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CFTC's Tarbert: Global standards for crypto and CCPs are top industry priorities

Top US derivatives regulator discusses digital assets, relations with Europe, and his agency reorganization

19 November 2020

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In July 2019, Heath Tarbert took over as chairman of the US Commodity Futures Trading Commission with an ambitious policy agenda in mind. In the first few months, he held more than two dozen meetings with almost all of the agency’s 700-plus employees and marshalled them behind a new mission statement. His vision for the agency, he said, was to promote the "integrity, resilience, and vibrancy of the derivative markets" and for the CFTC to set the "global standard for sound regulation."

As the pandemic of 2020 unfolded, the CFTC faced historic disruptions in its work environment. But though priorities shifted and the agency was forced to adapt, Tarbert still found a way to deliver. Since taking the helm of the agency, the chairman has presided over more than one open meeting per month. And even though many in Washington are taking a breather amid the transition of power from President Trump to President-elect Joe Biden, Tarbert is quick to point out there's still work to be done in December — and that he plans to do it.

MarketVoice spoke recently with CFTC Chairman Heath Tarbert via video call to get a sense of what he has accomplished in this unprecedented year, and what he sees as the future priorities for the agency.

FIA: A year ago at our Expo conference in Chicago, you previewed what some might call an aggressive agenda. Since then you have held 19 open meetings, proposed 24 rules and approved nearly 35 final rules, including the position limits rule that has been pending since Dodd-Frank. How did you manage to get so much done in such a short period of time?

In a speech at FIA Expo in October 2019, CFTC Chairman Heath Tarbert set out an ambitious agenda for the agency. A little over a year later, the agency has held 19 open meetings, proposed 24 rules and approved nearly 35 final rules under Tarbert's leadership.

Tarbert: The first thing I did even before I set foot in the agency was to figure out who the team was going to be. I couldn't do everything and get that much accomplished alone. We had to pick the right people.

Then, once we got the right people together, it became, "What are we going to focus on?" And focusing on something means that, by definition, you're not going to do other things. So we had to make trade-offs.

Then once we figured out what we were going to do, we had to be very focused on executing. That meant planning each and every week over the past year to get all this done. I always use the quote by Thomas Edison, "vision without execution is hallucination."

So really it was a matter of just staying on top of things, selling that vision, getting everyone on board and then meticulously planning to bring that vision into a reality. And then, of course, we had to keep our eye on the ball amid the pandemic, maybe the biggest challenge that the agency has had in its 45 years of existence.

FIA: There will be some new faces in Washington in 2021. What advice can you give about how to get things done at the CFTC?

Tarbert: First of all, for anyone that's going to have my job or any of the commissioners’ jobs in the future, regardless of when that is, I think it's really important that they take the time to understand the importance of the derivatives industry and how it contributes to the American economy.

Tarbert noted that "the issues confronting the derivatives markets are not political issues, but important and nuanced public policy issues that are often best served with thoughtful consensus, which involves dialogue with industry and other key stakeholders. What I've tried to do during my tenure thus far is to avoid the politicization of the agency, to have collegiality at the top level among the commissioners, and a healthy dialogue with all stakeholders."

Futures, options, and swaps are absolutely critical to risk management and mitigation but also to price formation. A lot of people look at the derivatives industry and they think, well, this is some esoteric group of financial instruments. But this industry has a really critical connection to the real economy. And if our derivatives markets aren't working well, there's a good chance our economy won't work as well as it could.

That's the first piece of advice. The second would be that the issues confronting the derivatives markets are not political issues, but important and nuanced public policy issues that are often best served with thoughtful consensus, which involves dialogue with industry and other key stakeholders. What I've tried to do during my tenure thus far is to avoid the politicization of the agency, to have collegiality at the top level among the commissioners, and a healthy dialogue with all stakeholders.

If we get this right, we won't have a situation where the CFTC has these bipolar swings back and forth with radical policy change. So while my agenda in some ways has been "aggressive," as some might say, I've tried to make it a largely consensus-driven moderate agenda so those changes will stand the test of time.

FIA: One of the main features of your recently completed position limits rule is that it delegates significant authority to the industry, via exchanges, to review and approve hedging strategies. Self-regulation is also a feature of the securities markets, but not other sectors of finance. What is your view on this idea of having an industry regulate itself?

