Under Control

Posted by Bart Chilton, Commissioner, U.S. Commodity Futures Trading Commission, on Sunday October 21, 2012 at 10:26 am
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Editor’s Note: Bart Chilton is a Commissioner at the U.S. Commodity Futures Trading Commission. This post is based on Commissioner Chilton’s remarks at a recent G-20 AMIS roundtable in Rome, Italy, available here.

People often complain and ask why nobody went to prison for taking a wrecking ball to the economy. Well, what was done didn’t break the law. Don’t get me wrong, there were many violations of the law, but these weren’t the actions that sent economies into the gutter. That is changing, but has not changed yet.

I am also asked frequently, if we are safer today than when the markets melted down in 2008. Sure we are, but we’ve got a long way to go. Could what happened in 2008 happen today? Unfortunately, yes, because regulators throughout the world have not approved and or implemented financial reforms to ensure that there is some control over markets.

Mario Andretti, the famous Italian racecar driver, used to say, “If everything seems under control, you just aren’t going fast enough.” Well, I do not believe we are under control in financial markets, but I do not think we are going fast enough on financial regulatory reforms. We need to move fast, fast, fast.

Let’s discuss exactly that: what we need to do and doing it faster.

How We Arrived

By way of background, however, let us begin with how we arrived at this place, this messy economic set of circumstances.

In 2008, the world witnessed the beginning of a serious and significant economic calamity—conditions with which we still have not recovered. It was the worst financial crisis in the U.S. since the Great Depression, but it obviously had significant global consequences. Banks melted down. Some even closed. Taxpayers were forced to bail out many of these institutions. In the U.S., that bailout accounted for more than $400 billion. Thankfully, most of that has been repaid. Worse, nine million people lost their jobs in our nation and many more globally. Millions more lost their homes. We also witnessed an astounding—and to many a dumbfounding—rise in global prices for raw commodities, and therefore, food. The results of that posed serious food security issues and the collateral issues nearly always associated with such high prices. As we know, when circumstances like these exist, they impact the least fortunate among us more than others.

How did that all occur? Well, there was a lack of laws, rules and regulations. That was a major part of it. Then, of course, there was the “greed is good crowd” that took advantage of that ultra-free market environment, and created hellish havoc around the globe. While those are my words, the thrust of what I said was confirmed by the U.S. Financial Crisis Inquiry Commission (FCIC), which was created by our Congress in the wake of the 2008 crash to determine what occurred.

To give you a few more specifics, in the U.S., the Depression-era Glass-Steagall law had been repealed in 1999. This allowed investment banks to get into myriad businesses that they had been prohibited from being involved with for decades. In particular, they were allowed to trade for their own proprietary accounts—trading for the house, as it were. Many times, they were involved in making risky, complicated bets—sometimes against their own customers. They were allowed to speculate at will. Many times, they were over-leveraged on these bets, leading to the eventual death of firms like the 180-plus year-old firm of Bear Stearns, and the 160 year-old firm, Lehman Brothers, which was leveraged 30 to one before it was ruined.

The dreadful results of that policy shift—the Glass-Steagall Act repeal—are littered around the globe and reflected to varying extents in varying economies. It was a mess and something had to be done.

Status Update

Have we made progress? It has been four years since economies tanked and more than two years since the Dodd-Frank Wall Street Reform and Consumer Protection Act became law. Some other regulators around the globe also are moving forward—some fast, some not so fast.

Well, for us in the States, there are almost 400 rules to craft under Dodd-Frank. Overall, the regulators working to implement the new law have been slow. Most of the rules were to be completed within a year. That means the law called for most everything to be done by July of 2011. Of the 398 regulations that need to be completed, only 131 have been finished. That’s only 33 percent. We need to go faster. My agency, by the way, has done better.

But sometimes, we have to acknowledge that we cannot go as fast as Mario Andretti. We want to be thoughtful and it takes time to work through all that. It was always our primary goal to get the rules correct.

So, what does it do, this Dodd-Frank of which we speak? Okay, thanks for the question. Dodd-Frank is good legislation and has many, many goals. But we can categorize them into four major areas: Transparency, Lowering Systemic Risk, Accountability, and Market Integrity.

