CFTC Nominee Calls for Increased Regulation of Derivatives
Introduction
Gary Gensler, President Obama’s nominee for Chairman of the Commodity Futures Trading Commission (CFTC), testified at his confirmation hearing before the Senate Committee on Agriculture, Nutrition, and Forestry (the “Agriculture Committee”) on February 25, 2009; the Agriculture Committee approved his nomination on March 16. In his opening statement, he mentioned four priorities that he would pursue if confirmed by the full Senate: (1) vigorous enforcement to prevent fraud and manipulation in futures and options markets; (2) position limits across all markets and platforms where there is a finite supply of the underlying commodity; (3) generally requiring the clearing and exchange trading of derivative instruments, and direct regulation of derivatives dealers; and (4) working with regulators around the globe to protect Americans impacted by world financial markets. The first and last of these goals are often cited by nominees to federal regulatory positions, and they are to be expected. The remainder of this article will focus upon his other goals, those concerning position limits and enhanced regulation of derivatives, which represent a departure from the current regulatory framework yet are in keeping with recent legislative initiatives.
Trading and Clearing of Derivatives
Mr. Gensler’s statements at his confirmation hearing are consistent with some of the recent bills before Congress addressing regulation of derivatives and the energy markets. Mr. Gensler did acknowledge that his current views may not be consistent with positions that he took as a senior official in the Treasury Department under President Clinton in the late 1990s, leading up to the passage of the Commodity Futures Modernization Act of 2000 (CFMA). The CFMA provided greater legal certainty for trading in financial and energy swaps by exempting those instruments (and certain related markets) from regulation by the CFTC or the Securities and Exchange Commission (SEC). Mr. Gensler stated that his views have since “evolved” and that there should have been more aggressive regulation of derivatives to protect the American public. Thus, Mr. Gensler’s current views are generally compatible with the regulatory direction of the provisions of H.R. 977, the “Derivatives Markets Transparency and Accountability Act of 2009,” addressing over-the-counter (“OTC”) commodity derivatives. That bill was approved by voice vote of the House Committee on Agriculture on February 12, 2009 (and the subject of a prior K&L Gates Alert). H.R. 977 would generally require the clearing of all swap transactions, but would leave open the possibility of reporting certain swap transactions to the CFTC if a clearing organization did not want to clear them.
S. 272, the “Derivatives Integrity Act of 2009,” which was introduced by Senator Harkin (D-Iowa) on January 15, 2009, goes beyond H.R. 977’s requirement for clearing to require that all swaps be traded exclusively on CFTC-regulated exchanges. That provision would effectively eliminate all OTC transactions in commodity derivatives. Senator Harkin, who is Chairman of the Agriculture Committee, tried to press Mr. Gensler during the confirmation hearing to support the thrust of his bill. Although Mr. Gensler indicated that he generally supported the concept of the greater transparency that would be provided by exchange trading and clearing of swaps, he resisted committing to support exchange trading of all swaps with no exceptions. Mr. Gensler recognized that there could be cases where customized transactions would not fit readily into an exchange-traded, clearinghouse framework, and exceptions might be necessary to accommodate such instruments. Senator Harkin expressed the view that it would be too easy to vary a particular term of a contract so that it could be labeled as “customized” rather than standardized and thereby permit such instruments to evade the exchange-trading requirement.
Regulation of Financial Swap Dealers
Mr. Gensler did express support for another facet of S. 272 -- the regulation of financial swap dealers (H.R. 977 does not provide for such regulation). Mr. Gensler stated that the entities involved in financial swap transactions needed to be subject to minimum financial, business conduct and reporting requirements. He stated that it was not enough for other affiliates of a swap dealer or its corporate parent holding company to be subject to regulation by the CFTC or the SEC; rather, in his view, the entity that is a party to financial swap transactions must itself be subject to minimum financial, business conduct and reporting requirements. Mr. Gensler indicated that the new requirements would apply to the 15 or 20 swap dealers that are involved in the vast majority of such transactions. Such a policy reversal would certainly be a large step away from the exemptive framework for swaps under the CFMA.
Position Limits
Mr. Gensler also indicated his support for H.R. 977’s objective of establishing position limits for physically deliverable commodities that have a finite supply. Part of the original purpose of H.R. 977 when it was introduced last year was to impose speculative limits on energy-related futures and options, because trading in those products has been blamed by many as contributing heavily to the run-up in gasoline prices last summer (although that view is disputed by the CFTC’s Office of Chief Economist and several other studies). In addition, Mr. Gensler expressed support for the regulation of OTC trading of energy and metals in the same manner as agricultural swaps. Agricultural swaps currently trade in accordance with CFTC regulations that date back almost 20 years, rather than pursuant to statutory exemptions, which in the case of energy and metals can fully exclude them from the reach of the CFTC. Accordingly, regulating OTC trading in energy and metals in the same manner as agricultural commodities would confer more power to the CFTC to impose restrictions on such trading. It appears that Mr. Gensler would not slow down efforts to increase the regulatory scrutiny of energy derivatives.
Relief Requests
Legislation regulating derivatives and imposing new speculative limits will likely take several months to finalize. Mr. Gensler also noted during his testimony two areas of CFTC procedures that he would want to review that may not require any additional legislative action (although H.R. 977 would mandate that CFTC conduct such a review). Mr. Gensler indicated that he wants to review any exemptions granted from hedging restrictions and position limits in the past 20 years by the CFTC, and that he also wants to review the “no-action” letter process, which is used, among other purposes, to grant exemptions for foreign energy markets. Mr. Gensler indicated that some decisions on requests for no-action relief could remain at the staff level, but he implied that certain matters previously handled by staff should be considered by the Commissioners. The overall message from Mr. Gensler is clear: his regime as Chairman of the CFTC will tend towards greater regulation and stricter scrutiny of requests for exemption or no-action relief.