Tarbert: I think people set up a dichotomy, where on one far extreme some say, "the government has to stay out of these markets and let markets take care of themselves" and on the other extreme, "markets can't regulate themselves, that's the fox guarding the henhouse."

That's a false dichotomy. To me the optimal system of regulation is this hybrid model where you have robust self-regulatory organizations like the exchanges and the National Futures Association, but you also recognize the inherent limitations of those self-regulatory bodies. That's where the government comes in, to back the system up, to provide oversight, supervision and ultimately to ensure core principles are met. But at the same time, our markets have flexibility and agility that you never would have with simply a government regulator.

I would argue that the hallmark of the American system and our derivatives markets is this proper blending of the two. If you harness both the attributes that the government has and only the government can bring to bear, but also those powerful private sector incentives, you will come up with the optimum regime for regulation.

FIA: You recently announced a structural reorganization of the CFTC. What was the primary purpose of those changes?

Tarbert: One of the biggest things was allocating resources to where they were needed the most. On the information technology side, we had a single unit that had the largest number of CFTC employees and contractors [and] that was not market facing. So we created a new Division of Data that really is going to be the interface for the future for the market--bringing in data, cleaning up that data, and then analyzing that data for the rest of the CFTC and to support all of the policy functions. We want to continue to become a data-driven agency, and this will enable us to do that.

tarbert cftc seal
While the disruptions caused by COVID created headaches for the CFTC, Tarbert said the "silver lining" was that he was "able to be more laser-focused on getting the agenda done" and "we've used it as an opportunity."

And what about market participants and ultimately customers? Well, the customer education function used to be housed with the same division where we had HR and the routine administrative things, and then it was moved to public affairs because it had an outward facing function. But my view was that all market participants, from the biggest swap dealers all the way down to the individual farmer or rancher, should be in the same division. The same people that are looking at FCMs should also be the same division that thinks about customer issues, and vice versa. So we took the customer education function and we put that into a single division that looks at market participants.

The other thing we did was we reallocate a number of examiners in New York to look at clearinghouses. We've seen the emergence of new clearinghouses, particularly in the crypto space, and unlike FCMs that have SROs like the exchanges or NFA there is no one looking at these new clearinghouses except for the CFTC.

FIA: In July you issued a four-year strategic plan that said, "We will develop a holistic framework to promote responsible innovation in digital assets." Can you expand on that?

Tarbert: Sure, let's unpack it and its various components. First of all, the term “digital assets” comprises a number of new 21st century commodities. The two biggest that are currently out there are bitcoin and ether. They are both commodities within the CFTC jurisdiction. So literally this agency covers everything from corn to crypto, as I like to say.

The next part of that plan, working backwards, is “responsible innovation.” We want our markets to innovate. As I said in my recent speech at the FIA Expo, energy derivatives, FX futures, all of these things at one time were viewed as radical and disruptive. But ultimately they became a bedrock of our derivatives markets. There's a chance that digital assets will do the same, so we want to see vibrancy in our markets, but we also want to see responsible innovation. When crypto exchanges are unregulated, there's a concern that it's a bit of a Wild West so we've stepped up our enforcement in that area for fraud and manipulation.

So then what does the "holistic" part of it mean? Well, digital assets present such unique issues. How does custody work? How are they valued? How do you store them when they are not like bushels of wheat? We have to go throughout our entire set of regulations from exchanges to clearinghouses to FCMs and we have to think about how digital assets are trading as a derivative instrument of some sort.

That's what I mean by holistic. If we're going to get it right, we can't do it piecemeal. We have to think systematically throughout our regime that dates back, at least statutorily, to the 1936 Commodity Exchange Act. We have to ask ourselves, “if we were to write that today, how would digital assets fit in?”

FIA: There is a jurisdictional boundary with the US Securities and Exchange Commission that affects the treatment of digital assets. If something is a security, it falls under the SEC. If it's a commodity, it falls under the CFTC. But digital assets don't always fall neatly on one side or the other. Could you talk about your relationship with the SEC on this issue?

Tarbert: The SEC is clearly one of our most important regulatory partners, if not the most regulatory important partner we have in the United States. Derivatives markets and the securities markets are highly interconnected. It's important because both agencies have a slightly different focus — the SEC on capital formation, and the CFTC on risk mitigation and price formation. It does make sense to have two specialist agencies, but because of the inherent connections, it's critical that we work together and we coordinate.

