ltd is directly licensed in ten
jurisdictions, has customers in 60 jurisdictions and offers clearing
services in 26 different currencies. LCH Ltd's home country regulator
is the Bank of England (``BoE'') and LCH Ltd has been registered with
the U.S. Commodity Futures Trading Commission (``CFTC'') as a
Derivatives Clearing Organization (``DCO'') since 2001. LCH also clears
futures traded on the London Stock Exchange Derivatives Market
(``LSEDM''), which is registered as a Foreign Board of Trade (``FBOT'')
by the CFTC.
---------------------------------------------------------------------------
\2\ LCH also operates LCH SA, domiciled in Paris, which is
regulated in four jurisdictions. LCH SA has been registered at the CFTC
since 2013 and the U.S. Securities and Exchange Commission (``SEC'')
since 2016. LCH SA's primary regulator is the Autorite de controle
prudentiel et de resolution (``ACPR'').
---------------------------------------------------------------------------
LCH's interest rate swap (``IRS'') clearing service, SwapClear,
clears over 90 percent of the cleared IRS market globally. The health
and liquidity of the IRS market allows banks and other financial
institutions to manage fluctuations in interest rates, which translates
into direct benefits for end-users, U.S. consumers and the broader U.S.
economy. Our U.S. end-user clients includes pension funds, regional
banks, Federal Home Loan Banks and government sponsored enterprises,
among many others.
Summary
My remarks today will focus on three related topics.
First, I will discuss LCH's response to Brexit and what this means
for our market participants, including U.S. banks and end-users.
Through the focused efforts of the derivatives industry and key central
banks and market regulators, contingency measures have been established
that will permit LCH and other clearing houses in the UK and EU to
continue to offer services to our clients in the event the UK exits the
EU without an agreement, referred to as ``no-deal'' or ``Hard'' Brexit.
Second, I will discuss the evolving international dialogue on
cross-border regulation of global clearing houses. Brexit has sharpened
the ongoing focus on this topic between the UK and EU as well as many
other jurisdictions around the world, including here in the U.S. We
have been encouraged by the progress and regulatory cooperation among
major jurisdictions, yet significant work lies ahead. LCH will continue
to work with our regulators, market partners and customers towards
outcomes that enhance financial stability and support global markets.
Finally, I will discuss the topic of clearing house resilience and
our views on how the global regulatory framework for clearing houses
can best support the common objective of strengthening these
increasingly important components of the financial markets. I will
specifically discuss the role central bank deposit accounts play in
enhancing the resilience of clearing houses as the safest place to
deposit cash margin, an issue that is widely agreed on by the industry
and regulatory community.
UK Withdrawal from the EU and ``Hard Brexit'' Contingency Measures
Three years ago, on June 23, 2016, the UK voted to leave the EU. In
March 2017, the legal instrument to commence this withdrawal, known as
Article 50, was triggered. The UK Government and EU began withdrawal
negotiations in June 2017. In November 2018, the UK Government and the
EU agreed on a Brexit deal, known as the Withdrawal Agreement, subject
to approval by the EU Council and UK Parliament. In a series of three
votes between January and March of this year, the UK Parliament voted
against the Withdrawal Agreement. It was subsequently agreed to extend
the deadline for Brexit until October 31, 2019.
Currently, if no agreement is reached by October 31 and no
extension of the current deadline is provided, the UK will leave the EU
without transitional arrangements in place. To avoid the significant
market disruption and financial stability risks in the event of a Hard
Brexit, on December 19, 2018, the European Commission (``EC'')
implemented its no-deal contingency action plan that includes a
conditional and temporary equivalence decision to allow UK clearing
houses to continue to provide services in the EU.\3\
---------------------------------------------------------------------------
\3\ Brexit: European Commission implements ``no-deal'' Contingency
Action Plan in specific sectors, available at http://europa.eu/rapid/
press-release_IP-18-6851_en.htm. Similar temporary equivalence was
granted by the BoE for EU27 domiciled clearing houses, including LCH SA
and LSEG's Italian clearing house, Cassa di Compensazione e Garanzia
(``CC&G'').
---------------------------------------------------------------------------
On February 18, 2019, the European Securities and Markets Authority
(``ESMA'') recognized three UK clearing houses following the EC's
equivalence decision.\4\ ESMA's recognition of LCH Ltd. as a ``third-
country CCP'' applies until March 30, 2020 and is only triggered in the
event of a Hard Brexit, allowing LCH Ltd. the ability to continue to
offer all clearing services for all products to all members and
clients. We welcomed these actions by the European Commission and ESMA,
which provided clarity for our market participants.\5\
---------------------------------------------------------------------------
\4\ ESMA to Recognise Three UK CCPs in the Event of a No-Deal
Brexit, available at https://www.esma.europa.eu/press-news/esma-news/
esma-recognise-three-UK-ccps-in-event-no-deal-brexit.
\5\ LCH Member Update, April 5, 2019, available at https://
www.lch.com/membership/ltd-membership/ltd-member-updates/brexit-update-
lch-limited-article-25-recognition-0.
---------------------------------------------------------------------------
As a systemically important institution, our main priority is
ensuring the orderly functioning of markets, continuity of service to
our customers and supporting financial stability. As the negotiations
progress, we will continue to engage with the relevant regulatory
authorities to secure the long-term recognition of LCH Ltd. in the EU.
It remains LCH's objective to ensure a smooth transition for our
customers whatever the outcome of the negotiations around the UK's
withdrawal from the EU.
Cross-Border Regulation of Global Clearing Houses
The IRS market, along with many other derivatives asset classes,
are global in nature. This requires different jurisdictions to agree on
regulatory mechanisms that allow national rules to interact on an
international level. This supports global market health and liquidity
and avoids fragmentation into smaller, localized markets.\6\ Creating a
harmonized, level playing field of regulation and cross-border market
access enhances competition among global markets and increases
financial stability. This results in lower costs and increased
protection for market participants, including end-users.
---------------------------------------------------------------------------
\6\ IOSCO notes fragmenting global markets into smaller, localized
markets increases counterparty risk, restricts liquidity, increases
costs and reduces financial stability, IOSCO Report on Market
Fragmentation & Cross-border Regulation, June 2019, available at
https://www.iosco.org/library/pubdocs/pdf/IOSCOPD629.pdf.
---------------------------------------------------------------------------
Large, global clearing houses manage different levels of risk in
the various jurisdictions where they operate. A key debate among
national regulators is how to measure a foreign clearing house's
importance in their jurisdiction and the resulting regulatory oversight
needed to oversee those clearing houses. We believe that regulation of
clearing houses outside of their home jurisdiction should be
proportionate to the risk that clearing house is managing in the host
jurisdiction. Host country regulators should afford deference to
comparable home country oversight where appropriate.
The regulatory frameworks governing the cleared swaps markets were
significantly enhanced and redefined with the Dodd-Frank Act in 2010
and the European Market Infrastructure Regulation (``EMIR'') in 2012.
Similar derivatives reforms were implemented in many other markets
around the world pursuant to the G20 financial regulatory reforms,
which were established following the 2008 financial crisis.\7\
---------------------------------------------------------------------------
\7\ Implementation and Effects of the G20 Financial Regulatory
Reforms: Fourth Annual Report, November 28, 2018, available at https://
www.fsb.org/2018/11/implementation-and-effects-of-the-g20-financial-
regulatory-reforms-fourth-annual-report/.
---------------------------------------------------------------------------
In 2016, an equivalence decision concerning the cross-border
regulation of clearing houses was made between the CFTC and EC.\8\ In
2017, the EC proposed amendments to EMIR, known as ``EMIR 2.2,'' which
were agreed this past March.\9\ Provisions in EMIR 2.2 will redefine
how non-EU domiciled clearing houses that provide clearing services to
EU participants will be regulated by EU authorities.
---------------------------------------------------------------------------
\8\ CFTC Approves Substituted Compliance Framework in Follow-up to
the Recent Equivalence Agreement between the U.S. and the EU, available
at https://www.cftc.gov/PressRoom/PressReleases/pr7342-16; European
Commission adopts equivalence decision for CCPs in USA, available at
http://europa.eu/rapid/press-release_IP-16-807_en.htm.
\9\ EMIR 2.2 Final Compromise Text, available at https://
data.consilium.europa.eu/doc/document/ST-7621-2019-ADD-1/en/pdf.
---------------------------------------------------------------------------
In the event of the UK departure from the EU, the UK will be
treated similar to the U.S. and other non-EU jurisdictions, referred to
as ``third countries'' in the EU regulatory context. We will continue
to work with our regulators in the UK, EU and U.S. to define how these
regulatory standards under EMIR 2.2 are developed, which will result in
enhanced regulatory cooperation among these three major jurisdictions
and beyond.
Given LCH's significant risk management role in the U.S. financial
markets, we have supported the direct registration of LCH Ltd with the
CFTC since our registration 18 years ago and the legal certainty this
has provided for our customers under the CFTC's customer protection
rules, which serve as an important cornerstone of the CFTC's mission.
We also believe the cooperative relationship between the BoE and the
CFTC is a model to follow for oversight of swaps clearing houses that
play a substantial risk management role in multiple jurisdictions.
Strengthening the Resiliency of Clearing Houses
A central component of the risk management function of clearing
houses is the collection of margin from counterparties to collateralize
their derivatives trades, serving as a buffer in the event a
counterparty or clearing member defaults on their financial
obligations. Clearing houses are prohibited from holding this margin
within their own legal entity and regulation carefully prescribes the
management and placement of collateral. Clearing house placement or
investment options for collateral is appropriately limited to a small
number of very conservative options.\10\
---------------------------------------------------------------------------
\10\ Including overnight reverse repurchase agreements, government
bonds, commercial banks, money market funds (allowed in the U.S. but
not the EU), and, where available, central bank deposit accounts.
---------------------------------------------------------------------------
Central bank deposit accounts are widely agreed as the safest
option for clearing houses to place collateral in any given currency,
especially during periods of financial market stress.\11\ LCH Ltd.
holds more margin than any other global clearinghouse.\12\ LCH Ltd
operates an extensive global collateral management function to ensure
the safety and liquidity of margin it receives, in line with applicable
regulation and conservative risk management practices that often exceed
minimum standards. LCH Ltd.'s SwapClear service daily U.S. dollar cash
margin holdings fluctuate between $35-$40 billion. Daily margin flows
range from $10-$20 billion in U.S. dollar cash. Currently, LCH does not
have access to a Federal Reserve Bank deposit account.
---------------------------------------------------------------------------
\11\ ``[Fed] accounts permit DFMUs to hold funds at the Federal
Reserve, but not to borrow from it. Allowing DFMUs to deposit balances
at the Federal Reserve helps them avoid some of the risk involved in
holding balances with their clearing members. Doing so also provides
CCPs with a flexible way to hold balances on days when margin payments
unexpectedly spike and it is difficult to find banks that are willing
to accept an unexpected influx in deposits. In such a case, it may also
be too late in the day to rely on the repo market. The availability of
Fed accounts could help avoid potential market disruptions in those
types of circumstances,'' Federal Reserve Governor Jerome Powell,
Central Clearing and Liquidity, June 2017, available at https://
www.federalreserve.gov/newsevents/speech/powell20170623a.htm; ``Where
CCPs are permitted to have deposit accounts at central banks, they can
deposit initial margin cash there instead of investing it, eliminating
investment risk. As many of the banks providing custodial services to
CCPs are also major clearing members, central bank deposit accounts
would also help CCPs avoid wrong-way exposure to clearing members.''
Federal Reserve Bank of Chicago, Non-default loss allocation at CCPs,
April 2017, available at https://www.chicagofed.org/ /media/
publications/policy-discussion-papers/2017/pdp-2017-02-pdf.pdf; ``CCP
access to central bank money in the currencies in which they do
business makes clearing more efficient and reduces risk to end-users
and the broader financial system. Access should include the ability to
use central bank money for payments, central bank accounts for safe-
keeping of participants' cash, and access to central bank liquidity, at
least in emergency situations.'' ISDA, The Case for CCP Cooperation,
April 2019, available at https://www.isda.org/2018/04/18/the-case-for-
ccp-supervisory-cooperation/; ``Allowing CCPs to hold cash initial
margin with central banks will reduce CCP exposure to commercial bank
risk generally. . . . Permitting CCPs to maintain central bank deposits
will also reduce the need for CCPs to utilize reverse repos and/or
directly purchase securities to reduce settlement or concentration bank
risk, which pose enormous investment challenges and risks, like forced
diversification.'' FIA Global, ``CCP Risk Position Paper,'' April 2015,
available at https://fia.org/sites/default/files/content_attachments/
FIAGLOBAL_CCP_RISK_POSITION_
PAPER.pdf; ``As a result of the initiative of our staff and the
assistance of the Federal Reserve, the pre-funded resources held by
systemically important clearinghouses can now be deposited and held at
Federal Reserve Banks. This is good for customer protection and for
financial stability,'' CFTC Chairman Timothy Massad, Keynote Remarks at
SEFCON VII, January 18, 2017, available at https://www.cftc.gov/
PressRoom/SpeechesTestimony/opamassad-55.
\12\ Per LCH Ltd's Q4 2018 CPMI-IOSCO quantitative disclosures, LCH
Ltd holds $195 billion U.S. dollar equivalent in margin. A list of all
clearing houses' CPMI-IOSCO quantitative disclosures is available at
https://ccp12.org/ccp12-public-quantitative-disclosures/.
---------------------------------------------------------------------------
In the U.S., Title VIII of Dodd-Frank provided a legal framework by
which clearing houses can deposit margin in central bank deposit
accounts.\13\ We believe the Financial Stability Oversight Council
(``FSOC'') has the statutory authority to take measures that would
allow non-U.S. domiciled DCOs that are systemically relevant to the
U.S. market to apply to the Federal Reserve for deposit account access.
---------------------------------------------------------------------------
\13\ Specifically, financial market utilities (``FMUs'') can be
designated by the Financial Stability Oversight Council (``FSOC'') as
systemically important or designated financial market utilities
(``DFMUs''). DFMUs may apply to a Federal Reserve Bank for a deposit
account. In 2012, FSOC designated eight DFMUs.
---------------------------------------------------------------------------
As the discussion over cross-border clearing house regulation
progresses, we believe it is critical for central banks to require
clearing houses that manage substantial risks in their jurisdiction to
maintain a deposit account for their respective currency. This would
further strengthen the financial resilience of clearing houses, and
overall, the financial markets. Central bank deposit accounts also
provide end-users with the ultimate reassurance that their U.S. dollar
cash margin is protected during times of market stress. In line with
the 2017 recommendation from the U.S. Department of the Treasury, we
call on Congress to further evaluate the important financial stability
role that central bank deposit accounts can play for non-U.S. domiciled
DCOs such as LCH who manage a substantial portion of cleared
derivatives risk in the U.S. markets.\14\
---------------------------------------------------------------------------
\14\ U.S. Department of the Treasury, A Financial System That
Creates Economic Opportunities: Capital Markets, page 217, October
2018, available at https://www.treasury.gov/press-center/press-
releases/documents/a-financial-system-capital-markets-final-final.pdf.
---------------------------------------------------------------------------
Conclusion
Despite the many challenges Brexit has presented, our industry and
regulatory community have worked collaboratively to mitigate the risk
of market disruption and preserve financial stability in the event of a
Hard Brexit scenario.
Brexit has also reshaped the ongoing debate around the future
cross-border framework for global clearing houses. We believe this
framework should support global markets and avoid fragmentation. LCH
believes the CFTC's direct registration model remains appropriate for
LCH Ltd in the U.S. and other jurisdictions where we manage a
substantial risk in the market. We recognize that other models may be
more proportionate for clearing houses that do not manage the same
level of risk in a foreign jurisdiction.
Strengthening the resiliency of clearing houses and ensuring that
client margin can be managed in the safest and most efficient manner,
including the role of central bank deposit accounts, should continue to
remain a key focus as the cross-border framework for global clearing
houses evolves.
The Chairman. Well, thank you, Mr. Maguire, and you have
certainly opened our eyes to much of what we really need to be
aware of, being on site there in London.
Mr. Lukken?
STATEMENT OF HON. WALTER L. LUKKEN, J.D., PRESIDENT AND CHIEF
EXECUTIVE OFFICER, FUTURES INDUSTRY
ASSOCIATION, WASHINGTON, D.C.
Mr. Lukken. Chairman Scott, Ranking Member Scott, Ranking
Member Conaway, and other Members of the Committee, thank you
for this opportunity to testify. I agree with the rest of the
panel, your leadership on this topic is extraordinarily
important.
FIA is the leading global trade organization for the
futures options and cleared derivatives markets. Our mission is
to support open, transparent, and competitive markets. I
highlight the word open in our mission, because open markets
allow people access to hedging vehicles around the world, as
you can see by the panel here today. Most importantly, open to
farmers, producers, and manufacturers who are looking to hedge
that risk. Open markets are extremely important. And certainly,
in fact, this Committee earlier this month in a separate
Subcommittee held a hearing entitled, The State of U.S.
Agricultural Products in Foreign Markets. Members of both sides
of the aisle agreed that U.S. producers benefit from fair
access to open markets.
The same holds true when it comes to financial markets as
well. The American farm economy benefits from open and fair
access to global derivatives markets. Without this access,
costs to farmers, ranchers, and producers to hedge their risk
would increase.
To illustrate the global nature of the derivatives markets,
FIA has polled several of its member exchanges, many of them
sitting at this table, regarding the percentage of their volume
that comes from foreign counterparties. The full results are
included in my written testimony, but the survey highlights
that, for example, CME Group reports that 42 percent of its
metals contract volume originates in jurisdictions outside the
United States. ICE reports that 35 percent of its volume in
agricultural business comes from outside of the borders of the
United States as well. European Exchange, Eurex, has 79 percent
of its volume for interstate products coming from outside of
Germany.
These global markets would not have developed without a
common-sense regulatory approach based on international
cooperation. FIA strongly supports the regulatory recognition
and deference model that has been the foundation of the futures
industry for years. This Committee well knows, but the CFTC was
one of the first regulators to put in place a cross-border
recognition and deference approach, starting with foreign
brokers back in the 1980s, and foreign exchanges in the 1990s.
The approach focuses on whether comparable foreign rules are
indeed comparable, and achieve a desired outcome, instead of a
line-by-line regulatory comparison.
As a former Commissioner and Chairman of the CFTC, I saw
the benefits of this flexible regulatory approach to our
domestic markets. However, with post-crisis reforms in the
Brexit decision, there are concerns that regulators are moving
away from the pragmatic approach by imposing direct authority
on third-country exchanges, clearinghouses, and transactions.
And this divergence could lead to conflicting rules and harmful
market fragmentation.
Europe, of course, as we have been discussing, is beginning
to design a regulatory framework without Britain, treating them
as any third-country nation outside the EU. This will have an
impact on all third-country nations, including the United
States. FIA is closely monitoring recent revisions to the EMIR
2.2 legislation on clearinghouse supervision. This law may
require U.S. clearinghouses that are deemed systemic to be in
compliance with significant elements of EU law, and to be
overseen by EU regulators. If implemented without proper
deference to U.S. supervision, this law could lead to
contradictory requirements, duplicative supervision, and
counter reactions by global regulatory authorities. Indeed, the
G20 has market fragmentation as an agenda item for discussion
later on this week in Japan. This is of real concern at all
levels.
The CFTC Chairman has announced his intent to strengthen
the CFTC's ability to recognize and to defer to home country
supervision for certain foreign CCPs. FIA stands ready to
comment on both EMIR 2.2 and the CFTC's proposals when they are
released to ensure that the proven regulatory deference and
recognition approach remains the standard for cross-border
regulation. It is imperative that we get cross-border issues
right, especially with Brexit looming. The stakes are
incredibly high. Without common ground, we may find ourselves
with increasingly fragmented markets. That doesn't benefit
anyone, especially customers and producers.
I want to thank this Committee for focusing on this
important topic, and I welcome any questions this Committee may
have.
[The prepared statement of Mr. Lukken follows:]
Prepared Statement of Hon. Walter L. Lukken, J.D., President and Chief
Executive Officer, Futures Industry Association, Washington, D.C.
Chairman Scott, Ranking Member Scott, and Members of the
Subcommittee, thank you for the opportunity to testify about Brexit and
various cross-border matters that impact derivatives markets and market
participants.
I am the President and Chief Executive Officer of FIA. FIA is the
leading global trade organization for the futures, options and
centrally cleared derivatives markets, with offices in London,
Brussels, Singapore and Washington, D.C. FIA's membership includes
clearing firms, exchanges, clearinghouses, trading firms and
commodities specialists from more than 48 countries as well as
technology vendors, law firms and other professionals serving the
industry.
FIA's mission is to support open, transparent and competitive
markets, protect and enhance the integrity of the financial system, and
to promote high standards of professional conduct. As the principal
members of derivatives clearinghouses worldwide, FIA's clearing firm
members help reduce systemic risk in global financial markets. Equally
important, our clearing firm members provide access to the commodity
futures markets, which allows a wide range of companies in the
commodity supply chain to manage their price risks.
Prior to serving as the President and CEO of FIA, I had the honor
of serving as a Commissioner of the Commodity Futures Trading
Commission from August 2002 to June 2009. During that time, I served as
the Acting Chairman from June 2007 to January 2009.
Earlier this month, a separate House Agriculture Subcommittee held
a hearing titled ``The State of U.S. Agricultural Products in Foreign
Markets.'' There was agreement from Members on both sides of the aisle
that American farmers, growers, and ranchers, and the farm economy more
broadly, benefit from fair access to foreign markets.
The same holds true when it comes to our financial markets. The
American farm economy benefits from open and fair access to global
derivatives markets. Without this access, the costs to hedge risk
become greater. Ultimately, this would be felt by American consumers
when they visit their local grocery stores or order food at a
restaurant.
Dating back to my time as a CFTC Commissioner, and even prior, the
derivatives markets have been global in nature. Transactions, clearing
and settlement often take place in different countries and across
different time zones and continents.
