On 14 May 2013, CFTC Commissioner Scott D O’Malia gave the keynote speech to the Energy Risk USA 2013 Conference. The speech makes interesting reading in that it amounts to the CFTC marking its own scorecard in terms of its response to the challenges presented by Dodd-Frank Act.
Rules and the Rulemaking Process
On the subject of rules and the rulemaking process, Commissioner O’Malia recognised a general failure to listen on the part of the CFTC as well as a need to work with foreign regulators to co-ordinate approaches to cross-border regulation of the derivatives markets. With almost two-thirds of the CFTC’s Dodd-Frank rulemaking now complete there was an acknowledgement that, unfortunately, a number of rules are “either unworkable or simply make no sense”. In turn, this had led to the issuance of approximately 90 exemptions documented in no-action letters. Unfortunately, many of the no-action letters contain “complicated and needless restrictions” for those seeking relief, the end result being that the industry is unable to rely on the CFTC’s regulations to determine their compliance obligations. There was a recognition that, in the longer term, the CFTC will have to revisit these rules and amend where necessary.
Commissioner O’Malia linked the CFTC’s inconsistent rulemaking to three unexpected market developments (dubbed “unknown unknowns”), being:
- futurisation: which came about as a result of the rules CFTC’s margin calculation rules for swaps and its complex swap dealer rule which combined to drive energy market participants away from swaps towards futures;
- SEFs: specifically, the need to provide for an efficient and clear registration process that allows for various execution methods; and
- the Volcker Rule: the main issues in relation to which remain unresolved 18 months after the rule was initially proposed.
Commissioner O’Malia recognised that the CFTC could and should have done more to protect end users. In particular, the definition of “hedging activity”, as applied to the swap dealer rule, makes it difficult for market participants to determine whether they are required to register with the CFTC. In addition, the definition of “Special Entity” has forced Special Entities to trade with large Wall Street banks since no other entity is willing to trade with them for fear of becoming a swap dealer, with the net result being that risk for these entities is now concentrated in fewer market participants. Similarly, whilst end users are not required to post margin, capital rules do have an impact as bank counterparties are required to apply this charge to all uncleared swap positions.
There was an acknowledgment that the CFTC is struggling to understand and monitor the large amount of additional data required to be submitted to it under the Dodd-Frank Act. In particular, Commissioner O’Malia admitted that they are yet to master the identification of trading patterns such as would have identified the London Whale, but are working to address this problem.