1. Transparency: The previously unregulated, off-the-grid, over-the-counter (OTC) trading (this is the trading of what are called swaps) volume is in the hundreds-of-trillions of dollars. The last figure I recall is $650 trillion or more worldwide. To put that in perspective, our agency currently regulates about $5 trillion in annualized trading on registered exchanges. We have a big job ahead of us. All of us do. Nevertheless, what’s important is that those off-the-grid trades, what have been termed “dark pools” who’ve never seen the regulatory light of day, will be brought onto regulated exchanges. Transparency is the best disinfectant for murky markets. Data will be collected by something brand new—what are called Swap Data Repositories—or SDRs. The SDRs will provide the transparency in the precise markets that got us into such trouble in 2008. And by the way, except for excessive speculation that we will talk about in a bit, it wasn’t the regulated markets that were the trouble-makers. Nope. It was these trillions in unregulated trades that nobody saw. That’s about to change.

2. Lowering Systemic Risk: We want to make sure that we stop folks from taking risks that undermine the whole financial system. Risk is part of markets and people should take as much as they’re comfortable with. But, if they slip and hang themselves, they better not hang the whole economy. So, we’re requiring new capital and margin requirements. That will avoid the over-leveraging problem that I referred to earlier. That’s what we will avoid.

3. Accountability: One thing was clear in 2008 and, sadly, still is today.

There just isn’t much accountability to the public in financial firm suites. So, you tried to rig the Libor rate—an interest rate benchmark which impacts just about everything everyone buys on credit throughout the world. “Hey, everybody does it.” So, you had a trader who lost you billions? “Hey, we screwed up.” So, you lost millions of customer dollars by not keeping that money segregated? “Hey, I didn’t know anything about it.” So, we aim to make improvements in so far as accountability is concerned by improving—in concrete, comprehensive, and crystal clear terms—our complement of customer protection rules, with a focus on meaningful controls and control-based examinations.

4. Market Integrity: We all want these markets to perform the functions they were set up to do—that is to manage risk and discover prices. At their core, that is why we have futures markets. They weren’t set up as gambling venues, but risk management markets for commercial hedgers—those with some physical commodity (like an agricultural commodity). Speculators are not just an important part of the markets; they are indispensable. Markets couldn’t exist without them. At the same time, the role of speculators should not be exceedingly disproportionate to the hedgers. We can never have too much commercial hedging, but we can and have had too much speculation.

That is what Dodd-Frank does.

Global Reforms

We are, in the U.S., ahead of other jurisdictions on regulatory reform—we have been going faster than others. Some are not that far behind. In the European Union (EU), in August, the European Market Infrastructure Regulation (EMIR) was approved (as called for at the G-20 meeting in Pittsburgh in 2009). EMIR will increase transparency of over-the-counter derivatives—those previously off-the-grid trades that were part and parcel to the economic collapse. It will also deal with capital and margin requirements and reduce counterparty credit risks and operational risks in relation to OTC trading. The European Commission (the Commission) still will adopt some final technical standards, it appears by the end of this year, and soon next year will move forward on implementation. In addition, the Commission is working on the Markets in Financial Instruments Directive (MiFID II) and the Markets in Financial Instruments Regulation (MiFIR) which will in tandem address a wide-ranging variety of requirements, including the trading of all derivatives subject to a clearing obligation to take place on regulated markets and the public reporting of derivatives transactions. It is, in many regards, similar to what Dodd-Frank does. By the way and importantly, the Commission is implementing standards for high-frequency trading (HFTs). I call these HFTs “cheetahs” due to their exceptional speed—trying to scoop up micro dollars in milliseconds. More on those cats later.

In Japan, their Financial Services Agency has completed an ordinance which will be effective very soon, like within the next month, that requires banks and other financial institutions to clear and report certain derivatives transactions.

In Hong Kong, the Monetary Authority and Securities Futures Commission are engaged in consultations to supplement their proposal for regulatory reform of the derivatives markets. Similar to what we are doing in the U.S. and in the EU, Hong Kong’s proposal would require clearing and reporting of these transactions, in addition to capital and margin requirements.