Ultimately, market participants benefit from the global nature of
the markets. The more participants, the stronger the market for those
seeking to hedge risks. Open markets improve competition, keep costs
affordable for customers and grow the economy. Our markets are not
defined by borders--they are defined by the ingenuity and determination
of buyers and sellers--no matter their location.
Cross-Border Trading Statistics
To illustrate the global nature of the markets, FIA has polled
several of its member exchanges regarding the percentage of their
volume that comes from foreign counterparties. The results are notable.
Cross-Border Trading
Trading originating outside the home jurisdiction as a
percentage of total volume during 2018.
As made clear by these statistics, the ability to access customers
on a cross-border basis strengthens markets. CME Group reports 42
percent of its metals contract volume originating in jurisdictions
outside the U.S. ICE Futures U.S. data shows that approximately 35
percent of the volume in its agricultural business comes from overseas.
Without access to global markets, end-users--including farmers and
ranchers seeking to hedge their risks in the derivatives markets--are
harmed.
A Cause of Global Market Fragmentation
At the time of the financial crisis in 2008, I was serving as the
Chairman of the CFTC. I vividly remember the panic and pain felt by so
many Americans. The entire financial system was on the brink of
collapse, and I was being called to the White House weekly as the
President, the Treasury Secretary and policymakers of the highest
levels searched for answers.
In the aftermath of the crisis, the member nations of the Group of
Twenty (G20) engaged in a fundamental restructuring of the regulatory
framework for OTC derivatives markets. The goal was simple: to improve
transparency, mitigate systemic risk and protect against market abuse.
When the G20 held a summit in Pittsburgh in 2009, jurisdictions
from across the globe were on the same page. They agreed on general
principles and reforms, including mandates to clear all standardized
over-the-counter derivatives.
For a time following the summit, implementation of the core
principles and reforms agreed upon at the summit was going smoothly.
There was an understanding that global implementation of identical
rules, on a line-by-line basis, was impracticable. Rather, the G20
sought to ensure the principles and reforms agreed upon in Pittsburgh
would be implemented to achieve equivalent regulatory outcomes.
Unfortunately, intervening political events have caused this
alignment to be tested over time. The best example is Brexit. Now, we
find ourselves with a radically different situation in Europe with the
financial center of Europe soon to be located outside the EU. This will
make it even more difficult to have consistent implementation of those
G20 standards.
FIA Advocacy Related to Brexit
Since the United Kingdom voted to leave the European Union (EU) in
2016, FIA has worked tirelessly to inform and work with our members,
policymakers, and the general public about the operational and market
impact of a possible no-deal Brexit scenario on the listed and cleared
derivatives market.
Unless the UK and the EU reach an agreement that delivers a smooth
transition in the Brexit process, market participants will be faced
with the prospects of significant disruption, financial instability,
and regulatory uncertainty. Preparations for Brexit are continuing in
the EU and UK and FIA firms have taken significant steps to ensure
continued access to financial services in the EU and UK after Britain
leaves the EU.
As we set out to address these challenges, our focus at FIA has
remained on:
Minimizing disruption.
Avoiding fragmentation of liquidity by regulatory actions.
Maintaining global access to markets and counterparties.
FIA worked extensively with our member firms and other trade
associations to secure a commitment from the European Commission to
allow UK clearinghouses temporary continued access to the EU in the
event of a no-deal Brexit. This commitment by the European Commission
was announced in December 2018 \1\ and was an enormous success for
market participants across the globe, including in the United States.
In response, the European Securities and Markets Authority (ESMA)
followed suit by adopting recognition decisions for three UK CCPs.
---------------------------------------------------------------------------
\1\ Due to the extension of the Article 50 of the Treaty of the
European Union deadline, an amended equivalence decision in relation to
the UK CCPs was adopted by the European Commission on April 3, 2019.
---------------------------------------------------------------------------
FIA, however, is closely monitoring several areas of concern that
could impact access to European and U.S. markets as the Brexit debate
continues. Recent revisions to the European Market Infrastructure
Regulation legislation (EMIR 2.2) on clearinghouse supervision may
require direct compliance with substantial elements of EU law and
supervision by EU regulators for U.S. clearinghouses deemed systemic
unless EU regulators find U.S. supervision to be equivalent.
If implemented without the proper recognition of home country
supervision, this could lead to contradictory requirements, duplicative
supervision and counter-reactions by global regulatory authorities.
These EU consultations, which are currently out for public comment, may
impact access to global markets if not properly clarified and
implemented. The current Chairman of the CFTC has also announced his
intention to strengthen the CFTC's ability to recognize and defer to
home country supervision for foreign CCPs. FIA stands ready to comment
on all these proposals to ensure the proven regulatory deference and
recognition approach remains the standard for cross-border regulation.
Additional Examples of Cross-Border Challenges
The listed and cleared derivatives markets are facing potential
regulatory change driven by a range of geopolitical developments that
pose a threat to the global markets.
As jurisdictions around the world implement G20 principles from the
2009 summit, they sometimes vary, overlap or contradict with the
implementation of other jurisdictions.
I'd like to highlight some specific examples of problematic
approaches which have taken place or been proposed in recent years:
Clearing: Japan requires certain transactions to be cleared
within its borders, rather than by a third-country CCP. In this
case, the level of local compliance is such that a local entity
must be established, which is costly and inefficient for many
market participants. These requirements greatly impact the
number of market participants available to offer clearing
services in a specific jurisdiction.
Reporting: The EU and the U.S. have introduced similar but
separate derivatives trade reporting rules. Although the goals
are the same, they did not coordinate the substance of what is
reported nor the timing of the implementation. As a result,
regulators in these two jurisdictions have imposed highly
operationally intensive rules that require firms to devote
significant operational resources on multiple separate
occasions to ensure effective compliance with the separate rule
sets.
Capital: Divergence in capital requirements across
jurisdictions is not uncommon. However, in the world of the
listed and cleared derivatives markets, this type of divergence
can have vast implications.
Responding to the financial crisis, the Basel Committee for
Banking Supervision adopted a leverage ratio as a backstop that
requires banks to hold capital against actual exposures to
loss. The Federal Reserve Board, the Federal Deposit Insurance
Corporation (FDIC), and the Office of the Comptroller of the
Currency (OCC) have implemented the Basel supplementary
leverage ratio (SLR) in the United States.
FIA strongly believes that capital requirements need to be
recalibrated so that it reflects the true amount of risk in
this activity. Unfortunately, the SLR fails to recognize the
collection of customer initial margin in the central clearing
process as an offset to a bank's exposures. Other jurisdictions
such as the EU have recognized client cleared initial margin as
exposure reducing under the leverage ratio. If the U.S. does
not correct course and do the same, capital costs associated
with central clearing in the U.S. will not be competitive with
the EU's. This impacts end-users and businesses across a wide
variety of industries that rely on derivatives for risk
management purposes, including agricultural businesses and
manufacturers.
It has also left end-users with less competition and access
to clearing services. The number of firms providing client
clearing services in the U.S. has dropped from 84 in 2008 to 55
in 2018. This result runs counter with the clearing mandates
contained in Title VII of the Dodd-Frank Act. This tax on
clearing places clearing firms and their customers in the U.S.
at a disadvantage relative to their foreign competitors as
jurisdictions outside of the U.S. have offered or plan to offer
an offset for client margin.
FIA was pleased to learn that last week the Basel Committee
on Banking Supervision agreed on allowing client initial margin
to offset the exposure amounts under the leverage ratio. We
look forward to the U.S. Prudential Regulators implementing
this global revision. FIA thanks Chairmen Peterson and Scott,
and Ranking Members Conaway and Scott, along with the current
Commissioners of the CFTC for their leadership on this issue.
FIA also thanks the Commissioners for their recent bipartisan
comment letter to the Prudential Regulators supporting this
needed recalibration.
The U.S. Prudential Regulators are currently consulting on a
rulemaking related to implementation of the standardized
approach for counterparty credit risk (SA-CCR) capital
framework. FIA has responded seeking an offset for client
cleared margin. In addition, FIA believes that this rulemaking
raises several concerns with FIA members, including its
commodity members.
Among the concerns are the very limited recognition of margin
under the risk weighted asset (RWA) capital requirements and
the punitive treatment of commodities trading. It is not
certain when and in what form SA-CCR will be adopted in other
jurisdictions that participate in the Basel Committee process.
If mandatory compliance with SA-CCR is required prior to its
adoption in other jurisdictions, U.S.-based commercial end-
users may be susceptible to significant competitive
disadvantages. FIA is also concerned, broadly, that the SA-CCR
proposal in its current form may have a significant adverse
impact on the liquidity of derivatives markets, especially
commodities markets.\2\
---------------------------------------------------------------------------
\2\ https://fia.org/file/8709/download?token=R_6EtxRk.
---------------------------------------------------------------------------
FIA Recommendations to Reduce Market Fragmentation
To better identify and address these growing concerns and the
cross-border uncertainty driven by a range of geopolitical
developments, FIA published a white paper in March 2019 titled:
Mitigating the Risk of Market Fragmentation.\3\ To summarize, we
encouraged regulators around the world to:
---------------------------------------------------------------------------
\3\ https://fia.org/sites/default/files/
FIA_WP_MItigating%20Risk.pdf.
Rely on counterparts in other jurisdictions to supervise
certain cross-border activity through ``deference'' or
---------------------------------------------------------------------------
``substituted compliance'';
Work collectively to develop international standards and
implementation guidelines while recognizing local flexibility
and conditions; and
Put in place mechanisms for cross-border cooperation,
information-sharing, and crisis-management planning, which is
critical for the day-to-day supervision of cross-border
business.
As noted in our March white paper, FIA strongly supports the
regulatory recognition and deference model that has been the foundation
of the futures industry for years. Deference raises standards in global
markets as it is used to assess whether jurisdictions have adopted
comparable rules to those in the U.S. This tested tool is one way to
bring other countries into compliance with global standards and make
the marketssafer.
We were excited to see that earlier this month, the Financial
Stability Board (FSB) published a report, which was delivered to G20
Finance Ministers and Central Bank Governors ahead of their meetings in
Fukuoka, Japan on June 8 and 9, 2019. The report lays out approaches
and mechanisms to improve international cooperation and mitigate market
fragmentation.\4\
---------------------------------------------------------------------------
\4\ https://www.fsb.org/wp-content/uploads/P040619-2.pdf.
---------------------------------------------------------------------------
Additionally, we are pleased to see that the issues of market
fragmentation will be discussed at the highest levels of government as
it will be on the agenda for the upcoming G20 Summit in Osaka, Japan
later this week. We hope that regulators will take from this meeting
the same commitment to working across borders as they did at the 2009
G20 meeting in Pittsburgh.
A History of the CFTC's Approach to Cross-Border
The CFTC has been a global regulatory leader in promoting the
principles of deference and regulatory recognition. In 1980, the CFTC
was one of the first regulators to put in place a cross-border
recognition approach for market participants. At that time, the CFTC
adopted a position that, notwithstanding the potential broad scope of
the CFTC's jurisdiction under the Commodity Exchange Act (CEA), ``it is
appropriate at this time to focus [the CFTC's] activities upon domestic
firms and firms soliciting or accepting orders from domestic users of
the futures markets and that the protection of foreign customers of
firms confining their activities to areas outside of this country . . .
may best be for local authorities in such areas.''
Congress also deserves credit for the agency's historical support
for the principles of recognition and deference.
In 1982, Congress amended the CEA to authorize the CFTC to adopt
rules governing the offer and sale of foreign futures to persons
located in the U.S. Congress was careful to limit the CFTC's authority
to the regulation of intermediaries that deal directly with persons
located in the U.S., while expressly prohibiting the CFTC from adopting
any rule that ``(1) requires [CFTC] approval of any contract, rule,
regulation, or action of any foreign board of trade, exchange, or
market or clearinghouse for such board of trade, exchange or market, or
(2) governs in any way any rule or contract term or action of any
foreign board of trade, exchange, market or clearinghouse for such
board of trade, exchange or market.''
The CFTC has allowed U.S. participants direct electronic access to
foreign markets if the non-U.S. entities have rules that are comparable
with the CFTC's. That process was formalized by Congress in the Dodd-
Frank Act, which authorized the CFTC to register Foreign Boards of
Trade (FBOT) that wish to permit direct access from the U.S. but
deferring to the home country regulator and rules where the rules are
comparable. Today, there are 18 registered FBOTs with the CFTC.
Finally, earlier this month, at FIA's annual International
Derivatives Expo conference in London, CFTC Chairman Christopher
Giancarlo highlighted the principles of his cross-border policy.
Specifically, he stated ``the CFTC should act with deference to non-
U.S. regulators in jurisdictions that have adopted comparable G20 swaps
reforms.'' He went on to say, ``Mutual commitment to cross-border
regulatory deference ideally should mean that market participants can
rely on one set of rules--in their totality--without fear that another
jurisdiction will seek to selectively impose an additional layer of
particular regulatory obligations that reflect differences in policy
emphasis, or application of local market-driven policy choices beyond
the local market. This approach is essential to ensuring strong and
stable derivatives markets that support economic growth both in the
U.S. and around the globe.''
FIA agrees with Chairman Giancarlo and looks forward to working
with the CFTC on future cross-border rulemakings
The CFTC has for decades, under Chairs from both parties,
understood that market fragmentation created though a patchwork of
international regulation undermines the resilience of the clearing
derivatives system and therefore weakens the safety mechanisms built
into the clearing system.
Cross-Border FinTech Challenges
With the international focus of this hearing, I would like to take
a moment to recognize an area where the CFTC is lagging other
international regulators, by no fault of its own.
According to CFTC Chairman Giancarlo, the agency has limitations in
its ability to test, demo, and generate proof of concepts around
emerging technologies and systems. At a recent hearing before this
Committee he said, ``Specifically, the CFTC lacks the legal authority
to partner and collaborate with outside entities engaging directly with
FinTech within a research and testing environment, including when the
CFTC receives something of value absent a formal procurement.'' \5\
---------------------------------------------------------------------------
\5\ https://www.cftc.gov/PressRoom/SpeechesTestimony/
opagiancarlo70.
---------------------------------------------------------------------------
This is problematic and prevents the CFTC from keeping pace with
emerging technologies and puts the U.S. at a competitive disadvantage
relative to its overseas counterparts. For example, the UK offers
regulatory sandboxes where FinTech firms can work with the regulator
and receive feedback and answer questions about their products.
Given the global nature of our markets, it is important that
regulators in the U.S. have access to the same emerging technology
available to regulators in the UK and elsewhere.
That is why I would like to recognize and thank Ranking Member
Austin Scott (R-GA) for his legislative efforts to provide the CFTC
with the necessary transaction authority to engage in public-private
partnerships with financial technology developers. FIA stands ready to
work with the Committee on solutions that provides the tools needed by
the CFTC and market participants alike.
Conclusion
FIA greatly appreciates the Subcommittee's interest in these
critical topics that affect the global financial markets and the end-
users who rely on derivatives products for price certainty and to hedge
their risks.
FIA strongly supports the regulatory recognition and deference
model that has been the foundation of the futures industry for years.
Identical rules, on a line-by-line basis, implemented globally across
jurisdictions is impracticable. Rather, the goal we should strive to
achieve is ensuring equivalent regulatory outcomes.
The good news is we have a window of opportunity to reset the
global approach to cross-border regulation. It is imperative we get
these cross-border issues right, especially with Brexit looming. The
stakes are incredibly high. Without common ground, we may find
ourselves with fragmented markets and regulation. That doesn't benefit
anyone, especially customers and end-users.
I appreciate the Committee's attention to this important topic.
Attachment
Mitigating the Risk of Market Fragmentation
March 2019
Contents
Introduction
Part I--What is Fragmentation and Why Does It Matter?
Part II--The Value of Co-Operation and the Importance of
Reliance by Regulators in Preventing Fragmentation
Part III--Recommendations for Cooperation and Reliance
Use of International Standards
Arrangements Between Regulatory Authorities
Conclusion
About FIA
FIA is the leading global trade organization for the futures,
options and centrally cleared derivatives markets, with offices
in Brussels, London, Singapore and Washington, D.C.
FIA's mission is to:
support open, transparent and competitive markets,
protect and enhance the integrity of the financial
system, and
promote high standards of professional conduct.
As the leading global trade association for the futures,
options and centrally cleared derivatives markets, FIA
represents all sectors of the industry, including clearing
firms, exchanges, clearing houses, trading firms and
commodities specialists from more than 48 countries, as well as
technology vendors, lawyers and other professionals serving the
industry.
Introduction
Cleared derivatives markets today are grappling with the challenge
of market fragmentation caused by regulation.
In modern derivatives markets, cross-border regulatory cooperation
is a necessity. Post-financial crisis reforms by the G20 nations
acknowledged as much when they enacted central clearing mandates and
put a vision of pragmatic oversight and regulatory deference above a
patchwork, country-by-country approach to derivatives regulation.
Lately, however, markets have become increasingly fragmented as
different jurisdictions have moved to implement G20 reforms on their
own. Some policymakers are exerting their national or regional
authority on third-country exchanges, clearinghouses, market
participants and transactions. The unfortunate result is market
fragmentation caused by regulation such that the original goal of
holistic cross-border solutions has been replaced by a siloed
regulatory and commercial landscape.
We see several types of regulatory issues causing market
fragmentation.
First, there has been divergence in the content of
implementation as policymakers have adapted the reforms to
local conditions and political priorities. The resulting
variations have made it more difficult for regulators to make a
determination that foreign financial institutions are subject
to equivalent regulation.
Second, there has been divergence in the pace of
implementation, causing some early-adopter nations to justify
imposing extra-territorial requirements on activity or
participants in jurisdictions that have not yet implemented
these reforms.
Third, new issues have arisen, such as Brexit, which have
caused policymakers to reconsider their implementations of the
G20 reforms and rethink their views on cross-border
cooperation.
As a result, we have seen a growing trend toward more direct
regulation of foreign activity and participants rather than reliance on
a foreign regulator to supervise that activity when such jurisdiction
has implemented a regulatory regime that achieves comparable outcomes
(an approach sometimes referred to as ``deference'' or ``substituted
compliance''). This issue is not unique to the derivatives markets, but
it is particularly acute because of the cross-border nature of this
industry.
More disturbingly, fragmented derivatives markets can also create
barriers to entry which, in turn, lead to a fall in the number of
participants that are able to mutualize risk and collectively withstand
the next adverse market event, minimizing the impact of the financial
crisis market reforms.
As an example, regulation which requires a market participant
active in two different jurisdictions (such as the U.S. and a European
jurisdiction) to comply with conflicting and duplicative rules limits
choices and increases costs for commercial end-users who are seeking to
hedge marketplace risks beyond their control. With costly and limited
options, market participants may choose to forgo hedging altogether
further contracting markets and liquidity.
The benefits of central clearing are well recognized by
policymakers. It is one of the central pillars of the G20 post-crisis
reforms to reduce the systemic risk associated with derivatives markets
and market data shows these efforts are succeeding. According to the
Bank for International Settlements, the use of clearing in the global
interest rate derivatives market rose from 24% in 2009 to 62% by mid-
year 2018. In the global credit derivatives market, the clearing level
rose from 5% to 37% over the same time period.
FIA believes strongly that derivatives markets must protect and
advance market participants' access to cross-border central clearing by
supporting regulatory reliance (deference), with national rules
benchmarked to internationally-agreed-upon standards. Such supervisory
reliance has been proven to be effective and remains a key plank in
ensuring open access to global cleared markets, reducing risk and
increasing market efficiency through competition.
An adherence to international standards enables pursuit of
legitimate public policy goals in respect of cleared derivatives
markets without causing market fragmentation. However, such an approach
depends on international standards being specific enough to enable a
reliance model. The CPMI-IOSCO Principles for Financial Market
Infrastructures (PFMIs) \1\ are a good example of international
standards that are sufficiently detailed, allowing for a reliance model
by national regulators.
---------------------------------------------------------------------------
\1\ https://www.bis.org/cpmi/info_pfmi.htm.
---------------------------------------------------------------------------
To be effective, a reliance approach also requires a high level of
cooperation and information-sharing among regulators. If the host
supervisor requires a right to supervise the entity, home and host
supervisors should coordinate their supervisory activities to improve
the effectiveness and efficiency of supervision of entities with a
cross-border footprint. In addition, periodic evaluations must take
place to ensure that regulatory regimes continue to pass the test of
equivalence.
In Part I of this paper, we describe the issue of market
fragmentation in cleared derivatives markets, explain why it is a
threat and provide examples. In Part II of this paper, we explain the
meaning of reliance, as our preferred solution to the risk of market
fragmentation. In Part III of this paper, we outline our
recommendations on the best approaches to reliance, building on the
work carried out so far by IOSCO, multilateral arrangements and the
bilateral achievements of regulators, and we set out specific
substantive recommendations for regulators.
Part I--What Is Fragmentation and Why Does It Matter?
For the purpose of this paper, market fragmentation is where
participants in an organic, shared market which crosses jurisdictions
are less able to interact freely with one another in one or more of
such jurisdictions. Thus, market participants are limited to
interacting in silos that are less liquid, less diverse and less
competitive.
In the context of cleared derivatives markets, fragmentation
results in both short-term economic costs, with reduced levels
of liquidity, and long-term threats to financial stability
thanks to inefficient risk management.
Market fragmentation can be caused by regulation--either
purposefully or inadvertently. Regulation that conflicts or overlaps
will necessarily require differing forms of compliance from the same
market participants (or even be impossible to comply with) and thus may
cause participants to operate in silos in order to meet their
regulatory requirements rather than operate in a shared market.
This is a particular concern in the cleared derivatives markets,
due to their cross-border nature. In the context of cleared derivatives
markets, fragmentation results in both short-term economic costs, with
reduced levels of liquidity, and long-term threats to financial
stability thanks to inefficient risk management. Cleared derivatives
are an essential product in today's financial markets and comprise a
significant proportion of global financial activity.2-3 As
stated by the President of the European Central Bank Mario Draghi:
``open markets are conducive to freeing human potential, expanding
opportunities, and improving well-being.'' \4\
---------------------------------------------------------------------------
\2\ https://www.bis.org/statistics/
about_derivatives_stats.htm?m=6%7C32.
