I finally finished reading Timothy Geithner’s Stress Test this week. I have a few reactions to share. Meanwhile, the Commodity Futures Trading Commission issued a trade surveillance report card to ICE Futures U.S. and delayed the compliance date for its new large trader reporting rules. Not to be outdone, the Securities and Exchange Commission finally issued amended rules on money market funds. It crafted one type of money market fund for retail clients and another for institutions. It was a busy week!
As a result, the following matters are covered in this week’s Bridging the Week:
My View: Reactions to Timothy Geithner’s Stress Test: An Unsatisfying Journey to the Abyss and Back
It has taken me longer than many but probably less time than others to finish reading Stress Test (Crown Publishers 2014), Timothy Geithner’s recently published observations on the 2008 financial crisis. I was disappointed.
I began with high hopes of finally understanding what prompted the massive overhaul of OTC derivatives markets that was initiated by adoption of Title VII of the Dodd-Frank Act in 2010. I figured that by the time I finished the ex-Treasury Secretary’s memoir, I would at last have a cathartic moment that would enable me to appreciate once and for all why a system of rules and procedures, which was close but different from that which had historically and successfully existed for futures had to be enacted to govern the trading and clearing of swaps. But this did not happen.
Instead I read, as I have read many times before, that the financial crisis began with excessive and in many cases inappropriate borrowing by consumers and institutions, risky investments (especially involving creatively engineered and packaged mortgage loans), and a lack of transparency.
I gained a few new insights into the decisions to let some troubled financial firms fail (i.e., Lehman Brothers and CIT Group) while greasing the wheels to enable other failing firms to be acquired by stronger brethren (e.g., Bear Stearns and Merrill Lynch) and some to stand on their own (e.g., AIG). However, there really is nothing groundbreaking here, and Mr. Geithner’s explanation of the decision to let Lehman fail (i.e., there were no other real options) seems more defensive than reflective.
I also acquired a heightened appreciation for the impact of the Federal Reserve-mandated bank stress tests in 2009 in restoring confidence in the banking sector and helping the US slowly crawl out of the prior year’s financial abyss.
Mr. Geithner’s observations on choosing between options that arguably increase moral hazard going forward (i.e., establishing precedents for rewarding wrongdoers) or lead to catastrophic results (i.e., spiraling towards another Great Depression) are also quite interesting – although many will argue, self-justifying.
Mr. Geithner seems like a pretty good guy too. He comes across as a modest, hard worker – a true patriot – who obviously played a significant role in many important economic matters before, during and after the financial crisis in the US. He emphasized two mantras: plan beats no plan (or as I prefer to say, "don’t the let the perfect get in the way of the imperfect") and winning a significant battle (even one involving recovery from a financial crisis) requires overwhelming force (echoing the famous doctrine of former US Secretary of State Colin Powell):
The original Powell Doctrine emphasizes that military policy-makers should go to war only as a last resort, and that is true of financial policy makers as well. But it’s also true for financial policymakers that once war is unavoidable, you need to commit to overwhelming force – a combination of fiscal policy, monetary policy and financial firefighting. None of these instruments will be powerful enough alone, and weakness in any of them will undermine the effectiveness of the others.
Undoubtedly, readers will have different views on whether Mr. Geithner should have pushed the Federal Reserve to require banks to have stronger capital and liquidity standards while he headed the Federal Reserve in NY prior to becoming Treasury Secretary (and before the financial crisis), and whether the decisions to let some firms survive and other firms fail while he was Treasury Secretary were right or wrong. Political orientation will likely dictate assessments regarding the effectiveness of Mr. Geithner’s formulation and implementation of the Obama's administration budget, tax and other economic policies.
But ultimately, no matter where you look in Mr. Geithner’s account, there is no real discussion justifying the adoption of Title VII, and this is very disappointing. In fact, the references to Title VII are almost gratuitous:
The bulk of our derivatives reforms also made it into Dodd-Frank. Standardized derivatives must now be submitted to central counterparties, or “clearinghouses” and traded on open platforms or “exchanges.” Derivatives dealers will face capital requirements, and will have to collect and post mandate margin on derivatives transactions.
To me, having been involved in the futures industry for more than 32 years, the benefits of central execution and clearing of futures are manifest. But was it such a good idea to so radically alter the dynamics of the OTC industry – where at least risk was dispersed among many players – to concentrate it among just a few clearinghouses? Would it have been better to promote the use of clearinghouses without requiring it, and to mandate instead only registration and higher capital requirements for dealers (including greater haircuts for non-cleared OTC transactions), trade transparency, and certain attributes of clearing (e.g., daily marking to markets and mandatory margin settlements)? And, in any case, why not more closely emulate the overall structure of futures markets’ oversight rather than create a new regulatory scheme especially for swaps? It would have been instructive to have Mr. Geithner’s insight.
Likewise, to me, the aftermath of the financial crisis would have been the perfect opportunity to rationalize the alphabet soup of regulators in the US overseeing the financial sector (instead of creating a new overseer body, the Financial Stability Oversight Council), and once and for all devise coordinated regulations that recognize that many different financial products are fungible, whether they are called futures, securities, options or swaps. However this sensible outcome was not achieved because of political expediency. Mr. Geithner recounts a conversation with then Congressman Barney Frank reflecting on this:
We thought one obvious fix would be to merge the Securities and Exchange Commission and the Commodity Futures Trading Commission, two market regulators whose overlapping mandates produced duplication and confusion... I asked [Congressman] Frank whether he thought we could round up the votes. “Sure, you can merge the SEC and the CFTC,” he said. “You just can’t do it in the United States.”
