United States: CFTC Chair Giancarlo Urges SEF Reform And Improved Stress Testing Of CCPs

CFTC Chair J. Christopher Giancarlo encouraged (i) reforming the rules recently adopted for regulating swap execution facilities ("SEFs") and (ii) engaging in collaborative efforts with other regulators to improve the stress testing of central counterparties ("CCPs").

In remarks before the ISDA Regulators and Industry Forum in Singapore, Chair Giancarlo expressed his support of the swap market reforms adopted by Congress in 2010, but criticized the CFTC's prior rulemakings. He stated:

Regarding rules governing the operation of SEFs, Chair Giancarlo criticized the CFTC for "attempt[ing] to re-engineer the entire market structure of swaps execution" and "dictat[ing] the business models of the SEFs themselves." Chair Giancarlo claimed that this approach is not conducive to liquidity formation. He asserted that the regulatory framework and incongruous rules and regulations have had several "unintended" consequences, including a shift of swaps price discovery and liquidity formation from SEFs to introducing brokers. This shift, Chair Giancarlo argued, is antithetical to the intended purpose of swaps regulations and the goals of Dodd-Frank.

Chair Giancarlo criticized the CFTC's role in not allowing SEFs to develop their own business models and in implementing "prescriptive and inflexible rules."

Regarding swaps clearing, Chair Giancarlo explained that default risk is now managed within regulated CCPs. He emphasized the importance of the stress testing recently conducted by the CFTC in measuring the resiliency of CCPs. Recent results demonstrated the ability of three major CCPs to withstand simultaneous default of two significant clearing members, he said. Further, Chair Giancarlo promised the continued development of multi-CCP stress testing in order to create a framework that is "thorough, data driven, econometrically sound and reflective of multi-CCP operations and their role in dynamic market ecosystems." He encouraged cooperation with the SEC and banking regulators in order to improve upon previous stress tests, and expressed confidence that collaborative efforts will continue to develop over the course of the next year. Chair Giancarlo also noted that he is open to receiving stress testing-related input from European regulators, but reiterated his opposition to European Union proposals that would subject certain U.S. CCPs to European oversight.

Commentary / Steven Lofchie

Chair Giancarlo's remarks are a blunt criticism of prior rulemakings. Mr. Giancarlo has been consistent in arguing that, while the government should regulate markets, it should not dictate or reinvent market structures (and, if it is so ambitious as to do so, it should at least check whether its dictates are having the intended effect). Notwithstanding this criticism of prior rulemakings, the Chair has nothing but good things to say about Dodd-Frank. Even those who do not share this optimism are hoping that he is able to make a silk purse from a sow's ear.

Those who have a view as to how the swaps markets should function should be seeking this opportunity to get their views in front of the CFTC. While some of the major market participants have already expressed their thoughts through the CFTC's "KISS" project, the fix of the CFTC's existing rules will take a good bit of time, and there is thus still opportunity for diverse views to be heard. Further, given that the existing CFTC rules did not draw support from either the buy side or the sell side, it is hard to imagine that there is much support for the status quo.

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