\3\ https://www.bis.org/publ/qtrpdf/r_qt1612b.htm.
\4\ https://www.ecb.europa.eu/press/key/date/2015/html/
sp151111.en.html.
---------------------------------------------------------------------------
One measure of cross-border activity is the amount of trading on
derivatives exchanges that originates from outside their home
countries. Derivatives markets benefit from network effects; the more
participants, the stronger the market. Open markets improve
competition, keep costs affordable for customers, and grow the economy.
Our markets are not defined by borders--they are defined by the
ingenuity and determination of buyers and sellers--no matter their
location. To illustrate, FIA has polled several major exchanges
regarding the percentage of their volume that comes from foreign
counterparties. The results show that cross-border trading makes up a
very significant percentage of the total volume at these exchanges.
Cross-Border Trading
Trading Originating Outside the Home Jurisdiction as a Percentage of
Total Volume During Q2 2018
Source: Data provided by each exchange upon the conclusion of
Q2 2018.
A second measure of cross-border derivatives activity comes from a
set of statistics published by the Commodity Futures Trading Commission
(``CFTC''), the primary regulator of derivatives markets in the U.S.
These statistics track the amount of customer funds held at clearing
firms, known in the U.S. as futures commission merchants (``FCMs'').
The funds are collected from customers for the purpose of meeting the
margin requirements set by U.S. clearinghouses for their derivatives
clearing. They represent one of the core protections against systemic
risk in the U.S. derivatives markets. These CFTC-registered FCMs can be
subsidiaries of banks or other financial companies that can be
headquartered anywhere in the world. FIA has conducted an analysis of
the market share held by all FCMs, using data published by the CFTC as
well as other sources of information. Our analysis shows that foreign
institutions are an important part of the FCM community in the U.S.
As of December 2018, there were 54 FCMs holding a total of $295.3
billion in customer funds, of which $203.6 billion was held in
segregated customer accounts for exchange-traded futures and options
and $91.7 billion for cleared swaps. Non-U.S. owned FCMs held 33% of
the futures-related customer funds and 21% of the swap-related customer
funds.\5\
---------------------------------------------------------------------------
\5\ https://fia.org/fcm-tracker.
---------------------------------------------------------------------------
This data shows cross-border activity is important to
intermediaries as well as to end-users. Customers rely on clearing
firms to provide access to markets as well as the services they need to
meet the requirements of central clearing. In the U.S., the population
of intermediaries includes a large number of institutions that are
headquartered in Europe and Asia-Pacific. The impact for the world
economy of fragmenting cleared derivatives markets will be significant
since a reduction in the efficiency and/or liquidity of these markets
will not only drive up costs for economic actors (including non-
financial services firms) but reduce financial stability.
Market Share of Customer Funds in Futures Accounts
Source: U.S. Commodity Futures Trading Commission.
Market Share of Customer Funds in Cleared Swaps Accounts
Source: U.S. Commodity Futures Trading Commission.
Conflicting and overlapping regulations discourage or even
prevent deep, efficient and liquid derivative markets from
functioning and direct market activity to national silos.
Due to the cross-border nature of the global financial crisis,
there is considerable public policy interest by regulators in cleared
derivatives markets. Although the CFTC's data on FCMs active in the
U.S. shows the global nature of derivatives markets, the challenge is
that local regulators may deal with issues relating to cleared
derivatives markets in different ways and at different times. Market
fragmentation results when separate regulations deal with the same type
of activity differently, because regulators narrowly concern themselves
with the impact of such activity in their own jurisdiction. Conflicting
and overlapping regulations discourage or even prevent deep, efficient
and liquid derivative markets from functioning and direct market
activity to national silos.
Complete consistency between all major jurisdictions is not
possible, and regulators have legitimate public policy reasons for
their national approaches. However, FIA believes this must be balanced
against the clear risks of market fragmentation caused by divergent,
overlapping or conflicting rules.
Regulation causing market fragmentation can be seen to emerge in
three key ways.
First, regulators may deal with existing, known issues in a market
in different ways from one another--even where there is agreement at a
global level as to the broad outline of how the issue should be dealt
with. This form of divergence is in respect of the content of
regulatory implementation. It may be caused by regulators fitting
global standards to existing national rules and law; by some regulators
prioritizing certain aspects of global standards while other regulators
take a contrary position; regulators choosing to deviate from global
standards for public policy reasons; or, regulators in different
countries developing different rules in respect of existing issues
where global standards do not exist or are insufficiently detailed to
form a basis for national rules.
Second, regulators may diverge on the timing of national
implementation of some or all parts of otherwise agreed global
standards. This form of divergence is in respect of the pace of
regulatory implementation. It may be caused by regulators attributing
different levels of priority to agreed global standards or simply
different levels of capacity on the part of regulators in different
jurisdictions.
Third, regulators may react differently to novel issues where
global standards or agreements have not been agreed. This form of
divergence is in respect of new issues that require a regulatory
response. It may be caused by political change that results in
governments or legislators demanding action for public policy reasons
or it may be caused by developments in the market, such as
technological change, which have occurred before consensus between
different regulators can form.
Here are examples of problematic approaches which have been taken
or proposed in recent years:
An example of content driven divergence relates to
requirements for offering clearing services in a specific
jurisdiction; for instance, Japan requires certain cleared
transactions to be cleared within its borders, rather than by a
third-country CCP--in this case the level of local compliance
is such that a local entity must be established which is costly
and inefficient for many market participants.
An example of pace driven divergence relates to requirements
for trade reporting; the EU and the U.S. have introduced
derivatives trade reporting rules, but they did not coordinate
the timing of the implementation. As a result, regulators have
imposed highly operationally intensive rules that cover the
same general topic but that ultimately required firms to devote
significant operational resources on multiple separate
occasions to ensure effective compliance with the separate rule
sets.
An example of a new issue driving divergence is Brexit.
Brexit has in the eyes of some policymakers necessitated
changes to current regulations and even market structures.
Thus, several EU proposals in response to Brexit, such as EMIR
2.2 and the Investment Firm Review, have included elements
requiring direct compliance with substantial elements of EU law
or supervision by EU entities in order for UK market
participants to be able to continue with their existing
business models, even where UK law would be substantively
equivalent to EU law.
Part II--The Value of Co-Operation and the Importance of Reliance By
Regulators in Preventing Fragmentation
Regulatory reliance can prevent fragmentation by averting overlaps
and conflicts. In the context of clearing and derivatives regulation,
we view supervisory reliance as a decision by one regulatory authority
not to seek to apply its regulations to activities conducted in another
jurisdiction, but, instead, to depend on the regulatory authorities in
the latter jurisdiction.
The process of supervisory reliance should comprise several steps:
First, a regulator should consider whether it has a genuine
need to oversee an activity or entity in another jurisdiction.
Second, if such a need is identified, then there should be
an assessment of the rules of the foreign regulator to
determine whether they are comparable in the outcomes they
achieve.
Third, if the rules are comparable, the regulator should
recognize those host country requirements as sufficient and
that oversight of such compliance by the relevant foreign
regulator is appropriate. This process will necessarily avoid
regulatory conflicts and overlaps where the two regulators have
comparable rules.
A regulatory authority seeking to rely on another authority will
thus need a basis to conclude that regulatory regime of the other
jurisdiction is comprehensive and achieves comparable outcomes, such
that the supervision and regulation of activities in accordance with
such regime's rules would be appropriate.
In coming to this conclusion, a jurisdiction's analysis should
center on an outcomes-based approach rather than a line-by-line
examination of the other jurisdiction's rules. Such an analysis can be
driven by a comparison of the foreign jurisdiction's regulatory
objectives, goals and outcomes to those of the domestic jurisdiction.
This approach has been applied successfully to a number of areas, such
as the EU's efforts with respect to EMIR equivalence and the CFTC's
Part 30 process for FCM registration exemptions, a longstanding model
dating to the late 1980s. Alternatively, the analysis can be driven by
a comparison of the foreign jurisdiction's approach to international
standards, such as the CPMI-IOSCO PFMIs.
The principal benefit of the reliance model is that it avoids the
market fragmentation that can arise when two authorities attempt to
regulate the same activity in different ways and ultimately create
legal complexity, operational risk, and added compliance costs. In
addition, the reliance model can strengthen the resilience of the
cleared derivatives markets by reducing the barriers to accessing
market infrastructure.
The market fragmentation created by the direct regulatory model
also undermines cooperation among regulatory authorities, weakening the
ability of the regulatory community to respond collectively to
unexpected market events such as the collapse of a globally significant
financial institution.
The most direct impact of duplicative rules that characterize a
fragmented market is the risk that compliance with one applicable set
of rules will nonetheless result in a violation of the other set of
rules. This results in increased cost borne by firms that need to
comply with more than one set of rules as the outcome often can be that
firms are forced to always comply with the ``worst of'' each rule set
in all circumstances to ensure there is never a material regulatory
breach; in the worst case, a particular market activity will cease when
a route to compliance is not apparent. The consequences of duplicative
and conflicting rules can create legal complexity, operational risk and
compliance costs for market participants both due to the inherent costs
of compliance with two sets of rules (seeking legal advice, developing
compliant operational processes, compliance function activities) but
also the costs generated through conflicts and inconsistencies in the
rules. In a survey of financial services executives published by the
International Federation of Accountants in February 2018, 75% said that
the costs of divergent regulations were a material cost to their
business.\6\
---------------------------------------------------------------------------
\6\ https://www.ifac.org/system/files/publications/files/IFAC-OECD-
Regulatory-Divergence.pdf.
---------------------------------------------------------------------------
It should also be noted that reliance will result in savings for
regulatory authorities themselves. When government authorities are
faced with finite regulatory resources, those resources can be deployed
more cost-effectively to its own market.
Supervisory reliance cannot exist in a vacuum, however. For the
reliance model to work properly, it must take place within a framework
of cooperation among regulators.
Part III--Recommendations for Cooperation and Reliance
In light of the international nature of cleared markets,
supervisory reliance is the ideal approach for avoiding market
fragmentation. As set out in Part II above, the benefits of reliance
are considerable both for ensuring stable, effective markets and in
assisting regulators fulfill their goals.
FIA sets out below proposals for enabling and improving supervisory
reliance. The proposals relate to:
1. Use of International Standards; and
2. Agreements between Regulatory Authorities.
Use of International Standards
FIA believes clear and effective standards will increase
consistency and predictability for market participants, reduce
market fragmentation and ultimately result in deep, efficient,
and liquid derivatives markets.
The key plank for supervisory reliance and preventing market
fragmentation, in the view of FIA, is recognition of rules that meet
international standards (or where those are not available, national
laws). Use of agreed international standards by regulatory authorities
will limit conflicts of rules between different jurisdictions. FIA
believes clear and effective standards will increase consistency and
predictability for market participants, reduce market fragmentation and
ultimately result in deep, efficient, and liquid derivatives markets.
Both the U.S. and EU, to varying degrees, currently recognize rules
of other jurisdictions (U.S. rules for foreign boards of trade, foreign
futures intermediaries, and swaps exemptive approach and, in the EU,
EMIR equivalence) and we encourage these authorities to continue doing
so. We also note that the EU and Singapore have deemed each other to be
equivalent in relation to the regulation and supervision of CCPs and
have announced plans for a common approach to trading venues that will
result in mutual recognition of each other's venues.
FIA recommends that international standards be set through a
dialogue between peer regulators in an effort to achieve better results
than rules set by one country alone. The varying perspectives and
experience of regulators ensure proposed rules endure greater scrutiny
and do not inadvertently result market fragmentation. It is critical
that these international standards go through rigorous public comment
and an opportunity for input given the importance of the standards and
principles in regulation.
The governance and rule-making processes for international
standard-setters may need to improve if regulatory authorities are to
place greater reliance on this collaborative method of rulemaking.
Furthermore, buy-in from local authorities is essential if greater
reliance on international standards is to occur. It should also be
noted that if international standards are to form the basis for
supervisory reliance, some existing international standards will need
to be improved: they must be specific and granular, not simply
statements of principle but provisions that can be used for outcomes-
based equivalence determinations. Specificity and granularity in
international standards play an important role in preventing content
driven regulatory divergence, caused by regulatory authorities
attempting to fill in the gaps where a relevant standard lacks
sufficient detail.
International standard setters should also consider increasing
their focus on monitoring implementation of standards, and benchmarking
jurisdictions against best-practices set out in agreed-upon
international standards. This could build on the Financial Stability
Board's Thematic Reviews \7\ and IOSCO's Assessment Committee. The
level of cross-border cooperation that a jurisdiction engages in could
be treated as a benchmark. The timing of implementation is also
significant and should be benchmarked; coordinated implementation of
standards in different jurisdictions can play an important role in
preventing pace-driven regulatory divergence, caused by regulatory
authorities implementing rules at different times and thus subjecting
market participants to different rules as the same point in time.
---------------------------------------------------------------------------
\7\ http://www.fsb.org/2017/04/handbook-for-fsb-peer-reviews-2/.
---------------------------------------------------------------------------
Arrangements Between Regulatory Authorities
In modern derivatives markets, information sharing and cross-border
crisis-management are crucial to market integrity. FIA believes that
regulatory authorities should widely adopt memoranda of understanding
(MOUs) in respect of information sharing.
Though the use of the standard MOU produced by IOSCO \8\ is
welcomed, the priority should be the substance of the MOUs in whatever
form regulatory authorities are mutually comfortable. FIA believes
regulatory authorities should provide a high level of information
disclosure to one another in respect of regulated firms and
infrastructure in their jurisdiction.
---------------------------------------------------------------------------
\8\ http://www.iosco.org/library/pubdocs/pdf/IOSCOPD322.pdf.
---------------------------------------------------------------------------
MOUs should be put in place both for general information sharing
and in respect of specific firms in which authorities have an interest
in for reasons of systemic financial stability. This partnership among
global regulators goes beyond information that can be used to identify
possible regulatory violations.
Perhaps most importantly, MOUs should build trust and cooperation
between authorities in an ongoing effort to reduce market fragmentation
and increase transparency and consistency in regulation. Regulatory
authorities should remain open-minded about allowing certain inspection
rights in relation to critical market infrastructure in MOUs, in this
spirit of transparency and cross-border cooperation.
Regulatory authorities should also put in place mechanisms for
cross-border crisis-management planning. Crisis-management processes
will be much more effective if they are agreed ex ante rather than
authorities attempting to agree them during the early stages of a
crisis. Further, the process of carrying out crisis-management plans
will ensure that authorities are better prepared for dealing with a
crisis, even if the permutations of the crisis deviate from those
subject to the plan.
International regulators have historically recognized this benefit
and formed crisis management groups for CCPs that are systemically
important.\9\ The working group for crisis management in respect of
LCH. Clearnet Ltd. is an example of this approach.\10\
---------------------------------------------------------------------------
\9\ FSB Guidance on Central Counterparty Resolution and Resolution
Planning, 5 July 2017, p. 16. http://www.fsb.org/wp-content/uploads/
P050717-1.pdf.
\10\ https://www.cftc.gov/sites/default/files/idc/groups/public/
@internationalaffairs/documents/file/cftc-lcharrangementmou090617.pdf
---------------------------------------------------------------------------
The global financial crisis provided graphic examples of the
benefits of cooperation between regulatory authorities in dealing with
crisis-stricken firms. Analysis of crisis management in respect of
Dexia Bank, Fortis Bank, Lehman Brothers and Kaupthing Bank has noted
the impact of cooperation and coordination by authorities (or lack
thereof) on the achievement of goals by authorities.\11\ The crisis
management actions in respect of Dexia benefited from a high degree of
cooperation by relevant supervisors, whereas the crisis management
actions in respect of Kaupthing showed a lack of cooperation and
coordination by the home regulatory authorities with affected host
authorities.
---------------------------------------------------------------------------
\11\ https://www.bis.org/publ/bcbs169.pdf.
---------------------------------------------------------------------------
Going back further, the collapse of Barings Bank in 1995 provides a
case study in the problems that can arise due to a lack of cross-border
cooperation.\12\ The cross-border nature of the bank's trading activity
in certain futures markets was not fully understood either by
regulatory authorities or other market participants. As a result, the
collapse posed a much greater threat to the stability of those markets
than the authorities were prepared for. The experience inspired
regulatory authorities from 16 jurisdictions to issue the Windsor
Declaration in 1995 in which they stated the need to improve ``co-
operative measures'' among regulatory authorities and in particular the
need for greater information sharing. This was followed by the Boca
Declaration in 1996, an arrangement under which the occurrence of
certain triggering events affecting an exchange member's financial
resources or exposures prompts the sharing of information among
regulators. The Boca Declaration was developed with the help of
industry representatives and trade associations, including FIA. It has
also been noted by the Bank for International Settlements that
cooperation between supervisors can also play a key role in averting
crisis situations.\13\
---------------------------------------------------------------------------
\12\ https://scholarlycommons.law.northwestern.edu/cgi/
viewcontent.cgi?referer=https://www.google.com/
&httpsredir=1&article=1536&context=njilb.
\13\ https://www.bis.org/speeches/sp170918.pdf.
---------------------------------------------------------------------------
Regulatory authorities should also consider the sharing of
information and best practices with both peer organizations and trade
associations to a greater degree. International standard-setting and
cooperation should include the joint development of best practices.
Networks can be established with the industry and their representatives
in an informal or ad hoc manner for particular subjects as a way of
sharing information and practices between authorities. Such networks
can act as fora for particular strategies or policy proposals to be
tested, before they are raised at the level of international standard
setters.
Conclusion
As set out above, reliance by regulatory authorities on agreed
international standards and supervision by fellow regulators in other
jurisdictions is the best way to prevent market fragmentation and
ensure deep, efficient, liquid and competitive derivatives markets.
Reliance, and the consultation and cooperation which it
necessitates, can demonstrate respect for the sovereignty of each
jurisdiction while still encouraging competition and efficient risk-
management in the era of global and interconnected derivative markets.
The benefits of legal certainty are tangible through lowered
regulatory costs, increased competition and more efficient
mutualization of market risk. However, the opportunity for local
regimes to consult with peers around the world and collectively work
towards market stability and regulatory certainty cannot be discounted.
FIA encourages all regulatory authorities to use existing
international bodies such as IOSCO to further enhance international
standards for the regulation of the derivatives markets. That will
permit greater reliance on each other by derivatives regulators that
are implementing regulations to advance the goals of the G20
commitments following the financial crisis. Furthermore, FIA believes
strongly that existing international standards should be reviewed with
an eye towards practical application for outcomes-based equivalence
determinations and not simply a soft statement of principles.
Reliance will result in better outcomes for both regulatory
authorities and market participants than attempting to restrict cross-
border activity. The current landscape of regulation for cross-border
cleared derivatives markets is an opportunity for regulators to reset
relations among themselves and move forwards on the basis of
cooperative approaches.
------------------------------------------------------------------------
------------------------------------------------------------------------
Brussels Singapore
Office 621, Level 21, Centennial Tower,
Square de Meeus 37, 3 Temasek Avenue,
1000 Brussels, Belgium, Singapore 039190,
+32 2.791.7572 Tel +65 6950.0691
------------------------------------------------------------------------
London Washington
Level 28, One Canada Square, 2001 Pennsylvania Avenue NW,
Canary Wharf, Suite 600,
London E14 5AB, Washington, DC 20006,
Tel +44 (0)20.7929.0081 Tel +1 202.466.5460
------------------------------------------------------------------------
http://fia.org/
------------------------------------------------------------------------
The Chairman. Excellent testimony, Mr. Lukken. I agree with
you 100 percent.
Now, we will hear from Mr. Berger.
STATEMENT OF STEPHEN JOHN BERGER, MANAGING
DIRECTOR, GLOBAL HEAD OF GOVERNMENT &
REGULATORY POLICY, CITADEL, LLC, NEW YORK, NY; ON
BEHALF OF MANAGED FUNDS ASSOCIATION
Mr. Berger. Chairman Scott, Ranking Member Scott, Members
of the Subcommittee, my name is Stephen Berger and I am the
Global Head of Government and Regulatory Policy at Citadel.
Citadel is a leading investor in the world's financial
markets. For over a quarter of a century, we have sought to
deliver industry-leading investment returns to clients,
including corporate pensions, endowments, foundations, public
institutions, and sovereign wealth funds.
I am here today on behalf of the Managed Funds Association
and its members, and am pleased to provide testimony as part of
today's hearing.
MFA represents the majority of the world's largest hedge
funds, and is the primary advocate for sound business practices
and thoughtful regulation of the industry. MFA has long
supported Congressional reforms of the OTC derivatives markets,
including central clearing. Central clearing has benefited the
derivatives markets by reducing systemic risk, increasing
investor protections, and promoting transparency and
competition.
MFA supports a coordinated global approach to the
regulation of clearing. The coordination between U.S. and
European regulators on clearing implementation is crucial to
its continued success and efficacy.
The United Kingdom's anticipated withdrawal from the
European Union introduces new complexities for global
regulatory coordination. MFA has been engaging with policy
makers and regulators to highlight potential regulatory
challenges and recommended solutions for the derivatives
markets. I will summarize some of these.
With respect to clearing, MFA has been a consistent
advocate for the central clearing of derivatives transactions.
Recently, the EU amended its derivatives regulation, dubbed
EMIR, to allow EU authorities to conduct enhanced supervision
of non-EU clearinghouses. In extreme cases, it also allows EU
authorities to require those clearinghouses to relocate
clearing activities to an EU member state.
The impact of these changes on the U.S. derivatives markets
will depend on how EU authorities choose to implement their new
power. The current U.S.-EU cross-border framework relies on the
regulatory tools of substituted compliance, equivalence, and
deference between comparable regulations. The new EU powers
granted by EMIR could affect that framework.
