Yesterday, Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler appeared before the Senate Committee on Energy and Natural Resources at a hearing regarding the regulation of over-the-counter derivatives, particularly with respect to the energy markets. Chairman Gensler acknowledged that “vibrant energy futures markets are vital to the American economy,” and that a “transparent and consistent playing field for all physical commodity futures … should be the foundation of [the CFTC’s] regulations.”
To facilitate comprehensive reform, to promote transparency and to reduce risk of the OTC markets, Chairman Gensler identified three essential components:
- An explicit regulatory framework for swap dealers and major swap participants should be adopted;
- Standardized derivatives should be traded on regulated trading platforms; and
- Standardized derivatives should be cleared through central clearinghouses.
Chairman Gensler maintained that swap dealers should be regulated with respect to all of their derivatives business, both customized and standardized transactions. Such regulation would include capital and margin requirements, business conduct standards and recordkeeping and reporting requirements. Additionally, he noted that regulators should have the authority to set aggregate position limits for OTC derivatives contracts when they perform a significant price discovery function in the regulated markets. He echoed the sentiment of various policymakers in stating that Congress should require all standardized OTC derivatives transactions be moved to regulated exchanges or trade execution facilities, but also stated that customized contracts should be permitted to be transacted bilaterally, with “dealers subject to comprehensive regulation for these transactions.” Chairman Gensler observed that “bilateral derivatives” leave a financial institution possibly “too interconnected to fail,” which he said reinforced the importance of requiring derivatives dealers to bring their standardized transactions to regulated clearinghouses. He also addressed concerns regarding increased costs due to collateral requirements, stating that it still remains unclear as to whether posting collateral increases costs to end-users, and cautioned against a broad exemption from clearing for commercial end-users.
In a speech given later in the day at the Markit’s Outlook for OTC Derivatives Market Conference, Chairman Gensler reiterated his three essential components for reform of the OTC derivatives market as a whole, and also took the opportunity to address the market for credit default swaps (CDS) specifically. He stressed that additional reforms should be considered to address the unique characteristics of CDS, whereby the CFTC and the Securities and Exchange Commission (SEC) have clear authority to monitor the OTC derivatives market for fraud, manipulation and other abuses.
To limit the risks posed by CDS, Chairman Gensler recommended reform of the bankruptcy laws in a manner that would either limit or restrict so-called “empty creditors,” or creditors who have CDS protection that exceeds their actual credit exposure, from participating in bankruptcy proceedings. He further recommended that bank capital requirements be modified to restrict the use of CDS for capital reduction, and that any end-user exemption contemplated by Congress not be applied to CDS.