Top 10 risk and compliance management related news stories and world events that (for better or for worse) shaped the week's agenda

International Association of Risk and Compliance
Professionals (IARCP)
1200 G Street NW Suite 800 Washington, DC 20005-6705 USA
Tel: 202-449-9750 www.risk-compliance-association.com

Monday, March 12, 2012 - Top 10 risk and compliance
management related news stories and world events that (for
better or for worse) shaped the week's agenda, and what is next

George Lekatis
President of the IARCP

Dear Member,

Do you have “definitional authority? 

The European Central Bank (ECB) tries hard to
understand the Dodd Frank Act (so do we).
In Number 1 we have an interesting “we would
therefore appreciate some clarification from you”
letter from the European Central Bank to the US
Commodity Futures Trading Commission.

The part of the letter I like: “We therefore respectfully ask the
Commissions to exercise their definitional authority…” 

In Number 2 we have the
developments in the
Cayman Islands –
environment, Basel ii,
Basel iii …

Welcome to the Top 10 list.

Enjoy!
_____________________________________________________________
International Association of Risk and Compliance Professionals (IARCP)
www.risk-compliance-association.com

NUMBER 1

A letter to

What is the letter about?

_____________________________________________________________

The point?

“We are therefore concerned about how Title VII of the Dodd-Frank Act
will apply to the official operations of the ECB and the Eurosystem, and
we would therefore appreciate some clarification from you in this regard.

To the extent that your agency is preparing implementation rules to the
Dodd-Frank Act, we would with all due respect seek from you due
consideration to the above arguments, as well as to international comity,
so that the case of International Organizations (such as the ECB) and of
foreign central banks are addressed in the final regulations in a manner
fitting with their official status and tasks.

In that direction, please note that the ECB's -and the Eurosystem's-
mandate requires them to perform public tasks that are broadly
comparable to those attributed in the United States to the Federal Reserve
System, which necessarily require the ECB to conduct operations in the
financial markets, including OTC derivatives.

These are activities that would, if conducted by a private sector entity,
necessarily fall within the ambit of Title VII of the Dodd-Frank Act.

In contrast, we note that if those same transactions were entered into by
the Federal Reserve System, they would be expressly excluded from the
_____________________________________________________________

definitions of "swap" and "security-based swap" contained in the
Dodd-Frank Ad.

We set out attached some considerations on the ECB and its mandate,
and its status under U.S. Law.

The point on which we seek regulatory clarification is whether official
transactions such as those entered into by the ECB and by the national
central banks of the Eurosystem would be captured by the definitions
of "swap" and "security-based swap" contained in the Dodd-Frank Act.

Clearly, our practice to date has been to transact with private sector
entities on market standard documentation for swaps, but given that we
have so far and would in the future only be entering into such transactions
purely in execution of our public mandate - and it is to be noted that we
are not authorised to enter into such transactions on any other basis - we
suggest that the transactions that we enter into should not be interpreted
and legally defined in the same way as otherwise similar transactions
entered into by private commercial entities:

• First, the considerations involved in the management of foreign reserves
are not amenable to control and supervision in the same way as
private-sector profit-maximising transactions.

Indeed, as an institution of the European Union, we are not subject to
supervision or licensing requirements and suggest' that it would be
inappropriate to be subjected to supervisory requirements by a non-EU
authority in respect of a part of our activities.

In particular, we are concerned that external control of our activities
might not be sufficiently sensitive to the practice of managing foreign
reserves and could thus frustrate the ECB's performance of the mandate
that it has been given by the TFEU.

• Second, performance of our mandate can require us to act confidentially
in certain circumstances.

_____________________________________________________________

Please note that in certain occasions central banks market activities, if
subject to public disclosure and external supervision, may cause
signalling effects to other market players and finally hinder the policy
objectives of such actions (the CCP itself would also have a privileged
view on the whole set of cleared central bank transactions).

This is probably the reason behind the exemption given by Dodd-Frank
Act to the Federal Reserve System (a similar exemption to the ECB and
other central banks and comparable international institutions is foreseen
in the proposed draft EU Regulation on Central Clearing of OTC
derivatives in course of definition in Europe).

Certain of the requirements of the Dodd Frank Act, if applicable to the
ECB, could compromise the ECB's ability to take such actions.

In this regard, it is noted that the ECB has worked closely with the
Federal Reserve System in responding to the financial crisis, and should
not be compromised by implementation of the Dodd-Frank Act in its
ability to respond similarly in the future.

• Third, the specificity of role and functions of central banks make their
use of CCPs, and other private financial market infrastructures for that
matter, a very sensitive issue, particularly in times of crisis.

For instance, if a central bank were to become a clearing member of a
CCP it would need to contribute to the CCP default procedures.

In case of crisis, this could force a central bank to eventually absorb other
participants' and possible the CCP's losses, thereby raising sensitive
moral hazard issues.

• Fourth, this may introduce inconsistency between EU and US
legislation concerning the central bank obligations to use designated
CCPs

The abovementioned arguments apply mutatis mutandis to the national
central banks of the Eurosystem.

_____________________________________________________________

As you of course know, Congress has vested the Commissions with the
rulemaking authority to further define certain terms, including "swap"
and "security-based swap, and such joint rulemaking on the definition of
the terms "swap" and "security-based swap" is to be done in
consultation with the Board of Governors.

In light of the above, we therefore respectfully ask the Commissions to
exercise their definitional authority under the Dodd-Frank Act to define
the terms "swap" and "security-based swap", as used in the Commodity
Exchange Act and Securities Exchange Act, respectively, to exclude any
agreement, contract or transaction a counterpatty of which is a Public
International Organisation such as the ECB, or indeed a national central
bank of a market economy.

We stand ready to elaborate on any of the matters raised above, including
with respect to the size and risk management of our US dollar interest rate
derivatives portfolio activities to the extent that this would be helpful to
you.”

_____________________________________________________________

NUMBER 2

Cayman Islands – An Overview
The three Cayman Islands, Grand Cayman, Cayman Brac and Little
Cayman, are located in the western Caribbean about 150 miles south of
Cuba, 460 miles south of Miami, Florida, and 167 miles northwest of
Jamaica.

George Town, the
capital, is on the
western shore of
Grand Cayman.

Grand Cayman, the
largest of the three
islands, has an area of about 76 square miles and is approximately 22
miles long with an average width of four miles.

Its most striking feature is the shallow, reef-protected lagoon, the North
Sound, which has an area of about 35 square miles. The island is
low-lying, with the highest point about 60 feet above sea level.

Cayman Brac lies about 89 miles northeast of Grand Cayman.
It is about 12 miles long with an average width of 1.25 miles and has an
area of about 15 square
miles.

Its terrain is the most
spectacular of the three
islands.