Any deterioration in U.S. and EU regulatory cooperation
could jeopardize cross-border clearing, which in turn could
fragment the derivatives markets. We urge U.S. and EU
regulators to work together to develop an agreed-upon approach
to cross-border CCP supervision using existing tools.
Another international clearing-related concern is the Basel
III leverage ratio. The current application of the leverage
ratio to investors cleared derivatives positions is
counterproductive and increases, rather than mitigates, risk.
Bank's capital requirements should reflect the risks of their
activities; however, the leverage ratio does not currently take
into account the fact that with respect to banks clearing
activities, customers post collateral that offsets the banks
clearing-related risks. Recognizing this offset is necessary to
ensure that customer clearing remains affordable, and that
customers have fair and equal access to clearinghouses.
MFA was pleased by the announcement last week that the
Basel Committee has finally called for an amendment to the
leverage ratio to provide that offset. If the Basel Committee's
upcoming published standards are consistent with that
announcement, we would join CFTC Chairman Giancarlo in his call
to U.S. Prudential Regulators to promptly implement the revised
leverage ratio into their rules.
Next, with respect to derivatives trading, the CFTC's
proposed amendments to its rules for trading on swap execution
facilities is also a key area of concern. The proposal could
jeopardize the current equivalence framework between U.S. and
EU trading venues that was built on shared commitments to
impartial access, straight through processing, and pre-trade
transparency. We encourage the CFTC to make the scope of any
amendments more targeted.
Last, the implementation dates of new margin rules for
uncleared swaps are approaching. However, these rules are
complex and involve significant compliance, expenses, and
resource commitments. In the near-term, the CFTC should work
with the Prudential Regulators to provide guidance to help
smooth the market's transition. In the longer-term, domestic
and international regulators should work to recalibrate the
regime. MFA has suggested a number of regulatory measures to
help avoid significant disruption to the swaps market, such as
extending the phase-in timeline.
As a final note, I want to reiterate that the successful
implementation of clearing in the U.S. and EU has greatly
benefitted the derivatives market. The coordination between
U.S. and EU regulators over the past several years has been
critical to achieving the robust derivatives clearing that we
see today. It is therefore important for the U.S. and EU to
find a path forward on clearing related issues.
We appreciate the Committee's oversight of international
developments affecting U.S. derivatives markets, and I thank
you for the opportunity to speak here today. I would be happy
to answer any questions.
[The prepared statement of Mr. Berger follows:]
Prepared Statement of Stephen John Berger, Managing Director, Global
Head of Government & Regulatory Policy, Citadel, LLC, New York, NY; on
Behalf of Managed Funds Association
Chairman Scott, Ranking Member Scott, my name is Stephen Berger and
I am the Managing Director, Global Head of Government & Regulatory
Policy, of Citadel LLC. Citadel is a global financial firm built around
world-class talent, sound risk management, and innovative market-
leading technology. Citadel is a leading investor in the world's
financial markets. For over a quarter of a century, we have sought to
deliver industry-leading investment returns to clients including
corporate pensions, endowments, foundations, public institutions, and
sovereign wealth funds. Our global team works to help our clients'
capital fulfill its greatest potential across a diverse range of
markets and investment strategies, including fixed income & macro,
equities, quantitative, commodities and credit.
I am here today to speak on behalf of Managed Funds Association
(``MFA'') and its members regarding Brexit and other international
developments affecting U.S. derivatives markets. MFA represents the
world's largest alternative investment funds and is the primary
advocate for sound business practices for hedge funds, funds of funds,
managed futures funds, and service providers. MFA's members manage a
substantial portion of the approximately $3 trillion invested in hedge
funds around the world. Our members serve pensions, university
endowments, and charities, among others.
MFA's members are a valuable component of the capital markets. They
provide liquidity and price discovery to capital markets, capital to
companies seeking to grow or improve their businesses, and important
investment options to investors seeking to increase portfolio returns
with less risk, such as pension funds trying to meet their future
obligations to plan beneficiaries. Our members' skills help their
customers plan for retirement, honor pension obligations, and fund
scholarships, among other important goals.
MFA members are also highly sophisticated investors who participate
in the commodities and derivatives markets. MFA has consistently
supported the reforms to the over-the-counter (``OTC'') derivatives
markets contained in Title VII of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (``Dodd-Frank Act'') that mitigate systemic
risk, increase transparency, and promote an open, competitive, and
level playing field. We welcomed the U.S. market's transition to
central clearing for liquid, standardized swaps that occurred over the
course of 2013. We believe that liquid, safe, and efficient derivatives
markets facilitate investment to the benefit of everyone in the market
place, including corporate treasurers, farmers, and ranchers who need
to protect themselves against swings in crop prices, and pensioners who
seek reliable returns on their retirement investments.
The hedge fund industry is a global industry active in many of the
largest economic centers in the world. Most of our members are
headquartered in the United States, but many also either are
headquartered in foreign jurisdictions, or have established legal
entities in foreign jurisdictions. Europe, and particularly the United
Kingdom (``UK''), is an active jurisdiction for our members.
Hedge funds are well-regulated investment tools. Many aspects of
our members' activities are subject to an array of regulations and
oversight both domestically and abroad. Regulators in the United
States, Europe, and beyond have a wealth of information about our
members' investment activities. As a result, MFA has devoted
substantial resources to advocating overseas--and especially in the
European Union (``EU'') given its importance--for open, efficient, and
fair capital markets.
MFA strongly supports a coordinated approach to regulation that
fosters capital formation, increases transparency, mitigates systemic
risk, and facilitates fair and open access to financial markets. We
were pleased that, following the financial crisis, there was robust
coordination between the United States and the EU, and both
jurisdictions implemented regulatory regimes with largely comparable
requirements that mitigated potential conflicts. The cross-border
regulatory tools of cooperation include deference, substituted
compliance, mutual reliance, and outcomes-based ``equivalence''
determinations. International convergence on regulatory outcomes makes
compliance easier for U.S.-based financial firms that operate on a
global basis, which in turn, facilitated the cross-border flow of
capital.
The UK's anticipated withdrawal (``Brexit'') from the EU will
introduce additional complexities for global regulatory coordination.
MFA has been actively engaging with policymakers in Brussels, London,
Frankfurt, Dublin, Paris, and elsewhere to highlight potential
challenges. We have also committed substantial time and resources to
preparing MFA members for potential regulatory uncertainties.
MFA continues to stand ready as a constructive partner to officials
in the U.S. and Europe to highlight areas of particular challenge for
asset managers, and to propose policy and regulatory solutions to those
challenges. We were pleased to be invited by the UK House of Commons
Treasury Select Committee to provide evidence to its inquiry on ``[t]he
future of the UK's financial services'', and we have also been engaging
with policy officials in Brussels to provide constructive suggestions
on the EU's Capital Markets Union project. MFA also interacts with
international bodies such as the International Organization of
Securities Commissions (``IOSCO''), the Financial Stability Board, and
the Bank for International Settlements and its associated committees,
including the Basel Committee on Banking Supervision.
Our members allocate substantial resources to ensure they comply
with the laws and regulations of all jurisdictions in which they
operate and invest. However, when policymakers and regulators do not
coordinate to achieve convergent regulatory outcomes, investment
managers end up subject to laws and regulations in other jurisdictions
that are inconsistent with, or unnecessarily duplicate, U.S. law and
regulations. Divergent or duplicative rules and, in some cases,
extraterritorial application of those rules, can increase costs to
investors by creating barriers to investment managers doing business in
multiple jurisdictions.
MFA has continuously been a constructive partner to this Committee.
In that spirit, and in support of the broader policy and regulatory
authorities in the United States and beyond, we offer observations on
the following seven key regulatory areas that are currently presenting
challenges for our members:
(1) The EU enhanced supervision regime (``EMIR 2.2'') for third-
country central counterparties (``CCPs''),\1\
---------------------------------------------------------------------------
\1\ Regulation of the European Parliament and of the Council of . .
. amending Regulation (EU) No 648/2012 as regards the procedures and
authorities involved for the authorisation of CCPs and requirements for
the recognition of third-country CCPs, available at: http://
www.europarl.europa.eu/doceo/document/A-8-2018-0190-AM-002-002_EN.pdf
(``EMIR CCP Regulation''). Please note that this link is to the final
text as agreed by European Parliament and the Council, but it remains
subject to the corrigendum procedure, and has not yet been published in
the Official Journal of the European Union.
---------------------------------------------------------------------------
(2) The Basel III leverage ratio (``Leverage Ratio'');
(3) Swaps market and liquidity fragmentation issues addressed by the
CFTC Global Markets Advisory Committee (``GMAC''); \2\
---------------------------------------------------------------------------
\2\ See letter from Laura Harper Powell, Associate General Counsel,
MFA, to the CFTC its response to its April 15, 2019 GMAC meeting, dated
May 10, 2019, available at: https://www.managedfunds.org/wp-content/
uploads/2019/05/MFA-Letter-on-CFTC-GMAC-Meeting-on-April-15-2019-
Final.pdf.
(4) The implementation of initial margin requirements for uncleared
---------------------------------------------------------------------------
derivatives;
(5) The EU General Data Protection Regulation (``GDPR''),\3\
---------------------------------------------------------------------------
\3\ Regulation (EU) 2016/679 of the European Parliament and of the
Council of 27 April 2016 on the protection of natural persons with
regard to the processing of personal data and on the free movement of
such data, and repealing Directive 95/46/EC, available at: https://eur-
lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:32016R0679&from=EN.
(6) The need for greater data protection at regulators through the
---------------------------------------------------------------------------
Protection of Source Code Act; and
(7) Regulatory coordination in the U.S. between the Securities and
Exchange Commission (``SEC'') and the CFTC.
On behalf of MFA, I appreciate the Committee's consideration of
Brexit and other international developments affecting U.S. derivatives
markets. MFA wishes to promote enhanced global coordination and ensure
the continued stability of our financial system. We believe our views
are consistent with the Committee's public policy goals, and as
investors, we would like to work with Congress, the Committee, EU
policymakers and regulators, the CFTC, and all other interested parties
in addressing these issues towards the goal of preserving the strength
of our nation's economy. Specific concerns about the effect of
international policymaking follows, as well as discussion on certain
U.S. policy matters.
EU EMIR CCP Regulation
MFA has long championed the post-crisis reform efforts of Congress,
and we broadly support the G20's efforts to apply the reforms in a
consistent way across jurisdictions. A major reform that MFA strongly
supports is the effort to reduce risk in the derivatives markets by
transitioning standardized and liquid OTC derivative contracts into
central clearing. MFA believes that central clearing has greatly
benefited the derivatives markets by reducing systemic, counterparty,
and operational risk, and has resulted in a well-functioning and safer
system where counterparties face a well-regulated CCP.
Recently, the EU amended its European Markets Infrastructure
Regulation (``EMIR''), which is the EU regulation that implemented the
G20 objective of mandating central clearing of derivatives. The
recently adopted changes to EMIR (commonly referred to as EMIR 2.2)
allow EU authorities to conduct enhanced supervision of CCPs
established outside the EU that clear derivatives denominated in one of
the currencies of the EU. In extreme cases where the EU perceives
excessive systemic risk, the amended EMIR regulation allows EU
authorities to require CCPs to relocate clearing activities to an EU
member state.
MFA understands that the EU's goal in modifying its rules for non-
EU CCPs is to improve financial stability--a goal MFA shares. This goal
becomes even more important as financial markets prepare for the UK's
withdrawal from the EU. However, the EU approach could have wide-
ranging implications for the U.S. derivatives markets depending on how
EU authorities exercise these new authorities.
The current transatlantic regulatory framework is built on
substituted compliance, equivalence, and the deference of U.S. and EU
regulators to each other's comparable regulatory regimes. It is the
product of significant effort and coordination over the last 9 years,
with input from stakeholders including MFA. MFA welcomes this cross-
border regulatory coherence between U.S. and EU rules, and encourages
policy and regulatory officials to collaborate even more closely to
avoid the risks of fragmenting derivatives markets. If cross-border
trading and clearing of derivatives were to become more costly and
burdensome, it would undermine the benefits that global central
clearing has achieved.
Much will depend on how EU authorities choose to implement their
new powers under EMIR 2.2 and how well U.S. and European authorities
employ the tools of cross-border regulatory cooperation. For example,
if EU authorities exercise their power to require a relocation of
clearing activities into the EU, the markets for derivatives clearing
would become fragmented along jurisdictional lines. If that
fragmentation occurs, it would harm the financial system by, among
other things, impeding competition, limiting market participants'
ability to operate in certain jurisdictions, and ultimately creating
barriers across the global marketplace.
Like CCPs and clearing members, the changes contained in the EMIR
CCP Regulation are relevant to our members, who are a vital part of the
cleared derivatives markets, and access central clearing and CCPs
indirectly through those clearing members. As a result, regulatory
changes that impact central clearing or CCPs also indirectly impact
customers and could expose customers to increased risks.
Therefore, MFA encourages U.S. and European authorities to continue
to coordinate, using tools of deference, substituted compliance, and
outcomes-based equivalence to ensure that customers and end-investors
who use central clearing do not experience disruptions to their
investing and hedging activities due to a breakdown of existing or
future equivalence arrangements. In particular, MFA urges Congress to
ensure that U.S. departments and regulatory agencies continue engaging
with the EU on EMIR so that there is an agreed and coordinated approach
to CCP supervision such that transatlantic central clearing is not
hindered and the risk-reducing benefits of central clearing remain
intact.
We note that with respect to U.S. and UK markets, earlier this
year, the CFTC, the Bank of England, and the UK Financial Conduct
Authority issued a joint statement providing assurances that they are
taking measures to ensure that the UK's withdrawal from the EU will not
impede or create regulatory uncertainty regarding derivatives clearing
and trading market activity between the UK and the United States. We
also welcome the joint statement issued by the CFTC and European
Commission in March clarifying that the updates to EMIR and the swaps
regulatory framework will result in more deference as between the CFTC
and the EU supervisors than is currently the case.
MFA strongly supports such efforts and the issuance of clear,
unified guidance as it relates to the EMIR CCP Regulation.
Leverage Ratio Impact on Customer Clearing
The ongoing success and benefits of central clearing have been at
risk of being undermined by the Leverage Ratio rules of the Basel
Committee on Banking Supervision (``BCBS'' or ``Basel Committee'').
Without revision, these rules threaten the affordability and
accessibility of customer clearing.
Specifically, the current Leverage Ratio disincentivizes
derivatives clearing because it does not provide an offset for customer
initial margin (``IM''). That unfavorable treatment limits the ability
of customers to use centrally cleared derivatives and could limit the
ability of end-users to hedge their risks. MFA was gratified,
therefore, by the announcement last week that the Basel Committee has
called for an offset for IM in the Leverage Ratio for customer-cleared
derivatives. If the Basel Committee's forthcoming published standards
are consistent with the announcement, we would join CFTC Chairman J.
Christopher Giancarlo in his call to U.S. Prudential Regulators to
implement expeditiously the revised leverage ratio in their respective
rules.
Customers have been key to the success of central clearing in the
United States and across the globe. While some clearing of swaps
between dealers existed prior to enactment of the Dodd-Frank Act,
artificial barriers to entry prevented customers from similarly
participating in the cleared swaps market. Implementation of the
central clearing requirement eliminated many of those artificial
barriers and resulted in substantial customer clearing.
At present, swaps customers exclusively access CCPs indirectly
through clearing members (typically banks), rather than becoming direct
members of CCPs, for a variety of reasons, both financial and
operational. Swaps customers must post IM, which is the customer's
money, and CFTC rules require clearing members to hold customer funds
from the clearing member's own assets (i.e., ``segregate'' the IM).
Unfortunately, the current BCBS Leverage Ratio rules fail to
provide an offset that recognizes the exposure-reducing effect of
customers' segregated IM. According to the BCBS, the reason for the
lack of an offset for customer IM that is held by the clearing member
and not segregated not only offsets exposures, but also can be used by
the clearing member for further leverage. In the U.S., segregation
rules severely restrict the ability of IM to be held in anything other
than extremely low-risk and extremely liquid assets, assuring that it
is always available to absorb losses ahead of the bank. Moreover, the
substantial majority of segregated IM is posted to the CCP, and
therefore, is entirely outside the control of the clearing member.
The failure of the Leverage Ratio to recognize the purpose of
segregated IM discourages the use of cleared derivatives by customers.
The lack of offset will result in clearing members incurring large
Leverage Ratio exposures, which will likely raise prices for customer
clearing significantly. As the CFTC stated in its recent letter to the
U.S. Prudential Regulators, ``[f]ailing to reduce a clearing member's
exposure by the segregated client margin it holds results in an
inflated measure of the clearing member's exposure for a cleared
trade.''
In addition, the Leverage Ratio's current overstatement of a
clearing member's actual economic exposure in a cleared derivative
transaction has disincentivized banking organizations from providing
clearing services to many customers. The Leverage Ratio is estimated to
increase significantly the cost of using cleared derivatives. As a
result, MFA members expect reduced access to clearing services and
higher prices for such access without an appropriate revision to the
Leverage Ratio. This substantial cost increase may cause customers to
reduce their hedging activities to levels that are inadequate to manage
their risk, which could result in price increases and volatility for
food, gasoline, and other consumer goods.
In MFA's view, prudential requirements that inflate the economic
risk of derivatives, particularly the Leverage Ratio, impose artificial
barriers for clients to access cleared derivatives and work at cross-
purposes with mandates to clear. We commend Chairman Scott for
recognizing the adverse impact of the current formulation of the U.S.
supplementary leverage ratio on customer clearing, and for serving as a
lead cosponsor in the last Congress of H.R. 4659 to require the
appropriate Federal banking agencies to recognize the exposure-reducing
nature of client margin for cleared derivatives.
Therefore, to ensure the continued affordability and robustness of
customer clearing in this country, we urge U.S. prudential regulatory
authorities to implement a similar offset for U.S. clearing members to
the announced BCBS revision to the Leverage Ratio. To avoid competitive
disadvantage to U.S. banks, U.S. Prudential Regulators should act
promptly.
CFTC GMAC Discussion of Swaps Market and Liquidity Fragmentation
During a recent CFTC GMAC meeting, MFA noted that much of the
discussion focused on the need for global regulators to address
purported market or liquidity fragmentation in swaps trading activity.
MFA would like to provide buy-side perspectives to the Committee on the
current state of global swaps market liquidity and liquidity
fragmentation.
MFA believes that, on the whole, the introduction of central
clearing, organized trading, and greater pre- and post-trade
transparency in the standardized interest rate swap and index credit
default swap (``CDS'') markets has improved--rather than fragmented--
liquidity. In these markets, central clearing has made it easier for
investors to transact with a wider array of trading counterparties
while organized trading has improved pricing and competition, among
other benefits. However, in other segments of the swaps market where
central clearing and organized trading are not as prevalent, such as
the single-name CDS markets, MFA members report that market liquidity
has suffered due to lack of participants and lack of breadth of names
traded.
MFA is concerned that, if implemented, the CFTC's proposed
comprehensive reforms for swaps trading on swap execution facilities
(``SEFs'') would result in the fragmentation of the swaps market. To
avoid this fragmentation, the SEF reforms should be targeted in scope.
A targeted approach is necessary to preserve the CFTC-EU mutual
recognition agreement on derivatives trading venues and to minimize
regulatory fragmentation where possible by reducing regulatory
divergence and related burdens on existing and potential participants
in OTC derivatives markets. Disruptions to such mutual recognition/
equivalence agreement may jeopardize impartial access to derivatives
trading venues, straight-through processing efficiencies, price
discovery, and post-trade transparency. MFA submitted a recent comment
letter on the CFTC's SEF proposals with alternative recommendations
that would preserve and enhance the CFTC-EU mutual recognition
agreement and its important benefits for investors in facilitating
cross-border swaps trading.\4\
---------------------------------------------------------------------------
\4\ See MFA letter in response to the CFTC's Proposed Rule, ``Swap
Execution Facilities and Trade Execution Requirement'' (RIN 3038-AE25),
submitted to Christopher Kirkpatrick, Secretary of the Commission, on
March 15, 2019, available at: https://www.managedfunds.org/wp-content/
uploads/2019/03/MFA-Comment-Letter-on-CFTC-SEF-Proposed-Rule-Final.pdf.
---------------------------------------------------------------------------
While the current SEF regime has improved conditions for investors,
it has failed to provide buy-side market participants with true
impartial access to the unique trading protocols and liquidity
available on inter-dealer (``IDB'') broker SEFs that historically
served the ``dealer-to-dealer'' segment of the market. For example,
buy-side firms do not have true impartial access to voice-based
execution protocols on IDB SEFs that may be best suited for their
specific trading activity. The continuing access barrier of post-trade
name give-up on IDB SEFs that offer anonymous execution for cleared
swaps reduces pre-trade transparency for investors regarding available
bids and offers on such SEFs and limits their choice of trading
protocols to those offered by a few viable SEFs serving the ``dealer-
to-client'' segment of the market.
We respectfully urge the Committee to support targeted reforms to
the CFTC's swaps trading regime to avoid the risk of introducing swaps
market and liquidity fragmentation.
UMR Initial Margin Implementation
The implementation of the final phases of the IM requirements under
the uncleared margin rules (``UMR'') adopted by the CFTC and other U.S.
regulators has presented a myriad of challenges for buy-side firms. We
are concerned that outstanding issues might result in prohibitive price
increases and decreases in liquidity. MFA has recommendations for
various short-term and long-term measures that are necessary to provide
certainty and clarity for market participants.
While our members support incentives for central clearing of
standardized OTC derivatives, we recognize that market participants
have an ongoing need to be able to enter into bespoke and customized
derivatives contracts that cannot be easily cleared by a CCP (so-called
``uncleared derivatives''). MFA supports requiring buy-side firms to
collateralize these uncleared derivatives through the posting of
margin. Many MFA members already post IM for their uncleared
derivatives, but currently, most do not collect IM from their swap
dealer counterparties. Under UMR, buy-side firms will be required to
receive regulatory IM from their swap dealers and segregate it with a
third-party custodian bank.