In Canada, they have provincial regulation, and where the majority of this trading occurs (in Ontario), they have required centralized clearing. In addition, the Canadian Securities Administrators (CSA) has proposed recommendations for clearing.

Finally, there are many other jurisdictions that have taken the initial steps—legislatively or from a regulation standpoint—to ensure that financial regulatory reforms are put in place. Australia, Korea and South Africa, for example, have initiated legislative proposals. Singapore, Mexico and Switzerland are preparing proposals for public consultation. The bottom line is that things are moving forward globally, albeit at slightly different rates. I’m sure that those who are behind will be thoughtful, like we are trying to be in the States. To the extent that they can press the accelerator, that certainly is not objectionable from my perspective. In fact, I think it would be helpful to the global effort to more fully harmonize financial regulations.

Cross-Border Issues

Now, let’s discuss how we actually move forward to get the right fixes in place to protect markets, economies and consumers—people around the world.

Everything we do these days in financial regulation has far-reaching global impacts. In promulgating those 400 rules under Dodd-Frank, we are always keenly aware of the global interconnectedness of financial markets. It’s amazing, really: traders are churning and burning all the time across every time zone on the planet, enabled by increasingly sophisticated technologies that allow them to engage in ever more sophisticated trading strategies, circling the globe in the blink of an eye.

As regulators, when we’re thinking about regulations that have international impacts—and given what I just said, that’s the majority of them—we always want to ensure against a “regulatory fire sale,” where traders migrate to the countries with the thinnest rulebooks. It’s an absolute “must” that we harmonize regulations to the greatest extent possible. This doesn’t mean that one country dictates global policies—individual nations have a right to do what they want. The point is that, unless we appropriately harmonize financial market regulations—both in content and in timing—we’ve got a whole host of problems on our hands.

In that vein, let me talk about our Agency’s recently proposed interpretive guidance and policy statement on cross-border issues. (And I’m really glad, by the way, that we called it “Cross-Border”; “extraterritoriality” is just too much of a mouthful).

Many of our regulatory requirements are targeted at U.S. persons and those non-U.S. persons who deal with participants in our country. As you can imagine, every stakeholder has a position on this—either that our definition of a U.S. person is too expansive or too limited.

There was, and will, of course, continue to be a great deal of discussion on the definitions of U.S. person and non-U.S. person. It’s important that we get those absolutely clear and correct. At the same time, we need to focus on Section III of the release, that is, on the list of core Dodd-Frank requirements that should have cross-border application. And I’m going to add a third factor to the deliberations: we need, as we’re developing our rules in the U.S., to comprehensively review cognate rules in other jurisdictions. We can’t look at what we’re doing in a vacuum.

A Different Approach

Today I’d like to offer that different approach to looking at the global reach of Dodd-Frank.

By that I mean, let’s think of things this way: do our proposed entity definitions and the grouped entity/transaction requirements, coupled with a thorough analysis of all concomitant proposed regulations elsewhere, result in any unacceptable regulatory gaps? And we don’t have an answer to that until we do a lot more analysis of other regulators’ proposals.

There will certainly be differences in regulatory approaches between countries—that’s to be expected. My focus here is to take the over-arching mandates of Dodd-Frank—increasing market transparency and protecting against systemic risk—and couple that with the Act’s requirement of application of U.S. rules to activities outside the U.S. if those activities have “a direct and significant connection with activities in, or effect on, commerce” of the United States. That language of 722(d) should not be read outside the context of the goals of Dodd-Frank.

To my mind, that means that we need to look at each discrete rule set—both entity and transaction level—and think about which ones are “first tier”—that is, absolutely necessary to achieve Dodd-Frank objectives, and “second tier”—that is, rules that may be satisfied by substituted compliance (where there is comprehensive, comparable regulation), in the context of other regulators’ rules. Let me reiterate: we cannot promulgate our rules in a vacuum.

