The CFTC Office of the Inspector General ("OIG") issued a report criticizing the CFTC's cost-benefit consideration of the M argin Rule for uncleared swaps. In the report, the OIG argued that the cost-benefit analysis failed to consider the following potential effects of the Margin Rule: (i) the reduction of market liquidity, (ii) the exacerbation of systemic risk induced by market stress, and (iii) the transfer of risk to other markets, resulting in increased systemic risk.
The OIG claimed that the Margin Rule may have certain beneficial effects, but the complexity of the financial markets necessitates a more comprehensive economic analysis of the rule:
"Our intent is not to pass judgment on the wisdom of the Margin Rule itself, but to emphasize how the Rule, and the public's understanding of the Rule, might have profited from a thorough cost-benefit analysis grounded in economics. . . . While we do not doubt that margin can act as a prophylactic against certain sources of systemic risk, it is conceivable that the Margin Rule will not have nearly as great a risk-reducing effect as expected, or will impose greater costs than anticipated, due to the complexity of financial markets and the behavioral responses of market participants. Moreover, it is possible that the Margin Rule will have unintended consequences that exacerbate or create other sources of systemic risk."
The OIG recommended a reevaluation of the Margin Rule, and argued that the CFTC must make an effort to "identify unintended consequences and strive to quantify costs and benefits." The OIG urged the CFTC to overhaul its data infrastructure in order to foster a more robust understanding of the market. In turn, the OIG claimed, the CFTC would be able to predict the potential effects of policy decisions more accurately. Additionally, the OIG suggested that the CFTC utilize the Office of the Chief Economist to provide ongoing market research that would contribute to the CFTC's understanding of regulated markets.
Commentary / Bob Zwirb
Perhaps the most important point made by the Inspector General in his call for a more "thorough consideration of costs and benefits based on rigorous economic analysis" is his explanation of why it matters. As the Inspector General explains, "[t]he public deserves robust economic analysis that determines whether the costs borne by society are outweighed by the actual benefits that will materialize, not the purported benefits intended by the rule-makers." That is, "[a] well-done cost-benefit analysis presents, for the benefit of the public, Congress, market participants, and the CFTC itself, evidence and discussion of the market failure, the reasoning justifying the regulation, and the likelihood the regulation will benefit the market sufficiently to outweigh the costs imposed on market participants." This undoubtedly underlies, for example, the Second Circuit's insistence that a regulatory agency "determine as best it can the economic implications" of a proposed rule. Chamber of Commerce v. SEC, 412 F.3d 133, 143 (D.C. Cir. 2005).
In the context of Dodd-Frank rulemaking, one can argue that even more is at stake. Simply referring to the 2007-2008 financial crisis as justification for a proposed rule and asserting without scrutiny that a proposed rule will reduce systemic risk, as CFTC often does, and as it is doing here in the view of the Inspector General, increases the risk that other risks (such as the pro-cyclical effects of margin requirements and the possibility that the Margin Rule could exacerbate systemic risk in times of market stress) will be "systematically ignored or underestimated."
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