Many of these crypto assets are in fact securities and they are not something that should be treated as commodities. So it's important for me to acknowledge and respect the SEC's expertise in making sure there's adequate disclosure and registration when something is in fact a security.

That said, I think when something approaches what I would call the “crypto ideal,” it starts to look a lot more like a commodity, in that it's a store of value that exists apart from the efforts of others or a particular business. Like gold or corn or wheat, with its own value that's based on its inherent relationship to supply and demand and not because of the actions of particular people that are backing it.

FIA: Relations between the CFTC and the SEC haven't always been smooth. You worked with SEC Chairman Jay Clayton before you joined the CFTC. How much of a role did that play in getting your two agencies to work together? 

Tarbert: The truth is, I have known Jay Clayton for 20 years. I also have known [SEC Commissioner] Hester Peirce for over 10 years. She was my colleague at the Senate Banking Committee. There's no question that those relationships were really helpful when I walked in the door at the CFTC. But we've put a lot of thought into our relationship. For the first time in 45 years of shared history, we had a joint open meeting where we voted on the security futures margining rule and a request for comment on portfolio margining. We also harmonized some of our swap regulations to match the SEC's definition of a US person because, in my view, there was no reason why the SEC and the CFTC had two different definitions of what it means to be an American!

FIA: Looking past the SEC to other global regulatory bodies, how would you describe the current state of those relationships, particularly with Europe?

Tarbert: I would say we probably have the best relationship now with Europe and its regulatory authorities that the CFTC has had in recent memory, and maybe ever. Most CFTC chairmen who were my predecessors came into the job with substantial domestic experience and had to learn the international stuff. Well, I was the opposite. I was very new to agricultural markets, energy markets and the traditional CFTC stakeholders, if you will. But I had served as head of the international division at the US Treasury Department and I was a full member of the Financial Stability Board in Basel. I also co-chaired both the US-EU financial regulatory forum and the newly set up US-UK financial regulatory working group. So I came to the job with a deep international background and had to learn the domestic side while my most of predecessors had to do the opposite.

Take someone like John Berrigan, the senior civil servant in the European Union that runs DG FISMA (Directorate-General for Financial Stability, Financial Services and Capital Markets Union). For two years he and I co-chaired the US-EU forum. So literally all outstanding financial regulatory issues between the United States and the European Union he and I had been working on together for a couple years.

That really made things a lot easier for me to know how Europe is thinking about this, about how we get from where we are today to a win-win solution. Because ultimately, you know, either side could beat the other side up, but my goal was to find how we can agree to a set of measures to strengthen our relationship — just like my consensus-building on the domestic rulemaking front.

FIA: Are you satisfied with the outcome with respect to how US clearinghouses will be supervised by European authorities under EMIR 2.2?

Tarbert: The short answer is yes. I think we've arrived at a win-win solution where none of our clearinghouses, at least under the current metrics, would be viewed as systemically important to Europe. But at the same time, we recognize that they are relevant to Europe. While they're not going to be supervised and directly regulated by Europe, we're working with ESMA [European Securities and Markets Authority] to create an MOU [memorandum of understanding] where there would be robust information sharing. So ESMA would understand and get insight into what's going on in our two largest and systemically important clearinghouses in the United States, but because they're not systemically important to Europe they would not be directly regulated by Europe. And that MOU will be reciprocal, so we'd get the same intelligence about their clearinghouses.

FIA: Can you talk specifically about the Brexit process and the potential negative effects on market participants in the US?

Tarbert: Well, one of the ways we view Brexit here at the CFTC is to make sure that whatever the UK and the EU ultimately do, vis-a-vis each other, has no unintended consequences from a financial stability perspective. Secondly, we want to ensure that the United States is not somehow collateral damage.

Ultimately we've asked both the Europeans and the British to say that regardless of what they ultimately are going to agree to, let's try to avoid a situation where there's some kind of forced liquidation at a clearinghouse in London, for example. We've been successful thus far, but this issue will come up this time again next year if there's not a resolution. We may find ourselves in the same situation, since equivalence has simply been extended one year but it may not be extended again.