So, for example, perhaps we say—hypothetically—that rules on clearing, Swap Data Repository reporting, capital, and margin for un-cleared swaps are first-tier. Then, let’s look at what the EU, Brazil and Pacific Rim countries, just to name a few, have proposed on those issues. And here’s another critically important bit to this analysis: as we’re doing the side-by-side of all those rules—ours and theirs—we need to look at timing. We’ve got final rules where others don’t, and if there is a timing gap on first-tier rule implementation and compliance dates, that’s not acceptable. But assuming we can coordinate timing (a big “if,” I know), if there is consonant implementation of harmonized rules, I think a lot of the heartburn about this issue is significantly decreased.

I know this appears monumental: to review application of Dodd-Frank internationally by comparing numerous rule sets, and trying to discern which rules need more “identicality” (that’s not a word you’ll find in the dictionary—I just made it up)—that is, first tier rules, and which rules can be satisfied by substituted compliance. In light of that, I am suggesting that we pause, take a breath, and think—globally—about implementation and compliance dates that are more reasonable—perhaps 1 June 2013.

That is, by no means, any indication that I want to slow down Dodd-Frank—absolutely not. I am, however, a pragmatist. I don’t want to go so fast that we run headlong into enactment of rules that are going to impair or impede legitimate and necessary business practices.

Excessive Speculation and Limitlessness

I’ve got a question for each of you. By a show of hands, if one trader controlled 85 percent of a market, could they manipulate prices? I’ve asked this often and generally a lot of folks raise their hands. How about 51 percent? What about 30 percent?

Let’s talk about our little survey here because the issues it raises are exceedingly important. In fact, this is another example of how one country’s regulations can affect many others: speculative position limits. I know these are being debated now in Europe and other parts of the world. I hope we harmonize position limits to the greatest extent possible. I’ll explain why that is so important, and ask for your help.

In the period between 2005 and 2008 we saw a massive increase in money moving into the futures markets. In fact we saw over $200 billion in managed money flood the U.S. commodity futures markets. There certainly isn’t anything wrong with folks putting their money in the futures markets, but these flows created an unprecedented link between financial markets and commodity markets. Commodities became a new investment asset class. Folks not satisfied with their returns in the equities markets, or simply wanting to expand their portfolio thought, “Hey, why not invest in wheat, corn, soybeans, crude oil or precious metals. And they did in great numbers.

It wasn’t just about the in-flow of money into these markets. It was what they (by and large) did with the money. It is about their trading strategy that differed from what speculators had done with their money, again generally, over the decades. They parked it. They went long, betting—yes betting—that the price would go up. “What, they say there’s gonna be a drought? Soybean prices will go up. Better pour some money in there.” “Will crude be worth more in a few years than it is today? I’ll take that bet.” Unlike the old-time speculators, they didn’t care much if the price went up or down. They weren’t much interested in a planting season or a driving season. They were interested in whatever was going on in several years. Their bets were similar to bets in stocks, not how speculators have traditionally invested in futures.

Many of these traders are exceedingly large. I’ve seen over 30 percent of a market controlled by one of them. I’ve termed these traders “Massive Passives” in that they are huge and have a relatively price-insensitive trading strategy: Massive Passives. I’m not suggesting that the Massive Passives necessarily violated any law. They didn’t do anything wrong by putting money into futures. There was no adequate law that said they couldn’t control 30, 51, or 85 percent of some markets. No law, until Dodd-Frank.

The worrisome thing, though, is that these funds are so massive that they have the ability to move markets just because of their sheer size. That’s particularly troublesome when it comes to food commodities, especially in third world countries, where it’s estimated that people spend between 60 and 80 percent of their income on food, compared with 10 to 20 percent in industrialized countries. Food prices hit an all-time high in July according to the World Bank. It’s been estimated that as many as a billion people in the world are undernourished. That’s one in six. We’ve heard about the food riots in places like Mexico and India and there was even a one-day pasta boycott here in Italy. Yes, supply and demand issues have had much to do with the price of commodities and ultimately food.

Demand for food has grown as the world’s population increases. High farm input costs, especially for anything made from crude oil, has disrupted the supply side. There’s no question that bad harvests in the U.S. and Russia this year are having an impact. But, what’s also true is that when prices are poised to rise for whatever reasons, speculators get excited and they pour in the money. How much influence they have over the ultimate price of commodities and food has led to hours of good discussion in this building, at the G-20 and elsewhere around the world.