The Bluff, a massive
central limestone
outcrop, rises steadily
along the length of the island up to 140 ft. above the sea at the eastern end.

_____________________________________________________________

Little Cayman lies five miles west of Cayman Brac and is approximately
ten miles long with an average width of just over a mile.

It has an area of about 11 square miles. The island is low-lying with a few
areas on the north shore rising to 40 ft. above sea level.

There are no rivers on
any of the islands. The
coasts are largely
protected by offshore
reefs and in some places
by a mangrove fringe
that sometimes extends
into inland swamps.

Geographically, the Cayman Islands is part of the Cayman Ridge, which
extends westward from Cuba. The Cayman Trench, the deepest part of
the Caribbean at a depth of over four miles, separates the three small
islands from Jamaica.

The islands are also located on the plate boundary between the North
American and Caribbean tectonic plates.

The tectonic plates in Cayman’s region are in continuous lateral
movement against each other.

This movement, with the Caribbean plate travelling in an eastward
direction and the North American plate moving west, limits the size of
earthquakes and there has never been an event recorded of more than
magnitude 7.

It is not unusual for minor tremors to be recorded. Many residents don’t
even notice them. However in December 2004 a quake of 6.8 magnitude
rocked Grand Cayman and everyone noticed. The earthquake, short in
duration, opened some small sinkholes but otherwise didn’t cause any
damage.

_____________________________________________________________

Christopher Columbus first sighted Cayman Brac and Little Cayman on
10 May 1503. On his fourth trip to the New World, Columbus was en route
to Hispaniola when his ship was thrust westward toward "two very small
and low islands, full of tortoises, as was all the sea all about, insomuch
that they looked like little rocks, for which reason these islands were
called Las Tortugas."

A 1523 map show all three Islands with the name Lagartos, meaning
alligators or large lizards, but by 1530 the name Caymanas was being used.
It is derived from the Carib Indian word for the marine crocodile, which is
now known to have lived in the Islands.

Sir Francis Drake, on his 1585-86 voyage, reported seeing "great serpents
called Caymanas, like large lizards, which are edible."

It was the Islands' ample supply of turtle, however, that made them a
popular calling place for ships sailing the Caribbean and in need of meat
for their crews. This began a trend that eventually denuded local waters of
the turtle, compelling local turtle fishermen to go further afield to Cuba
and the Miskito Cays in search of their catch.

The first recorded settlements were located on Little Cayman and
Cayman Brac during 1661-71.

Because of the depredations of Spanish privateers, the governor of
Jamaica called the settlers back to Jamaica, though by this time Spain had
recognised British possession of the Islands in the 1670 Treaty of Madrid.

Often in breach of the treaty, British privateers roamed the area taking
their prizes, probably using the Cayman Islands to replenish stocks of
food and water and careen their vessels.

The first royal grant of land in Grand Cayman was made by the governor
of Jamaica in 1734.

It covered 3,000 acres in the area between Prospect and North Sound.
Others followed up to 1742, developing an existing settlement, which
included the use of slaves.
_____________________________________________________________

On 8 February 1794, an event occurred which grew into one of Cayman's
favourite legends -- The Wreck of the Ten Sail.

A convoy of more than 58 merchantmen sailing from Jamaica to England
found itself dangerously close to the reef on the east end of Grand
Cayman.

Ten of the ships, including HMS Convert, the navy vessel providing
protection, foundered on the reef. With the aid of Caymanians, the crews
and passengers mostly survived, although some eight lives were lost.

The first census of the Islands was taken in 1802, showing a population on
Grand Cayman of 933, of whom 545 were slaves. Before slavery was
abolished in 1834, there were over 950 slaves owned by 116 families.

Though Cayman was regarded as a dependency of Jamaica, the reins of
government by that colony were loosely held in the early years, and a
tradition grew of self-government, with matters of public concern decided
at meetings of all free males. In 1831 a legislative assembly was
established.

The constitutional relationship between Cayman and Jamaica remained
ambiguous until 1863 when an act of the British parliament formally made
the Cayman Islands a dependency of Jamaica.

When Jamaica achieved independence in 1962, the Islands opted to
remain under the British Crown, and an administrator appointed from
London assumed the responsibilities previously held by the governor of
Jamaica

The constitution currently provides for a Crown-appointed Governor, a
Legislative Assembly and a Cabinet.

Unless there are exceptional reasons, the Governor accepts the advice of
the Cabinet, which comprises three appointed official members and five
ministers elected from the 15 elected members of the Assembly.

_____________________________________________________________

The Governor has responsibility for the police, civil service, defence and
external affairs but handed over the presidency of the Legislative
Assembly to the Speaker in 1991.

Cayman Islands, Banking Statistics

Overview

There were a total of 234 banks
under the supervision of the
Banking Supervision Division at
the end of December 2011.

The fundamentals of the banking
sector remain sound and the
industry in general has been
relatively resilient in a very challenging market environment.

Banks continue to consolidate and restructure in search of cost
efficiencies, and improvements in operational risk management and
governance.

As of September 2011, total assets were reported at US$1.607
trillion down from the same period of the previous year where total assets
stood at US$1.725 trillion.

_____________________________________________________________

_____________________________________________________________

The Cayman Islands is recognised as one of the top 10 international
financial centres in the world, with over 40 of the top 50 banks holding
licences here.

Over 80 percent of more than US$1 trillion on deposit and booked through
the Cayman Islands, represents inter-bank bookings between onshore
banks and their Cayman Islands branches or subsidiaries.

These institutions present a very low risk profile for money laundering.

Basel II
The Cayman Island Monetary Authority (CIMA) is implementing the
Basel II Framework.
The Basel II Framework describes a more comprehensive measure and
minimum standard for capital adequacy that seeks to improve on the
existing Basel I rules by aligning regulatory capital requirements more
closely to the underlying risks that banks face.
The Framework is intended to promote a more forward looking approach
to capital supervision that encourages banks to identify risks and to
develop or improve their ability to manage those risks.
As a result, it is intended to be more flexible and better able to evolve with
advances in markets and risk management practices.
A key objective of the revised Framework is to promote the adoption of
stronger risk management practices by the banking industry.
Banks to Which Basel II Applies
The Basel II Framework applies to banks that are locally incorporated in
the Cayman Islands (Category A and B banks), all home regulated banks
and host regulated banks (subsidiaries of foreign banks), with or without
a physical presence.

Branches of foreign banks operating the Cayman Islands, will not be
required to maintain a separate capital requirement, and as such will be
excluded from the local Basel II requirements.

_____________________________________________________________

However, these foreign banks including the operations of the Cayman
Islands branches must maintain the minimum capital adequacy
requirements as stipulated by their home jurisdictions.
Implementation Phases
CIMA proposes to apply the Basel II Framework in two
phases leveraging a practical measured approach.