But that’s for a different article!
Ultimately, Stress Test leaves too many questions unanswered. It’s interesting, but in the end, it’s like a cup of lukewarm tea: somewhat tasty but unsatisfying.
ICE Futures U.S. Receives Report Card from the CFTC for Its Market Surveillance Program; Grades Appear Good Overall
Last week the Division of Market Oversight of the Commodity Futures Trading Commission published a rule enforcement review of ICE Futures US, a registered designated contract market under US law. Overall the Division did not make many recommendations for improvement although it did suggest that the exchange formalize its role in enforcing ICE Clear U.S.’s open interest reporting requirements and tighten up some processes around market participants applying for hedge exemptions.
DMO’s review covered the period from June 15, 2011 to June 15, 2012 and addressed the market surveillance program of the exchange.
DMO specifically recommended that if the exchange continues to sanction market participants for misreporting open interest, it should adopt a rule specifically stating that misreporting is a violation and that any sanctions be “sufficient to deter recidivism.”
In addition, although DMO found that ICE Futures has “an adequate procedure for setting and monitoring for position limits and accountability levels," it should enhance certain procedures regarding the process for market participants to apply for exemption requests. Among other things, the exchange should require that all questions in applications be answered and that information submitted to support exemptions should be updated at least annually.
DMO also observed that ICE Futures permits market participants to request hedge exemptions in connection with unfixed-price purchases and sales, while the CFTC’s own rules only permit hedge exemptions for fixed-price purchases and sales. The exchange committed to amend its rule to conform to the CFTC requirement, but had not done so by the report’s date.
Finally, DMO noted that ICE Futures is unique among US futures exchanges in authorizing members to apply for a cash-and-carry exemption. Although DMO made no recommendation regarding “the effectiveness” of this exemption, it warned in a footnote that “[i]n the event that the Division determines that the [e]xchange’s cash and carry exemptions…may not be effective, the Division will contact the [e]xchange to address this issue.”
In a similar rule enforcement review of the Chicago Mercantile Exchange dated July 26, 2013, DMO criticized the CME's handling of exchange of futures for related position transactions, among other matters. (For more details, see the article “CFTC CME Surveillance Review: EFRP Monitoring Inadequate” in the August 5, 2013 edition of Bridging the Week entitled by clicking here.) Subsequently CME amended its EFRP rules and guidance, and appeared to bring a large number of disciplinary actions related to alleged EFRP offenses. (For more information, click here to see the article “Lord Voldemort Hovers over the Futures Industry: CME Prohibits All Transitory Exchange of Futures for Related Positions by Name” on this website.)
(For additional information, click here to see the article “CFTC Release Rule Enforcement Review of ICE Futures US” in the July 25 Katten Muchin Rosenman Corporate and Financial Weekly Digest.)
Hard to Believe: Recently the LME committed to maintain the Ring, its open-outcry trading floor, beyond 2015, and is investing GBP 1 million in enhanced technology; helping to integrate Ring and LMEselect™; and facilitating business in the Ring. (For more details regarding the LME's plans, click here.) Seatbelts too?
And even more briefly:
For more information, see:
AIFMD Q&A’s Updated by ESMA to Address Reporting Obligations to Regulators:
ASIC Seeks Comments on Proposed Amendments to Trade Reporting Obligations for OTC Derivatives:
Barclays Formally Responds to NY Attorney General's Dark Pool Allegations:
Credit Suisse Securities Pays ICE Futures U.S. Fine Following ATS Breakdown:
Decision not posted as of publication date.
CFTC Delays OCR Compliance Date:
ESMA Initiates Consultation on Counterparty Risk Limits for UCITS Centrally-Cleared OTC Derivatives:
FSB Formalizes Plans to Implement Interest Rate Benchmark Reforms:
ICE Futures US Receives Report Card from the CFTC for Its Market Surveillance Program; Grades Appear Good Overall:
ISDA Study Finds Increased Cross-Border Fragmentation of Global OTC Derivatives:
Located at: http://www2.isda.org/functional-areas/research/research-notes/
LME Fines Ring Dealers for Standing:
SEC Adopts New Rules Regarding Money Market Funds:
SEC Charges Citigroup Unit With Not Adequately Protecting Trading Data of ECN Subscribers; LavaFlow Pays US $5 Million to Settle:
UK Serious Fraud Office Opens Criminal Investigation Related to Possible Fraud in the FX Market: http://www.sfo.gov.uk/press-room/latest-press-releases/press-releases-2014/forex-investigation.aspx
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of July 26, 2014. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP and/or Gary DeWaal may represent one or more entities mentioned in this article.
Quotations attributable to speeches are from published remarks and may not reflect statements actually made.
Gary DeWaal is currently Special Counsel with Katten Muchin Rosenman LLP in its New York office.
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Bridging the Week by Gary DeWaal: July 21 to 25 and 28, 2014 (Stress Test: Tasty But Unsatisfying; ICE Futures U.S. Report Card; Sit Don't Stand at the LME)Jump to: Bridging the Week My View Hard to Believe