For the last several years, MFA has engaged with U.S. and
international regulatory bodies on implementation of UMR. Our primary
concern with UMR implementation is maintaining reasonable costs and
sufficient market liquidity for this important part of the swaps
market. If the cost of trading uncleared derivatives is
disproportionately increased by UMR implementation, it could reduce
liquidity and adversely impact market participants' ability to invest
and properly hedge their portfolios using these instruments. Moreover,
for products where no central clearing offering is available and/or
where central clearing is not appropriate, calibrating UMR to
incentivize such clearing is unrealistic, and accordingly, may need to
be revisited. UMR should be designed to properly mitigate the risks
associated with uncleared derivatives, not to penalize market
participants for using uncleared derivatives to meet their trading
needs for prudent risk management, including entering into customized
transactions where warranted.
On March 5, 2019, BCBS and IOSCO \5\ issued a public statement that
the BCBS-IOSCO international margin framework does not specify
documentation, custodial or operational requirements if the bilateral
IM amount does not exceed the framework's 50 million U.S.$/Euro IM
threshold. Although the BCBS-IOSCO Guidance is a good first step in
providing needed clarity to market participants, MFA urges the CFTC,
the U.S. Prudential Regulators, and other regulators to adopt expressly
the BCBS-IOSCO Guidance this summer.
---------------------------------------------------------------------------
\5\ Available at: https://www.bis.org/press/p190305a.htm (the
``BCBS-IOSCO Guidance'').
---------------------------------------------------------------------------
Although the UMR does not require an in-scope entity to post
regulatory IM until its bilateral IM amount in a counterparty
relationship exceeds $50 million, the requested guidance would,
nonetheless, help clarify the obligations of market participants and
manage and prioritize their resources. MFA believes the issuance of the
requested guidance this summer is critical to ease resource burdens and
avoid trading disruptions for swaps market participants in the final
phases, especially for the relatively large influx of newly in-scope
entities, including many MFA members, on the September 1, 2020
implementation date for Phase 5.
MFA also requests that the CFTC coordinate with the U.S. Prudential
Regulators and other regulators to provide a forbearance period of 6
months after a Phase 5 entity's counterparty relationship that was
initially below the $50 million regulatory IM exchange threshold later
exceeds such exchange threshold. Such forbearance is necessary to allow
the Phase 5 entity to put the necessary bilateral collateral
documentation and trilateral custodial arrangements in place to both
post and receive regulatory IM and avoid trading disruptions. A
reasonable forbearance period would help to alleviate the complexities,
compliance expenses, and resource constraints facing Phase 5 entities,
including with respect to separately managed accounts and associated
risks.
In addition to these near-term measures, MFA urges the CFTC to
coordinate with the U.S. Prudential Regulators and other regulators
through the BCBS-IOSCO Working Group on Margining Requirements
(``WGMR'') to implement broader regulatory solutions that would involve
targeted recalibration of UMR IM requirements. MFA recommends that the
CFTC and other WGMR members consider:
Excluding physically settled foreign exchange swaps and
forwards in calculations of aggregate average notional amount
thresholds for determining whether counterparties are in-scope
of the UMR IM requirements. This recalibration is logical and
would smooth implementation by avoiding the inclusion of
products that should not otherwise be affected by the rules
into the process.
Adopting another phase-in threshold between 750 billion
U.S.$/Euro and 8 billion U.S.$/Euro; specifically, MFA
recommended a Phase 5.a. threshold of 100 billion U.S.$/Euro in
2020, with 8 billion U.S.$/Euro pushed back to 2021 as Phase
5.b. A more gradual and orderly staging would ensure that there
is market infrastructure in place to support the final stages
of IM phase-in and avoid market disruption. Such a further
phase-in would also be preferable to a blanket delay of Phase
5, which would simply defer the cliff-edge effect of the
threshold dropping from 750 billion U.S.$/Euro to 8 billion
U.S.$/Euro without further facilitating the industry's
transition.
Enhancing the use and risk-sensitivity of approved IM
models, including the ISDA SIMMTM, by:
Exempting Phase 4-5 non-dealer counterparties from
prudential-style governance of IM models designed for bank
capital standards;
Enhancing portfolio margining in IM models;
Accelerating regulatory approvals of business-specific
IM models to avoid model herding to a single standard IM
model; and
Authorizing opt-in margining of non-regulated products
to enhance portfolio offsets in IM models.
Requiring robust data security protections by third-party
software vendors that provide functionality for regulatory IM
calculations, reconciliation, and margin workflows.
We respectfully urge the Committee to encourage the CFTC to
coordinate with other regulators and the WGMR to implement our
requested regulatory measures as soon as possible to avoid significant
swaps market disruption.
EU General Data Protection Regulation
MFA supports robust data privacy and protection of confidential or
sensitive data. GDPR took effect in May 2018 and seeks to protect the
personal data of EU citizens. Because the rules under GDPR extend
beyond the EU's geographical borders, GDPR has had a significant impact
on the operations of many U.S. businesses.
MFA members are subject to a panoply of U.S. Federal and state
privacy requirements because most are registered with the CFTC and/or
SEC as commodity trading advisors (``CTAs''), commodity pool operators
(``CPOs''), or investment advisers. Nevertheless, many U.S.-based
investment managers that do not have EU offices are, or may be, subject
to GDPR as well because it has broad extraterritorial application that
extends to non-EU businesses that offer goods or services to
individuals in the EU.
While GDPR does not appear to directly conflict with U.S. privacy
regulations, it has imposed requirements on U.S.-based investment
managers and other U.S. businesses that are significantly more
stringent than what U.S. privacy rules impose. As a result, U.S. firms
have had to modify their operations to comply with GDPR,
notwithstanding their compliance with existing U.S. privacy laws. In
effect, GDPR has become the primary privacy rule with which firms must
comply with because it sets more stringent and prescriptive compliance
standards than the U.S. privacy regimes prescribed by Federal agencies
through the Gramm-Leach-Bliley Act and other Federal legislation, as
well as by state law.
GDPR is an example of an EU law that has a significant impact on
U.S. businesses and markets. While MFA does not take a position on
whether GDPR is the appropriate rulemaking for U.S. entities, we note
that Congress may wish to consider that it is now effectively a set of
rules with which many U.S. firms must comply even though U.S. actors
had little or no influence over the EU's rulemaking in this important
area. Once again, MFA strongly encourages U.S. and EU authorities to
engage in active regulatory collaboration to ensure coordination of
approaches on privacy matters across jurisdictions, and we encourage
Congress to exercise its oversight and lawmaking powers as appropriate.
Enhancing Data Protection
For several years now, MFA has engaged with regulators, including
the CFTC, on the issue of data security and treatment of confidential
information. MFA and its members have significant concerns about
information security at regulatory agencies. Information security
vulnerabilities at a regulator jeopardize not only market participants
and their investors, but also the U.S. economy through the loss of
domestic trade secrets and confidence in the integrity of the
regulatory framework. This month, the CFTC Office of Inspector General
issued a report highlighting the vulnerability of the CFTC's Integrated
Surveillance System to hacking, which reinforces this concern.
Over the last several years, due to both statutory mandates and
regulatory discretion, agencies have expanded the scope and breadth of
the types of information that they request of registrants. These
agencies, however, have generally continued to rely on the same
frameworks for information collection and protection. Thus, we were
especially pleased with the announcement earlier this year of CFTC
Commissioner Dawn Stump's data protection initiative. That initiative
aims to ensure that the CFTC only collects data required for its
regulatory responsibilities, removes duplicative reporting streams,
explores alternative mechanisms for accessing sensitive information,
enhances internal controls for interacting with data, examines response
procedures to cyber incidents, and updates data retention best
practices.
MFA believes that the Committee should also consider legislative
solutions with respect to enhancing data privacy, protection, and
collection. We commend Chairman Scott for his leadership during the
115th Congress in supporting the ``Protection of Source Code Act'', and
for cosponsoring H.R. 3948, companion legislation that would amend
securities statutes to apply the same scheme proposed for the CFTC to
the SEC. The Protection of Source Code Act would amend the Commodity
Exchange Act to require the CFTC to issue a subpoena before compelling
a person to ``produce or furnish source code, including algorithmic
trading source code or similar intellectual property that forms the
basis for design of the source code.''
MFA believes that legislation such as the Protection of Source Code
Act and companion Senate legislation introduced in the 115th Congress
(S. 3732 and S. 3733) would be an important and constructive step for
implementing and ensuring that regulators have a robust process in
place when it comes to determining the necessity of highly sensitive,
confidential information. Significantly, the legislative measure does
not impede regulators from seeking the information they need, it only
ensures that regulators have a process in place before seeking certain
types of information, balancing the needs of regulators and
registrants.
As such, MFA supports the policy of the ``Protection of Source Code
Act'' and recommends that the Committee consider proceeding with such
legislation during this Congress.
A Harmonized U.S. Approach to Regulation
MFA supports the harmonization efforts that CFTC Commissioner Brian
Quintenz and SEC Commissioner Hester Peirce have undertaken to enhance
regulatory efficiency and effectiveness between the SEC and CFTC. To
support this initiative and the goals of the CFTC, SEC, and Treasury
that relate to promoting coordination, harmonization, and efficiency
across regulators, MFA developed a proposal for a harmonized approach
to CFTC and SEC regulation of firms that are registered with both the
CFTC as CPOs or CTAs and with the SEC as investment advisers (``dual
registrants'').\6\ We have urged the CFTC and SEC to enhance
coordination and efficiency in the regulation of dual registrants, and
we believe that this Committee has an important oversight role to play
in ensuring that regulators take a more harmonized or coordinated
approach to regulation of dual registrants.
---------------------------------------------------------------------------
\6\ See letter from the Honorable Richard H. Baker, President and
CEO, MFA, and Jennifer W. Han, Associate General Counsel, MFA, to the
Honorable Jay Clayton, Chairman, SEC, and the Honorable Christopher
Giancarlo, Chairman, CFTC, dated November 15, 2018, on ``A Proposal for
a Harmonized Primary Regulator Approach to SEC and CFTC Regulation of
Dual Registrants'', available at: https://www.managedfunds.org/wp-
content/uploads/2018/11/MFA-Proposal-for-Dual-
Registrants.final_.11.15.18.pdf.
---------------------------------------------------------------------------
Dual registrants are subject to a wide range of related, but not
identical, requirements arising from CFTC, SEC, and National Futures
Association (``NFA'') rules. These requirements include systemic risk
reporting, examinations, advertising, marketing, sales practice and
promotional materials, recordkeeping, privacy policies, information
security and cybersecurity, self-assessment, business continuity and
disaster recovery planning, ethics, and registration forms.
Under our proposed CFTC-SEC approach to harmonized regulation,
currently dual registrants would continue to be registered with, and
subject to oversight by, both agencies. All trading activities in the
futures and swaps market would continue to be governed by CFTC rules
and all securities market activities would continue to be subject to
SEC rules. However, through an exemptive-relief safe harbor, each
agency would provide substituted compliance for CPO/CTA and adviser
regulations, whereby a registrant would be able to satisfy its
compliance obligations with one agency by complying with the other
agency's rules that serve the same purpose. A dual registrant would
determine which agency's rules it would need to comply with based upon
an assets under management test. For example, if a majority of a
registrant's exposure was from derivatives overseen by the CFTC, it
would comply with the CFTC and NFA regulations, and would be granted
substituted compliance by the SEC for certain investment adviser
regulations.
MFA believes that a harmonized approach to CFTC-SEC regulation of
dual registrants could significantly enhance regulatory efficiency and
effectiveness, and reduce regulatory burdens by streamlining systemic
risk reporting and implementing joint or coordinated exams of dual
registrants. These aspects to dual regulation create the greatest
additional ongoing cost and burden. A harmonized approach would also
provide clear and quantifiable benefits to the CFTC and SEC,
registrants and the investing public, as well as conserve valuable
government resources, reduce waste, promote good governance, and
greatly enhance regulatory efficiency and effectiveness.
MFA continues to engage with CFTC and SEC staffs to discuss an
optimal framework for a harmonized approach to CFTC and SEC regulation
of dual registrants. MFA has recommended that the CFTC and SEC
prioritize adopting a harmonized framework approach to regulation of
dual registrants that would decrease duplicative regulation, allow for
substituted compliance, joint, or coordinated exams, and permit the
submission of a single systemic risk report to the CFTC, SEC, and NFA.
We respectfully request that the Committee exercise its oversight
role in ensuring that regulators take a more harmonized or coordinated
approach to regulation of dual registrants.
Conclusion
On behalf of MFA, I appreciate the Committee's consideration of
Brexit and other international developments affecting U.S. derivatives
markets. As discussed, we strongly support global regulatory
coordination and regulatory efforts to define consistent, effective,
and fair cross-border rules that foster capital formation, increase
transparency, mitigate systemic risk, and facilitate open access to the
financial markets. To prevent the financial markets from becoming
fragmented along jurisdictional lines and otherwise undermining the
progress made in safeguarding the financial system against another
financial crisis, we urge Congress, through its oversight powers, to
examine and encourage Treasury and regulators to formulate positions in
each of these important areas, and then work with their international
counterparts to resolve impediments to the objectives of open,
efficient, and fair capital markets.
In addition, to strengthen the U.S. financial system, we would
appreciate Congress' continued oversight on harmonization issues by
requesting that the CFTC and SEC implement a more harmonized and
coordinated approach to regulation of dual registrants. We also request
that Congress consider adoption of measures to enhance protection of
U.S. intellectual property.
MFA is committed to working with Members and staff of Congress, the
Committee, and regulators to address these issues towards the goal of
preserving the strength of our nation's economy. MFA is also committed
to its role as a constructive partner to policy and regulatory
officials in overseas jurisdictions, including in Europe. Thank you for
the opportunity to appear before you today. I would be happy to answer
any questions that you may have.
The Chairman. Well thank you. Thanks to each of you for
your very informative remarks and information you relayed. I
certainly at this time want to thank my staff, our Agriculture
Committee staff, for pulling such a distinguished panel
together. Thank you all very, very much.
Now, Members will be recognized for questioning in order of
seniority for Members who were here at the start of the
hearing. After that, Members will be recognized in order of
arrival.
I will start with myself for 5 minutes.
As I said at the outset, we want to really find out from
you what we should do in this situation as Members of Congress,
what we can do to make sure that there are no impediments.
And from each of your testimonies, you have shared with us
some impediments, some things that are standing in the way that
need to be removed because of this Brexit situation. And so, we
want you to be frank. We want you to give us some direction in
how we can make sure that our market participants in the cross-
border are not inhibited by this divorce that is going on, and
also, this kind of untoward activity that the EU in and of
itself is doing, that appears to be some sort of power play.
And we want to be knowledgeable from you so we can put into
action the necessary movements that can help make sure that our
market participants, the United States financial industry, are
not put at a disadvantage with what is happening with the
European Union and Brexit.
But first and foremost, I would like to get the panel's
take on what you think about the most recent and timely news
from the CFTC. What are your thoughts on the CFTC's
announcement yesterday of the creation of a process to
terminate the exemptive relief they have offered to foreign
firms under their Part 30 rules?
We will start with you, Mr. Duffy, and then I would just
like very quickly to get each of your take on this. The CFTC's
movement yesterday is very important. I want to kind of find
out how you all feel about it.
Mr. Duffy. I will save my comments on what you should do. I
think that was the original question. But I will talk about
what the question you just asked is. What do we feel about what
the action that was taken yesterday? I think it was very
significant for a couple of reasons there, because I think it
was the first time we have seen a unanimous decision come out
of the Commission for all five Commissioners from both sides of
the aisle to agree that this is a big issue. Not to just
somewhere, what we are hearing from your Committee here today.
I think that was a very, very strong positive message. And
if they were to enact to take away the exemption of the Part
30, it would make it very, very difficult obviously for
European brokers to deal with U.S. clients. They would have a
whole host of new hurdles they would have to go under, which in
return would be a lot of costs associated with them.
I was very heartened to see that the Chairman and the rest
of the Commissioners put that out for comment, and that is
their position. I think that is a really good strong starting
point.
The Chairman. Very good. Mr. Edmonds, advice?
Mr. Edmonds. I certainly recognize what they did yesterday
was adding a tool to the tool chest they had. I think on an
historical basis, everyone has looked at that as something that
would not be touched. But now, they have been very clear about
what they put out there, giving them the opportunity to take
advantage of that, given certain circumstances once it is
warranted. I think there is going to be a lot of collection of
tools that go in the tool box before we get through this
conversation at a holistic level.
The Chairman. All right. Mr. Maguire?
Mr. Maguire. Thank you, Chairman Scott. I will be brief.
To reiterate what Chris said, I think it is a tool in the
tool box. I think that is clear. From our perspective, we are
clearly a known U.S.-domiciled CCP. It doesn't directly impact,
as we operate here, as I mentioned in my testimony, under a
direct registration model, which we are strong advocates of. We
are fully compliant with all the rules and don't rely on
elements of this.
What I would encourage, though, I think it is a potential
tool and a potential set of circumstances. There is definitely
a need all around to consider this--how do I put it? To think
about not having an arms race and thinking about more
cooperation. I think the danger as this thing escalates, things
get turned into an arms race and it is very important that we
take the temperature down in time. But I understand the
motivation for doing the change in the rule.
The Chairman. Right. Mr. Lukken?
Mr. Lukken. Yes, Part 30 is the regulation the CFTC has to
allow U.S. customers access to foreign markets through foreign
brokers that are deemed comparable. Their action yesterday was
codifying how you would revoke a Part 30 comparability analysis
if certain conditions arose. This was codifying, I think, what
was already a regulatory practice. Again, it is a tool in the
tool box. If you are looking at carrots and sticks, regulators
need carrots and sticks. This was a stick. The regulator, and
Chairman Giancarlo has also talked about some carrots as well,
which is we need to get to a more comparable regulatory
structure so we don't have to register DCOs around the globe. I
am looking forward to the holistic package that he is planning
to put out, both Part 30 yesterday as a stick, and hopefully
some carrots in the coming weeks.
The Chairman. Right, and Mr. Berger?
Mr. Berger. Thank you.
As you noted, Mr. Chairman, the proposal was voted out
yesterday, so MFA looks forward to reviewing and commenting
during the public comment period. I would note, seconding what
Mr. Duffy said, there was a unanimous and bipartisan vote by
the CFTC Commissioners to move forward. And as a general
matter, I think it is good public policy to codify powers that
currently only exist as part of exemptive relief.
The Chairman. Right. Thank you very much. My time has
expired on that; but hopefully, I will have a chance to maybe
get to it with one or the other. But what I may want to come
back on is that I want to make sure that we get back to this
EMIR 2.2, and what we in Congress need to do in terms of this.
I have talked with the CFTC and there may be a move that we
have to put in place to retaliate, and we will examine that,
and perhaps Mr. Scott and some of the others will get to that.
I now recognize the Ranking Member for his questions.
Mr. Austin Scott of Georgia. Thank you, Chairman Scott, and
Mr. Maguire, I appreciate your comments about reducing the
temperature. I think that would certainly be the desire of the
Committee, and many of the others.
Mr. Duffy, you discussed the idea of regulatory sovereignty
and how infringement on the CFTC's ability to regulate U.S.-
domiciled entities could be harmful. Can you expand on the
dangers you see when you look at the potential of having two
regulatory masters?
Mr. Duffy. Yes, sir, and thank you for the question.
Having--first of all, it is against the law for the CME to
be in compliance with EMIR 2.2 because under the U.S. law, the
CFTC is our primary regulator and that is it. We would actually
be in technical violation of U.S. law if we were to be in
compliance with EMIR 2.2. That is just for starters.
So, the answer to that is what do we do? Well, we can not
do business in Europe, but that doesn't make any sense for all
of the reasons that we outlined. Having duplicate costs
associated with this, again, I don't think anybody can
understand really what that is going to do to the ultimate
consumers, and it is not just in the U.S., it is everywhere.
When these spreads widen those costs have to be borne by
somebody, and market participants will bear them and they will
bear them in a way that they can widen their spread, so that is
how they do it. And that puts the cost on the consumers. I
think that is very damaging. And again, as I said earlier, this
is just not agricultural products. This is your home mortgages.
This is your 401(k)s. The illiquidity that you mentioned
earlier, sir, that is a big, big issue. Duplicate regulation
makes absolutely no sense, and for a company like CME, which is
the largest exchange in the world, we have roughly less than
five percent euro-denominated products traded in Europe. How
are we possibly deemed systemically important to the European
Union when we have less than five percent euro-denominated
products?
This is nothing more than what Ranking Member Conaway said
earlier. This is a little retribution from 2010, 2012, but
also, this can't go forward, and I think hopefully we are past
that. I thought we were past it in 2016. I am very hopeful that
this Congress will be very much involved.
Mr. Austin Scott of Georgia. Thank you, Mr. Duffy.
Mr. Edmonds, as you noted, Chairman Giancarlo has recently
proposed changes to how it interacts with overseas
clearinghouses. How would the changes that he is proposing
change the regulation of clearinghouses?
Mr. Edmonds. Well, the proposal that is out there now is
really more around what we thought we had in 2016 in the
agreement, and where that is headed. We have spent the better
part of the last 2 decades--Terry will say it is longer, and
that is fine--creating a global market, and everything we are
doing right now is trying to combat the balkanization of that
market and all the costs that come along with that on the ride.
I agree with Terry's comments that the risk it faces on the
widening spread.
But, Chairman Giancarlo and what he is trying to propose is
to take that down and get that--we know what we do really well
here in the U.S. We understand what the Europeans do really
well, and to take advantage of that on both sides of that so we
have a very harmonious global financial system. And if we are
not going to do that, as you have articulated and as other
members of this panel today have articulated, there is a risk
of an arms race. And I don't think as any market practitioner,
we are looking for that. And if you think about it from a cost
perspective, how are we making the markets safer? I mean, it is
very difficult for either side of the aisle to say the market
is safer at the end of the day because we are balkanizing it. I
think that is going to be a challenge for all of us to look at.