First Phase
The first phase of the implementation was completed on December 31,
2010 and comprised the following Pillar 1 approaches:
• Credit Risk – Standardized
• Market Risk – Standardized
• Operational Risk – Basic Indicator Approach and The Standardized
Approach

The first phase of the Basel II implementation includes Pillar 2 –
Supervisory Review Process and Pillar 3 - Market Discipline.

Second Phase
The second phase of the CIMA Basel II implementation will be
considered for implementation after 2012.
It will include considering the implementation of advanced approaches,
specifically Pillar 1 – Credit Risk – Advanced Approaches (IRB),
Operations Risk – Advanced Measurement Approaches (AMA) and
Market Risk – Internal Risk Management Models.
Industry Input
Since the majority of banks impacted by the application of the Basel II
Framework are members of the Cayman Island Bankers Association
(CIBA), CIMA has established a joint CIMA/CIBA Basel II Working
Committee.
The primary objective of the working committee is to provide banks and
CIMA a forum for consultation, discussion and agreement on Basel II
related issues. CIMA proposes to obtain the majority of feedback on Basel
II related issues from the CIBA/CIMA Basel II Working Committee.
_____________________________________________________________

CIMA also proposes to communicate directly with those banks that are
not members of CIBA or those banks that have principal agents that are
not members of CIBA.
However, these banks will not have the benefit of consultation or
participation in discussions on Basel II issues with the majority of
impacted banks.
Banks wishing to participate in the CIBA consultations and discussions
should contact CIBA directly.
Basel iii
This is the next step, but we have no timeline yet.
According to Reina Ebanks, Head of Banking Supervision, Cayman
Islands Monetary Authority at the Opening of the FSI & CGBS Seminar -
Regional Seminar on Capital Adequacy & Basel III George Town, Grand
Cayman, Cayman Islands February 22-24, 2011:
“It is good that so many of our colleagues from regulatory bodies in the
Caribbean region have seen the value of this seminar and have seized this
opportunity to participate.

I also appreciate the involvement of our local industry partners who will
serve as presenters.

We all have experiences to share, and by sharing those experiences we
will learn from each other.

The Cayman Islands Monetary Authority believes strongly in the
necessity and benefits of professional training.

We have always sought to ensure that our own staff members have every
opportunity to enhance the skills that are necessary for the Authority to
effectively carry out its role.

The regulatory reform package of the Basel Committee addresses
identified weaknesses of the pre-crisis banking sector and outlines several
measures to promote a more resilient banking sector.

_____________________________________________________________

The objective of the reforms is to improve the banking sector’s ability to
absorb shocks arising from financial and economic stress, thus reducing
the risk of spill over from the financial sector to the real economy.

The new global standards referred to a “Basel III” cover both
firm-specific and broader, systematic risks. At this 3 day seminar our
presenters who are experts in their field are expected to cover specific
aspects of Basel III.

One of the things you learn quickly as a regulator is how rapidly changes
occur within today’s financial systems and how interconnected and
interdependent they are.

The international financial crisis underscored this forcefully, but it is not
going to change it.

Products will continue to evolve; markets will continue to change; ways of
doing business will continue to be constantly challenged by new
innovations despite the new regulations and standards put in place as a
result of the crisis.
However, one of the strong lessons which it has taught us as regulators is
that, in order to stay ahead of the curve, we must expand our knowledge
of the markets and products we are charged with regulating and the role
of the different jurisdictions, large and small, that are part of the global
marketplace.
We must apply that knowledge efficiently in our day-to-day operations.
We must cooperate as regulators at the organizational level.
We must engage in dialogue and we must take joint action.
This is necessary if we are to regulate effectively without stifling
legitimate business and economic growth.”

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NUMBER 3

SPEECHES & TESTIMONY

"Please Listen Carefully, Some Menu Options Have Changed"
Speech of Commissioner Bart Chilton, Trade Tech 2012, New York, NY
March 8, 2012

Important parts

It is amazing if you think about the elaborate, intricate and inter-related
global financial markets of gargantuan size and breadth—churning,
burning, millisecond-splitting, markets operating nearly every day all day.

It is amazing that it all works so well. But then again, it hasn’t always
done so, right?

We have banks and other institutions (think AIG) which were so large
that just a few years ago when they were toppling, or about to topple,
we—all of us—had to fork over hundreds-of-billions of dollars in a
hideous, budget-busting bailout.

There isn't much doubt about the causes of the economic crash, and
complexity had a whole lot to do with it.

The Financial Crisis Inquiry Commission (FCIC) was established to look
at what happened (always a good thing to do after you spend hundreds of
billions of dollars. Hey, why did we have to spend that loot?).

FCIC concluded the Troubled Asset Relief Program or TARP was needed
_____________________________________________________________

due to two culprits to the crisis.

One culprit: regulators. People like me. You see, in 1999, Congress and
the President deregulated banks.

Banks were no longer bound by that pesky Depression-era Glass-Steagall
Act that cramped their style and limited what they could do with the
money in their institutions.

With the repeal of Glass-Steagall, regulators got the message to let the
free markets roll. And, roll they did. They rolled right over the American
people.

The second culprit: The captains of Wall Street. FCIC concluded that
since they were allowed to do so much more without those rules and
regulations, they devised all sorts of creative, exotic and,
yes-complex-financial products.

Some of these things were so multifaceted hardly anyone knew what was
going on or how to place a value upon them.

Here’s an example. Exhibit A: Credit Default Swaps (CDSs)—bizarre
bets upon bets that certain things would actually fail.

And these CDSs were sold and resold around the Street to the point that
nobody really understood what they had and how much it was worth. It
was all way too complicated.

The value of CDSs was in the eye of the beholder.

Folks were over-leveraged if their books called for it to be so. Make it so
Number One.

A case in point would be Lehman Brothers. They were leveraged 30 to 1,
according to the last annual financial statement.

That data showed the firm held $691 billion in assets divided by only $22
billion in actual shareholder equity.
_____________________________________________________________

If all those mind-altering financial products weren’t enough to fuel-inject
the festivities, as a special bonus to the traders, it was completely and
unreservedly unregulated. “Party on Garth.”

CDSs were part and parcel to creating this humongous dark market with
no oversight by regulators.

When I say humongous, I mean it. We at the CFTC currently oversee
roughly $5 trillion in annualized trading on regulated exchanges, but the
over-the-counter (OTC) market is roughly—wait for it—$708 trillion.

In fact, there are well over 160 million financial transactions taking place
each day. Like I said, it is humongous.

Bottom line: the 2008 economic disaster was created due to

- (1) crappy or non-existent oversight and regulation; and

- (2) Wall Street creativity and a penchant for the exotic that created
financial products so complex they would give Rubik a migraine.

