Streetwise Professor

October 12, 2017

Trump Treasury Channels SWP

SWP doesn’t work for the Trump Treasury Department, and is in fact neuralgic to the idea of working for any government agency. Yet the Treasury’s recent report on financial regulatory reform is very congenial to my thinking, on derivatives related issues anyways. (I haven’t delved into the other portions.)

A few of the greatest hits.

Position limits. The Report expresses skepticism about the existence of “excessive speculation.” Therefore, it recommends limiting the role of position limits to reducing manipulation during the delivery period. Along those lines, it recommends spot month on limits, because that is “where the risk of manipulation is greatest.” It also says that limits should be designed so as to not burden unduly hedgers. I made both of these points in my 2011 comment letter on position limits, and in the paper submitted in conjunction with ISDA’s comment letter in 2014. They are also reflected in the report on the deliberations of the Energy and Environmental Markets Advisory Committee that I penned (to accurately represent the consensus of the Committee) in 2016–much to Lizzie Warren’s chagrin.

The one problematic recommendation is that spot month position limits be based on “holistic” definitions of deliverable supply–e.g., the world gold market. This could have extremely mischievous effects in manipulation litigation: such expansive and economically illogical notions of deliverable supplies in CFTC decisions like Cox & Frey make it difficult to prosecute corners and squeezes.

CFTC-SEC Merger. I have ridiculed this idea for literally decades–starting when I was yet but a babe in arms 😉 It is a hardy perennial in DC, which I have called a solution in search of a problem. (I think I used the same language in regards to position limits–this is apparently a common thing in DC.) The Treasury thinks little of the idea either, and recommends against it.

SEFs. I called the SEF mandate “the worst of Frankendodd” immediately upon the passage of the law in July, 2010. The Treasury Report identifies many of the flaws I did, and recommends a much less restrictive requirement than GiGi imposed in the CFTC SEF rules. I also called out the Made Available For Trade rule the dumbest part of the worst of Frankendodd, and Treasury recommends eliminating these flaws as well. Finally, four years ago I blogged about the insanity of the dueling footnotes, and Treasury recommends “clarifying or eliminating” footnote 88, which threatened to greatly expand the scope of the SEF mandate.

CCPs. Although it does not address the main concern I have about the clearing mandate, Treasury does note that many issues regarding systemic risks relating to CCPs remain unresolved. I’ve been on about this since before DFA was passed, warning that the supposed solution to systemic risk originating in derivatives markets created its own risks.

Uncleared swap margin. I’ve written that uncleared swap margin rules were too rigid and posed risks. I have specifically written about the 10-day margining period rule as being too crude and poorly calibrated to risk: Treasury agrees. Similarly, it argues for easing affiliate margin rules, reducing the rigidity of the timing of margin payments (which will ease liquidity burdens), and overbroad application of the rule to include entities that do not impose systemic risks.

De minimis threshold for swap dealers. I’m on the record for saying using a notional amount to determine the de minimis threshold to determine who must register as a swap dealer made no sense, given the wide variation in riskiness of different swaps of the same notional value. I also am on the record that the $8 billion threshold sweeps in firms that do not pose systemic risks, and that a reduced threshold of $3 billion would be even more ridiculously over inclusive. Treasury largely agrees.

The impact of capital rules on clearing. One concern I’ve raised is that various capital rules, in particular those that include initial margin amounts in determining liquidity ratios for banks, and hence their capital requirements, make no economic sense, and and unnecessarily drive up the costs banks/FCMs incur to clear for clients. This is contrary to the purpose of clearing mandates, and moreover, has contributed to increased concentration among FCMs, which is in itself a systemic risk. Treasury recommends “the deduction of initial margin for centrally cleared derivatives from the SLR denominator.” Hear, hear.

I could go into more detail, but these are the biggies. All of these recommendations are very sensible, and with the one exception noted above, in the Title VII-related section I see no non-sensical recommendations. This is actually a very thoughtful piece of work that if followed, will  undo some of the most gratuitously burdensome parts of Frankendodd, and the Gensler CFTC’s embodiment (or attempts to embody) those parts in rules.

