Gensler and Schapiro Testify on Dodd-Frank Implementation and Address MF Global Bankruptcy
Fanni Koszeg | Bloomberg Law
Gary Gensler, Chairman of the Commodity Futures Trading Commission (CFTC) and Mary Schapiro, head of the Securities and Exchange Commission (SEC), testified before the U.S. Senate Committee on Agriculture, Nutrition and Forestry (Committee) at a hearing scheduled to address implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). In their prepared testimonies, both regulators detailed the progress of their respective rulemaking efforts to implement Title VII of Dodd-Frank, but the overwhelming majority of questions required them to address the MF Global, Inc. (MF Global) bankruptcy. The Committee is in charge of overseeing the CFTC and, accordingly, Gary Gensler was the target of many questions regarding his role in the events leading up to the MF Global bankruptcy and his subsequent recusal from the investigation initiated by the CFTC.
Need for Inter-agency and International Cooperation in Regulating the OTC Derivatives Marketplace
In her opening statement, the Chairwoman of the Committee, Debbie Stabenow, pointed out that the MF Global bankruptcy has shown how dangerously exposed the U.S. economy is to the European debt crisis and encouraged the regulators to harmonize their rules with each other and other prudential regulators, working closely with their global counterparts. Since the multi-trillion dollar global swaps market is by its nature highly interconnected, as painfully demonstrated by the financial crisis, effective regulation and oversight must be harmonized to avoid gaps and overlaps.
In his testimony, Gensler emphasized that, especially in the context of the current European debt crisis, regulators must ensure through appropriate oversight, monitoring, and cooperation with foreign regulators, that a situation similar to the 2008 near collapse of the banking system does not happen again. To that end, the CFTC is engaged in ongoing dialogues with regulators around the world and, together with the SEC, will participate in a meeting of international regulators, including the European Securities Market Authority (ESMA), on December 8, 2011, to discuss how to regulate the global swaps market in a consistent, comprehensive, and coordinated manner. Schapiro also pointed to extensive international cooperation in her testimony and, in response to subsequent questioning, emphasized that the SEC is monitoring clearing houses and money market funds in particular to assess how they would withstand shocks coming out of Europe.
With respect to coordination of rulemaking efforts, both Gensler and Schapiro said that they are working closely together and the differences in approach to certain technical elements of the rules stem largely from differences between futures markets and securities markets. The regulators expect to finalize the definition of “swap dealer” and certain other key terms as soon as possible next year.
Progress Report on Dodd-Frank Reforms
Gensler and Schapiro each gave a status update on rulemaking progress, including their rulemaking goals, processes, and covered areas.
— Promoting Transparency
Gensler said that the CFTC finalized the large trader reporting rule that establishes what information swap dealers and clearinghouses must report to the CFTC about large trader activity in the physical commodity swaps markets. In addition, the CFTC finalized an important rule establishing registration requirements for swap data repositories, which will gather data on all swaps transactions. Schapiro said that the SEC proposed rules regarding trade reporting, data elements, and real-time public dissemination of trade information for security-based swaps. In addition, the SEC has also proposed rules regarding security-based swap data repositories.
According to Gensler, central clearing of standardized swaps will be a crucial tool to lowering risk in swaps markets. One Senator questioned why the proposed minimum capital for clearing houses was set at $50 million, arguing that this level had been criticized as too low by some in the market. Gensler argued that the CFTC was attempting to make swaps markets more accessible and competitive because, unlike securities and traditional futures markets, swaps markets have been dominated by very few large institutions.
— Economic Impact of Rulemaking
Schapiro was asked to comment on a recent court decision vacating the SEC’s proxy rule, which the court deemed “arbitrary and capricious” due to the SEC’s failure to carry out an adequate cost-benefit analysis. For background on the decision see Bloomberg Law Reports®―Securities Law, D.C. Circuit Vacates SEC Proxy Rule Requiring Company Proxies to Include Shareholder Nominees (July 26, 2011). Schapiro said that, while the SEC may not agree with every aspect of the court’s decision, it understood that there was a need to better explain its choices and include more economic data into the analysis at the proposal stage and when finalizing a rule.
Gensler and Schapiro agreed that these impact analyses can be very challenging. However, Gensler asserted that the CFTC also understands how important the issue is and noted that it has hired a few more economists who are included throughout the rulemaking process.
Sen. Stabenow asked both Gensler and Schapiro if they were able to effectively implement Dodd-Frank with currently available resources. Gensler said that the CFTC would probably be able to complete Dodd-Frank rule writing but would need additional resources going forward. The swaps market is seven times the size of the futures market and additional resources will be necessary to effectively police this new market. Gensler said that to properly oversee a market as vast and complex as the swaps market, CFTC funding should be increased by 40-50 percent, including resources for very important new technology and also to increase staff by 30-40 percent.
Schapiro pointed out that the scope of the SEC’s responsibilities is extraordinarily broad and asked that the SEC’s funding be kept intact so that it is able to expand enforcement activities and capabilities to finalize rules. She said that the SEC is deficit neutral and depriving it from funding would not benefit anyone else.
MF Global Questions
— Gensler’s Role
Much of the questioning revolved around the CFTC Chairman’s recusal from all MF Global related matters following the start of the investigation. Gensler explained his recusal by repeatedly stating that even though he had not been legally required to withdraw from the matter because of his prior relationship with Jon Corzine, he decided to do so to avoid being a “distraction” from the actual investigation. In this he did not succeed, as some of the Senators present kept going back to the issue of his recusal in several rounds of questioning.
— Missing Customer Funds
Gensler did not address concrete questions regarding the MF Global investigation, but CFTC Commissioner Jill Sommers was available to respond. She pointed out, agreeing with the Senators, that segregation of customer funds has been a cornerstone of futures markets, and the CFTC should do everything in its power to recover missing customer funds possibly amounting to $1.2 billion. The CFTC will be looking into what additional audits of futures commission merchants may be necessary to restore confidence in futures markets. Schapiro said that for securities brokers there was a clear requirement codified inRule 15c3-3 under the Securities Exchange Act of 1934 that customer funds are segregated at all times of the day. The SEC performs additional audits of segregated accounts and Sommers said that the CFTC is looking into requiring such additional audits going forward.
— Permitted Investment of Customer Funds
Schapiro said that on the securities side, customer funds can only be invested in government securities. For commodities brokers, the CFTC had widened the range of assets (e.g., to include foreign sovereign debt) they could invest in through exemptions granted starting in the early 2000s. In particular, the CFTC granted the exemption in 2005 to allow cross-affiliate lending of customer funds through repo agreements, which is what happened in the MF Global case. The CFTC is about to review these exemptions and narrow the range of permissible investments.
— Enhanced Oversight for Companies Raising Red Flags?
One Senator pointed out that the CFTC fined MF Global in 2009 and the Financial Industry Regulatory Authority had taken 35 regulatory actions against the company by the time it filed for bankruptcy. The question is whether companies that raise such red flags should systematically be subject to enhanced oversight and supervision. Schapiro said that the system depends upon people following the rules, but more detailed financial reporting by self-regulatory organizations and more involved auditing of problematic companies may be necessary. In addition, if violations do occur, tough enforcement and strong sanctions are crucial to preserving investor confidence.
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