We need speculators in markets. We don’t have markets without them. And by the way, we are not price-setters, however we are charged with ensuring markets operate fairly. But, when speculators account for 80-plus percent of some of these markets that used to be dominated by farmers and commercial agricultural interests, it’s unfathomable to me that they don’t play a role in prices—unfathomable. I’m not suggesting they actually drive prices (certainly not all of the time), but the buy pressure they bring to markets creates a speculative premium on commodity prices—that’s right a speculative premium. That shouldn’t be allowed in my view.

Perhaps the too obvious point here is that we must zealously guard these commodity markets to make sure they are functioning efficiently and effectively. One step in doing that is the imposition of speculative position limits across all physical commodity derivatives (where price discovery happens) and, hopefully, across the world.

The call for limits to ensure that no single trader controls an out-sized portion of any given market was something that finally gained traction after years of folks like me arguing for it. A number of world leaders, including some in Europe and the Caribbean have also called for limits on speculation and recent drafts of European legislation have reserved a place for limits on speculation.

The Dodd-Frank Act mandated that our Commission impose position limits on commodity derivatives markets. Well, a group of international bankers and another group took us to court to stop us from going forward. Get this: most of the dates that our Congress required for implementation of Dodd-Frank were within a year. But position limits were to be done sooner, within six months. You can surmise why they wanted them done soon. I happen to know. They knew limits were urgent and important. Now, the law says that we were to implement these limits as appropriate. That means we set the limit levels correctly. Well, we received 13,000 comment letters and only a handful suggested our proposed levels were too stringent. We proposed roughly 10 percent of a market as the limit level. But the international bankers said, and this is reflected in their law suit, “Hold on, we think that the word ‘appropriate’ could mean that you have no limits whatsoever.” Seriously? Can you believe it? Why our Congress wanted us to implement them soon was to ensure that they did take effect. In fact, many of the members of Congress who wrote the position limits section of Dodd-Frank made their views clear to the Court.

There is an old saying in Washington: “If you aren’t part of the solution, there is plenty of money to be made being part of the problem.” Well, we live in a litigious society and no place more so than the States, it seems. We love lawsuits. And, by the way, those that can afford it, love lobbyists. There are ten—count them—ten financial sector lobbyists for each member of our U.S. Congress.

So, in my remarks with you, I was going to be pleased to report that on October 12, ten days from today, the first set of new CFTC speculative position limits would become effective. But, I can’t say that. Why? Unfortunately, the international bankers have temporarily prevailed on this lawsuit battle.

Last Friday afternoon, the Court ruled that the position limits rule be vacated—that means we don’t go forward to implement it. That’s tough news for those of us who believe there’s too much speculation in commodity futures and swap markets. But, the struggle isn’t over. I, for one, will continue to push hard for what Congress mandated—a position limits rule. I think the Court opinion is deeply flawed.


In that regard, today I’m publicly suggesting (right here and right now) that we do a few things to help remedy the circumstances. Position limits are simply too important. We can be limitless.

First—The Agency should immediately appeal the Court decision and seek a stay in order to allow us to go forward.

Second—We should start drafting yet another rule proposal to address any concerns the Court had, drafted in a way that satisfies the objections raised by the court. I am confident we can do so. Any additional proposal should be done on an expedited time frame. We already know what most folks think. So, I suggest we do what is called an interim final rule with a short comment period, perhaps 15 days. This would allow us to quickly do what we had planned, and the exchanges and market participants had already planned to do in 10 days.

Third—While I will continue to push for limits on speculation in the U.S., I think there is room for more coordination at the international level. Food and energy prices affect the well-being of people across the planet and governments around the world owe their citizens action on the problems posed by the financialization of commodity markets. So today, I am also calling on international regulators to look into and address the issues raised by the massive influx of commodity investor money into commodity markets. This effort should begin with a thorough and sustained inquiry into the effect commodity index funds or Massive Passives have on food and energy commodity prices. A lot of us have a lot of good data and we can use that as a starting point. Where the data is lacking, we need to come up with smart ways get it.

