CFTC Commissioner Bowen Assesses Safety of Derivatives Market
Commentary by Bob Zwirb and Steven Lofchie
CFTC Commissioner Bowen discussed regulations and rules that were put in place after the 2008 crisis and asked whether they helped to create a safer derivatives market. To answer that question, she revisited the first four initiatives set out in the G-20 Accord just after the crash. The initiatives require (i) clearing standardized swaps, (ii) executing standardized swaps, (iii) reporting all swaps and (iv) "higher capital" for uncleared swaps. Overall, she concluded, "our track record in meeting these four goals has been mixed."
She stressed that in order to ensure protection for consumers, the CFTC must:
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Continue to support clearing by addressing the leverage ratio issue;
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Support the transparent trading of swaps on exchanges by establishing one swap execution facility ("SEF") self-regulatory organization and ending post-trade name disclosures of SEFs;
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Continue the work begun by CFTC staff to refine reported data;
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Effect appropriate risk mitigation requirements for uncleared swaps;
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Finalize the CFTC's cybersecurity rules, and expand their requirements to other market participants; and
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Finalize the CFTC's automated trading rules in order to address the risks raised by high-frequency trading.
Commissioner Bowen then examined whether Wall Street's reform since the 2008 crisis has been successful. She stated that in order to truly reform Wall Street, the CFTC must address two areas:
Enforcement. "First, we need higher enforcement penalties. Second, we need privilege protection when cooperating with other agencies."
Conduct Rules. "We need to insist on having governance rules for the derivatives markets."
Ultimately, she affirmed that "we are, without question, better protected today than we were prior to 2008," but added that "we have so much more to do in order to give the American people the economy that they deserve."
Commentary
It is encouraging when a regulator invokes law, economics and "the concept of the economic theory of regulation," as Commissioner Bowen does here. However, one of the fundamental principles of the theory of economic regulation – a principle that was developed by economist George Stigler – is that regulation usually benefits large firms at the expense of consumers and smaller firms. Given the all-encompassing nature of Dodd-Frank, and the cumulative burden of numerous complex rulemakings, it is not surprising to see the exit of smaller firms in areas such as the futures commission merchant and retail forex sectors, since they suffer a disadvantage compared to their larger brethren in complying with these new requirements. The interesting policy question in the near future will be this: will the dramatic increase in industry concentration that has resulted from these new regulations continue to force small and medium-sized firms out of the market?
Commentary
Considering the burdens Dodd-Frank imposed on the financial industry and the markets generally, it seems remarkable how little evidence exists to suggest there has been any material benefit. At this point, it is clear that central clearing has its limits (it only works for highly liquid products) and its risks (central counterparties are too big to fail and can drain liquidity from the economy). When it comes to cybersecurity, firms are motivated to address these risks with or without a CFTC "order" for them to do so.
Further, the idea that more enforcement is the solution to every problem is not only simplistic, but it leads to troubling government behavior. Here is the headline from the CFTC's report on its annual enforcement results for 2015: "Agency Achieved a Record $3.14 Billion in Civil Monetary Penalties Ordered." From the perspective of the market, many of the penalties appear to be evidence of a government, unencumbered by restraint, that uses fines for revenue and publicity.