The Fixers: Dodd-Frank

As a result of the monstrous economic mess, a mess of which we are still
crawling out, in 2010, Congress passed and President Obama signed into
law the Wall Street Reform and Consumer Protection Act—otherwise
known as Dodd-Frank.

The Act is over 2,000 pages long, and has over 300 provisions requiring
rulemakings, 80% of which are to be promulgated by the SEC, the CFTC,
the Fed, and the CFPB (Consumer Financial Protection Bureau).

To fix a complex problem, sometimes there isn’t an easy fix, and that has
been the case with financial reform.

It isn’t that Members of Congress had voices in their heads telling them to
legislate. Nope, their action was a detailed response to the economic
crisis.
_____________________________________________________________

For those that say Dodd-Frank should be repealed, I guess I don’t
understand why they’d want to go back to the set of circumstances that
led to the ultimate demise of our economy. I just don’t get that.

Dodd-Frank generally imposed a 360-day deadline for approval of all the
regulations, and while we’ve obviously missed that, we’re working hard to
get the regulations in place.

A few times we proposed a rule, yet when we received the comments,
realized we had totally missed the target and we had to re-propose.

For those that follow every move we make, every breath we take, this is all
part of the process: getting the rules right and ensuring they are balanced.
But I understand that people have to be diligent to keep up here.

I have a lot of sympathy. This is very complex. Like I said, people may
want to listen carefully, some menu options may have changed.

So far, the CFTC has issued 28 final rules, and it’s my hope and
expectation that we will meet our Congressional mandate within the next
few months and finish the 21 additional final rules that we are required to
write.

Certain “T’

However, just because I expect us to finish all the rules, that doesn’t tell
people when they will be implemented, or when compliance is necessary.

Aside from complexity and changing menu options, one of the worst
things for our industry, from anyone’s perspective, is uncertainty.

Regulators don’t like it. Market participants don’t like it. Members of
Congress don’t like it, and the public certainly doesn’t like it.

When we aren’t clear about exactly what we’re doing, when rules are to go
into effect, and when people have to comply with those rules, that creates
uncertainty with a capital “T.” Let me explain.

_____________________________________________________________

One of the refrains we keep hearing is that we need to identify what “T”
is.

In other words, we’ve said that we will give folks time to comply with our
rules—T+90 days, T+180 days, T+270.

The legitimate question is: what the heck is T?

Just like the robotic phone tree, people have pushed an options button,
and they keep getting an answer, but it either isn’t the answer they want
or it’s not the fulsome answer they need.

They may be pushing one for English and then saying “agent” or
“operator” but they never get to something or someone who can actually
help them out.

We all know that feeling, and it can be maddening. So now, it’s time we
provide another “menu option,” and answer this timing question.

We hear folks, and here’s a way to get there.

First, we need to get the review of swaps for mandatory clearing rule
done.

Second, we need to finalize the implementation timetable rule.

This will give all of us—market participants, regulators, Congress, the
public—firm compliance dates and it will all seem a lot less complex.

We should give folks a visual of what we are doing and update that as
menu options change.

I have seen some firms that have these.

I’ve urged that we simply put all these expected rule dates on a chart so
that people can see them in concert with each other.

_____________________________________________________________

When is the rule expected to be completed? What might be the
implementation timetable? It seems like a fairly modest thing to do, yet
we haven’t done so yet. I mean, “Got rudimentary technology?” Does
anyone have PowerPoint in the house?

Uncertainty is not just an irritation. It’s bad government, and it’s time we
make sure everyone gets the certain “T” with a capital “T” they need, and
firm answers when they “push the button.”

Position Limits—The Time is Now

One of the rules that has been very difficult to get a visual upon is position
limits. Remember when I said that most of the rules were to be completed
within 360 days? That would have been last July.

Well, there were just a few exceptions to that, and position limits was one.
Congress wanted limits done sooner, and told us very specifically so in
the law.

We were supposed to start implementing them a year ago January. But
guess what? On one of these charts that a firm showed me a few weeks
ago, position limits were actually the last regulation to be implemented. I
think their chart was actually wrong.

I hope it was wrong, but I can understand why they might think limits
would be delayed.

The Commission passed a final position limits rule in October, but it has
yet to be implemented.

We are actually waiting, of all things, for a joint rule with the SEC on
definitions to be approved before the implementation clock—the
T—starts ticking.

The problem is this: we need these limits now. I’ve been calling for them
since 2008. We have needed them for years. If you’ve been to the gas
station lately or watched the news, you know people are experiencing a lot
of pump price pain.
_____________________________________________________________

The CFTC is not a price-setting agency. That isn’t our job. However, we
do have a mission to ensure that the price discovery process is fair.
Position limits can assist in ensuring prices they are fair.

If we look back to 2008 when there was relatively stable supply and
demand for crude oil, we saw prices ride a rough-and-tumble roller
coaster—going from below a hundred dollars-a-barrel early in the year to
nearly $150 in June, then moving all the way down to just over $30-a-barrel
in December.

There was no justification for such a price swing based upon the
fundamentals of supply and demand. The only good explanation is what
many researchers and prominent economists and others have said about
the link to excessive speculation.

And guess what? We are seeing something similar this year. The supply
of oil and gasoline is greater today than it was in 2008 and demand for oil
in the U.S. is at its lowest level since April of 1997 (so, says the Energy
Information Administration). Yet, we see what is happening to prices.
They are once again rising sharply.

The increased cost of fuel can also dampen the economic recovery. Data
confirms the economy is on the mend, but there is no question the
recovery is still fragile.

According to the International Monetary Fund, for every $10 increase in
the price of a barrel of crude oil, the entire U.S. GDP is reduced by a half
percent.

We all know fuel prices have a direct impact upon individuals, but think
about the enormous drain on businesses large and small. The airlines, for
example, will spend billions more this year than they had anticipated due
to higher fuel costs.

A few days ago, I spoke with Delta Air Lines executives Ben Hirst (the
General Counsel) and Jon Ruggles (the Vice President for fuel). They tell
me that each incremental dollar per barrel of crude impacts their fuel
prices by $96 million per year.
_____________________________________________________________

They are now expecting to spend at least $1 billion more in 2012 than
initially budgeted. Do they believe speculators are having an impact on
rising prices? You bet they do, and they are not alone.

In fact, the association that represents all of the major air carriers has
been urging us to impose positions limits for years. They urged even
more restrictive limit levels that the Commission approved.

And by the way, federal, state and local governments are also impacted
very directly by fuel costs, so this is a drain on taxpayers not just with
regard to their family budget but because it increases the costs of
government.

Here is an example: the U.S. Department of Defense spent $17.3 billion
on fuel in 2011.

Now, before some of you who have an opposing view about speculation
get too worked up, let me say unequivocally that markets need
speculators.

