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From Securities Regulation Daily, July 29, 2015

House Agriculture Committee concerned about lack of global coordination on derivatives reform

By Lene Powell, J.D.

The House Agriculture Committee heard testimony today from market participants regarding progress of global derivatives reforms imposed by the Dodd-Frank Act. According to Agriculture Committee Chairman K. Michael Conaway (R-Tex), the committee is concerned that a lack of international coordination and harmonization is jeopardizing the implementation of promised and widely supported reforms to global swaps markets. In particular, there are unresolved issues with data reporting, clearinghouse recognition, and margin and capital rules.

“Despite 50 rulemakings by the CFTC, so far, these reforms have not lived up to their promises, and there is a lot of work to be done.  Each failure to harmonize rules drives a regulatory wedge between the United States and our global trading partners, needlessly complicating financial markets and weakening the derivatives reforms the G-20 sought to achieve,” said Conaway.

Conaway also said he opposes increased funding for the CFTC until it is reauthorized. CFTC reauthorization is supposed to occur every five years, and is currently overdue since the last reauthorization expired in 2013. The House passed a CFTC reauthorization bill in June (H.R. 2289) and Senate Agriculture Chairman Pat Roberts has said reauthorization is a priority, but legislation has not yet progressed in the Senate. The House and Senate Appropriations Committees have proposed funding of $250 million, the agency’s current funding level. Conaway said he does not believe it is appropriate to move that line “while so many end-user and good-government issues remain outstanding and unresolved.”

Data reporting problems. The Dodd-Frank imposed extensive new swaps reporting requirements. The CFTC has implemented these to create a reporting regime which, according to some, still has some bugs needing to be worked out. Ranking Member Collin Peterson (D-Minn) asked the panel of witnesses for input about reporting issues.

“Reporting is very important, and non-controversial, but it is no secret that it isn’t working as well as it should. Something appears to be needed to be done in that area,” said Peterson.

Dr. John E. Parsons of the Massachusetts Institute of Technology put it more bluntly. “The problem is a lot of the data is trash.” Parsons, an economist who represents Better Markets on the CFTC’s Global Markets Advisory Committee, explained that some data is not being asked for in a sensible way, and also some companies are “gaming the system.” The result is that a lot of the data is “simply gobbledygook.” For example, the most recent CFTC Weekly Swaps Report shows “N/A” for every subcategory of commodity swaps. Further, the total value of commodity derivatives as reported in the CFTC Weekly Swaps Report has been exactly $1.7 trillion for 92 weeks in a row. That’s not an estimate, said Parsons—it’s a plug. He added that it would be more honest to report “N/A”.

Data reporting is important for risk management, said Parsons. For example, during the financial crisis of 2008, regulators did not have data about the financial status of AIG, which had to be bailed out. In providing information and supervision, Dodd-Frank gives regulators and legislative committees more control and greater ability to respond sensibly, he said.

Asked by Rep. Austin Scott (R-Ga) about the need for harmonizing data reporting internationally, Parsons said work needed to be done but at this point, the U.S. does not even have good data within its borders, let alone cross-border. Larry Thompson, vice chairman and general counsel for The Depository Trust & Clearing Corporation, said some problems have arisen because of differences in definitions and reporting formats. One example is the date field, with differences in whether the day or month is written first. Another issue is that Europe requires reporting from both sides of a trade, whereas the U.S. only requires single-sided reporting.

Margin issues. CME Group chief Terry Duffy expressed significant concern with differing margin requirements between the U.S. and E.U. U.S. clearinghouses use a one-day-gross minimum liquidation period, while the European regulatory regime requires a two-day-net amount. The two jurisdictions disagree over which margin methodology is the best to manage risk, and it has been a sticking point in negotiations over the recognition of U.S. clearinghouses by the E.U. According to Duffy, it’s a competitive issue because the E.U. is trying to give its clearinghouses a leg up. The E.U. has granted equivalency on this issue to smaller jurisdictions like Hong Kong as well as Singapore, which, according to Duffy, has the same margin regime as the U.S. It’s a “slap in the face” that the E.U. has not granted equivalence to the U.S., he said.

Not only do differing methodologies create the problem that U.S. clearinghouses are not recognized by the U.S., it’s bad because it creates market uncertainty and systemic risk, Duffy noted.

“We said, ‘We’ll take the higher of the two [margin methodologies] but it has to be the same.’ They threw that out the window. If you want to introduce more risk in the system, just have a race to the bottom on margin. If you don’t have global coordination, you’re going to have the problems we’re talking about today,” said Duffy.

Supplemental Leverage Ratio. Duffy also had objections to the Supplemental Leverage Ratio (SLR), which imposes capital requirements on financial institutions under Basel III and U.S. Federal Reserve rules. He said it will increase costs for end-users by up to five times to clear trades. He explained that it overstates clearing member leverage exposures because it does not allow clearing members to net segregated margin held for a cleared trade against the clearing member’s exposure on the trade. This is inappropriate because under the Commodity Exchange Act, segregated margin cannot be touched, he said. The CME Group has worked with the Basel Committee and Federal Reserve and others to resolve discrepancies. Asked by Rep. Peterson how the problem could be corrected and whether it needed legislation, Duffy said it can be fixed by the Basel Committee and Federal Reserve and does not require legislation.

MainStory: TopStory CFTCNews CommodityFutures Derivatives DoddFrankAct Swaps

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