If I look at the Chairman's comments earlier about what we
can encourage Congress to do is make sure not only at the
regulatory side but also on the market operators that we are
walking down a path to one that is comparable. And if we are
there, then we can manage a global financial market pretty
well.
Mr. Austin Scott of Georgia. Would any of the rest of you
like to comment on that in the last 50 seconds?
Mr. Lukken. I would just mention risk management. I think
the fear, as much as we can talk about costs and access, but
during a crisis when a CCP is trying to preserve the safety and
soundness of the system and you have two regulators telling you
conflicting things, I think that is, to me, the scariest part
of this. And we want to make sure that in this deference
approach that it is clear who the principle regulator is and
who CCP has to listen to so they are not conflicted during a
time of crisis that could have significant market disruption.
Mr. Austin Scott of Georgia. Thank you. Mr. Chairman, my
time has expired, but it is pretty clear to me the extreme risk
and cost that comes with not having the harmonization not just
the U.S. markets, but the global markets and the end-users out
there, and that, again, is very, as you know, damaging to the
global economy.
With that, I yield the remainder.
The Chairman. I certainly agree with you, Ranking Member.
That is an excellent comment.
And now we will hear from Ms. Spanberger, please.
Ms. Spanberger. Thank you, Mr. Chairman. Good afternoon to
our witnesses.
I represent central Virginia, home to farmers and producers
across the 7th District of Virginia. We have touched on some of
the risks to global markets that would be created in the event
of a hard Brexit, and some of the steps that might be taken to
mitigate those risks. But given the lack of certainty that we
have about the future and what we could be facing, I would love
to hear from anyone on the panel who would like to comment on
this. What could be the possible outcomes and scenarios facing
some of the folks in my district? I am concerned about the
farmers who mitigate commodity price risk through future
markets that trade on your exchanges, and other constituents
from my district who may have pensions that are affected by
these regulatory changes.
Could you comment on how a soft Brexit might affect U.S.
commodity futures and pensions, and how this would compare to
the risks of a hard Brexit and what some of my constituents on
an individual basis might face in the future?
Mr. Lukken. This is something that FIA has taken a lead on,
both in Europe and the United States, on preparing for Brexit.
At the marketplace, we have worked with all these exchanges and
buy-side members at the panel to make sure that either a hard
Brexit or a soft Brexit, that there is transitional relief. In
a hard Brexit, of course, there is no transition. But, we have
received from the Europeans regulatory relief that will allow
people to continue to access clearing in a hard Brexit
scenario. We are hopeful that the two parties reach a soft
Brexit and there is a long lead time that will allow us to
transition to the new arrangement.
But I think the biggest fear is just the political risk
involved with this, things outside of our control. I think this
industry has done a very good job of planning for either a hard
or a soft Brexit; but, during a hard Brexit, they will cause
market volatility most likely, and that volatility could impact
prices, including agricultural prices.
We have done about as much as we can to prepare for this,
but there are certain things we just can't know, especially in
a hard Brexit volatility situation.
Mr. Duffy. I will say, Congresswoman, from our standpoint,
CME has already set up operations outside of the UK so we are
incurring duplicate costs in order to be in compliance with
whatever happens, whether it is a soft Brexit or a hard one.
But I think for the good people of Virginia, the good news is
that they will have access to the U.S. clearing entities today
completely uninterrupted to mitigate their risks as they
continue to run their business.
I don't see much of a risk to your constituents,
thankfully, but the risk is the liquidity issue that I think we
have all talked about, because there is a continuity of
liquidity in the ecosystem that could have an impact on prices.
But I am fairly confident that because of some of the moves
that we have made and others, that it should be relatively not
interrupted for your constituents.
Ms. Spanberger. Okay, thank you.
Would anyone else care to respond?
Mr. Maguire. Thank you, Congresswoman. Yes, just briefly.
Ms. Spanberger. Thank you.
Mr. Maguire. We say we are hopeful of a soft Brexit. We are
prepared for a hard Brexit, clearly. And to echo comments about
this, there has been a lot of great work done by many across
the industry to prepare for that.
I think really the area to focus then is on EMIR 2.2, which
has been referred to already, which is not specifically Brexit
but is sort of interlinked with that.
The outcome of, and I always raise the outcome of a lack of
harmonization that has been referred to, is that markets
fragment. The outcome of markets fragmenting is liquidity
splits; therefore, supply goes down, demand stays the same, and
in very simple first grade economics, if supply is down and
demand is the same, the price increases.
Certainly, in the financial products that we clear, I am
not really clear on agriculture, but things that would affect
pensions, loans, 401(k)s and mortgages and other things, if
markets do fragment as a result of EMIR 2.2, we will see an
impact to the end-user and the customers and the constituents
using those financial products.
Ms. Spanberger. Thank you very much. My time is starting to
get close to running down, but I was wondering, Mr. Berger, if
you could comment on the risks that uncleared swaps pose, and
how well you expect the uncleared margin rules will work to
mitigate this risk?
Mr. Berger. Implementing new margin and collateral
requirements for uncleared swaps was a key component of the G20
reforms to the OTC derivatives markets, and we are in the
process of phasing that in through a phased timeline that
extends into 2020. And I think what the industry has
experienced is the last phase includes the largest number of
counterparties, so all those counterparties kind of getting
ready and getting through the gate is proving to be a little
bit of a challenge. Providing some additional time to phase-in
the buy-side would be a welcome development.
Ms. Spanberger. Thank you, and my time has expired. I yield
back. Thank you.
The Chairman. Mr. Crawford, you are recognized.
Mr. Crawford. Thank you, Mr. Chairman. I appreciate you
convening this hearing today.
Mr. Duffy, I was at the 2012 hearing that Ranking Member
Conaway mentioned. At that hearing, Patrick Pearson testified
on behalf of the European Commission, and raised an important
point about the danger of unenforceable regulations. He said:
``If the European Union were to try and enforce its rules on
all of its affiliates in the United States of America, we would
be doing two things that are horribly wrong. We would be trying
to enforce something we can't enforce in practice. Even worse,
we would be giving the impression that we will be able to
enforce it. And if something goes wrong, where will the plane
land? Will it land here in the United States, or with a
regulator in Europe? That is the thing that we are trying to
avoid. We do not afford ourselves the luxury of putting in
place a regulatory system that we know we cannot enforce.''
Is the EU in danger of putting in place a regulatory system
it can't enforce?
Mr. Duffy. I am not so sure it is in danger of putting in
something that it can't enforce. I think what it is doing, it
is trying to put something in place to displace you and the
rest of the United States and take over as the regulators.
In today's global market, they probably could enforce it,
and I think that is one of the main reasons why we are here
today is because of the concern that U.S. entities are going to
be regulated by European oversight, and it will displace the
United States Congress and its own government agencies. We
think that is the damaging part.
Whether they could do it, or not, is something that is yet
to be decided, because they haven't done it. I would not be
able to pass judgment on that just yet.
Mr. Crawford. Well, let me thank you for your candor. You
indicated this. I do think there is a political dynamic here. I
appreciate your candor on that subject, but in the bigger
picture here, what we are talking about today, we have heard
this recurring theme about liquidity and things of this nature,
and quite frankly, what we are discussing here today, if we
don't get it right, we are scaring a lot of liquidity out of
the market.
I have some concerns about my farmers back home who have
over the years, particularly since Dodd-Frank, have been
literally scared out of the market, and at the same time, we in
this Committee have been told we need to move to a market-based
system of agriculture support. And what is the market-based
system? It would be obviously using the tools that CME offers.
And yet, farmers are afraid to get in it. There is a liquidity
problem which creates more volatility, which further
exacerbates the problem for farmers that have become relegated
to price takers.
I don't think a local basis contract is a sufficient risk
management tool. Do you?
Mr. Duffy. Well, I don't know if it is not, but I will tell
you that your comments are not on deaf ears. We have worked
very, very hard with the community. That is our roots, is in
agriculture, as you know.
Mr. Crawford. Sure.
Mr. Duffy. And we want to continue to make sure we provide
a level playing field for people to manage their risk in the
farm community. We are talking about feeding nine billion
people by 2050, and the American farmer is a big part of that.
But they are not going to be able to be a big part of that if
they don't have good risk management tools to do so.
We need to do more with less, as you know from your
community, and we are in a very difficult situation. What I
said at the outset, why in the world would this Congress or our
government agencies sit back as somebody from another country
is trying to take away the jurisdiction and create more
uncertainty for the farmers of the United States versus the
certainty they need? Because you know what, sometimes you can't
blame them for not wanting to dip their toes in the water,
because if you don't know the rules of the road, you are not
going to drive.
Mr. Crawford. Well, I will tell you, I think what we have
to do in this Committee and then broadly in this Congress is we
have to prepare ourselves to direct ag policy in that direction
with regard to utilizing these free market tools. In the end,
that is the only thing that is going to be left available to
farmers. If we don't get that right now, if we scare that out
of the market, what are we left with? And farmers are behind
the eight-ball and have been for quite some time.
And so, when we talk about this in the context of hedge
funds and all the terms that we have heard used, sort of the
industry vernacular, that creates even more discomfort, for
lack of a better term, among the very folks that these markets
were designed to help protect with regard to risk management
strategies.
As we move forward in that, I want to work with you on this
because I think we most definitely need to be incentivizing
farmers to use these risk management tools. And this is a much
more relevant question here in this Committee to advocate for
farmers. I have nothing against hedge funds. I think they are
important. They are important parts of the market, but the very
basis of this, the very basic level, if we get this wrong, we
have done maybe irreparable damage to our farmers.
I appreciate your work on this and look forward to working
with you, going forward.
Mr. Duffy. Thank you, sir. I completely agree with you. I
will also say one thing. The sophistication of the American
farmer on risk management is at an all-time high right now, and
good for them. They are really doing an amazing job.
Mr. Crawford. Thank you, and I yield back. Thank you, Mr.
Chairman.
The Chairman. Thank you, Mr. Crawford, and now, I will
recognize the gentleman from New York, Mr. Maloney.
Mr. Maloney. Thank you, Mr. Chairman. I apologize for
arriving late. I want to thank the witnesses for being here on
this important subject, and I wouldn't have missed the first
part of the hearing if I hadn't been shepherding a bill for my
Subcommittee on the Coast Guard through the Transportation and
Infrastructure Committee this morning at a markup. But I
appreciate the opportunity to be here. I appreciate the
testimony you have all submitted.
I am curious, Mr. Berger, from the buy-side perspective,
and forgive me if some of these questions have been covered
already. But from a buy-side perspective, could you elaborate
on some of the harm, from your perspective, with the EU
proposals?
Mr. Berger. As I have noted in my testimony, MFA is a
proponent of central clearing of derivatives. We think that
central clearing mitigates systemic risk, increases investor
protections, and provides for a more transparent and
competitive marketplace.
Our derivatives markets are global markets, and for buy-
side market participants, we want to have the ability to
conduct our investment activities, our hedging activities in
the largest possible liquidity pools with the most diversity of
other participants. That ensures we can get the best pricing
for the folks that we are investing on behalf of.
That means that it is important for us to have access to
CCPs, to clearinghouses, whether they are headquartered in
Chicago, Atlanta, New York, London, Paris, or Frankfurt. And
so, it is essential for our members that regulators work
together to use the tools of substitutive compliance,
deference, and equivalence to ensure that there is that access.
Taking to the extreme the concern with the EMIR 2.2
proposal is that it would require the relocation of certain
clearing activities, exclusively to a certain jurisdiction,
which would fragment that global liquidity pool that we all
benefit from operating in.
Mr. Maloney. I appreciate that.
Mr. Duffy, CME is certainly systemically important in the
U.S. ESMA seems to want to give you that designation in Europe.
Why do you think they want to do that?
Mr. Duffy. Well, as I said earlier, Congressman, I think it
is more of a regulatory grab, for lack of a better term. I
think they are looking to become the regulators for the world,
and when they want to deem a systemically important institution
like CME here in the United States and give us that same
designation in the EU, and as I said earlier, roughly less than
five percent of CME's products are euro-denominated. It is kind
of a stretch to say that we are a threat to the European
economy.
There is nothing else other than they want to have one set
of rules and they want the rest of the world to fit into their
rules, and as we have heard earlier, they were testifying here
in 2012 how that didn't work, but now all of a sudden, that is
the model they want to apply. They want to deem us systemically
important because of our designation here in the United States,
and that has no bearing whatsoever with what CME brings to the
European Union.
Mr. Maloney. Right. As a proponent of central clearing
believes it is one of the kind of wonders of the world, the
fact is, is that some of us are worried about clearinghouse
risk. What are the risks that we should be worried about today
in terms of your business?
Mr. Duffy. Well I mean, there is risk associated with
everything we do, Congressman, as you well know. I think what
we do is we are a neutral facilitator of risk management, so we
do not participate in the markets----
Mr. Maloney. Yes, I understand your business model, sir,
and I understand the role you play. What are the risks?
Mr. Duffy. Well, the risks are, if there is a major default
by more than two of the biggest counterparties in the business.
If you had two or three major banks go down at the same time,
that would be a risk not only to CME, but to the entire
financial system.
Mr. Maloney. And what would happen in that scenario? What
would----
Mr. Duffy. I don't even want to make a comment of what I
think could happen, sir, because I don't think it would be very
pretty.
Mr. Maloney. And would the European approach to this be
justified by those risk scenarios, or are those likely to be
outside of their purview?
Mr. Duffy. Well, if there, and I am referring to U.S.
entities. I am not referring to European entities.
Mr. Maloney. Right.
Mr. Duffy. I am referring to U.S., so I don't know what the
European entities would have any say in that matter whatsoever.
Mr. Maloney. It wouldn't support their position that there
might be systemic risk here? Even if we were concerned about
clearinghouse risk in the United States, would it support their
position in designating you systemically important?
Mr. Duffy. No.
Mr. Maloney. Right. I yield back, Mr. Chairman. Thanks.
The Chairman. Thank you very much, and now the gentleman
from Illinois, Mr. Bost. Thank you.
Mr. Bost. Thank you, Chairman.
Mr. Duffy, when you closed out your testimony, you
encouraged Congress and the CFTC to consider whether additional
regulatory and statutory tools might be useful or necessary. As
you know, the Committee right now, we are preparing to
reauthorize the Commission again this year.
That being said, as we do so, what remedies might--and I
think this is what the Chairman asked earlier and I would like
to get into that. What remedies might be effective to protect
U.S. markets and participants from ill effects of the EU's
overreach?
Mr. Duffy. Thank you, sir, and I think when you look at the
reauthorization process, you can definitely implement new tools
that the CFTC can have in their tool chest, as was referred to
by Mr. Edmonds. I think what the U.S. Congress can do is a lot
more aggressive than just on reauthorization putting in things
to the CFTC. I think the United States Congress, who does a lot
with the European Union on a whole host of issues, should put
this in their side of the ledger sheet, saying we need to make
sure this is fixed. We have other big issues as it relates
between the European Union and the United States. Let's deal
with them, but we also have this issue, and we are not going to
have duplicate regulation associated with our products by your
people. We are not doing it to you, so don't do it to us.
There is something that the Congress can take to the next
level, and I think that is exactly why, and I applaud the
Chairman for holding this hearing, because when the CFTC voted
yesterday unanimously in a bipartisan way, and I am hearing
nothing but bipartisan by this Committee, this is what the
Congress, I am hopeful, will continue to do and send a very
strong message to the European Union that we have a whole host
of issues we have to deal with outside of financial services
that we are dealing with you on, and that we are going to put
financial services and regulation in that bucket, so make sure
you get this accomplished.
Mr. Bost. Thank you. I am letting you know that this
Committee is really in agreement with you. We just want to make
sure we are positioned correctly.
Mr. Edmonds and Mr. Duffy and Mr. Maguire, now while all
your operations, all of you operate clearinghouses that welcome
participation from international clients, the mix of products
that you clear is a bit substantially different. Can you
describe those differences, as well as the differences in the
regulatory and international coordination for these products so
we know the difference?
Mr. Edmonds. Well, I think if we were going to describe the
differences in all of our products, we might need more than
this hearing allows today.
Mr. Bost. Probably more than 5 minutes, too, correct?
Mr. Edmonds. A little more than 5 minutes. I think I would
sum it up for you this way and I am happy to follow up with you
offline, if greater detail is needed.
From an ICE perspective, when we look around the globe, we
are not going to tell anyone how to trade, where to trade, or
what to trade at the end of the day. What we want is the
opportunity to earn your business when you make a decision to
trade. If you want to be in a certain regulatory jurisdiction,
we provide services in that. Some people do, others don't. My
colleagues up here who we compete with head-to-head on a daily
basis, they have slightly different philosophies from time to
time. But once you get at the philosophical level, you are
going to pick your jurisdiction as a customer. You are going to
understand exactly how you are going to manage the risk that is
most important to you and the business that you are running at
that time. We want to give you all the tools necessary to do it
within that jurisdiction. Slightly different perspective than
others have, both work, and that creates competition across the
marketplace, and ultimately benefits the consumer at the end of
the day for having that choice.
Mr. Maguire. If I may embellish, Congressman.
The LCH Group, I won't, again, give you the full plateau of
the products we clear and the differences, but our focus is
predominantly on interest rate swaps, which is really the
preeminent service that we clear and are responsible for.
The swaps market is very much a global market. It has
active participants globally for many different jurisdictions,
and these are tools, as I referred to earlier, that are used
for real economy hedging purposes. That is the product that we
have a material position in.
And that product is traded globally and is overseen
globally, so it is a slightly different fact pattern, different
sort of slightly unique organization in that regard. We have
oversight through direct registration in many different
jurisdictions, where we have worked through that over many,
many years. As I mentioned in my testimony, we have been a
registered DCO here in the states for 18 years. That is proven
through the test of time through Lehman Brothers, through MF
Global, the coordination not just at an operating level, but
between the regulatory supervisory authorities of CFTC and Bank
of England have operated well there.
We have a regulatory architecture that we sit within, which
is maybe not the architecture you would apply for some of the
futures markets. It is very much a global OTC market. I think
there is definitely a case here for different regulatory
architectures for different types of markets and different
types of products. That would be my main contribution.
Mr. Duffy. If I may, sir? CME Group is the largest exchange
in the world, and it lists all the major asset classes that
touch everyone's lives on a daily basis. To give you an example
of how important this is, CME Group had 44 percent of the
notional value of trade of the U.S. Treasury market 5 years
ago. Today, CME has 118 percent of the notional value of trade
of the U.S. debt market.
What does that mean? When you have inverted rates going on
right now, when you have the rates that are happening in
Germany and other parts of Europe, people are looking to invest
in certain types of issuance, such as U.S. debt products. They
are using CME to manage that risk. That is a very big deal for
European participants that participate in U.S. markets, which
as you know, helps benefit us by running our economy, by
selling our debt to them as well.
Mr. Bost. I want to just say thank you to all of you. My
time has expired. Thank you, Mr. Chairman. I yield back.
The Chairman. Thank you, and now the gentleman from Kansas,
Mr. Marshall.
Mr. Marshall. Thank you so much, Mr. Chairman. I think for
my first question I am going to go with Mr. Maguire.
Mr. Maguire, my farmers, my cattlemen, pork producers back
home use the derivatives market a lot, and I have talked to
hundreds of them. They say it is not broken. It is working
fine. This Committee and many of us individuals have tried to
understand the swaps and derivatives market, and I think it is
going along great.
When I study big picture analyses, I like to understand the
culture of what is happening. I am afraid the culture with the
European Union is going the wrong direction. I feel like maybe
they are being a bully. They won't let us do trade with
agriculture in the next trade agreement, and this is another
example, it feels like, of them pushing us around and taking
advantage of Brexit.
Tell me what is going on with the cultural relationship
with United States and the European Union through your eyes
sitting there in London?
Mr. Maguire. This could take longer than 4 minutes.
We have a unique position in the UK. We are exiting. We are
now going to become a third-country, much the same as the U.S.
I think it sort of really echoes some of the points that have
been raised already in that this seems to be an increasing--I
will use that phrase again, I don't use it lightly--that arms
race where there are different incentives or different
positions being taken maybe than there were historically.
Our position is that I think you need to take the
temperature down. I think there were views historically that
may be in the first instance when we had the legislation after
the crisis in the G20 committee in 2009, Dodd-Frank went first,
that sort of--the pendulum shifted one way and I think there is
a feeling now that Europe is shifting the pendulum the other
way. I think you need to bring things back to more of an
equilibrium where actually in the eventuality of this arms race
continues to escalate, what we are going to end up with is
fragmentation, which is going to be a bad impact for all.
There is really a need to take the temperature down. It is
hard for me to say as I am not involved in the U.S.-EU
negotiations and discussions directly. It would be wrong for me
to comment, but it does strike me that we need to sort of
deescalate rather than continue to escalate for the benefit of
the end-users that are involved here.
Mr. Marshall. Okay. Next question, as the dollar, the euro,
and the British pound is, they fluctuate in values. Does that
give anybody any heartburn as we make this transition, going
forward? Maybe I am worried about nothing.
Mr. Edmonds. There are always macroeconomic events at the
end of the day that impact volatility as it relates to currency
markets in any one of those sovereign nations that you make
reference to in your question. I don't know that anything and
what we are doing here is any different than what you see on a
daily basis. There could be individuals that have an opinion
and choose to express that opinion through risk management
tools and trading the products that any of us offer at that
moment in time, based on their opinion of where our market is
heading or isn't. But that is a moment in time decision they
will make and they will either profit from that or they will
lose.
Mr. Marshall. All right. I will go to Mr. Lukken next.
If a CCP is faced with two regulators that are unwilling to
defer to one another, is it possible that a foreign regulator,
such as in the European Union, could impose requirements not
for safety and soundness, but instead for competitive reasons?
What does that look like? How would they take advantage of us
on this, and how would it impact my farmers back home?
Mr. Lukken. Well, that is what we are really trying to
avoid here is that type of duplicative situation. There have
been situations in the past where two competing regulators have
been talking to clearinghouses--LCH has had examples of this in
the past--during systemic events, and thankfully during those
times one regulator deferred to the other and they were allowed
to do what was in the best interest of the clearinghouse.
