Since Timothy Massad stepped down as chairman of the Commodity Futures Trading Commission (CFTC) in January, the regulator has become “frozen in place” – unable to make important decisions or even conduct routine business. With only two of five commissioners in place, the agency was falling behind a market that continues to develop faster every day. So says now-departing commissioner Sharon Bowen, who announced her departure to the Market Risk Advisory Committee on June 21. The regulator’s inability to keep up with the market had become “intolerable”, she said. She’s far from alone. A case in point: commodity companies say the CFTC’s recent capital requirements proposals for swap dealers could drive them out of the market.
The proposals were opened for industry comment in December last year, a month before the Massad regime drew to a close. The comment period was extended by 60 days – closing on May 15 – and the proposal elicited some scathing feedback from the industry. The CFTC has had ample time to reappraise the proposals, but is yet to offer any tweaks. The regulator’s clumsy effort to set capital requirements for commercial swap dealers – those whose main business is not predominantly financial in nature and as such should qualify for less stringent capital requirements – is a microcosm of the wider problems inherent in the proposals.
The US Federal Reserve defines a firm as a financial entity if 85% or more of its revenues or assets are ﬁnancial in nature. Put another way, if 84.99% or less of a firm’s activities are financial in nature, it is not considered a financial entity. Under the CFTC’s proposals, however, a firm must have less than 15% of consolidated assets and less than 15% of revenue related to or derived from activities that are ﬁnancial in nature to qualify as a non-financial entity. As such, the CFTC proposal effectively lowers the threshold for what constitutes a non-financial entity by a whopping 70 percentage points, forcing non-banks to apply capital requirements reserved for banks and financial institutions. As if to rub salt in the wounds, the CFTC proposal would apply the test to the swap-dealer entity, rather than the parent company within which it sits – making it almost impossible for non-financial firms to qualify for the tangible net worth approach for calculating capital requirements, which was designed specifically for commercial swap dealers.
Market participants are struggling to understand the CFTC’s thinking. “I don’t know if they had fully thought it out,” one lawyer says. Further, while the proposals themselves outline a threshold of “less than 15%”, the accompanying fact sheet states it is “not more than 15%”. One commentator refers to these issues as “landmines”, while another lawyer wonders if it’s a case of human error. Pressed to that end, a CFTC spokesman declined to comment.
Market participants are struggling to understand the CFTC’s thinking. “I don’t know if they had fully thought it out,” one lawyer says
When it created the tangible net worth approach, the CFTC recognised that commercial swap dealers are not banks, and do not pose the same amount of systemic risk to the financial sector. In 2012, when the Securities and Exchange Commission proposed capital requirements on swap dealers, the CFTC itself suggested that these companies be treated differently. Now, the CFTC’s own rules could force commercial swap dealers to reorganise their activities to avoid bank-style capital and liquidity requirements.
Of course, one of the many reasons for public comment periods is to allow for constructive industry feedback on a proposal’s applicability to the market. But one might expect those proposals to be somewhat closer to the real thing, and for the regulator to be quicker in offering clarity where disparities arise.
The problems with the CFTC’s proposed swap-dealer capital rules are symptomatic of the constraints at the regulator, according to market observers. Craig Pirrong, professor of finance at the University of Houston, agrees with Bowen’s sentiment that an increasing lack of resources and the CFTC’s shortcomings in penning proposals are linked. “I think the frequency of such issues is greater due to the greater workload, and the stakes tend to be bigger.”
And the resource problem doesn’t end there: a former CFTC general council told Risk.net recently that budgetary constraints limit the agency’s ability to monitor markets at certain levels. Acting chairman Christopher Giancarlo has tried to some extent to remedy that – in late May, he asked Congress to increase the regulator’s 2018 budget by $31.5 million, to $281.5 million. Bowen voted for the budget, but said in a statement that she didn’t support it, describing it as “inadequate”.
Bowen’s abrupt announcement, which could leave Giancarlo as the CFTC’s lone commissioner, will make it even harder for the agency to craft and adopt effective rules. Reinforcements are on the way, however. The Trump administration has nominated Dawn DeBerry Stump, a former vice-president at NYSE Euronext, and Brian Quintenz, a fund manager and former congressional policymaker, to serve on the commission. Bowen has said she’ll leave in a few months, or sooner if another commissioner can be approved by the Senate quickly. But that’s a highly politicalised process. On the same day Bowen declared her resignation, Giancarlo was granted a hearing before a Senate subcommittee – a key step towards a confirmation vote. That urgency could be interpreted as an attempt to inject the agency with some stability at the top.
Regardless, should Congress not approve another commissioner soon, Giancarlo might find himself alone at the top of an agency that doesn’t reflect its markets and that lacks the resources to deliver on its mission.