There are no markets without them. Speculators are good. But like a lot of
good things, too much can be problematic.

Therefore, it is the excessive speculation that can cause problems, contort
markets, and result in consumers and businesses paying an unfair price.

Some people say: “Well these markets have worked pretty well over the
years. How can you really tag speculation with being a problem in 2008
and is it more than just a guess that excessive speculation is a problem
today?” Well, good question Grasshopper.

Between 2005 and 2008 we saw over $200 billion come into futures
markets from non-traditional investors. I call them “Massive Passives.”

They are the likes of pension funds, index funds, hedge funds and mutual
funds. These funds are very large—massive—and have a fairly
price-insensitive, passive trading strategy.

_____________________________________________________________

When I say this, I’m talking generally. I realize that all these traders aren’t
passive all the time, but we do see a pattern.

In fact, new CFTC data says that massive passive long speculators have
shorts outnumbered 12 to 1.

Like a rising tide lifts all boats, when we see this unprecedented increase
in speculation, it has an impact.

I’m not suggesting that the Massive Passives, or speculators in general,
are actually driving prices.

Let me be clear. I’m not suggesting that they were all in cahoots and
decided to raise oil prices. What I am saying is that they contribute to
price swings, and have a proportional impact in markets based upon their
size as a whole, and certainly individual traders can push prices around if
they have a large enough concentration.

When prices are on the rise, like now, and the Massive Passives and
others get into markets, they push prices to levels that may be
uneconomic—certainly not tied directly to supply and demand—and the
prices stay higher longer than they normally would.

By the way, although it isn’t as interesting to the media and others, the
same takes place when speculators exit markets. That’s why prices shot
down so far in 2008 by the end of the year.

Every trader was bailing from the markets because of the bottom falling
out of the economy and prices for a lot of things tumbled.

Now, if people believe there was a lot of speculation with that $200 billion
infusion back in 2008, guess what? It is even higher this year.

In energy markets, it’s 43 percent higher than in June of 2008. And
remember, it’s pretty early in the year for gas prices to be this high. It was
even higher last year and not just a little higher.

From June of 2008 until January of last year, speculation in energy
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markets had increased by 64 percent. In the metals and agricultural
complexes, it had increased by roughly 20 percent.

Is that speculation excessive speculation and is it impacting prices? I
think so and so do many members of the U.S. House and Senate.

In fact, in the last two weeks, we have received numerous letters from
dozens of members of the House and Senate—those that actually voted
for the reform law—telling us to get with it and implement position limits.
Earlier this week, we received a letter from 23 Senators and 45 Members
of the House.

They were clear: get on with position limits already. We gave you that tool.
Use it now. Also, last week President Obama said, “When uncertainty
increases, speculative trading on Wall Street can drive up prices even
more.”

But you don’t have to take it from me, from Senators or U.S.
Representatives, or from the President of the United States.

In fact, you don’t have to take it at all. There are many who don’t. I can
continue to explain all this to people, but I can’t comprehend it for them.

Nonetheless, let me lay one more piece of research on you with regard to
speculation. This one doesn’t come from some lefty progressive group. It
comes from one of the big Wall Street banks. In fact, I met with them
again yesterday.

Their researchers said that each million barrels of net speculative length
adds as much as 10 cents to the price of a barrel of crude oil. The
speculative length is a known quantity.

With a little math, you can determine that the “speculative premium” on
oil these days is around $23 a barrel—and that translates into about an
extra 56 cents for a gallon of gas.

What that means is this: if you drive a Honda Civic, the speculative
premium costs $7.39 every time you filler-up. If you drive a Ford Explorer
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or F-150, the total is $10.41 and $14.56, respectively. I don’t know how
often you fill up, but over the course of a year we’re talking real
money—hundreds of dollars.

Imagine a trucker who pays a speculative premium of $112 more to fill up
a Freightliner, driving 120,000 miles per year at 6 miles per gallon.

The annual cost to the trucking industry: $29.1 billion. For the airline
industry: $9.8 billion.

Our position limits rule is one of the only tools regulators have in our
utility belt to combat unfair prices. We need to use it.

We need to implement the rule as soon as possible and I’m working to do
just that.

But there is another fly in the ointment on this, and a lot of you know
about it. Certain Wall Street interests are suing the government in an
effort to stop the rule from going into effect.

They contend, among other things, that we didn’t do an appropriate Cost
Benefit Analysis—a CBA. I suppose they want the ability to speculate
with no limits whatsoever. That’s not good for markets, for the economy
or for businesses or consumers.

Will position limits take us back to the days of $1.00- per-gallon gasoline?
Oh, heck no. Limits will, if we can survive the court challenges and
implementing delays—help reduce the pump price pain.

A More Perfect Regulation?

We live in not only a complex, but a litigious society. Sure people have the
right to go to court and challenge things.

But regulators need to keep our eye on the ball and not be scared into
making rules and regulations weak or ineffective because we are overly
concerned about what we call “litigation risk.”

_____________________________________________________________

This is an issue that has troubled me for a while, and I’m going to use this
forum as an occasion to talk a little about something that is significant.
Bear with me a little here.

In the preamble to the Constitution of the United States, there is this
wonderful aspirational language:

We the people of the United States, in order to form a more perfect union,
establish justice, insure domestic tranquility, provide for the common
defense, promote the general welfare, and secure the blessings of liberty
to ourselves and our posterity, do ordain and establish this Constitution
for the United States of America.

“In order to form a more perfect union.” Those words, “in order
to”—they meant that our forefathers were working toward, hoping,
aspiring, to form a more perfect union. It wasn’t perfect, and it might not
reach perfection, but they were trying to get there.

So, here’s something to think about: those wonderful “planks” toward
making that “more perfect union”—establishing justice, insuring
domestic tranquility, promoting the general welfare—each one of those
distinct factors didn’t in and of itself create the more perfect union.

Rather, each facet was a building block that the Founding Fathers
intended to use to “get there,” to become that more perfect union.

In other words, “providing for the common defense,” wasn’t the be all
and end all, but instead it was one of the important pieces used to get to
the ultimate goal: a more perfect union.

Now I’m going to take what you may think is an odd turn. In a similar
fashion, Cost Benefit Analyses, like the CBA I mentioned a moment ago
with regard to the position limits lawsuit, in regulatory rulemaking are
analogous to those discrete building block factors in the Constitution’s
preamble.

A CBA is not the ultimate goal of rulemaking, although if you listen to
some you might think it so. A CBA is an important piece of reaching the
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ultimate goal: a “more perfect regulation.” Like the framers of our
Constitution, regulators aspire to reach objectives that protect the
commonweal. That’s our job.

In the recent past, however, our jobs have been made significantly more
difficult by a contortion—but I’ll call it as I see it: a bastardization—it is a
bastardization of the conduct and use of CBAs in regulatory rulemaking.

