Outgoing CFTC Chair J. Christopher Giancarlo defended the approach taken by global regulators to mitigate risk in derivatives markets.

In remarks before the FIA Law and Compliance Division Conference, Mr. Giancarlo outlined the CFTC's initiatives, which include:

  • establishing protocols to respond to the "highly unlikely" failure of a systemically important clearinghouse, pursuant to the FDIC's Orderly Liquidation Authority under Dodd-Frank;
  • engaging in cross-border regulatory discussions concerning common problems and oversight for clearinghouse resolution in the U.S. and UK; and
  • cooperating with domestic, bilateral and international regulators, specifically on the international standard-setting work of CCP (i.e., "Central Counterparty Clearing") Resolution at the Financial Stability Board.

Mr. Giancarlo stated that The New York Times and the Systemic Risk Council ("SRC") were "ill-informed" concerning claims that, among other things, global regulators have not adequately prepared for clearinghouse failures. Mr. Giancarlo declared that regulators are aware of, and prepared for, clearinghouse failures.

Mr. Giancarlo focused on the SRC's criticism, particularly the suggestion that CCP resolution was the only meaningful action that has been taken. Mr. Giancarlo stated that regulators have already met a number of the SRC's demands in the past five years, including (i) a "set of high-level principles that will guide [FSB's] approach to CCP resolution," and (ii) recovery arrangements that allocate any uncovered credit loss.

Further, Mr. Giancarlo criticized the SRC's recommendations as lacking clarity and encouraging regulatory overreach. Mr. Giancarlo stated that the SRC does not explain several claims, including how recovery tools mentioned in CPMI-IOSCO guidance and self-liquidation would create systemic risk. Mr. Giancarlo also stated that several recommendations are "unprecedented and unexplored" and may "engender unintended consequences." Specifically, he cited the SRC's urging that CCPs be required to (i) issue debt that "they do not need," and (ii) join in a mutualized international CCP-default fund invested in the Bank for International Settlements.

Mr. Giancarlo noted that, instead of the SRC's recommendations, the CFTC would pursue other initiatives, including:

  • enhancing qualitative derivatives clearing organization (DCO) examination capabilities and quantitative analysis abilities;
  • assessing the resiliency of the client clearing industry as a whole;
  • developing a "more sophisticated" monitoring system for the cleared derivatives industry;
  • expanding its risk analysis scope to include both cleared and uncleared swaps; and
  • creating an overview of the interconnectedness of regulated derivatives markets to the "broader financial system" to better study risk transmission.

Declaring that the CFTC's regulatory framework "provides multiple and overlapping layers of support for CCP resilience," Mr. Giancarlo expressed confidence that the framework will enable DCOs to survive losses of any size.

Commentary / Bob Zwirb

Chair Giancarlo paints a positive picture of both the clearing mandate and the regulatory system's ability to handle the risks associated with it. However, it might be more prudent to take "a more nuanced view of . . . clearing that recognizes its limits," as former Goldman Sachs CEO Gary Cohn puts it. (Gary Cohn, Clearing houses reduce risk, they do not eliminate it, Financial Times, June 22, 2015.) For CCPs, as Mr. Cohn also observes, can become "centres of risk, amplifying problems instead of alleviating them." Id.

Moreover, notwithstanding the impressive array of risk management tools that CCPs and regulators have at their disposal (some of which are a result of Dodd-Frank), one should not be too sanguine. The decision to require central clearing of swaps, as Fed Chairman Jerome Powell points out, has "raised the stakes" for everyone, including CCPs, clearing members, regulators, and the general public. And while CCPs made it through the 2008 financial crisis without direct government assistance, many of their major clearing members did not, as Mr. Powell also notes.

For a less bullish take on all this, see Hester Peirce, Derivatives Clearinghouses: Clearing the Way to Failure, 64 Clev. St. L. Rev. 589 (2016) or Craig Pirrong, A Bill of Goods: Central Counterparties and Systemic Risk, 2 J. Fin. Mkt. Infrastructures 55 (2014).

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