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CFTC’s Gary Gensler: Shining a Light on Swaps Transparency

CFTC chairman Gary Gensler has urged market practitioners to rally behind the Dodd-Frank regulatory reforms that will boost transparency in derivatives markets and outlined the steps the derivatives regulatory agency has taken to improve transparency in the swaps markets it oversees.

Speaking at a conference hosted by the Office of Financial Research and the Financial Stability Oversight Council, Gensler suggested that the swaps market bore much blame for the financial crisis that started in 2008.

“While the crisis had many causes,,” he said, “it is evident that unregulated derivatives, called swaps, played a central role. Developed in the 1980s, swaps, along with the regulated futures market, help producers, merchants and companies lower their risk by locking in the price of a commodity, interest rate, currency or other financial index. Our nation’s economy relies on a well-functioning derivatives market – an essential piece of a healthy financial system.

“But over the last thirty years, the unregulated swaps market grew by orders of magnitude and is now seven times the size of the futures market. During its growth, the market lacked the transparency of the futures and securities markets, and risk accumulated. Swaps, which were developed to mitigate and spread risk, actually added leverage to the financial system – with more risk backed by less capital.

“Swaps also contributed significantly to the interconnectedness between banks, investment banks, hedge funds and other financial entities. Large financial institutions once regarded as too big to fail were also regarded as too interconnected to fail. Swaps concentrated and heightened risk in the financial system and to the public.”

According to Gensler, the Dodd-Frank Act gave the CFTC and the SEC oversight of the US swaps market, valued at more than $300 trillion To date, the CFTC has finalized 18 rules to make the swaps marketplace more open and transparent and lower risk to taxpayers.

To help protect the public, Gensler said, the Dodd-Frank Act included the establishment of the Financial Stability Oversight Council. This Council is an opportunity for regulators – now and in the future – to ensure that the financial system works better. The Dodd-Frank Act also created the Office of Financial Research (OFR) within the Treasury Department to support the Council and its member agencies by collecting and standardizing data and using this data to perform analysis of our financial system.

Gensler said, however, that one of the Act’s most important goals is to “shine the light of transparency on the opaque swaps markets.” He suggested that while the derivatives market has changed significantly since swaps were first transacted, a constant is that the financial community maintains information advantages over many members of the public. Specifically, he said: “When a Wall Street bank enters into a bilateral derivative transaction with a corporation, the bank knows how much its other customers are willing to pay for similar transactions. That information, however, is not generally made available to the public. The bank benefits from internalizing this information.

“The Dodd-Frank Act helps level the playing field by bringing transparency to the three phases of a swaps transaction,” said Gensler.

“First, it brings pre-trade transparency by requiring standardized swaps – those that are cleared, made available for trading and not blocks – to be traded on exchanges or swap execution facilities.

“Second, it brings real-time, post-trade transparency to the swaps markets. This provides all market participants with important pricing information as they consider their investments and whether to lower their risk through similar transactions.

“Such public transparency, both pre-trade and post-trade transparency, reduces the costs to users of swaps. Furthermore, such transparency enhances clearinghouses as reliable pricing and liquidity are at the core of clearinghouse risk management.

“And third, Dodd-Frank brings transparency to swaps over the lifetime of the contracts. If the contract is bilateral, swap dealers will be required to share mid-market pricing with their counterparties. If the contract is cleared, the clearinghouse will be required to publicly disclose the pricing of the swap.”

Furthermore, “The Dodd-Frank Act also includes robust recordkeeping and reporting requirements for all swaps transactions. The CFTC and the OFR are working closely together to gather data that will give regulators a window into the risks posed to the system. By contrast, in the fall of 2008, there was no required reporting about swaps trading, and this lack of market transparency made the risk that had spread throughout the financial system all the more difficult to identify.”

According to Gensler, CFTC has completed rules that, for the first time, provide a detailed and up-to-date view of the physical commodity swaps markets so regulators can police for fraud, manipulation and other abuses. The large trader reporting rule we finalized establishes that clearinghouses and swap dealers must report to the CFTC information about large trader activity in the physical commodity swaps markets. The rule went into effect November 21. For decades, the American public has benefitted from the Commission’s gathering of large trader data in the futures market, and now will benefit from the CFTC’s new ability to monitor swaps markets for agricultural, energy and metal products.

“We also finished a rule, which became effective October 31, establishing registration and regulatory requirements for Swap Data Repositories, which will gather data on all swaps transactions.

“Moving forward, we are working to finish rules relating to the specific data that will have to be reported to the CFTC for swaps, including a regime for legal entity identifiers. These reforms will provide the Commission with a comprehensive view of the entire swaps market, furthering our ability to monitor market participants and to protect against systemic risk.

“We also are looking to soon finalize real-time reporting rules, which will give the public critical information on transactions – similar to what has been working for decades in the securities and futures markets.

In addition, we are working on final regulations for trading platforms, such as Designated Contract Markets, Swap Execution Facilities and Foreign Boards of Trade – all of which will help make the swaps market more open and transparent. On Monday, the Commission will consider a final rule to implement the Dodd-Frank provision for registration of Foreign Boards of Trade.

“Exchanges and trading platforms will allow investors, hedgers and speculators to meet in an open and competitive central market. Even market participants who are exempted from the mandatory trading requirements will benefit from the transparent pricing and liquidity that trading venues provide.”

Gensler said he believes that times of heightened market uncertainty transparency is even more essential, making it critical that Dodd-Frank gets implemented.”

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