Today, the House Agriculture Committee held a hearing to assess the progress of global derivatives reforms since the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law five years ago. Dodd-Frank imposed sweeping new regulations over the financial industry, including the regulation of swaps under Title VII, which had previously not been regulated in the U.S.
Remarks by Rep. K. Michael Conaway to the Second Annual Swap Execution Facility Conference
Tamara Hinton, 202.225.0184
As prepared for delivery
Thank you for that kind introduction. And thank you all for being here.
As you just heard in my introduction, I am a CPA by profession, but I have also spent a number of years as the Chief Financial Officer for a small community bank in Midland, Texas.
Consequently, I have spent a lot of time doing some of the things you and your clients do every day - crunching numbers, balancing income and expenses, and most importantly, managing financial risks. This experience has taught me that it is as important to Main Street as it is to Wall Street that the markets that you operate in work and work well.
The ability to transfer risk and mitigate uncertainty has unlocked a tremendous amount of capital for businesses across our nation.
My biggest focus as we work on implementing Dodd-Frank is that we do not harm the ability of market participants to utilize these financial tools. That is why I was pleased to be invited to this conference. I appreciate that this event brings together legislators, regulators, and market participants to have meaningful discussions about what this financial reform should look like. I hope that these are productive discussions.
The Dodd-Frank regulations have been developed quickly and it is essential for legislators and regulators to take the time to listen to what market participants like you are saying.
In turn, I hope I can give you a clearer idea of how my colleagues and I plan to bring some balance to the regulations that are being developed.
When Congress passed Dodd-Frank, the goal was to prevent the widespread, systemic risk that contributed to the financial meltdown, in part by bringing needed transparency to the derivatives markets. Our financial system will benefit from greater transparency and a sound regulatory framework. But it is imperative that we do not sacrifice flexibility as we develop that framework.
Healthy markets are both safe and dynamic. Our regulators must walk a fine line between the safety offered by transparency and regulation, and the dynamism found in liquidity and innovative products. We need to strike an appropriate balance between transparency and liquidity, and regulation and innovation.
I am concerned that many of the proposed Dodd-Frank regulations have swung out of balance and create a false choice between the Commission’s proposals and unhealthy markets. I do not want to see us stifle economic growth because of overregulation.
To that end, I would like to take this opportunity to discuss four actions that I think are critical to the implementation of Dodd-Frank:
- Preparing a proper cost-benefit analysis for each proposed regulation.
- Reducing the uncertainty created by the unknown timing and broad scope of the regulations.
- Preserving flexibility in the new regulations to promote continued innovation and market growth.
- Understanding the implications of global regulatory reform to our financial sector’s international competiveness.
I will also offer some insight into the Agriculture Committee’s coming agenda.
Our first priority must be a commitment to comprehensive economic analysis.
Throughout the rulemaking process the Commodity Futures Trading Commission (CFTC) has never truly tried to estimate the cost of complying with each new rule. When costs were considered - which was infrequently - they were described vaguely, with subjective statements like, “costs could be significant.” Other times, they were woefully underestimated. In one example, cost estimates conducted by an affected market participant were 63 times greater than those estimated by the CFTC.
The new derivatives regulations will have an unparalleled impact on our nation. Every sector of our economy will be affected by them, so it is important that we get them right. It is irresponsible to continue developing new regulations without a clear knowledge of their likely effects.
Now, more than ever, the federal government needs to be accountable so these new regulations will not create any new barriers to job growth and economic recovery.
Last spring, I asked the CFTC Inspector General (IG) to investigate the Agency’s cost benefit analysis process associated with the Dodd-Frank rulemaking. Unfortunately, the IG confirmed our concerns – the CFTC is taking a check-the-box approach to economic analysis.
Thousands of financial and non-financial entities now find themselves subject to CFTC oversight. Not only has the CFTC failed to meet is statutory requirement to conduct cost-benefit analysis, but the statute itself is outdated in light of the CFTC’s expansive new authority.
I have introduced legislation that significantly raises the standard of economic analysis the CFTC is required to perform. This analysis is the next best thing to putting regulators in the shoes of the business owners they govern. It will force them to consider each regulation’s potential impact on growth and job creation. This legislation will be central to the Ag Committee’s efforts to improve the CFTC’s regulatory process.
Second, we must work to untangle the confusion surrounding the timing and the scope of the new regulations.
In the past, the CFTC has averaged only a handful of new regulations per year. This year alone, we have seen more than 50 proposed rules related to Dodd-Frank.
We have asked the regulators to slow their pace, instead of rushing to meet arbitrary deadlines. Thankfully, the CFTC has heeded our requests and delayed some of the rules effective dates for six months.
Unfortunately, though they have slowed down, the CFTC’s transition to final rule proposals has brought no greater order or logic to the rulemaking schedule. Ignoring calls from Congress and its own Commissioners, the CFTC has yet to publish a timeline or implementation schedule to give market participants the clarity necessary to begin building the systems and infrastructure needed to comply with the new regulatory regime.
While the CFTC has issued 17 final rules, they have not finalized the rules that define the very building blocks of Title VII – what constitutes a swap and who are swap dealers. The way those terms are defined will have a significant impact on businesses across the country.
The CFTC’s proposed swap-dealer definition is overly broad. It includes vague terms that have created significant uncertainty for hundreds of businesses. Organizations that have never been considered swap dealers may now be swept into this new definition. These entities range from electric utilities in Texas, to dairy cooperatives in New York, to the smallest community banks throughout the country.