This by no means is a new phenomenon. It has cropped up over the years,
time and again, as a convenient tool to scuttle regulatory initiatives.

Its use at this moment in history is, however, particularly galling to me,
given the focus of the regulations that are being decelerated and the harm
that was caused to the public as a result of the economic crisis of 2008.

There are those who bellow about the “costs” of regulation. To those
catcalls, I would simply ask, what were the “costs” of that multi-hundred
billion dollar taxpayer-funded bailout?

What are the “costs” of families losing their homes? What are the “costs”
to our economy of skyrocketing oil and gas prices, fueled by unbridled
excessive speculative activity?

CBAs are being used as a Sword of Damocles over regulatory agencies.
Some regulators live in constant fear and are virtually paralyzed by the
threat—or, indeed, the actuality—of lawsuits brought (spuriously, in my
opinion) on the bases of allegedly poor CBAs.

When this happens, rulemaking activity slows, or grinds to a halt—and
that is the precise intent of some who threaten, design, and bring, these
lawsuits.

And at the same time, American consumers and taxpayers continue to
pay more at the pump for a gallon of gas. The airlines will pay billions
more. Our Department of Defense and state and local governments will
pay more.

We will continue to see the devaluation of homes, and continue to face
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high unemployment rates. How do we measure those “costs?”

It’s time to put some sense (and cents) back into CBAs, and to criticisms
of rules. By that I mean, I’d like to see reasonable, accurate, and
well-supported analyses, and those who criticize our CBAs should be
required to provide, not “masked data,” with no clear or hard figures, but
real, verifiable dollars and cents to rebut our analyses.

For example, we put out a proposal, ask for comments and ask what the
costs might be. Then we either aren’t provided with costs of the
regulation, or what we get from the commenters isn’t very helpful.

We develop the rule and do the best job we can with all the data we have
and go final. Then, opponents of the rules say, “Hey, you didn’t do an
adequate CBA.” Give me a break.

Then, some talk about or take the government to court. People have a
right to go to court, but there is a point at which it seems to me some
might be taking advantage of the system.

If we are all held to the same reasonable standards on providing and
developing good thoughtful data, and not just throwing mud to try and
slow the process down, CBAs might actually be a whole lot more
useful—as they were intended: as a factor in forming “more perfect
regulations.”

Ah, good. That feels better.

Helen, Mike and MF Global

Finally, I don’t want to leave here without discussing a little bit about MF
Global and the mysterious missing millions.

Let’s be clear: this was a fresh slap-in-the-face reminder that we need
appropriate regulations in place now. MF Global is the new poster child
for why thoughtful financial regulation is needed more than ever.

No matter how I talk about this horrific set of circumstances with regard
_____________________________________________________________

to MF Global, I can’t express what a sorry situation this has caused for
many MF Global customers. I have a one paragraph letter I received in
January and I want to share it with you. It said:

“I am 75 years old and my husband is 76 years old. We take care of our
brain injured son who is 55 years old. All of our money—over $900
thousand—was invested in commodities with MF Global.

We have no income except for a small Social Security check for both of us
and some for my son. We will be losing our home we have lived in for 30
years if these funds aren’t returned to us soon.

We really made a mistake by trusting too much. We are too old to work
anymore. All of our strength we have goes to caring for our son. Can
someone please help? We are desperate!”

I’m not going to use their last name or tell you where they are from
because I didn’t check with them, but I have it right here and I’ve been
carrying it around for the last few days to remind me that the MF Global
matter isn’t some esoteric policy issue.

It is a real and dire matter for thousands of people like Helen and Mike.

For us, job one is always—no excuses—to ensure that customer funds are
held sacrosanct in what are called “segregated accounts,” and that they
are safe and secure. In this case, those funds were not secure.

Hundreds of millions of dollars isn’t where it should have been.

Aside from trying to find and claw back all the funds and conducting our
investigation and going after anyone who broke the law, we also need to
ensure that we do all we can to avoid this happening in the future.

In that regard I have suggested several things that can be done, although
there are others:

One, we need to engage in regular and robust deep data dives. By that I
mean we need to regularly ensure that customer funds are where they are
_____________________________________________________________

supposed to be. Rather than taking a firm’s word at face value that the
money is where it is supposed to be, we need to do the Jerry Maguire and
insist that they “show us the money.”

Two, we should allow customers a choice of how or if their funds in
segregated accounts are used.

People make choices about the types of investment that can be made with
their money in their pension funds.

They should be able to do the same with segregated funds. They should
also be able to say: “My money sits there as margin and nothing can be
done with it.”

By the way, customer choice is something that is already done in the
United Kingdom, so we should look to them for guidance on how best to
formulate such a plan, and;

Three, Congress should approve legislation to establish an insurance
fund to serve as a backstop for customers like Helen and Mike should
there be a loss in the future.

The securities world has such an insurance fund. We all know the
banking world has the Federal Deposit Insurance Corporation.

We need such an insurance fund in the futures world.

Conclusion—Some Menu Options
I am grateful for your attention.

We live in a complex world and these are all complicated issues. Here is
what I know: we are in a rapidly changing environment. Markets are
morphing.

Laws from less than two years ago don’t even mention things—like high
frequency traders — that are clearly issues for regulators today —
something we didn’t have time to discuss.
_____________________________________________________________

It is all moving and changing fast, fast, fast.

We can’t do the job we need to do as regulators without the serious and
thoughtful help of people involved in these markets.

We need to know what you think. That is why I’ll be very pleased to take
your comments and questions if there is time.

If we have gotten something wrong, you need to tell us. If something
needs changed, shout it out.

Here is my personal promise to you: I will listen carefully, because I
understand that some menu options may have changed.

