As we reported earlier this week, Scott D. O’Malia, commissioner for the CFTC, was the bearer of bad news about the regulator’s data gathering for its swaps data repository (SDR). Yet in his revelatory speech last week to SIFMA members O’Malia was very forthcoming about other thorny issues that got scant coverage.One of the thorniest of concerns is the commission’s current methods of protecting market participants’ confidential information.
“Because of its expanded jurisdiction, the commission now obtains and stores a lot of commercially sensitive data, including trading algorithms and other trading strategies that are unique to a specific entity,” O’Malia said. “Thus, the commission must ensure that it has necessary system safeguards in place for collecting, storing and distributing such data to the outside parties. I don’t feel the current policies and procedures to protect current and future market data are adequate and must be upgraded.”
This rather important matter was overshadowed by his news about the proprietary data flows to the SDR. Yet he offered no more details on what the new, more protective policies should be. I suspect this issue will get more attention if hackers access and distribute this treasure trove of algorithms and trading strategies.
As for the hot-button matter of cooperation between the CFTC and the SEC, not surprisingly O’Malia found that a lot of work still needs to be done especially when it comes to harmonizing cross-border rules. In particular, he said the SEC and CFTC should:
- Devise a single definition of a U.S. person that allows for the analogous treatment of similarly situated entities;
- Interpret the Dodd-Frank requirement that U.S. law only apply to activities outside the U.S. “if such activities have a ‘direct and significant connection with U.S. activities;’ ”
- Resolve “some significant differences over implementation of transaction rules and application of substituted compliance” with international regulators. “It makes sense for both the CFTC and the SEC to give foreign regulators additional time to work out these differences,” he added;
- And harmonize margining efficiency for cleared credit products via cost effective and jointly agreeable margining rules that give customers the same margining standards as clearing banks.
On that last point, O’Malia said that there’s a divergence as the SEC has issued a portfolio margining order “despite the CFTC’s objections to the SEC’s methodology for setting customer margin.” The problem, he said, is that the actual methodology of margin calculation offered by the SEC is not risk-based like the CFTC approach for clearing houses.
“The SEC’s methodology, on the other hand, simply imposes a margin of at least 200% of the clearing house’s calculated portfolio margining amount, without even looking to the underlying risks of the swaps in question,” O’Malia said. The margin requirement of 200% is too steep for many market participants. “What’s the point of allowing for portfolio margining that no one has an economic incentive to use?”
In addition, O’Malia argued that the SEC’s margin requirement creates “a huge disparity between dealers and customers” and doesn’t allow customers to commingle swaps in dealer accounts in the same way that the CFTC allows clearing houses to do so. “The SEC’s order effectively prevents customers from enjoying the same benefit. Why not allow the same margining process for customer accounts to provide reduced costs to customers with no increase in systemic risk?”
One upside might be greater cooperation between the two regulators when it comes to technology that will help both do a better job of surveillance. In fact, O’Malia wants to build upon the goodwill that came after the May 6, 2010 Flash Crash. “I also invite the SEC to join the CFTC’s efforts in researching the issues surrounding high-frequency trading and the impact of such strategies on the financial markets. These types of trading are increasingly prevalent in our markets and, as such, deserve the attention of both regulators,” he added.
As the chairman of the technology advisory committee, O’Malia stressed that economic research and rulemakings are not enough for regulatory oversight, “and they alone cannot assure a viable regulatory protection in the absence of modern technology.” He is encouraged by the pro-technology attitude of the likely next SEC chairwoman Mary Jo White.
While none of these thorny controversies will be easily or quickly resolved, I am encouraged by O’Malia’s straightforward take on them, and I think the industry generally responds well to this kind of transparency. I don’t think that he’s demanding that the industry mindlessly agree with him; I think he wants to start an intelligent discussion.
Let’s hope that O’Malia is serving as a useful catalyst for that.
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