But, of course, on the Lizzie Warren left and in the chin pulling mainstream media, the report is viewed as a call to gut essential regulations. Gutting stupid is actually a good idea, and that’s what this report proposes. Alas, Lizzie et al are incapable of even conceiving that regulations could possibly be stupid.

Hamstrung by inane Russia investigations and a recalcitrant (and largely gutless and incompetent) Republican House and Senate, the Trump administration has accomplished basically zero on the legislative front. It’s only real achievement so far is to start–and just to start–the rationalization and in some cases termination (with extreme prejudice) of Obama-era regulation. If implemented, the recommendations in the Treasury Report (at least insofar as Title VII of DFA is concerned), would represent a real achievement. (As would rollbacks or elimination of the Clean Power Plan, Net Neutrality, and other 2009-2016 inanity.)

But of course this will require painstaking efforts by regulatory agencies, and will have to be accomplished in the face of an unrelentingly hostile media and the lawfare efforts of the regulatory class. But at least the administration has laid out a cogent plan of action, and is getting people in place who are dedicated to put that plan into action (e.g., Chris Giancarlo at CFTC). So let’s get on with it.




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  1. What he said.

    Comment by Thomas Jefferson — October 13, 2017 @ 11:03 am

  2. I remember when Jack Sandner wanted to merge the two agencies…..

    Comment by jeff — October 14, 2017 @ 9:30 pm

  3. From your lips to Gary Cohn’s ears?

    Comment by Highgamma — October 15, 2017 @ 10:57 pm

  4. @Highgamma-I was going to blog on that later. Suffice it to say that since I’ve been saying this for almost 9 years, sound travels very slow in DC!

    The ProfessorComment by The Professor — October 16, 2017 @ 1:05 pm

  5. Hey Professor, curious as to your issue with the CFTCs stress test and why you don’t think it covers those liquidity worries? Thanks!

    Comment by Matt — October 17, 2017 @ 12:32 am

  6. @Matt-I was going to blog on that today. My issue with the liquidity stress test is that it looks at only a part, and arguably the less important part, of the liquidity issue. It focuses on whether the CCP will have enough liquid resources to meet its payment obligations in the event of the default of the biggest 2 FCM members. That is, it focuses on CCP survival. That’s not chopped liver, but to me the more important issue is the effects of big VM calls on the health of the financial system overall. VM calls are intended to protect the CCP, but they can cause huge collateral damage elsewhere in the financial system by spiking the demand for liquidity precisely during times when liquidity is likely to dry up.

    The ProfessorComment by The Professor — October 17, 2017 @ 9:10 am

  7. Prof, can you unpack this:

    “The one problematic recommendation is that spot month position limits be based on “holistic” definitions of deliverable supply–e.g., the world gold market.”

    I’m aware that the volume of paper contracts traded in gold is many multiples of physical supply – are you hinting at how this proposed change might significantly affect (disrupt?) trading in the precious metals markets?


    LOL. Never gets old.

    Comment by Global Super-Regulator on Lunch Break — October 21, 2017 @ 1:47 pm

  8. @Global–I’m guessing GiGi thinks it’s pretty old 😛

    I don’t think that gold or other precious metals are likely to be the real areas of concern to an application of “holistic” deliverable supply, but it is possible. For example, Buffett cornered the silver market in London in 1998 by exploiting a bottleneck in assaying that made it impossible to increase supplies in London by bringing in silver from elsewhere. A “holistic” definition of deliverable supply would have ignored the crucial bottleneck.

    The “holistic” approach is more problematic for physical commodities that are more costly to ship as a fraction of value than precious metals, and for which logistical bottlenecks are more likely to be important, namely grains, cotton, and some industrial metals and even some energy products. The Cox & Frey case adopted such a holistic definition and in effect, defined market power manipulation out of existence.

    The ProfessorComment by The Professor — October 22, 2017 @ 5:09 pm

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