Another point is that I've emphasized the importance of actually enhancing our relationships with both the UK and the EU as a result of Brexit. Rather than looking at it as just mitigating downside risk — to make sure that the US is not collateral damage — let's also look at this as an opportunity to build stronger relationships with each. We recently signed a historic MOU with the Bank of England that enhances our comity and deference together with respect to clearinghouses based in the UK and US.

FIA: Sticking with the international theme, you are actively engaged in IOSCO. What are the top issues that you think are on the horizon for international standard-setters?

Tarbert: I must say that for too long, the CFTC simply did not have a seat at the table when it came to international standards. Literally it was just seven years ago before we finally got admitted as a full member of IOSCO. And I was privileged to become the vice chair of the board, which I think ensures that the CFTC not only has a seat at the table but has an influential seat.

As far as the big issues you'll see IOSCO, the FSB and other standard-setting bodies focused on, in the last 10 years since the financial crisis we've seen large parts of the global financial system move from the traditional banking sector to what people often refer to as “market-based finance.” When we say that we're really talking about funds and asset managers. So there's this question as to how we should regulate that part of the industry. Do they represent financial stability and other risks? And how do we grapple with that? There's been a continuing work stream on non-bank financial intermediation and non-bank finance, and that will continue to go on because I think that trend is only continuing. With COVID, for example, you saw the banks quite frankly not lending as much as one would expect as they were constrained by liquidity and capital and other things. Instead, you saw market-based finance jumping in.

There's also an issue of what all of these bodies do with respect to the potential emergence of a global stablecoin. The idea that you could have one or more crypto assets that becomes so important that it functions just like another fiat currency and has that kind of constituency is a horizon issue. What does that mean for monetary policy? What does that mean for financial stability? What does that mean for money laundering and terrorism financing concerns?

And finally, near and dear to our hearts and to those of FIA's members, you'll see a continued workstream on CCPs. That's particularly true with respect to resolution and recovery planning as well as issues relating to margin sensitivity and procyclicality. One of the big takeaways from the historic volatility due to COVID was that the derivatives markets not only worked but they worked extremely well. They were not amplifiers for systemic risk. In fact, quite the opposite. They were shock absorbers for systemic risks. But I think people will continue to look back at margin models and look at the interplay of the various market participants and continue to ask questions about how it could work better.

FIA: FIA recently released a white paper on the impact of pandemic volatility on CCP margin requirements and potential liquidity risk. How do you think policymakers around the globe are thinking about this margin issue right now and how things might be improved?

Tarbert: I think there are issues regarding transparency and predictability. It's one thing for margins simply to be procyclical but it's another to catch people off guard and not understand the magnitude of the margin calls vis-a-vis the magnitude of market movements.

Based on anecdotal evidence, I think the transparency levels are not necessarily the same across CCPs. In some cases, we know some market participants were caught off guard. But there's also the question as to whether market participants themselves were prepared, particularly not so much the clearing members but rather the customers. Then there's the question, how procyclical should initial margin be? Should you have measures that would mitigate the procyclicality and how should those metrics be built in — either from a product or a portfolio approach? There are pros and cons, and some would argue that the portfolio approach makes more sense if you're truly worried about systemic effects and defaults. But there's a price to that: if there's more margin posted in good times that puts a strain on farmers, ranchers and other end-users in the markets.

Unlike some of the other areas like global stablecoins, I'm not expecting this to be an area of radical change but more of a technical and nuanced approach to potentially calibrating certain things. But nonetheless, given its criticality to the FIA and your membership, it's something that you're going to want to watch closely.

FIA: On a more personal note, how are you doing in this new working environment brought on by the pandemic?

Tarbert: Well, personally I think I'm working harder than ever. There's less time for chit-chat and for traveling, but I try to find the silver lining. And the silver lining here is that by having such a reduced travel schedule and less face time in the office, I'm able to be more laser-focused on getting the agenda done. I believe that's true with the senior leadership team at the CFTC, but also much of the staff as well. It's enabled us to focus in a way that maybe would have been much more difficult during normal times and we've used it as an opportunity. LabCFTC, for example, has had some 60 different trainings inside the CFTC. So we're doing a lot more reading, a lot more writing, and we've tried to make the most of it.

The other thing is, as Nietzsche said, “that which does not kill you will only make you stronger.” And the fact that we accomplished this historic agenda but we did it during COVID makes me a much more battle-tested CEO and leader, and so hopefully I can bring those skills to bear not only at the agency but in whatever I do afterwards.

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