In an address before the 32nd annual meeting of the International Swaps and Derivatives Association in Lisbon, Portugal, last week, J. Christopher Giancarlo, Acting Chairman of the Commodity Futures Trading Commission, expressed concern that, since the 2008 financial crisis and passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, financial markets “have signaled warnings that liquidity has been significantly curtailed.” Mr. Giancarlo attributed a significant cause of this development to bank-dealer firms moving from a principal to an agency model where they “no longer hold [the] ability to support trading liquidity by risking capital and holding inventory.” Mr. Giancarlo observed that, part of this movement has been prompted by requirements for banks to “significantly increase their regulatory capital and leverage ratios by raising more equity in relation to their total assets." However, “swaps market reforms … have so far failed to adequately address the question of whether the amount of capital that bank regulators have caused financial institutions to take out of trading markets is at all calibrated to the amount of capital needed to be kept in global markets to support overall market health and durability.”

Mr. Giancarlo also bemoaned the supplemental leverage ratio imposed by banking regulators that requires banks to set aside additional capital for cash held by their affiliated derivatives clearing brokers for their customers. This has reduced the profitability of such clearing brokers and consequently reduced the willingness of banks to be in the futures commission merchant business, said Mr. Giancarlo. However, “[a] consolidated FCM industry could pose difficulties in transferring customer positions and margin to other FCMs in times of stress or an FCM default,” warned the Acting Chairman.

In his presentation, Mr. Giancarlo encouraged making cross-border regulatory comity work in order to enhance market certainty and expressed reservations about US swaps trading rules that he believes have heightened market fragmentation.

Mr. Giancarlo’s nomination as Chairman of the CFTC was formally passed by the White House to the Senate last week for the Committee on Agriculture, Nutrition & Forestry to begin processing (click here for background). Mr. Giancarlo noted during his speech before ISDA that he looked forward to restating during his nomination process his “long-standing support for swaps market reform and some of the current and long-term challenges facing trading markets.”