Keynote Remarks of FIA President and CEO Walt Lukken
78th Shanghai Clearing House Forum: Financial Risk and Innovation
June 27, 2018
Thank you Bill for that kind introduction. Bill runs our Asia- Pacific region, and he and his team do a terrific job for us.
Thank you to the Shanghai Clearing House for hosting the 78th Shanghai Clearing House Forum, and specifically Chairman XU Zhen for being our partner in hosting this informative and insightful event.
We have had a good day, and I thank our speakers and panelists for traveling so far to take part in this forum. To conclude our day, I want to touch on three important themes that have been discussed throughout this forum: the benefits of central clearing, the opening of China's financial system, and the path forward for cross-border regulation.
I will start by going back in time. Ten years ago this year, the world stared into an economic abyss as the financial system teetered on the brink of collapse. At the time, I was the Acting Chairman of the U.S. Commodity Futures Trading Commission. I was responsible, together with my colleagues at the Federal Reserve, the Treasury Department and the Securities and Exchange Commission, for protecting the stability of the financial markets.
Those were desperate and dangerous times, culminating with Lehman Brothers collapse and AIG bailout. Panic spread across the markets as credit lines were revoked, money markets froze and liquidity in the over-the-counter markets disappeared.
Most damaging of all, the economy was pushed into the worst recession of our lifetime with millions of people losing their jobs, their homes and their savings.
There are many things we can learn from the financial crisis but one important lesson is the value of central clearing. When Lehman failed, the clearinghouses holding its positions, such as CME, Eurex and LCH, immediately took action to protect market participants and prevent a systemic ripple in the markets.
Collectively, these CCPs were able to quickly auction, liquidate and port Lehman’s house and customer positions in a manner that isolated Lehman’s default and prevented a contagion event in the markets. It’s also important to remember that this process occurred in extremely stressed market conditions without a single customer losing money.
In short, the listed futures and options markets remained liquid and open for business when other markets went dark. These events caused a lightbulb to go on in the collective minds of the global policymaking community.
Policymakers realized that clearing—with its rules-based and prefunded model—institutionalizes trust and confidence in the system. That is why the Group of 20 leaders decided in 2009 to make clearing one of the pillars of the post-crisis reforms for the over-the-counter derivatives markets.
I take this walk down memory lane—not to dwell on the past—but to allow history to help set our course for the future that is filled with opportunities for growth and innovation. Like the phoenix arising from the ashes, the crisis has given birth to an improved regulatory and market structure for these products.
This brings me to my second theme—the opening of China's financial system. Because China was not as integrated in the global financial system during the financial crisis ten years ago, it did not experience the same degree of financial collapse as the rest of the world.
China benefits from a second-mover advantage in that it has learned from the mistakes of others while not having to directly experience the impact of those mistakes. President Xi has noted that China must open its financial system to the outside world because China needs a mature financial system that can service the second largest economy in the world. And we have seen this opening in almost every area of finance.
We see it in the futures markets, with the launch of the new crude oil futures contract at the INE and the opening of the iron ore contract in Dalian to foreign institutions. We see it in the interbank bond market, with the Bond Connect program paving the way for foreign investment in Chinese bonds. We see it in the foreign exchange market, with an ever-increasing number of institutions buying, selling, borrowing and investing in RMB.
This trend toward greater openness of the Chinese financial system is one of the most important developments in finance. In a recent survey of the major global clearing firms, these leaders identified the opening of China’s markets as the topic with the greatest prospect for growth, beating out other issues like rising interest rates and fintech developments.
And no wonder. As institutional investors in Europe and the Americas begin to invest more in Chinese bonds, currencies and commodities, they will need robust risk management tools, like futures, options and swaps, to help manage this exposure.
The other side of the coin is of course greater participation of Chinese financial institutions in foreign markets. Chinese banks and securities firms are joining clearinghouses in London, Chicago and Singapore, and Chinese investors are trading on futures exchanges in all three of those cities and many more.
The tide of capital flowing out of China and into the global financial markets is lifting boats large and small all over the world.
As an aside, I note that the Shanghai Clearing House opened a representative office in London in March 2017 and hosted an international conference on financial infrastructures as part of the UK-China cooperation.
It must have been a very impressive event, because a year later the Lord Mayor of London travelled to China to visit the Shanghai Clearing House. It seems like the whole world is beating a path to your door. Let me now conclude with my third and final theme--the path forward for cross-border regulation.
Since the advent of electronic trading and the introduction of direct market access, trading on derivatives markets has become increasingly global. Today, a trader sitting in the some remote outpost can potentially have the same direct access as a person sitting in one of the world’s financial centers. A company wishing to hedge its currency risk can do that at an exchange in Europe, the U.S. or here in the Asia-Pacific region.
The globalization of markets brings many benefits. It creates more choices for end-users. It creates more efficiencies for international companies. And it creates more diversity in the market ecosystem, which is the secret to true liquidity and perhaps the most essential quality of a healthy market.
This is one reason why I am glad to see China’s markets opening up to the outside world. Greater international participation will lead to more diversity among the users of these markets. Our experience has been that greater diversity leads to deeper liquidity, which leads to more resilience in price discovery.
In other words, markets that have different types of investors with different time horizons and investment goals tend to be less vulnerable to wild swings in prices and more effective at accurately measuring supply and demand in the real economy.
The benefits of globalization come with challenges, however. Today’s global financial markets may have an exchange and clearinghouse located in one country, the clearing member in another jurisdiction and the customer located in a third.
Regulators, on the other hand, are bound by national laws and boundaries and cannot fulfill its oversight function without working with other jurisdictions around the globe. This is why FIA supports the concept of regulatory deference and cooperation as the most effective way to oversee these cross-border markets. We know that we are never going to have the same rules in every jurisdiction.
That is neither possible nor practical. Instead foreign regulators should recognize and defer to home country authorities—bound by international standards—when their rules are deemed comprehensive and comparable.
During my time at the CFTC, we used this approach to allow many non-U.S. exchanges to offer their products in the U.S. Under Part 30 of the CFTC's rules, the agency has the authority to allow cross-border access if a foreign exchange can show that it operates under rules in its home country that are "comparable" to the rules in the U.S.
Just last month, the National Stock Exchange of India received “Part 30” designation from the CFTC. India is the fourteenth country to receive this designation, and the eighth in the Asia-Pacific region.
In my view, this approach has been a win-win; a global network of futures exchanges are connected to customers in the U.S., and customers in the U.S. have access to a global network of futures markets.
Deference is not a one-time event, however. The CFTC maintains constant dialogue with its counterparts in other jurisdictions, sharing information about market conditions and working together to identify emerging risks.
This dialogue takes place at both the bilateral level and at the multilateral level through organizations such as CPMI and IOSCO. This dialogue is essential to developing the trust and understanding that are so critical to cooperation in a crisis.
It is events like today that build on this trust and understanding among market participants and regulators alike and I want to thank the Shanghai Clearing House for hosting this wonderful forum. Going forward, I hope we can continue to work together to grow the global derivatives markets.
And if we work together—I am confident that the cleared derivatives industry will continue to make major contributions to the health and vibrancy of our global economy.
Thank you.