Coupling uncertainty regarding their own regulatory status with the lack of a public implementation schedule means many of these businesses are in a holding pattern that is bad for job creation and worse for the economy.
The scope of the proposed regulations is an issue the Agriculture Committee will be addressing in the coming weeks.
The third action we ought to take is to reexamine the inflexibility of some of the proposed rules. The CFTC is overreaching in its interpretation of the law, to the detriment of market innovation and liquidity.
Congress writes laws that provide legal certainty and expresses our intent, acknowledging that we often do not have the expertise to write detailed regulations. Regulators are charged with implementing the laws according to both the statutes and the intent behind the legislation.
I am concerned that the Commission is not considering Congressional intent. For instance, Congress intended for the regulators to provide flexibility in the form and evolution of Swap Execution Facilities (SEFs).
Historically, the CFTC has not been a prescriptive, rules based agency. This approach has served the futures markets well, both with regard to innovation and stability. However, instead of continuing that precedent, the CFTC has proposed to limit the effectiveness of SEF’s through overly prescriptive proposals.
Congress was clear that SEF’s should permit multiple market participants to trade by accepting bids and offers by multiple market participants. Congress did not intend for the CFTC to limit the mode or method by which a SEF meets those requirements.
Requiring a SEF to look like an exchange, or otherwise limiting their ability to accommodate differences in markets will undermine the very transparency and liquidity that Congress intended SEF’s to provide.
In addition, the CFTC has proposed new conduct rules for dealers when they enter into swap transactions with special entities, like pension funds or municipal power authorities. Just like other end-users, access to the swaps markets allow these organizations to reduce the risks they face every day, whether it is a pension fund working to meet its financial obligations to retirees, or a municipal power authority working to keep the lights on for residents.
Yet, contrary to congressional intent, the CFTC’s proposed rule may eliminate or unnecessarily encumber these entities’ ability to access the swaps market.
Both these important issues will be before the Agriculture Committee in the coming weeks.
Unfortunately, not only has the CFTC overreached in its interpretation of the Dodd-Frank legislation, it has proposed rules that were not even required by the new law. For example, the CFTC has proposed to amend certain exclusions and exceptions for Commodity Pool Operator and Commodity Trading Advisor registration requirements. These modifications could require tens of thousands of new entities, such as mutual funds, to register with the CFTC, even though many are already highly regulated by the SEC.
At the very least, the CFTC should withdraw and postpone the proposal, considering it outside the context of Dodd-Frank.
Finally, we must remain mindful of the effect these rules will have on our global competitiveness. The timing of our rules alone makes it difficult for our regulators to coordinate with their counterparts overseas.
Although the Administration seems confident that foreign jurisdictions will simply follow our lead, I am not so sure. Market activity will inevitably flow to the nations and financial markets where the regulatory burden is lowest. Significant differences in regulatory proposals will lead to arbitrage. That undermines the very stability and transparency these reforms were intended to promote.
It is critical that our regulatory agencies do a better job coordinating – not only with each other, but also with foreign regulators – to ensure the proposed rules do not create competitive disadvantages for U.S. businesses and financial centers like New York and Chicago.
Just as markets are global, so are market participants. American financial regulators have a history of deferring to foreign regulators when it comes to activities that occur outside of the United States. Yet, significant uncertainty remains around the application of Dodd-Frank internationally.
Recent proposals indicate our regulatory agencies intend to apply Dodd-Frank even to activities that occur beyond our borders. For example, if a foreign subsidiary of a U.S. firm conducts a swap with a foreign organization, that transaction could be subject to our margin requirements.
Not only is this an unprecedented expansion of our regulatory reach, but it also puts American companies at a competitive disadvantage.
America’s long-term economic growth depends on our competitiveness in international markets. We need to uphold recognized principles of international law and limit the scope of the new rules to activities within our borders.
Let me summarize the four actions that I will continue to push the CFTC to do as we complete the implementation of Dodd-Frank over the coming months:
1. The CFTC must complete a comprehensive cost-benefit analysis for each rule.
Regulators simply cannot competently undertake structural reforms to the financial markets of this magnitude without performing this basic task.
2. The CFTC must publish a rational schedule for the consideration and implementation of final rulemakings.
Market participants need to know the sequence and scope of final rulemakings so they have an opportunity to fully comprehend and comment on each rule.
3. The CFTC needs to refocus its rules and priorities to reflect the statute and intent of Congress.
The CFTC has overreached in its interpretation of Dodd-Frank and undertaken rulemakings that are not mandated by the law.
4. The CFTC must consider the impact that these rules will have on the international competitiveness of U.S. based firms and markets.
Failing to coordinate and harmonize financial regulations will lead to regulatory arbitrage that is detrimental to the global financial system.
By addressing these four points, the CFTC can ensure the new regulatory framework will be both strong and flexible.
My colleagues on the Ag Committee and I will be working hard over the coming weeks to bring this process back into balance and ensure that in the haste to implement Dodd-Frank, we are not inadvertently damaging the financial system it was meant to protect.
Today’s conversation is not an esoteric discussion. The reason it is so important to get Dodd-Frank right is because American jobs depend on a healthy financial system. Americans want economic security, plain and simple.
While I suspect that most of my constituents could not give a rat’s rear end about the differences between a swap dealer and a non-financial end-user, they do care about having stable food and energy prices. They do care about having access to capital. And they most certainly care about businesses being able to create jobs in their communities.
We need to ensure that we do not hinder economic development in our attempt to provide greater stability.
We need to bring Dodd-Frank regulations back into balance.
Thank you for your time today. Now, I will be happy to take any questions you may have.