I want to thank the World Federation of Exchanges for inviting me to join you, and a special thanks to the Johannesburg Stock Exchange for hosting the conference events this week.
Before I begin giving my remarks, I have to provide my standard disclaimer: The views I share today are my own and do not necessarily reflect the views of the Commodity Futures Trading Commission (“CFTC”), on which I am proud to serve, or my fellow commissioners.
One Year Ago
The timing of WFECLEAR 2023 is significant to me because a year ago the U.S. Senate voted unanimously to confirm four women – Kristin Johnson, Christy Goldsmith Romero, Caroline Pham and me – to serve as commissioners at the CFTC, creating the first-ever women-majority commission. March 30 will mark exactly a year since I took my oath of office and was officially sworn in. I’m not sure what expectations I had for my first year as a commissioner, but what a period it has been.
The past 12 months brought global inflationary pressures, continuing economic dislocations resulting from the pandemic, the notable collapse of several entities engaged in digital asset activities, a war in Europe involving two of the world’s largest agricultural producers, and let’s not forget the past few weeks of banking stress and failures. Undoubtedly, markets and clearing houses around the world have faced unprecedented challenges over the past year.
My Year in Review: Visiting the Real Economy
In the last 12 months, I have spent a lot of time meeting with stakeholders and experts in many fields related to the CFTC’s regulatory remit over derivatives markets, including in the clearing space. I have reviewed proposed CFTC rules, considered public comment letters on those proposals, voted to finalise those rules, and monitored the agency’s implementation of rules that it has adopted. I have read thousands of pages of CFTC staff memos, court filings, settlement documents, and the same IOSCO papers that most of you have probably enjoyed as well.
Given today’s theme of clearing and the real economy, I want to share with you some of my experiences over the last 12 months, away from my desk in Washington, D.C., in the real economy. These visits left me with a renewed appreciation for the importance of the derivatives markets in providing price discovery and hedging opportunities to producers, manufacturers, end-users and other commercial business enterprises – large and small – that depend on these markets and the importance of centralised clearing in providing certainty and transparency in these markets.
As I shared the last time, I addressed a WFE event, my roots are in agriculture. I grew up on a farm in South Dakota, and my parents still grow and harvest row crops to make a living. My background in agriculture influences my approach to this job, putting a high value on the benefits and impacts of our market regulations to those in the real economy.
In August 2022, I had the fortunate opportunity to join United States Senator John Boozman, the ranking member of the Senate Agriculture Committee, in Arkansas to meet with individuals looking at opportunities for blockchain technology in the economy, followed by tours of a livestock barn, a soybean research test plot, orchards, wineries and a lumber mill.
The following month, I visited Cushing, Oklahoma, the delivery point for the WTI Crude Oil futures contract. During my time in Cushing, I learned about the pipeline system we rely on in the United States to move crude oil and how the storage, blending and transfer of crude is managed to ensure affordable and reliable access to this source of thermal energy in the real economy.
While in Oklahoma, I also held a meeting of the CFTC’s Energy and Environmental Markets Advisory Committee, which I sponsor. We assessed energy needs in the U.S. and discussed future needs that will arise as we move from thermal energy to renewable energy. This transition presents new and significant risks to businesses in the real economy, and it is critical that well-functioning derivatives markets are available to them to manage those risks.
I shifted from energy in Oklahoma to agriculture in Tennessee for a day of learning about the cotton industry. We spent time meeting with individuals at the U.S. Department of Agriculture who grade cotton, visited a cotton gin, and watched farmers harvesting their cotton fields. We discussed how the derivatives markets play a role all along the supply chain for cotton, eventually impacting the pocketbooks of consumers purchasing the many products made from cotton.
And just last month, I was at an automotive factory outside of Nashville, Tennessee, watching vehicles of all shapes and sizes being built, including new electric vehicle models, through a combination of factory automation and skilled employees working in tandem to produce cars and trucks not only for U.S. consumers, but for markets around the globe. After witnessing the impressive manufacturing process, we talked to those on the finance side of the business who use derivatives markets to hedge the many risks they face as a large, manufacturing business.
The following day, we were in downtown Nashville with the Energy and Environmental Markets Advisory Committee again. We talked more about electricity transmission and the increasing importance of critical minerals and metals in transitioning from fossil fuel-based energy to more green sources of energy, and the development of derivatives products on those commodities.
Viewing Regulation Through the Lens of the Real Economy
Thank you for indulging me as I took a “trip down memory lane,” focusing on U.S.-centric examples of the real economy. I think it is important to share those experiences with all of you because we are not just thinking about centralised clearing today, but rather the intersection of clearing and the real economy.
As I mentioned before, I firmly believe the markets we regulate at the CFTC must work for the real economy. Therefore, I view every action my agency takes as a regulator through the lens of its impact on the real economy. Understanding what those actions mean for the real economy, in my view, is crucial to being an effective regulator – and seeing the real economy first-hand is crucial to gaining such an understanding.
Viewing regulation through the lens of the real economy requires that we think about our work in practical terms, not just theoretical terms, and this concept is critical in considering the role of central clearing to the real economy. The rules and regulations we apply to central clearing must work in practice, not just on paper.
Almost 14 years post the G-20 meeting in Pittsburgh focused on a global response to the 2008 financial crisis, issues around central clearing continue to take a priority position on the agendas for many global regulators. This was true of the agenda I faced during my first year as a CFTC commissioner, and it will continue to be true in the months and years ahead.
Non-Intermediation – One Year Later
For example, a year ago, the CFTC was considering a proposal by LedgerX LLC, a derivatives clearing organisation (“DCO”) registered with the CFTC and owned by FTX, to amend its order of registration to permit it to clear margined products for retail participants using a non-intermediated model. That was a new model, and its supporters heralded it as an innovative approach offering promise for our industry.
