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From Securities Regulation Daily, November 29, 2018

Giancarlo advocates ‘agile and iterative’ approach to market reform

By John M. Jascob, J.D., LL.M.

With a nod to MIT Professor Andrew Lo’s hypothesis that markets are inherently dynamic and adapt in fits and starts over time, CFTC Chairman J. Christopher Giancarlo offered the view that market reform is not a "one and done" event. Accordingly, the CFTC currently approaches market reform, such as reforms to the swaps market and the transition from LIBOR to alternative benchmarks, as representing a continuous, agile, and iterative process. Giancarlo's remarks came before the 2018 Financial Stability: Markets and Spill overs conference held by the Federal Reserve Bank of Cleveland and the Office of Financial Research in Washington, D.C.

Swaps market reform. Despite his support of Title VII of Dodd-Frank, Giancarlo noted that he has been critical of the CFTC’s implementation of the Act’s swaps trading mandate, questioning whether the agency’s prescriptive rules on execution methods improve financial stability or simply increase market concentration by platform operators. This is why, Giancarlo said, the CFTC recently voted on a proposal to amend its swaps trading rules to encompass a wider scope of trading activity while enabling greater transactional flexibility to foster increased competition and innovation.

In addition, the CFTC has been looking outside its own turf to other rules, both in the U.S. and internationally, that may present impediments to clearing. In particular, Giancarlo said, there has been bi-partisan concern at the agency about the impact of the bank capital rules on incentives to submit swaps transactions to central counterparty clearing, one of the key G-20 swaps market reforms.

Giancarlo observed that the recent study conducted by the Financial Stability Board's Derivative Assessment Team (DAT) found that large banks and large buy-side firms, especially those active in the derivatives markets, are incentivized to clear. On the other hand, the reforms appear to be having a negative impact on smaller and less active market participants that are obligated to centrally clear standardized swaps. Giancarlo said that this is because clearing service providers, which are mostly affiliates of large banks, are dis-incentivized by capital rules from accepting the business of these less active market participants. Giancarlo said that he remains optimistic that the empirical evidence presented by the DAT study will persuade various authorities to consider rule amendments to help incentivize central clearing without having to compromise financial stability goals.

Benchmark reform. In the area of benchmark reform, Giancarlo said that a regulatory response in the wake of the LIBOR rigging scandal is clearly appropriate, given the potential for systemic risk. Giancarlo observed that LIBOR remains widely used across the financial system even though there is no longer a liquid market in unsecured inter-bank term lending underpinning it. Despite governance improvements, the days are numbered for LIBOR because it is only the regulatory authority of the U.K.'s Financial Conduct Authority (FCA) that causes major banks to continue making submissions from which LIBOR is calculated. In his words, LIBOR is "a heavy edifice on a deteriorating foundation, a tower waiting to fall."

Giancarlo said that his agency will continue to work with other regulators to encourage and coordinate—but not dictate the details of—the enormous project of LIBOR benchmark reform. In his view, the forward course for the U.S. markets is clear—away from LIBOR toward the Secured Overnight Financing Rate (SOFR), a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities. Although the official sector will assist and stay close by the course, helping to coordinate and encourage, ultimately it is a market derived solution driven by market participants from both the buy-side and the sell-side, Giancarlo said.

MainStory: TopStory CFTCNews ClearanceSettlement CommodityFutures Derivatives DoddFrankAct InternationalNews Swaps

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