Thank you.
March 8, 2012

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NUMBER 4

Remarks before the Institute of International Bankers, Annual
Washington Conference
Commissioner Jill E. Sommers, March 5, 2012
Important parts
I would like to touch on a few developments and give my thoughts on the
current state of derivatives regulation both here in the US and abroad.
Since September of 2010, the Commission has held 24 public meetings to
vote on various Dodd-Frank matters and has issued nearly 60 proposed
rules, notices, or other requests seeking public comment, and has
completed 28 final rules, interim final rules, and exemptions.
I think we are about at the half-way mark with at least twenty more rules
to go, including the most significant rules like definitions of a swap dealer
and swap.
We have one meeting scheduled for March and four more meetings
scheduled for April and May.
The Process
When it comes to the rulemaking process, I believe a reasonable,
measured approach is critical.
Swap markets developed without our involvement, and we have little
experience with these markets. The truth is we don’t know what the full
impact of our rules will be, and we don’t know whether the assumptions
we operate under are valid.
_____________________________________________________________

Given this knowledge gap, it makes sense to start with a broader, more
flexible approach, and become narrower and more restrictive only as
necessary and after we have sufficient experience and data to make these
decisions.
Unfortunately the Commission has not taken this sensible approach.
By way of example, last month the Commission held an open meeting to
consider a final rule related to business conduct standards and a proposed
rule related to block trading.
Dodd-Frank mandates that the Commission specify the criteria for
determining what constitutes a large notional swap transaction—or block
trade— for particular markets and contracts.
In determining appropriate block trade sizes, Congress has directed that
the Commission take into account whether public disclosure of
transactions will reduce market liquidity.
This requires a balancing act—if the block threshold is set too low, there
will be reduced transparency in the market.
If the block threshold is set too high, there will be reduced liquidity in the
market.
Setting block sizes for swaps is not an easy task, and absent robust data,
comprehensive analysis, and the benefit of market experience, we could
severely harm liquidity at this critical regulatory juncture where we seek
to bring more swaps onto swap execution facilities.
The proposal, which passed by a 3-2 vote, recommends utilizing a
formula to determine block size whereby only the largest 6% of all interest
rate swaps and credit default swaps would be block trades.
This proposal ignores Congress’ mandate that we take into account the
impact of public disclosure on liquidity.
We now run the risk of sacrificing liquidity at the altar of transparency.
More troubling, the rule writing team only had access to 3 months’ worth
of transaction data, and that transaction data dates back to the summer of
2010.
_____________________________________________________________

In writing these rules we are relying on stale data, and far too little of it.
This is just one instance where we have proposed rules without sufficient
data, robust analysis, and complete knowledge of their impact.
Extraterritoriality
I am guessing that the issue first and foremost on many of your minds is
extraterritoriality.
As everyone in this room knows, the swaps market is a global market.
Harmonizing our rules to the greatest extent possible with the SEC, other
US regulators and our foreign counterparts is absolutely crucial for
ensuring that we accomplish the overall global objectives of reducing
systemic risk and limiting opportunities for regulatory arbitrage.
As required by Dodd-Frank, and in keeping with the commitments
reached by the G-20 leaders in Pittsburgh in September of 2009,
Commission staff has been in constant contact with our counterparts in
London, the European Union and Asia.
These issues are very complex, and the possibility of divergent views
among international regulators is very real.
The challenge lies in building a consistent philosophy for how the
regulatory frameworks of many nations fit together to ensure cross-border
swap activities are not disrupted.
In Dodd-Frank Congress expressed intent for the statute to apply to
activities abroad in certain circumstances, but was not crystal clear on the
parameters.
While the statute gives us some direction, the Commission is considering
how broadly or narrowly it intends to interpret the scope of this limitation.
Setting the precise scope of Dodd-Frank with respect to the cross-border
activities of foreign entities is necessary to preserve the continuity of
global business operations and the risk management tools that swaps
provide.

_____________________________________________________________

To that end, I expect the Commission to issue proposed guidance on this
issue in the coming weeks; however, it is my understanding the scope of
the guidance will only speak to who will be required to register as a US
swap dealer or major swap participant.
The Commission intends to tackle other issues such as clearing and
market infrastructure in subsequent guidance.
I am deeply concerned that there has not been adequate coordination
with the SEC and the international regulatory community.
Of even greater concern to me is that the Commission appears to be
considering a piecemeal approach to issues of extraterritoriality by
proposing guidance in stages rather than by proposing one
comprehensive rule that will give market participants some degree of
certainty and the entire framework we are considering.
I cannot imagine the global consequences of an inconsistent approach to
these issues by the SEC and CFTC.
I have spoken to many foreign entities and foreign regulators who are
very interested in how far the CFTC intends to reach into the operations
of entities located overseas.
I believe this is one of the single most important issues the Commission
will address during the implementation of Dodd/Frank.
There has been an enormous amount of congressional interest and if we
do not get this one right, I am confident Congress will step in. I would
like to see the CFTC propose a joint rule or at the least a coordinated rule
with the SEC.
The CFTC has a long history of international cooperation and recognition
for comparable foreign regulatory regimes.
This is not the time for us to abandon policies that have worked well for
us over decades of international practice.

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Volcker
I am also going to guess that the other important issue on your mind is
the much discussed “Volcker rule”.
The CFTC waited until January of this year to put out its Volcker
proposal, notwithstanding the fact that other US regulators put out their
version of Volcker last October.
The proposal is lengthy and extremely complex and I do not think we
spent sufficient time to fully consider all of its implications. I am troubled
that this is the path the Commission has chosen.
Given that we waited until January to propose our version of Volcker, well
after other regulators issued proposals and received comments, we had a
unique opportunity to take into consideration the comments filed with
those other agencies.
Unfortunately, even with the lag time and the benefit of comment letters
we proposed a rule that is virtually identical to the other agencies’
proposed Volcker rule.
I had concerns about what the CFTC would do if other agencies
re-propose their rules.
I hope we will be prepared to withdraw our proposal and join a
re-proposed Volcker Rule with the other agencies.
Otherwise, it seems as if we have put ourselves on a separate track, which
I fear will needlessly complicate an already convoluted and likely
unworkable set of rules.
Central bankers and regulators from around the world have expressed
concern that the rule, which as proposed would apply to the US
operations of foreign banks, may also extend to a firms’ operations
outside the US.
Many countries in Europe and Asia have weighed in, and many industry
bodies such as yours have filed helpful comment letters too.
In fact, the CFTC, Treasury and other regulators received over 17,000
comment letters. We have seen these concerns voiced by high ranking
_____________________________________________________________

officials, such as Bank of Canada Governor Mark Carney, EU Financial
Services Commissioner Michel Barnier, and FSA chairman Lord Adair
Turner.
For example, the UK and Japanese finance ministers weighed in saying
that, without an exemption from the rule, their governments’ borrowing
costs would rise.
Japan and Britain have called on the US to rewrite the Volcker rule given
concerns that it could reduce liquidity in sovereign debt markets at a
crucial moment for some European governments.
Japanese Finance Minister Jun Azumi and his British counterpart George
Osborne pointed out that Volcker may be the "wrong prescription," with
unintended consequences.
Of particular concern to other nations is the fact that, while the new rule
may adversely impact market liquidity in stocks and corporate and
government bonds, there is an exemption that allows the banks to buy US
government securities -- but not other sovereign debt instruments.
As a consequence, explained Azumi and Osborne, "it could reduce
liquidity in non-US sovereign markets, making it more difficult, costlier
and riskier for countries to issue and distribute debt."
Government debt and related obligations are a major part of the banking
sector’s liquid assets.
I believe that we need to really consider, especially at this troubled time in
the sovereign debt markets, whether this exclusion should be applied in a
broad manner that allows banks, especially those outside the US, to
engage in liquidity management using assets accepted as liquid reserves
such as foreign sovereign debt.
Second, after reviewing the many critical comments we should
re-evaluate the foreign banking entities exemption.
I do not believe this exemption should be narrower than is required by
Dodd-Frank.

