Is the CFTC using a misleading argument about swaps regulation?

At some point next year, the US Commodity Futures Trading Commission is expected to start regulating a market that has a notional value about seven times the size of the market the agency currently regulates.

But whether that means the CFTC will have seven times the work or even if it should get a boost in funding to undertake these new regulatory duties has become a source of fierce debate between regulators, lawmakers, lobbyists and exchange executives.

At this week’s Futures Industry Association conference in Chicago, for example, Terrence Duffy, the executive chairman of CME Group, parent company of NYMEX, said the argument CFTC chairman Gary Gensler has been making about needing additional resources is somewhat misleading.

“To me [Gensler’s argument is] not a very smart way of looking at it because you don’t need more people just because the notional value is higher,” Duffy said. “It has nothing to do with the actual volume of trade.”

The US over-the-counter derivatives market, which the CFTC is mandated to regulate under the mandates of the Dodd-Frank Wall Street Reform and Consumer Protection Act, has a notional value of roughly $300 trillion. The futures market, which the CFTC currently regulates, has a notional value of about $40 trillion. At least, that’s the estimated size coming from Gensler, though the figures have been cited frequently by others.

The seven-fold difference between these markets means that the CFTC will take on seven times the workload, Gensler has said in his pitches for more money from Congress. It’s an argument the head of the CFTC has made frequently this year.

“The CFTC’s remit is growing from a marketplace that has a notional value of approximately $40 trillion to one with a notional value of approximately $300 trillion,” Gensler said in testimony before the House Financial Services Committee on June 16. “The CFTC is taking on a significantly expanded scope and mission,” he said in testimony before the House Agriculture Committee on June 21. “By way of analogy, it is as if the agency previously had the role to oversee the markets in the state of Louisiana and was just mandated by Congress to extend oversight to Alabama, Kentucky, Mississippi, Missouri, Oklahoma, South Carolina, and Tennessee – we now have seven times the population to police.”

And there’s more: “The agency is taking on a significantly expanded scope and mission,” Gensler said during a September 22 conference at Georgetown University. “Without sufficient funding, though, we will not have the resources to be as responsive to the public as we should be.” Over the past 30 years “the unregulated swaps market grew by orders of magnitude in size and complexity,” Gensler said in a speech at a swap execution facility conference in New York on October 3. “It is now seven times the size of the futures market,” he said.

So that’s the message he took to Chicago. “The swaps market is seven times the size of the futures market that we currently oversee, and it is far more complex,” Gensler said in a speech Tuesday at the FIA conference.

And on Thursday, in a speech at the London School of Economics, Gensler argued that because of the sheer size of the swaps market his agency will now oversee, the CFTC should be granted membership into the International Organization of Securities Commissions as a full voting member.

“For IOSCO to be the premier standard-setter for both securities and derivatives, it is critical that the CFTC–which will regulate both the $300 trillion U.S. swaps market as well as the $40 trillion U.S. futures market, in aggregate the largest derivatives markets in the world–have membership status in this body commensurate with our regulatory responsibilities,” Gensler said.

But at the FIA conference, Duffy said that Gensler may be overstating the new duties the agency will be undertaking. Swaps markets see roughly 2,000 to 4,000 transactions per day, Duffy said, while CME sees an average of 14.7 million futures and options transactions per day. “It’s the number of transactions, that’s the key,” said John Damgard, FIA’s president.

In addition, Robert Pickel, executive vice chairman International Swaps and Derivatives Association, pointed out that the notional value of the swaps market is inflated by numerous outstanding swaps that may date back more than 20 years.

On Thursday, CFTC Commissioner Bart Chilton said, however, that the argument being made by the industry is the flawed one. “There may be–probably are–many times less trades in OTC land as a percentage of whatever it is being traded compared to the currently regulated exchanges,” Chilton said. “That doesn’t mean we don’t need significantly greater resources.”

Individual swaps in the largely unregulated OTC derivatives market “may be gigantic,” Chilton said. “That’s a greater concern for me, not less of one. It is true regulators (nor anyone else) knows the full number of trades or even the size of the OTC market. Is it $300 trillion, $600 trillion, or what? Here is what we do know: the dark OTC market is ginormous. Some of the OTC trading was part and parcel to what went so horribly wrong in 2008 when there was zero, nada, zippo regulation.” (Yes, he did use the word ginormous, which presumably is a combination of giant and enormous.)

In addition, these swaps are far more complex than most futures since they can be “individualized and idiosyncratic,” Chilton said. This “will take many more surveillance, oversight and enforcement resources than standardized on-exchange trading,” he said. “That is a simple fact.”

Platts