Of course, you all know how the story ends. Today, FTX is a disgraced entity in bankruptcy, and the company and its principals are facing civil litigation and criminal prosecution. And LedgerX withdrew its clearing proposal before the CFTC rendered a decision on it. But I doubt that will be the last time we – or regulators in other countries – will be asked to approve similar innovations in clearing based on newly emergent technologies.
In the United States, our Congress has specifically tasked the CFTC with promoting responsible innovation among derivatives markets and market participants. But when regulators help assure that regulated markets reap the efficiencies and benefits of new technologies, it is imperative that they do so in a manner that ensures both market integrity and customer protection.4
That can be a difficult balance to achieve, and regulators must consider whether the potential benefits of a given technological innovation can be achieved without sacrificing market integrity or customer protection in the realities of the marketplace. Responsible innovation has enabled the derivatives markets to flourish throughout history and will continue to drive efficiencies in these markets in the future.
Another Year of Volatility
Over the last 12 months, the high levels of market volatility almost seem to have become the norm. As volatility rises, customer margin requirements increase, a reality anyone in the derivatives markets knows well. The safety of customer collateral and the ability of a clearinghouse to quickly access that collateral are foundational to the clearing system.
Within the last few weeks, volatility has spiked again. But this time, the resulting margin increases have been coupled with instability in the banking sector. These circumstances highlight the benefits of a clearing house having direct access to an account at a central bank where it can safely deposit customer collateral.
In the United States, a deposit account at the Federal Reserve is the safest and most liquid location for a clearing house to store U.S. dollar-denominated collateral. Accordingly, I encourage regulators – and, if necessary, lawmakers – to consider policy changes that would permit DCOs registered with the CFTC (regardless of their location) to have deposit account access at the Federal Reserve. Let me be clear – this is not the same thing as access to the Federal Reserve’s discount window. I believe the Federal Reserve can and should provide deposit account access to CFTC-registered DCOs without necessarily providing access to the discount window.
The volatility that we have experienced during the past year – in recovering from the pandemic, as a result of Russia’s invasion of Ukraine, and recently accompanied by instability in the banking system – is a case study in why DCOs should have deposit accounts at the Federal Reserve. Though CFTC-registered clearing houses have remained resilient in the face of these recent challenges, we should take this step to improve their ability to manage in times of turbulence. Access to central bank deposit accounts for clearing houses would offer a much-needed tool in the risk management toolbox.
Timeless Considerations Concerning the Regulation of Clearing
While the past year has been a challenge for everybody in this room, I believe there are some timeless considerations that can help us navigate rough waters, and overcome impediments to well-functioning practices and procedures, whenever they arise. In particular, I want to highlight two fundamental tenets of the CFTC’s derivatives regulatory regime.
First, I want to emphasise the benefits of global harmonisation and mutual recognition of comparable, comprehensive regulatory and supervisory regimes in place in other countries. And the analysis of whether one country’s regulation is comparable to another’s should be principles-based analysis that focuses on whether the regulatory and supervisory regimes of the two countries achieve comparable outcomes. These have long been hallmarks of the CFTC’s cross-border work with its international colleagues around the world.
Going back to when the G-20 leaders met in Pittsburgh in 2009 in response to the financial crisis, they recognized the global nature of the derivatives markets and explicitly committed to taking action to raise standards together so that national authorities would implement global standards consistently in a way that would ensure a level playing field and avoid fragmentation of markets, protectionism and regulatory arbitrage. The U.S. Congress memorialised these commitments throughout the Dodd-Frank Act and, consistent with its historical practice, the CFTC has implemented a regulatory framework that respects these commitments.
Clearing regulation will only work in practice where there is international harmonisation and mutual recognition. Protectionist policies do not serve our markets. Nor do line-by-line assessments of whether each detail of a country’s regulatory and supervisory regime is identical to another’s.
This brings me to my second point. The CFTC has a long history of implementing a principles-based approach to regulation. Some view the phrase “principles-based regulation” as a euphemism for “lite touch regulation” or “deregulation.” That is simply not the case. Strong, clear principles can apply in a myriad of factual circumstances that have not been contemplated by a set of prescriptive rules. This approach allows the CFTC to be nimble and adapt to changes in our markets – of which we have seen many lately.
I believe that setting forth principles with which our market participants must abide leads to a stronger regulatory regime than we would have if we were constantly writing and enforcing new prescriptive rules in reaction to the latest market and technological developments. Whether principles-based regulations at the CFTC or global principles around clearing activities, this regulatory approach can transcend the limitations inherent in a prescriptive, rules-based regime.
Concluding Thoughts: The Year Ahead
Given the eventful first year in my role as a CFTC commissioner, I suspect the next 12 months will not be any different. As much as we would all benefit from a 12-month playbook telling us what is to come, the reality is that we do not know what the year ahead will bring.
In preparing for that uncertain future, I truly believe that focusing on the needs of the real economy and on regulation that works in practice, guided by timeless considerations of global harmonisation through mutual recognition and a strong principles-based regulatory regime, will make the clearing system stronger and more resilient than the year before.
Thank you again to the WFE for inviting me to speak with all of you today and to our host, the JSE. I also want to thank every one of you attending this conference. The benefit to me of your shared knowledge and experience is invaluable as I face whatever may lie ahead next year, and beyond.
For further information on WFEClear: The WFE’s Clearing and Derivatives Conference 2023, see https://wfeclear.wfecm.com/
The views, thoughts and opinions contained in this Focus article belong solely to the author and do not necessarily reflect the WFE’s policy position on the issue, or the WFE’s views or opinions.