These are the things that regulators need to work out now.
This is a level, it comes down to as much as we can paper this
with agreements, it comes down to trust. And for some reason
right now, there is a lack of trust between the Europeans and
the United States that we are trying to figure out how do we
get back to that level of cooperation that has existed for a
long period of time between our two jurisdictions.
Our hope is, and EMIR has the capability of, the Europeans
recognizing the 2016 equivalence agreement and agreeing to
defer to U.S. regulation. And I hope they take that common-
sense approach so that we avoid the situation that you are
talking about.
Mr. Marshall. Mr. Duffy, I just have a second left.
CME has been around a while, a great reputation. How do you
see this culturally, is this something new or just another
chapter of this relationship with the EU?
Mr. Duffy. I think it is a bit of another chapter, and we
have been around 175 years, so you are right, a long time.
I really believe people want to do the right thing, sir, to
be honest with you, and I think people understand that there is
a regulatory regime and it is not a one-size-fits-all, and we
can all get along together and operate in a global marketplace,
because that is truly what it is today. It is not a centric
marketplace. It has grown exponentially, and it has benefitted
everybody. I think when cooler heads prevail so the good people
that you represent will be able to sell their products
internationally without somebody maybe manipulating their
currency to avoid a tariff, things of that nature. Those are
all big, big issues that this Congress needs to address, but I
don't believe that the European Union is doing anything other
than when you look at what happened in 2010 with Dodd-Frank,
when you create new legislation, the pendulum always goes to a
certain way. And it did it in 2003 with Sarbanes-Oxley. It
doesn't make it wrong, because you can always walk it back. It
is hard to walk it forward.
What is going on right now is you are seeing the same thing
happening in Europe, and I think they are going for a little
bit of an overreach right now. And I think just alone with
Congress being involved, you can walk them back to where they
need to be.
Mr. Marshall. Great insight. Thank you.
Mr. Chairman, I yield back.
The Chairman. Thank you, and now we will hear from the
gentleman from Florida, Mr. Dunn.
Mr. Dunn. Thank you very much, Mr. Chairman.
I think we all see the problems in the risks in the
proposed EU regulations. I want to highlight several of those
problems.
Mr. Duffy, the EMIR 2.2 proposal does not provide ESMA with
oversight over European clearinghouses, rather, it defers
oversight to what they recognize as competent national
regulators in the EU member states. But that does make ESMA in
the space of clearinghouse oversight an international regulator
focus really only on the third-country clearinghouses. And
while that is strange enough, the proposal also envisions fees
on these third-country CCPs would cover the entire cost of this
activity. It means the CCP in the United States, for example,
would pay for the privilege of being regulated by a foreign
entity and pay handsomely indeed.
I believe that that is an egregiously bad infringement on
U.S. sovereignty, and you said earlier in your testimony, a
crime under U.S. law. If we are honest with ourselves, I think
this entire regulatory exercise is an attempt to punish the UK
for Brexit and to ensure that the punishment is so severe that
subsequent members will never attempt to leave the Union.
Because ESMA's proposal caps the fees on Tier 1 CCPs and
divides the cost of ESMA's clearinghouse budget between all the
Tier 2s, and they designate who is a Tier 2, does that not seem
to incentivize them to designate more CCPs as Tier 2 in order
to expand their staff, build their regulatory footprint, a sin
we frequently see in bureaucracies?
Mr. Duffy. Spot on, sir. I mean, that's all I can say is
spot on.
When you are talking about a proposal that doesn't even
charge the local entities for their own regulatory cost and
they want other parts of the world to pay for it for them that
are not even systemically important to that part of the Union
in order to do business, it doesn't pass the ha-ha test, as
they say in the business. I think you are spot on with the fee
issue, and it is really a shame what the European Union is
trying to do right now.
Mr. Dunn. Thank you very much.
Mr. Lukken, your testimony contains a chart detailing the
cross-border activity that occurs at several of the FIA's
membership. If I am reading correctly, it looks like the Eurex
has well over 50 percent of its transactions originating
outside its home jurisdiction.
I would like a sense from you, either now or in writing
later, of what those percentages represent in a dollar value,
and what percent of the overall business in the European CCPs
is dollar-denominated derivatives and futures originate in the
United States. Also, if we are threatening the concept of
equivalence between the United States and Europe, what does
that impact look like on European exchanges? And I ask that
because the U.S. is unlikely to cede regulatory authority to,
or sovereignty to, the EU, and in that case, are the EU
regulators really willing to walk away entirely from any access
to U.S. derivatives in the future? Are they willing to give up
all access to American markets for swaps and hedges? That looks
like that is what is on the table.
Mr. Lukken. No, it is exactly what we are trying to portray
in that chart is all of these global exchanges require, in
order to have the proper liquidity, to serve domestic markets,
they need foreign participation. And Eurex is one example where
they get a significant amount of their trades from outside of
Germany. A lot of it may be coming from the UK, a lot of it is
coming from the United States. But again, if any of these
proposals end up causing a loss of access to either Europe or
the United States, that harms everybody. And that is what we
are trying to say is we really need to be sensible about this.
Open markets benefit everybody. All boats rise.
Mr. Dunn. It hurts our ability to manage the risk, right?
Mr. Lukken. Absolutely, absolutely.
Mr. Dunn. My time is growing short, but I want to say that
I--it seems to me like there are no winners in failing to
provide equivalence where equivalence is clearly due. I believe
that the U.S. should us--and the Congress should use any
leverage necessary to ensure that we do not get stuck with a
raw deal.
In the meantime, I think Congress should request or even
demand that the European regulators come before Congress and
explain to us how this is going to work, and why we should
allow this regulatory invasion of the United States.
And with that, Mr. Chairman, I yield back.
The Chairman. Well certainly we appreciate that, and we
will move forthrightly on that. I agree with you. As a matter
of fact, the Ranking Member and I were just talking about the
next steps we need to take. But I assure you, there will be a
very strong and adequate response for this. We are not going to
put and make our financial service industry be turned into
second class citizens on the world financial stage. You can bet
that. Thank you, sir.
Now we will hear from Mr. Johnson.
Mr. Johnson. Thank you, Mr. Chairman, and I will have some
questions for Mr. Lukken.
I think picking up thematically on the lines of questioning
from Mr. Marshall and Mr. Dunn, and it seems as I have heard
everybody speak today, it seems as though we have a shared
understanding of the value of the 2016 equivalence agreement.
It seems we have a shared concern about EU efforts to pull back
or perhaps complicate that system of regulatory deference. And
I am surprised by that, because it seems as though the
fundamental landscape is the same as it was in 2016, save for
one thing, and that is a pretty substantial member default, and
I think a concerning response at a European CCP regulated under
the EMIR framework.
My first question for you, Mr. Lukken, FIA has a wide cross
section of market participants, including a number in Europe.
What were your thoughts or the thoughts of your company when
you saw this pretty substantial failure?
Mr. Lukken. Well, I think there was significant concern
among the entire industry, and a lot of soul searching even
among panelists up here on what went wrong during the NASDAQ
default. And as you mentioned, they appeared to be EMIR
compliant, that entity, and they are owned by the NASDAQ
Corporation, the holding company here in the United States. And
we did a review of that default and have recommendations.
NASDAQ, to its credit, has also done an internal--hired outside
consultants to help it identify what went wrong.
Even though you can be in regulatory compliance, that
doesn't absolve you from active risk management. I think these
clearinghouses can talk about this. Even though on paper you
may be compliant, there is an active daily risk management that
has to be carefully considered, and for whatever reason, the
NASDAQ had, especially as it gained new members, individual
members of the clearinghouse, may have let in more risk than
was appropriate. It was something concerning to us.
Mr. Johnson. And I certainly understand that it is hard to
be a perfect safety and soundness regulator, right? I mean,
there is risk inherent in the system. But as we said here today
talking about a potential pretty substantial shift of that
safety and soundness being evaluated in this country to being
evaluated in the EU, I have to be left with the question is
there any reason to believe they are any good at it? I mean, if
they miss the warning signs that led up to this again, a pretty
decent sized failure, should we doubt the prudence of the
European regulators?
Mr. Lukken. I think it is a very good question. Here is
ESMA deferring to the national competent authority of the
NASDAQ of Sweden in this situation, but not directly regulating
that CCP. That is the way the EU law is written, but I think it
does raise a question that if you are not regulating your own
CCPs, why should you be regulating outside CCPs? That is the
way the law is written, but I do think fundamentally,
philosophically it raises a good concern and question.
Mr. Johnson. Thank goodness we didn't have a serious
contagion problem in the wake of that. Were there components or
fact sets within this environment that kept the ripple impact
to the, I don't want to call it modest, but to the non-systemic
level that we had?
Mr. Lukken. Well, I would say that clearing worked, and one
of the reasons that G20 recommended clearing as a safety net
for our markets is it has several layers of its waterfall of
clearinghouses that ensure that a default does not have
contagion risk.
Unfortunately, it got pretty far down into the waterfall,
including into the guarantee fund. It took down about \2/3\ of
the guarantee fund. But it quickly recovered and members put
more money into the guarantee fund and clearing worked. That
doesn't mean we shouldn't use that example, though, to see what
the lessons learned might be, and we are in the midst of doing
that.
Mr. Johnson. My understanding is that it was in the third
tier of that waterfall you described. Had the entirety of that
default fund been exhausted, is there a fourth level to the
waterfall?
Mr. Lukken. CCPs have the ability to assess clearing
members, again, to replenish the guarantee fund, and certainly,
that would have occurred. This was not a major size clearing
organization like the ones here, and I think the clearing
members would have done so.
But still, I mean, if you extrapolate that to larger
clearinghouses, it is problematic and we want to make sure that
whatever problems existed there that we, as an industry, try to
address those things.
Mr. Johnson. Particularly if you have a couple of problems
happen during the same time period, you start to exhaust these
management mechanisms pretty quickly.
Thank you very much, Mr. Lukken. Thank you very much, Mr.
Chairman. I yield back.
The Chairman. Now we will hear from the gentleman from
Indiana, Mr. Baird, and I might mention, in case any of you
don't know, that the Ranking Member and I have decided we will
have just a short second round so we can come back and put some
final touches on this. If you want to hang around and have a
second series, you certainly can.
Mr. Baird, you are recognized.
Mr. Baird. Thank you, Mr. Chairman. I certainly appreciate
the comments from some of my colleagues about agriculture and
the livestock industry, and farmers and ranchers. Mr. Duffy, I
really appreciate you recognizing the importance of agriculture
in the CME.
But my question, Mr. Edmonds, deals with some background
for you. They held a hearing here on the clearinghouse recovery
and resolution last year. One thing we learned is that the
certainty about the rights and obligations of affected parties
and clarity about who is in control is essential to managing
the crisis and restoring order. In your testimony, you briefly
discussed the challenges of overlapping regulators during a
time of crisis. While no one expects a clearinghouse failure,
if there was a failure at a non-European Tier 2 CCP that was
not extended substitute compliance, is it clear exactly which
regulator would be in charge?
Mr. Edmonds. As we answer the question today, I think it is
difficult for us to say with absolute certainty who would be in
charge at that point in time. As Mr. Duffy said, if it were CME
Group that found itself in that, there would be problems with
the U.S. law here. I mean, certainly we have clearinghouse
operations around the world that we would also have local and
national regulators at the time having that concern at that
moment wanting to weigh in.
The one word that keeps coming up, and many of us have
touched on it here, really at the epicenter of the issue is
whether or not we are creating certainty. And the less
certainty we have or the more uncertainty we create, that is
where you begin to see all of the questions and the waterfall
of what you might determine bad things happening. Whether it is
inside the clearinghouse, there is a lack of certainty when
these things take place. Whether it is in the market, the lack
of certainty creates volatility. Sometimes that is good and it
means that people are on the right side of that. Other times if
it is overwhelming, like we saw in the financial crisis, of the
uncertainty, it is really bad for national economic policy or
international economic policy at the time.
I can't answer your question with absolute certainty if we
would at that time of stress. I think, as Mr. Lukken said, we
all want to avoid that. We are all committed to finding ways
through that, and if we weren't, we wouldn't be sitting here
today and wouldn't be taking the stances we do on the
international stage and attempt to drive to that certainty. The
worst thing that we can do is wake up and have a customer call
us on any one of our venues and say at a given moment in time,
what is the answer to this question and not be able to give
them a complete answer. And right now, I think as a whole until
some of the arms race as Mr. Maguire has articulated settles a
bit, we are faced with that issue of having an incomplete
answer.
Mr. Baird. Thank you. Anyone else care to comment on that
question?
Okay. My next question goes to Mr. Maguire. You are
registered with the CFTC, and the same as any U.S.-based
clearinghouse, and yet you are domiciled in the United Kingdom.
Can you describe to me how that relationship between LCH, the
CFTC, and the UK regulators works?
Mr. Maguire. Sure. Thank you for the question, Congressman.
I think the way I would describe it is simply it works
well. I think the relationships are, you need to think things
through, let's say, sunny day scenarios and rainy day
scenarios, and the sunny days business as usual, and there are
no major defaults or crises, and the rainy days are crises or
defaults such as Lehman or MF Global. And over the course of 18
years with those events, and also with the enactment of Dodd-
Frank and European regulation and other regulation around the
globe, we have always found a way between LCH with the Bank of
England, who is a primary regulator in the UK, and the CFTC,
who have oversight as well, to navigate through any of those
legal or regulatory texts, and always arrived at a sensible
outcome.
That has enabled us to be 100 percent compliant with all of
the DCO core principles here in the U.S. We are fully compliant
with the--and our clients benefit from the client asset
protection rules and Part 190 Bankruptcy Code here in the U.S.
We hold assets on shore.
It is a way to show that it is possible to navigate where
you are systemically important to a jurisdiction, which we
clearly are. In this case, it is possible to achieve it.
But, the main point I would say is that the key to that is
trust. The key to that is cooperation. The key to that is
deference between the regulators and constant communication and
transparency.
Mr. Baird. Thank you, and I am running out of time, so I
yield back, Mr. Chairman.
The Chairman. Thank you very much.
As I mentioned, the Ranking Member and I have a few more
questions, and you may as well, Mr. Baird.
But, let me get to the heart of the matter, and the heart
of the matter is, quite honestly, we have a problem here. There
is no getting around it. I think in each of your testimonies,
you pointed at that.
We want to try to find out what do we do about it? And
judging from what I am hearing and what we have heard, I can
assure you that we in this Committee, myself and Ranking
Member, are prepared to move on some action to very quickly and
decisively get a message to the European Union in a proper way.
And second, we need to devise a way in which we can use our
leverage to respond to this. We are the strongest, most
powerful, and fairest economy and financial system in the
world, and the European Union is really messing with the wrong
tiger here. And we need to get that message out, because if we
don't--for example, this whole EMIR situation is wrong in so
many ways.
First of all, setting up a way in which you all become or
we become what is affectionately called third countries. What
does all that mean? Why? And then Great Britain is thrown in
with that, and between the United States and Great Britain, we
are the two largest, most significant financial systems. And
they are operating in a very haphazard and dangerous way to
themselves. We need to get that out.
We also need to examine how we offer some form of
retaliation. Do we pull back our market to them? We have the
largest, so we have to think very seriously how we use our
leverage. I hope we don't have to go there, but we have to send
that message.
What I want to do with this period is to hear from each of
you in terms of what specifically you all would recommend that
we here in Congress do, and the incubator of this action will
be our Subcommittee, because this is our territory. We have an
excellent staff. The full bipartisanship of this Committee is
ready to spring into action quickly and decisively to do
something. What that something is, we need to discuss and come
to some decision very quickly on to what it is we need to do to
make sure that our financial system, our market participants
are not put at a disadvantage on the world stage at this time,
or at any time.
That is what I want to try to get to at this point, and may
I please start with you, Mr. Duffy, on what it is you think we
can do to address this problem with the European Union right
now?
Mr. Duffy. I appreciate that, Mr. Chairman, and as we have
been talking about, I think you have already done a lot more
than anybody else has done historically, just by holding this
hearing and giving the time and attention it so deserves. That
is greatly appreciated, and it is has been so bipartisan, as I
said earlier, that it is a very powerful message when the
United States Congress gets involved, not just the regulators.
I am very much appreciative of that, and I know the industry is
as well.
I want to go back to what one of your colleagues said
earlier, that the UK is the bully. I don't believe the UK is
the bully, nor is Mr. Maguire. I think Mr. Maguire and the UK
are in the same situation as the U.S. is right now. The EU is
trying to show their dominance throughout this process on the
Brexit, and that is part of what this hearing is about, and
they are using the U.S. as part of their leverage against the
UK. I don't believe they are the bully. As you said earlier, I
think they are a very powerful economy and they are going to
maintain that.
What Mr. Lukken said earlier is critically important, and I
hope to remind everybody of the statistics he gave: 70 percent
of the German bond is traded outside of Germany, and if you
really want to get to the heart of the matter, you get the
German authorities in here and ask them what they think they
are doing with their European counterparts in order to drive
this regulation. Because if you take the liquidity out of the
German bond, that will cripple their economy to a degree, and
if that liquidity going into that bond is coming out of the UK
and the U.S., which I believe a good chunk is coming out of the
U.S., and you limit that, that would be a very powerful
statement to limit that type of activity.
Now is that a good thing? Absolutely not, but if they are
going to go down this path, we have to also understand that we
can just as well by going through the Part 30 process.
The Chairman. Thank you very much.
Mr. Edmonds?
Mr. Edmonds. I think you have a multitude of options and
probably know, certainly better than I do, and maybe better
than the rest of us on the panel, of all the levers you have to
pull. I am going to talk to you a little bit about when you
pull those levers, whatever, how they are perceived on the
other side.
You have heard us all talk about certainty and anything
that you can do to increase certainty, I think, is an absolute
must, and you should find great favor in it when you are
drafting whatever response you deem is appropriate and
proportionate to make sure that it is promoting certainty.
I think you should promote equivalence. We have taken a
lead on this as a country. I don't know on the regulatory side;
I am not exactly sure of the benefit of us going in a different
direction than the leadership we have shown to date----
The Chairman. You did say equivalence?
Mr. Edmonds. Right. That is correct.
If we are providing a framework and supporting other
frameworks that provide that level of deference through the
equivalence process, and we are providing certainty along the
way, I think what you are doing is to the benefit for the
marketplace as a whole to be able to operate within a set of
rules in order to manage the businesses they have, no matter
where they are, from a hedge fund down to a farmer, and
everyone in between, that you want to get to that have a
crucial function to play within our market system as a whole.
The Chairman. Yes.
Mr. Edmonds. And then if you don't get what you are looking
for there, you have to be prepared to act. And those are the
levers that you are going to know better than we are exactly
what is best. This is not a binary decision that you are going
to make, whichever one. There are going to be other actions and
reactions to whatever you decide to do, and I think you have to
look at that holistically and you have a much better point of
view or vision of that than we are going to be able to see.
Because we are going to take your action and we are going to
have to react to it, whatever that is. And we are going to have
change parts of our business, whether it is in London, whether
it is in Chicago, or anywhere else here in the United States,
in order to continue to provide for our customers. That is our
job at the end of the day is to get through all of it at the
end of the day and give them some level that they can continue
to manage their business within the confines of that regulatory
framework.
Just to reiterate, the more that you can promote
equivalence, the more you can promote certainty from that
equivalence, and being that leader by example, I think we get
to a better place at the end of the day.
The Chairman. All right.
Mr. Maguire, yes?
Mr. Maguire. Thank you, Chairman. I want to make two
remarks to your request.
In the first, I just point to the long established and well
working relationship between both the U.S. and the UK financial
systems markets, and I would hold those up as the epitome of
something that works and works well, and it works well into,
repeating what I said earlier, sunny days and rainy days, good
times and bad times. I think it is important to lean on that
when we talk about how equivalence and deference can work
around the globe from financial markets. We have a model in
place between the UK authorities and the U.S. authorities for
overseeing the firm that I lead. It works well, and I think
that should be held up as a model and I think it should be used
as an artifact in explaining how things could and should work,
and do work.
I think the second remark I would make is that when we talk
around Tier 2, which has been referred to, slight technical
point in EMIR 2.2, right now things are in, let's say, an
ambiguous state. There is a full range of tools available to
the European authorities in the bucket of Tier 2, and it is
really expected to be a continuum of either Tier 2 heavy
oversight versus Tier 2 light oversight. But what is lacking
and what makes us all nervous and gives us that lack of
certainty and clarity that Mr. Edmonds refers to is there is no
definition or precision around that.
The sooner there is more precision and definition of what
Tier 2 means, what it means for each firm, what kind of
oversight that that could potentially mean, I think that could
very much help bring the temperature down here on how things
are looked at from the third countries.
But right now, absent that clarity and certainty, it is
difficult, and a key point being that that determination of
level 2 tiering is likely to commence towards the back end of
this year and into Q1 2020. The time, I would say, is opportune
to request that level of specificity and definition.
The Chairman. Okay, thank you.
Mr. Lukken?
Mr. Lukken. Thank you, Mr. Chairman.
I think the most powerful tool that this Committee has at
the moment is its oversight function; this hearing being a part
of that. There is an open comment period right now in Europe on
EMIR 2.2. I would be sending a letter to the ESMA agency and
with the record of this hearing as part of that comment period,
so they understand what the view of Congress is and the view of
the United States might be on this topic. You certainly have
the ability through your oversight to make sure that it is
clear that there will be collateral damage as a result of this
EMIR 2.2 if the United States is not recognized as part of that
regulation.
I do want to make clear though on one of the issues that
the Europeans have raised with us when we see them is that the
CFTC over time, and this dates back to Dodd-Frank, has laws and
regulations in place that regulate and require the registration
of foreign CCPs.
Now, the current Chairman has said he wants to walk that
back and he wants to propose something very soon that would put
in place a recognition regime like we are talking about.
Because of the transition to the new Chairman, that has not
occurred yet. But I would give this new Chairman some room,
some breathing room to try to negotiate with the Europeans to
get them to make the right choice.
