Director Joshua B. Sterling of the CFTC’s Division of Swap Dealer and Intermediary Oversight (DSIO or Division) delivered several speeches in September and early October 2019, setting forth certain guiding principles and the “Five Building Blocks” that will comprise the Division’s regulatory program during his tenure. The Director also discussed certain other developments relevant to asset managers, both exempt and registered with the CFTC as commodity pool operators (CPOs) and/or commodity trading advisors (CTAs). The principles and Five Building Blocks appears to mark a departure from previous practice in the Division, and may signal new ways that the CFTC will oversee and regulate asset managers.
Remarks to the District of Columbia Bar Association1
Director Sterling delivered an address to the District of Columbia Bar Association on September 25th, marking his first formal speech since his appointment was announced by CFTC Chairman Heath P. Tarbert. During his remarks, Director Sterling: (i) introduced certain guiding principles for his and his Staff’s approach to regulation; (ii) discussed the current regulatory framework under Title VII of the Dodd-Frank Act; and (iii) laid out his plans to implement a “programmatic approach,” which he called the “Five Building Blocks.”
Guiding Principles. Director Sterling stated that DSIO’s actions will “provide market participants with certainty” by being “purposeful (rather than hollow) and clear (rather than ambiguous).” He explained that “'certainty' means that the reasons for what [DISO does] will be clear, so that all similarly-situated market participants will be able to understand better our actions and rely more firmly on our pronouncements.”
Revisiting the Current State of Play. Director Sterling requested that market participants inform the Division regarding their priorities to improve DSIO. The Director also offered his thoughts on revisiting the expansion of the CFTC’s Part 4 regime2 to encompass a broader range of asset managers. Director Sterling acknowledged the 2018 Part 4 reform proposal, but opined that a “deeper look” should be taken at what Part 4 intends to achieve, as well as how to “get to a better result that yields more effective outcomes.” He noted that, in considering potential reforms in these areas, the Division will not depend exclusively on harmonization with SEC regulations.3
The Division’s Five Building Blocks. Director Sterling stated that each building block reflects “a core piece of a complete regulatory program” that is designed to further the CFTC’s values – “to strengthen the resilience and integrity of our markets, to enhance the regulatory experience for market participants, and to be tough on those who break our rules.”
Director Sterling indicated that the Five Building Blocks consist of: an examination program; a reporting framework; a guidance program; DSIO’s relationship with the CFTC Enforcement Division; and DSIO’s rulemaking function.
- Examination Program. Director Sterling indicated that DSIO is working closely with the National Futures Association (NFA, the self-regulatory organization of the U.S. derivatives industry) to design “a program of targeted thematic reviews of select large swap dealers and CPOs” to be carried out by the Division Staff starting in the first quarter of 2020. The Director stated that this “thematic approach” will not duplicate or replace NFA’s ongoing efforts, but is instead meant to lead DSIO “to understanding better how the big shops approach key compliance issues like risk management and risk reporting.” He anticipates reporting general observations later next year. In subsequent public remarks,4 Director Sterling noted that these examinations are “unlikely to result in formal deficiency findings.” He further stated that “we will need to publish a formal examinations book before we can do so” (make formal deficiency findings) and that preparation of “such a document will get underway soon.”
- Reporting Framework. Director Sterling reported that DSIO is “actively assessing whether existing data inputs to the [CFTC] can help DSIO do its part to ensure that [the Division has] a more holistic and dynamic view of ... registrants’ market exposures, counterparty relationships, and risks.” To that end, he noted that DSIO is “assessing the relative value of historical data versus daily data feeds,” and will support CFTC Commissioner-level efforts in this area.
- Guidance Program. Director Sterling indicated that DSIO “will be formalizing [its] communications program for registrants, to provide more general guidance on a more frequent basis than in the past.” He indicated an expectation that the Division will reduce the use of letter relief for specific parties and instead “focus across registrant categories to provide guidance applicable to all, rather than taking on issues one by one for individual firms.” The Director continued that this might necessitate the private bar assuming “a greater role in solving client problems.”
- Relationship with Enforcement Division. Director Sterling stated that DSIO is “strengthening [its] relationship with the Division of Enforcement with a more focused approach to referrals, so that ... coordination efforts become more programmatic.” Emphasizing that “referrals are not a new thing,” the Director stated that when making referrals to the Division of Enforcement, DSIO “will assess not only the issue in isolation but its potential impact on [DSIO’s] efforts to strengthen industry-wide compliance” through its other programs.
- Rulemaking Function. Director Sterling expressed DSIO’s intention to improve its rules through the “outputs” of the above programs and initiatives, which he indicated would inform the Division “whether rule amendments should be proposed – whether because an existing rule isn’t working as intended, because a rule hasn’t kept up with the times, or for other practical reasons.”
Remarks to the ABA Securities Association5
The next day, Director Sterling addressed the American Bar Association Securities Association. In addition to reiterating the Five Building Blocks and sharing his thoughts on “a few key areas” which he believes to be “top of mind for bank-affiliated registrants,” the Director discussed the following developments that will be relevant to asset managers and other market participants.
Additional Compliance Date for CFTC Uncleared Margin Requirements. Director Sterling highlighted the upcoming September 1, 2020 “Phase 5” implementation of the CFTC’s uncleared margin rule initial margin requirement.6 He stated that “in recognition of developments with our colleagues at the banking regulators,” DSIO expects “to recommend that the [CFTC] amend its compliance schedule to add a sixth phase of compliance for certain smaller entities that are currently subject to the Phase 5 compliance deadline.”7 He continued that “[s]maller entities would be those, in each case, with an average aggregate notional amount (AANA) of swaps from $8 billion up to $50 billion. The existing requirement, by contrast, would require compliance by all counterparties with an AANA from $8 billion to $750 billion no later than September 1, 2020. The deadline for this additional phase, if proposed and adopted, would be September 1, 2021.”
Amendments to Uncleared Swaps to Reflect Certain Market Developments. Director Sterling discussed regulatory actions the CFTC recently has taken under its uncleared margin rules related to: the impact of a “no-deal” Brexit on swap dealers and their counterparties; and allowing certain amendments to legacy swaps. He also noted that the Division staff is working with banking regulators to address requests by industry participants that U.S. regulators propose changes to the U.S. uncleared margin rules, in order to facilitate the industry’s effort to transition away from the use of LIBOR as a reference rate without affecting the legacy status of swaps under those rules.8