By Jill E Sommers
I am sure that by now many of you are familiar with the broad framework for regulatory reform announced by the U.S. Secretary of the Treasury, Timothy Geithner, dealing specifically with recommendations for establishing a comprehensive regulatory framework for OTC derivatives. In Congressional testimony last week, Chairman Gensler voiced his full support for Secretary Geithner’s proposals and provided more detail regarding his vision of what the regulatory regime should include.

Specifically, Chairman Gensler committed to working with the Congress and the CFTC to bring more transparency to the markets by comprehensively regulating both derivative dealers and the markets in which derivative dealers trade. This regulatory regime would subject OTC derivatives dealers to conservative capital requirements, initial margin requirements, business conduct rules and recordkeeping and reporting requirements.
In addition, derivative markets would be regulated, based on the following four principles:

1. Require all standardized OTC products to be cleared through regulated clearinghouses;

2. Move standardized portions of these markets onto regulated exchanges and regulated transparent electronic trading systems;

3. Develop a system for reporting and disseminating OTC prices and other OTC trade information; and

4. Require all OTC transactions, both standardized and non-standardized, to be reported to a regulated trade repository, make aggregate data on open positions available to the public, and data on individual trades and positions available to the CFTC and other regulators on a confidential basis.

Chairman Gensler also called for clear CFTC authority to police fraud, manipulation and excessive speculation in the OTC space and for the need to establish position limits. In order to prevent traders from avoiding position limits by moving to a related exchange or market, he recommended that the agency be given the power to set limits on OTC positions and that limits be aggregated across all markets and trading platforms, including foreign exchanges that have received no-action relief from the CFTC to offer look-alike contracts to U.S. customers. He urged, moreover, that Congress give the CFTC clear authority to promulgate rules governing foreign boards of trade doing business in the U.S.
Enter Currency Trading Contest now. Win $ 25,000

By anyone’s measure this is an ambitious agenda. And our policy initiatives are complicated by the fact that much of it will require amendments to the Commodity Exchange Act (CEA) and other laws. In addition, we will need to resolve thorny questions such as:
-how to define standardized derivatives;
-which regulator or regulators should oversee trade repositories;
-how in practice can position limits across all markets be aggregated and enforced; and
should clearing facilities for OTC derivatives be able to choose their regulator, similar to the model developed for credit default swaps, and if so, how do we ensure that uniform standards are applied across the board, to name just a few.

I don’t like to predict how any legislative process might unfold, but given the complexity of the issues it seems likely that ironing out the details will take time. I look forward to working with Chairman Gensler, my fellow Commissioners, and other decision makers as we move forward.

In the meantime, despite the absence of a confirmed chairman, we have not been standing still at the CFTC. To the contrary, our staff has worked many long hours over the past year to help the Commission resolve some long standing issues and to propose new initiatives to strengthen the regulatory structure. I’d like to mention just a few of these projects that may be of interest to you.

In January of this year the Commission amended its no-action policy for foreign boards of trade that permit direct access by U.S. customers to close what’s been referred to as the “London loophole.” Under the Commission’s new policy, foreign exchanges that list contracts linked to contracts listed on U.S. exchanges must adopt speculative position limits or accountability rules comparable to those of the linked U.S. exchange; identify traders with positions above the limit and whether they were granted a hedge exemption and if not, whether disciplinary action was taken; publish daily trading information on volume, open interest, settlement prices and opening and closing ranges; and provide the CFTC with a daily report of large trader positions in each linked contract for all contract months.

The only foreign exchange currently affected by the new policy is ICE Futures Europe, which lists a WTI crude oil contract linked to the contract listed on the New York Mercantile Exchange. As I mentioned earlier, Chairman Gensler has stated that he is in favor of statutory authority that would allow the Commission to formalize this policy through rulemaking, and I expect that this is something that will be considered in any legislation that is formulated by Congress.

  Continued...