It reminds me of my parents. They would tell me you have
two choices, choice one and the right choice. This Committee
can be very effective at making sure that they are making the
right choice on this and allowing the new Chairman to come in
and help us to get us to that place.
The Chairman. Now, you said a letter. What would be the
most emphatic points that we need to make within that letter,
and I think you also mentioned that we would send them this
hearing in and of itself.
Mr. Lukken. This is part of the public record, this hearing
here, and our testimony is part of the public record. They are
in the midst of a consultation, and just like any public
record, this is an important factor that should be a part of
their determination.
Whatever cover letter you would like to summarize the
hearing here, and your views that includes the entire record of
this hearing, I think, would be important.
The Chairman. And you are saying within the European Union,
who specifically, you mentioned the----
Mr. Lukken. ESMA is the agency that has an open
consultation period right now for this regulation.
The Chairman. All right. Good. Thank you.
Yes, Mr. Berger?
Mr. Berger. Thank you.
The U.S. has a robust framework for the regulation and
supervision of our clearinghouses, and that is what helps make
the U.S. markets the most deep liquid and efficient markets in
the world. And as market participants who are active on all the
clearinghouses that are represented here, MFA members don't
trust that blindly. We remain vigilant. We care about the
governance and risk management practices of all CCPs that we
participate on, and sometimes comment on those to even enhance
them further.
To pick up on the points that Mr. Lukken just made, where
we stand right now in the European process is they are
evaluating how they approach two decisions. One is how they
evaluate which foreign or non-EU CCPs they deem to be
systemically important, and then if they make that decision
that they are systemically important or Tier 2 CCP, then the
next step is how do they evaluate whether the framework in that
other jurisdiction is comparable. They call it comparable
compliance.
I suspect everyone up here will be weighing in with advice
on how they take those next steps in the process. EMIR 2.2 is
now a piece of legislation, but the implementing rules are
still under development. I still think there is ample
opportunity for our voices to be heard, and your leadership and
bringing attention to these important points will, I think,
help amplify the voices that are providing advice to ESMA as
they consider the next steps here.
The Chairman. Thank you, and now we will recognize and hear
from the Ranking Member, Mr. Scott.
Mr. Austin Scott of Georgia. Thank you, Mr. Chairman.
I want to go back again to some of the statements I made
earlier.
We share common interests and common values, and we need
each other. And while we need each other now for economic
growth, we will need each other more in the case of a financial
crisis in any one of the countries or regions that we are
talking about.
The best path forward to me is very clear, to take a couple
of steps back. Let's take a look at what Commissioner Giancarlo
or the new Commissioner of the CFTC would put out, and
hopefully, no additional steps would be necessary from this
Committee to achieve global harmonization.
But with that said, while I prefer to take a couple of
steps back and end up with that harmonization from the
regulatory agencies, if necessary, I stand prepared to move
forward with my colleague, Chairman Scott, as I believe the
full Agriculture Committee would be, if necessary, to make sure
that we achieve that global harmonization. But again, I do
believe the best path forward is to take a--everybody take a
couple steps back and recognize that we need each other.
We have talked about, and this gets to my question, we have
talked about the transactions, if you will, but one of the
things we haven't talked about much is the technology. And this
question is for you, Mr. Lukken, because you mentioned it
specifically with regard to FinTech and the R&D capabilities.
You talked about the emergence of the importance of the
emerging financial technology. You talked a little bit about
legislation that this Committee, including myself, has been
working on.
Can you speak to why it is so important that U.S.
regulators, and quite honestly, global regulators are able to
stay abreast of the latest financial technologies and keep up
with the capabilities, both for the U.S. and for foreign
regulators?
Mr. Lukken. FIA as a trade association oftentimes have
conferences, and we have oftentimes new innovators--we call it
Innovators Pavilion--where we ask for the latest technology
being developed. Oftentimes, it is on the private-sector
trading side, but oftentimes it is on the reg tech side. It is
giving us technology on how you surveil the markets, making
sure that traders aren't trading ahead or doing illegal
activity, or if risk is building up in the system. All these
CCPs around this table have private companies that are helping
them to manage the risk of their exchanges.
You have shown some leadership on this and have introduced
some legislation that would allow the CFTC to partner with
private-sector financial firms to allow them to utilize some of
this technology in a fair way, in a transparent way, currently,
the CFTC is not allowed because this would be an in-private
inurement to the CFTC, and governments can't receive gifts.
This would be an exception.
Right now, the Defense Department allows this sort of
partnership arrangement. A lot of the EU and the UK allows this
type of partnership arrangement. As a former Commissioner and
Chairman of the CFTC, having access to that kind of technology
would be tremendous in a way that will better the markets,
further the public interest.
We as an agency, or we as the FIA, certainly support this
initiative that you put forward.
Mr. Austin Scott of Georgia. And let me say as one of the
authors of the legislation, we recognize the word gift can be
misconstrued. If there is a way to change that definition to
relieve any concerns that some individual is actually receiving
something of monetary value, because that is clearly not the
intention of the legislation, then we are happy to work to find
the definitions that resolve any of those questions. But the
goal is simply to allow our regulators to see and work within
that technology so that they understand what is actually
happening in the technological side of the market and the
trades.
Thank you for your comments. Mr. Chairman, thank you for
your leadership on this. As I said, I think the best path
forward is a step back, but if necessary, I am perfectly
willing to work with you to push ahead with legislation.
With that, I yield the remainder of my time.
The Chairman. Thank you very much, Ranking Member. Oh, yes,
sir, Mr. Duffy.
Mr. Duffy. I am so sorry, but may I make a comment?
The Chairman. Sure.
Mr. Duffy. I would be remiss if I walked out of here
without making this comment, because I really feel passionate
about this.
I understand what the Ranking Member said about taking a
step back, and I understand what Mr. Lukken said about giving
the new Chairman an opportunity to deal with this issue. The
new Chairman has a lot on his plate, other than just dealing
with equivalence by running this government agency. I think
having the confidence of the United States Congress working
with him is a very powerful tool that he would embrace, and I
don't think he would shun it away.
I also want to talk a little bit about the timing. As you
know, the EMIR 2.2 has already been agreed upon by the European
Union. Also, I think it would be critically important for this
Congress to send a very strong message that you do not move
forward any further until our answers have been addressed and
our concerns have been recognized. Because I think when Mr.
Maguire referenced here, too, under EMIR 2.0, I don't know if
everybody realizes what that means. They are talking about
having the ability to set margins on products here in the
United States. You tell me what they know about the livestock
market that your colleagues talked about. You tell me what they
know about the risk management of these products and they are
going to set the margins that won't put the U.S. at risk.
They are also going to charge fees, as we discussed
earlier, to fund their own agencies. They are also going to
have the ability to fine CCPs up to 30 percent of their revenue
unilaterally, whatever they want to do. They also get to decide
the governance of these entities, which is in direct conflict
with Delaware law, as public companies. And as far as it goes
with the regulation by the U.S. on the EU or on the UK, we do
not regulate their base futures and options business. What Mr.
Lukken was referring to is swaps. We have a very light touch on
anything that relates to futures and options. They want to
regulate our entire business, not just what our government is
doing with them right now on the swap side.
There are some major differences here, and I applaud you
again, Mr. Chairman and this Committee, for taking this up.
Thank you for allowing me the time.
The Chairman. Thank you so very much.
And as we conclude, let me just say this. I feel very
strongly about this, and we are going to take the results of
this hearing and all of our remarks and concerns. We are going
to take it to the full Committee Chairman and Ranking Member,
Chairman Peterson and as well as Ranking Member Conaway, and I
am going to be pushing very hard to hopefully convince them
that we need to take a step. We need to send a message to the
European Union. I think the least we can do is follow your
recommendation, Mr. Lukken, that they make sure--we love C-
SPAN. It would be wonderful if they were watching this now
there, but we can work with C-SPAN to make sure they get the
full hearing.
It is not just me. It is not just our Committee, our
Subcommittee here. It is you. It is you all who are the ones
that have to make it work. You all are the ones that are being
put at a disadvantage. And when you are being put at a
disadvantage, the American people are being put at a
disadvantage. I am telling you, I feel it very insulting that
this EMIR 2.2 coming at this time, and they are going to take
away the regulation of our financial services industry from us
to them, and then charge you a fee for regulating them. This is
insulting. It is wrong, and we need to respond to it.
It is important that we respond as a full, bipartisan
Congress, so you can rest assured that your testimonies and the
results of this will be discussed and we will meet with the
full Committee. We will take it from that point. We will also
speak with the leadership of the full Congress, Speaker Pelosi,
as well as the Minority Leader, Mr. McCarthy, on that side, and
move forward.
This is an insult to the American people. It is an insult
to us. We are going to respond. We have an excellent staff that
has been taking copious notes, and we have the recording. We
will let you know that this meeting has not been in vain. The
ESMA will hear this voice that we spoke this morning. I can
assure you that certainly will be the first step.
And now with that, I want to thank everybody for coming----
Mr. Austin Scott of Georgia. Mr. Chairman, just in my
closing remark, I want to address what Mr. Duffy said and make
it clear. When I say the best path forward is to take a step
back, a step forward on EMIR 2.2 triggers what others have been
referring to as the arms race.
The Chairman. Yes.
Certainly, and Ranking Member, I want to thank you as well.
I mean, we have been fighting so many battles together. This is
just another one. We had to fight to get the emergency funding
down to our farmers. He and I have been at it, and now we are
fighting to protect our financial system on the world's stage.
With that, thank you all very much, and I may say, under
the Rules of the Committee, the record of today's hearing will
remain open for 10 calendar days to receive additional material
and supplementary written responses from the witnesses to any
questions posed by a Member.
This hearing of the Subcommittee on Commodity Exchanges,
Energy, and Credit is adjourned.
[Whereupon, at 12:13 p.m., the Subcommittee was adjourned.]
[Material submitted for inclusion in the record follows:]
Appendix
The listed material is being submitted as attachments to the
Committee on Agriculture of the United States House of Representatives
Consultation submission of ESMA's EMIR 2.2 proposal. The documents are
also retained in Committee file.
1. Duffy Ref. No. 01: Minutes of the Financial Stability Oversight
Council, July 18, 2012, https://www.treasury.gov/
initiatives/fsoc/Documents/July%2018
%20FSOC%20Meeting%20Minutes.pdf.
2. Duffy Ref. No. 02: Commission Implementing Decision (EU) 2016/377
of 15 March 2016 on the equivalence of the regulatory
framework of the United States of America for central
counterparties that are authorised and supervised by the
Commodity Futures Trading Commission to the requirements of
Regulation (EU) No 648/2012 of the European Parliament and
of the Council, March 15, 2016, https://eur-lex.europa.eu/
legal-content/EN/TXT/PDF/?uri=CELEX:32016D0377&from=EN.
3. Duffy Ref. No. 03: COM(2017) 331 final--Proposal for a Regulation
of the European Parliament and of the Council amending
Regulation (EU) No 1095/2010 establishing a European
Supervisory Authority (European Securities and Markets
Authority) and amending Regulation (EU) No 648/2012 as
regards the procedures and authorities involved for the
authorisation of CCPs and requirements for the recognition
of third-country CCPs, June 13, 2017, https://eur-
lex.europa.eu/resource.html?uri=cellar:80b1cafa-50fe-11e7-
a5ca-01aa75
ed71a1.0001.02/DOC_1&format=PDF.
4. Duffy Ref. No. 04: 7621/19--Interinstitutional File: 2017/0136
(COD), COM(2017) 331 final, Regulation of the European
Parliament and of the Council amending Regulation (EU) No
648/2012 as regards the procedures and authorities involved
for the authorisation of CCPs and requirements for the
recognition of third-country CCPs--Confirmation of the
final compromise text with a view to agreement, March 19,
2019, https://data.consilium.europa.eu/doc/document/ST-
7621-2019-ADD-1/en/pdf.
5. Duffy Ref. No. 05: ESMA, Consultation Paper, ESMA 70-151-2138,
Draft technical advice on criteria for tiering under
Article 25(2a) of EMIR2.2, May 28, 2019, https://
www.esma.europa.eu/sites/default/files/library/esma70-151-
2138_cp_ta_on_tiering_criteria.pdf.
6. Duffy Ref. No. 06: ESMA, Consultation Paper, ESMA 70-151-2179,
Technical Advice on Comparable Compliance under article 25a
of EMIR, May 28, 2019, https://www.esma.europa.eu/sites/
default/files/library/esma70-151-2179_
cp_ta_on_comparable_compliance.pdf.
7. Duffy Ref. No. 07: ESMA, Consultation Paper, ESMA 70-151-1663,
ESMA fees for Third-Country CCPs under EMIR 2.2, May 28,
2019, https://www.esma.europa.eu/sites/default/files/
library/esma70-151-1663_cp_on_
emir_2_2_ccp_fees.pdf.
8. Duffy Ref. No. 08: COM(2018) 796 final--Communication from the
Commission to the European Parliament, the European Council
(Euro Summit), the Council, the European Central Bank, the
European Economic and Social Committee and the Committee of
the Regions, Towards a stronger international role of the
euro, May 12, 2018, https://eur-lex.europa.eu/legal-
content/EN/TXT/PDF/?uri=CELEX:52018DC0796&from=en.
9. Edmonds Ref. No. 01: PR7342-16, CFTC Approves Substituted
Compliance Framework in Follow-up to the Recent Equivalence
Agreement between the US and the EU, March 16, 2016,
https://www.cftc.gov/PressRoom/PressReleases/pr7342-16.
Attachment 9a: Comparability Determination for the
European Union:
Dually-Registered Derivatives Clearing Organizations and
Central
Counterparties, Federal Register, March 22, 2016 pp.
15260-15272,
https://www.cftc.gov/idc/groups/public/
@lrfederalregister/documents/
file/2016-06261a.pdf.
Attachment 9b: Staff Letter, 16-26, No-Action Relief for
EU-Based Reg-
istered Derivatives Clearing Organizations that are
Authorized to Operate in
the European Union, from Certain Requirements under Part
22 and Part 39
of Commission Regulations, March 16, 2016, https://
www.cftc.gov/idc/
groups/public/@lrlettergeneral/documents/letter/16-
26.pdf.
Attachment 9c: Statement of CFTC Chairman Timothy Massad
regarding
Substituted Compliance Determination for the European
Union, March 16,
2016, https://www.cftc.gov/PressRoom/SpeechesTestimony/
massadstate
ment031616.
Attachment 9d: Statement of CFTC Commissioner J.
Christopher Giancarlo
Comparability Determination for the European Union:
Dually-Registered
Derivatives Clearing Organizations and Central
Counterparties, March 16,
2016, https://www.cftc.gov/PressRoom/SpeechesTestimony/
giancarlostate
ment031616.
10. Edmonds Ref. No. 02: PR7817-18, Chairman Giancarlo Releases
Cross-Border White Paper, October 1, 2018, https://
www.cftc.gov/PressRoom/PressReleases/7817-18.
Attachment 10a: Cross-Border Swaps Regulation Version
2.0: A Risk-Based
Approach with Deference to Comparable Non-U.S.
Regulation.
11. Maguire Ref. No. 01: European Commission, Brexit: European
Commission implements ``no-deal'' Contingency Action Plan
in specific sectors, December 19, 2018, http://europa.eu/
rapid/press-release_IP-18-6851_en.htm.
12. Maguire Ref. No. 02: European Securities and Markets Authority,
ESMA-71-99-1114--ESMA to recognise three UK CCPs in the
event of a no-deal Brexit, February 18, 2019, https://
www.esma.europa.eu/press-news/esma-news/esma-recognise-
three-UK-ccps-in-event-no-deal-brexit.
13. Maguire Ref. No. 03: LCH Member Update, Brexit Update: LCH
Limited Article 25 Recognition by ESMA under an Article 50
extension, April 5, 2019, https://www.lch.com/membership/
ltd-membership/ltd-member-updates/brexit-update-lch-
limited-article-25-recognition-0.
14. Maguire Ref. No. 04: International Organization of Securities
Commissions, FR07/2019, Market Fragmentation & Cross-border
Regulation, June 2019, https://www.iosco.org/library/
pubdocs/pdf/IOSCOPD629.pdf.
15. Maguire Ref. No. 05: Financial Stability Board, Implementation
and Effects of the G20 Financial Regulatory Reforms, 4th
Annual Report, November 28, 2018, https://www.fsb.org/2018/
11/implementation-and-effects-of-the-g20-financial-
regulatory-reforms-fourth-annual-report/.
16. Maguire Ref. No. 06: European Commission, European Commission
adopts equivalence decision for CCPs in USA, March 15,
2016, http://europa.eu/rapid/press-release_IP-16-
807_en.htm.
17. Maguire Ref. No. 07: Remarks by Jerome H. Powell, Member, Board
of Governors of the Federal Reserve System at The Federal
Reserve Bank of Chicago Symposium on Central Clearing,
Chicago, Illinois, Central Clearing and Liquidity, June 23,
2017, https://www.federalreserve.gov/newsevents/speech/
powell20170623a.htm.
18. Maguire Ref. No. 08: Lewis, Rebecca, John McPartland, Federal
Reserve Bank of Chicago, PDP-2017-02, Non-default loss
allocation at CCPs, April 2017, https://www.chicagofed.org/
/media/publications/policy-discussion-papers/2017/pdp-
2017-02-pdf.pdf
19. Maguire Ref. No. 09: International Swaps and Derivatives
Association, The Case for CCP Supervisory Cooperation,
April 2018, https://www.isda.org/2018/04/18/the-case-for-
ccp-supervisory-cooperation/.
20. Maguire Ref. No. 10: Futures Industry Association, FIA Global:
CCP Risk Position Paper, April 2015, https://fia.org/sites/
default/files/content_attachments/
FIAGLOBAL_CCP_RISK_POSITION_PAPER.pdf.
21. Maguire Ref. No. 11: Keynote Remarks of Chairman Timothy Massad
at SEFCON VII, January 18, 2017, https://www.cftc.gov/
PressRoom/SpeechesTestimony/opamassad-55.
Attachment 21a: Accomplishments of the Commodity Futures
Trading Com-
mission, June 2014-January 2017, January 18, 2017,
https://
www.cftc.gov/idc/groups/public/@newsroom/documents/file/
massadaccom
plishments0614_1216.pdf.
22. Maguire Ref. No. 12: U.S. Department of the Treasury, A
Financial System That Creates Economic Opportunities
Capital Markets-Capital Markets, October 2017, https://
www.treasury.gov/press-center/press-releases/documents/a-
financial-system-capital-markets-final-final.pdf.
23. Lukken Ref. No. 01: Comment Letter, March 18, 2019, Jacqueline
H. Mesa, COO and SVP, Global Advocacy, FIA, Re:
Standardized Approach for Calculating the Exposure Amount
of Derivative Contracts, https://fia.org/file/8709/
download?token=R_6EtxRk.
24. Lukken Ref. No. 02: \1\ Futures Industry Association, Mitigating
the Risk of Market Fragmentation, March 2019, https://
fia.org/sites/default/files/FIA_WP_MItigating%20Risk.pdf.
---------------------------------------------------------------------------
\1\ Note: this report is attached following the prepared statement
of Mr. Lukken, see p. 29.
25. Lukken Ref. No. 03: Financial Stability Board, FSB Report on
Market Fragmentation, June 4, 2019, https://www.fsb.org/wp-
---------------------------------------------------------------------------
content/uploads/P040619-2.pdf.
26. Lukken Ref. No. 04: \2\ Testimony of Chairman J. Christopher
Giancarlo Before the House Committee on Agriculture
Subcommittee on Commodity Exchanges, Energy and Credit,
Washington, D.C., May 1, 2019, https://www.cftc.gov/
PressRoom/SpeechesTestimony/opagiancarlo70.
---------------------------------------------------------------------------
\2\ This is the press release issued by the CFTC posting Chairman
Giancarlo's prepared statement. In the case of this submission,
attached is the actual hearing: The State of the Commodity Futures
Trading Commission, held on May 1, 2019 by the Commodity Exchanges,
Energy, and Credit Subcommittee.
27. Berger Ref. No. 01: Committee on Economic and Monetary Affairs,
A8-0190/2018, Authorisation of CCPs and recognition of
third-country CCPs, Amendments By the European Parliament
to the Commission proposal Regulation (EU) 2019/ . . . of
the European Parliament and of the Council of . . ., April
10, 2019, http://www.europarl.europa.eu/doceo/document/A-8-
---------------------------------------------------------------------------
2018-0190-AM-002-002_EN.pdf.
28. Berger Ref. No. 02: Comment Letter: May 10, 2019, Laura Harper
Powell, Associate General Counsel, Managed Funds
Association, Re: Global Markets Advisory Committee, https:/
/www.managedfunds.org/wp-content/uploads/2019/05/MFA-
Letter-on-CFTC-GMAC-Meeting-on-April-15-2019-Final.pdf.
29. Berger Ref. No. 03: Comment Letter: March 15, 2019, Laura Harper
Powell, Associate General Counsel, Managed Funds
Association, Re: Swap Execution Facilities and the Trade
Execution Requirement (RIN Number 3038-AE25), https://
www.managedfunds.org/wp-content/uploads/2019/03/MFA-
Comment-Letter-on-CFTC-SEF-Proposed-Rule-Final.pdf.
30. Berger Ref. No. 04: Bank for International Settlements, BCBS/
IOSCO statement on the final implementation phases of the
Margin requirements for non-centrally cleared derivatives,
March 5, 2019, https://www.bis.org/press/p190305a.htm.
31. Berger Ref. No. 05: Comment Letter: November 15, 2018, Richard
H. Baker, President and CEO; and Jennifer W. Han, Associate
General Counsel, Re: A Proposal for a Harmonized Primary
Regulator Approach to SEC and CFTC Regulation of Dual
Registrants, https://www.managedfunds.org/wp-content/
uploads/2018/11/MFA-Proposal-for-Dual-
Registrants.final_.11.15.
18.pdf.
[all]