In our rules, we always look at the cost of imposing and implementing things. We call them cost benefit analyses. We now include, as part of that analysis, the cost of not doing the rules. What is the cost to society of not taking some action? So, I hope international regulators, too, will look at the human cost of not implementing position limits.

In this regard, AMIS, as a G-20 initiative for enhancing food market transparency, can and should play an important role in these efforts.

It’s my opinion that there is a link between the enormous in-flow of money into these Massive Passive funds and commodity price levels and volatility. Many traders and commercial hedgers I’ve spoken with over the years agree, some publicly, some in private. And there are dozens of studies by economists that agree as well.

It is time that the relevant regulators give this issue the serious attention it deserves and step one is a thorough investigation of the issue. This effort will, in my opinion, corroborate the case made persuasively by countless experts and strengthen the resolve of regulators to impose limits on speculation in commodity markets across the globe.

Ironically, just before the Court ruling vacating the position limits rule came out on Friday, there was more than a seven percent spike in U.S. gasoline futures prices over the previous day’s close. Now, I’m not saying those two things are related. At the same time, this price spike, not unlike price spikes that can be attributed to overwhelming speculation, serves as an illustration that the problem of excessive speculation remains. What a reminder on the very day speculative position limits suffered a setback.


One final policy area let’s discuss is markets and technology. I know this is being debated by regulators the world over. High frequency traders are the folks I have termed “cheetahs” due to their exceptional speed. They are fast, fast, fast—out there every day, all day, trying to scoop up micro dollars in milliseconds. They are amazing and I have a lot of respect for them and the technology being used in markets today.

At the same time, I do not think trading technology is the best thing ever invented. Technology just isn’t what it always should be. Many times, it falls far short of our expectations. We see many examples where problems have existed. The Tokyo Stock Exchange shut down a few weeks back due to technology problems. I’ve seen market volatility increase wildly: natural gas dropping 8 percent in 15 seconds last year. One day silver dropped 12 percent in about as many minutes. One energy trader lost $1 million in one second. We saw crude oil drop $3 in a minute a few weeks ago. We continually see sharp rises and falls in precious metals. Some of you may recall the NASDAQ issue with the Facebook IPO. Knight Capital Group, in August, lost $440 million based on software trading errors. There are many more examples.

Technology needs the attention of regulators. We need to be careful and I do not think we have done enough to protect markets and consumers alike. That’s why I’ve called for registration of the cheetahs. Can you believe they aren’t even required to be registered with us? I was very pleased that last week the German government advanced legislation to do just that. In fact, regulators in Canada and Australia have proposed limits on cheetah trading. And, also just last week, the European parliament voted to require exchanges to impose a half-second delay on executing orders in order to tamp down excessive volatility.

I applaud regulators and lawmakers in those countries for addressing these issues. In addition to being registered, cheetahs should be required to test their programs before they go to a live production trading environment. They should be required to have kill switches in the event that they go feral. I am pleased that the U.S. Securities and Exchange Commission (SEC), some exchanges and my Agency are looking into that. I also think that cheetahs should be required to establish pre-trade risk controls to prevent wash trades—trades against themselves—period. After all, those trades are illegal in the U.S. Nevertheless, as it stands now, things are moving so fast in this gizmo-gadget trading world that they don’t even claim to know when a wash trade happens. I’ve also suggested that there be periodic compliance reports from the cheetahs and that the senior executives sign their names and be held personally liable for any false or misleading information. The days of “he said, she said” accountability in financial markets needs to stop, and now.


There is a great deal to discuss these days in the financial world, and there is a lot that we need to stay on top of in order to avoid another cataclysmic crisis in our economies. There is also more that we can do to have better markets that result in helping people. The devastation to our global financial system should be enough for us to ensure we continue to be vigilant in our efforts at reform.

Whether I’m back home in the U.S. or abroad, I always say that these complex reforms can only be accomplished if we all work together—regulators, market participants, people like you and your organizations, and especially consumers. Let’s do that, and let’s do it fast, fast, fast.


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