The CFTC is the derivatives cop on the Wall Street beat. Indeed, it is the only agency standing between Main Street and Wall Street’s reckless, high risk derivatives gambling that will cause another financial crash if it is not adequately regulated. And Main Street will again foot the bailout bill.
The House Agriculture Committee’s CFTC re-authorization bill (“Bill”) will derail future derivatives reforms and roll back past progress in bringing transparency, oversight and accountability to the dark, unregulated derivatives markets, which caused the last financial crash and economic crisis. While the Bill contains a few small victories, they are wrapped in a package of anti-reform provisions aimed at tying the hands of the underfunded derivatives regulator. It will also undermine the CFTC’s critical mission to prevent another derivatives-fueled financial crash, which is particularly unforgiveable given that the American people are still paying the bill for the last crisis. Outlined below are a few of the most important provisions in the Bill:
Anti-Reform, Anti-Main Street Provisions:
Funding: While the CFTC has been mandated to protect the American people from the devastation of derivatives, it has been grossly underfunded and simply cannot adequately do the job Congress and the law already require it to do. Nevertheless, the Bill proposes significant new responsibilities to be performed by the CFTC, such as additional reports to review and submit, and the establishment of a new Office of the Chief Economist to perform onerous and needless additional “economic analyses” of all new rules. But the Bill does not provide any means for the already woefully-underfunded agency to pay for these greatly expanded activities.
The Bill is a missed opportunity for Congress to provide the CFTC with a long overdue mechanism to meet its funding needs through a miniscule user fee assessed on the industry it regulates – just as the other financial regulators, like the SEC, are funded. Importantly, such a funding mechanism would actually save taxpayers money and require the industry that uses the markets to fund the agency required to police those markets. Not only does the Bill fail to propose a solution to the chronic and indefensible underfunding crisis at the CFTC, but it actually makes the problem worse by piling on even more responsibilities that it won’t have the resources to carry out.
Cross-Border: The Bill proposes to repeal the essential cross-border guidance issued by the CFTC last year, which will become effective later this year. The Bill would throw out years of painstaking work (which included massive input from the industry) to prevent overseas derivatives activities and risks – like those of AIG and Lehman Brothers – from coming back to the U.S. to hit U.S. taxpayers. Indeed, the Bill would effectively outsource the protection of U.S. taxpayers to foreign regulations and regulators, who have failed miserably and repeatedly to protect their own taxpayers and treasuries from reckless derivatives dealers.
The Bill does this by requiring the CFTC to undertake an entirely new rulemaking for any cross-border application of derivatives swap rules, and those rules would then be required to include several significant requirements specified in the Bill. For example, the new rule:
· must assume foreign compliance regimes for the 9 largest swap markets are substitutable for U.S. law and rules unless the CFTC determines that they are not “broadly equivalent” to U.S. requirements
· must explain the specific circumstances under which U.S. deference to a foreign jurisdiction’s regime is appropriate
· must follow a staged compliance schedule according to foreign swaps market size
· must establish new and specific criteria for determining such broad equivalence
The Bill subordinates U.S. law and rules, and the CFTC itself, to foreign law, rules and regulators by other onerous requirements in this newly required rulemaking as well:
· The CFTC is prohibited from even beginning an assessment of foreign laws and rules for equivalence until after its rules are final, which will be many years in the future and almost certainly followed by more years of fighting industry litigation.
· CFTC determinations of non-equivalence with U.S. law and rules must then be submitted in a written report to both houses of Congress before any such determination is effective.
The Bill does much more to undermine the CFTC’s mission to protect the American people from high risk threats of derivatives dealers operating overseas, but an overriding harm is the grossly extended timeline for completion of a cross-border framework. Existing guidance and compliance schedules would be effectively cancelled and cross-border regulation could be delayed many years, leaving the U.S. taxpayer and financial system unprotected from future AIGs, Lehman Brothers and other overseas derivatives activities that directly and significantly threaten the U.S.
Cost-Benefit Analysis: The Bill imposes onerous and dangerous so-called “Cost-Benefit Analysis” requirements on the CFTC for each rulemaking – in addition to the already existing legal requirement to consider costs and benefits under the law. These many new requirements really amount to “industry-cost only analyses” that disregard, ignore or underweight the public interest, including the catastrophic cost of the last crisis and the trillions more the next crisis will cost.
Specifically, the Bill says the CFTC must:
· Place a heightened focus on the costs to industry – requiring the CFTC to quantify them. However, in stark and telling contrast, there is no significant requirement to look at the benefits to market participants, the markets, the financial system, or, even more importantly, to look at or consider the costs to the public of leaving them at the mercy of Wall Street, which would in effect be allowed to regulate itself once again.
· Consider alternatives to a formal rulemaking, and determine whether any such alternative in fact maximizes the net benefits, which will be biased in favor of Wall Street’s interests because its costs are already required to be prioritized while the costs to the public are virtually ignored.
Further, the Bill requires the CFTC to solicit public comment on any guidance issued by the CFTC (currently, under the Administrative Procedures Act, the Commission is only required to provide notice and comment on rules and regulations – not less formal actions such as CFTC guidance). This would effectively require the CFTC to always engage in costly, lengthy and time consuming rulemaking-like activities whenever they want to provide even noncontroversial guidance, which – as in the case of the cross-border guidance – is often requested by the industry itself.
Pro-Reform, Pro-Main Street Provisions:
Reporting Requirements: The Bill adds several reporting requirements to ensure proper monitoring of customer funds and add customer protections. In particular, requiring:
· electronic confirmation of customer account balances on deposit
· notification to regulators of undercapitalized firms
· an annual report submitted to regulators on compliance programs
· prior reporting when moving customer funds between accounts
These common sense requirements will streamline protections and information sharing between regulators, merchants and customers and help prevent instances of fraud (such as Peregrine Financial and MF Global) that the market has experienced in recent years.
It should be noted, however, that the Bill does not designate additional funds to the agency or address where it would find the resources to process these additional required reports. (Remember, any member of Congress who promotes such provisions without also providing any reasonable means to accomplish them – such as increased funding – is simply posturing.)
High-Frequency Trading Study: While not as significant as a mandated rulemaking to regulate predatory HFT, the Bill does require the CFTC to study High-Frequency Trading (“HFT”) strategies in the derivatives markets. The study must include:
· the resources required by the Commission to effectively monitor HFT;
· the effects such strategies may have on market liquidity and stability; and
· whether the Commission’s current authority is sufficient to protect markets from the consequences of such strategies
Of course, again, there are no additional resources for the CFTC to conduct the study (part of which is to determine what additional resources would be needed for the CFTC to effectively police predatory HFT.)