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At a minimum, we could clarify that use of US financial infrastructure
(e.g. clearing, settlement, and trade facilitation) would not make the
transaction subject to the rule.
It is critical for US regulators to come together and form a reasonable
approach to the many difficult issues included in the prohibitions and
restrictions on proprietary trading.
The implications of this rule will most definitely be felt around the globe.
International Update
As you know, I chair the Commission’s Global Markets Advisory
Committee and have participated for the last three years in the Technical
Committee meetings of IOSCO and so am particularly sensitive to
international regulatory issues.
As a quick recap on other jurisdictions, we continue to monitor the
progress of the European Market Infrastructure Regulation (EMIR), the
Markets in Financial Instruments Directive (MIFID) and the related
Markets in Financial Instruments Regulation (MIFIR), as well as the
proposed revisions to the Market Abuse Directive (MAD) and the Basel
Committee on Banking Supervision and IOSCO joint working group on
margin requirements for uncleared derivatives.
A political agreement on EMIR was reached last month; however, an
official version has yet to be released publicly.
Based on conversations with our European Commission (EC)
counterparts, EMIR will come into force on January 1, 2013, but will not
be applied until later in 2013.
More specifically, authorization of CCPs will not occur until mid-2013 and
we do not have an estimated date for when trade repositories will enter
into force.
With regard to MiFID and MiFIR, we expect that the European
Parliament will consider them at some point this summer.
All three of these proposals are the EU’s responses to the commitments
made by G-20 leaders in 2009 to address less regulated parts of the

_____________________________________________________________

financial system, such as OTC derivatives, and to improve the oversight
and transparency of commodity derivative markets.
MAD/MAR: The European Commission has also proposed regulations
to increase the number of commodity derivatives and OTC derivatives
that are covered by the market abuse regime.
The proposals extend the market manipulation prohibition to
instruments whose value relates to exchange traded instruments.
So for instance, an OTC derivative referenced to a contract traded on ICE
Futures Europe would fall within the new Directive.
These updated regulations now include prohibitions against attempted
manipulation, where the old rules only covered actual manipulation.
I should also point out that the new regulation gives the member states
more enforcement tools and criminalizes certain insider trading and
market manipulation offenses.
We expect these proposals will also be taken up by the European
Parliament this summer.
The IOSCO Task Force on OTC derivatives (TF) has been busy. Here’s a
sense of where various work is in the pipeline:
- the report on requirements for mandatory clearing;
- the TF’s “Follow on analysis to the report on trading”; and
- the report on OTC Derivatives Data Reporting and Aggregation
Requirements, which is the joint work of the TF and the Committee
on Payment and Settlement Systems (CPSS)
were all approved before or during the Feb. 2012 Tokyo Technical
Committee Meeting.
The last report left for the task force to take up, the report on OTC
Derivatives Market Intermediaries’ oversight, is nearly finished and likely
to be approved at the May IOSCO Annual meeting in Beijing.

_____________________________________________________________

Lastly, on the international front, I would like to report that the Basel
Committee on Banking Supervision and IOSCO has established a joint
working group on margin requirements for uncleared derivatives.
The group includes representatives from more than twenty regulatory
authorities, including the CFTC, and has held two in-person meetings
and numerous conference calls.
The topics discussed have included:
- the purposes of margin;
- the instruments subject to margin;
- entities subject to margin;
- categorization of counterparties;
- calculation of margin;
- eligible collateral;
- segregation of collateral;
- treatment of affiliates; and
- cross-border issues.
The group is working toward issuing a consultative paper mid-year.
US regulators will coordinate with the international effort, and my hope is
that US regulators will not take up the final rulemaking on margin
requirements for uncleared derivatives until after the international
standards have been settled.
Finally, I will turn to recent developments in Asia.
Japan
The Japanese legislature passed the Amendment to the Financial
Instruments and Exchange Act (“FIEA”) in May 2010.
This amendment gave the Japanese financial regulator, the JFSA, the
authority to regulate OTC derivatives.
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The JFSA expects the implementing cabinet ordinance and other
measures to be finalized by November 2012.
Hong Kong
The Hong Kong Monetary Authority (“HKMA”) and Hong Kong
Securities and Futures Commission (“SFC”, together with the HKMA,
the “Hong Kong Authorities”) released a consultation paper on their
proposed OTC regulatory regime in October 2011.
The Hong Kong Authorities propose amending the Securities and
Futures Ordinance to set out a general framework for the regulation of the
OTC derivatives market, which includes providing relevant rulemaking
powers to the HKMA and SFC.
Hong Kong is working to adopt these regulations by the end of 2012.
Singapore
On February 13, 2012 the Monetary Authority of Singapore (“MAS”)
published a consultation paper with proposals to meet the G20 mandate
on the trading, clearing and reporting of OTC derivatives.
To implement the recommendations of the international standard setting
bodies, MAS proposed to expand the scope of the Securities and Futures
Act (“SFA”) to mandate central clearing and reporting of OTC derivatives
contracts, as well as regulate market operators, clearing facilities, trade
repositories and market intermediaries for OTC derivatives contracts.
Generally there is a fair amount of consistency between jurisdictions. Of
course there are some areas where coordination and cooperation are
essential.
I know the concept of indemnity in the context of swap data repositories
is an issue, as well as the desire by some for a central bank exemption
from the registration, public reporting and clearing requirements of
Dodd-Frank.
There is also a conflict regarding the open access to CCP’s rules which we
finalized in October of last year.

_____________________________________________________________

The rules prohibit a DCO from setting a minimum adjusted net capital
requirement of more than $50million for any person that seeks to become
a clearing member in order to clear swaps.
This very low number has generated concern from other authorities.
As you all know very well, market regulators around the globe are working
diligently to respond to the commitments made at the G-20 level.
Considering the scope of the work for all of these jurisdictions, I think the
progress made up to this point has been remarkable.
We will continue our efforts at the Commission coordinating with our
global counterparts and will probably be working to establish appropriate
rules and regulations for many years to come.
Conclusion
In closing, I would like to convey my persistent grief regarding the
process the Commission is using to finalize these very important rules.
I believe we should be crafting all of our regulations in a way that will
allow them to stand the test of time and to not favor one market segment
over another.
I believe that it is crucial for the marketplace and for market participants
that we get these rules right and that we finalize them in a way that is
reasonable and to not politicize them.
It would not be a good outcome if we are re-writing most of these rules in
the next couple of years because the rules do not reflect the useful input
we have received from the market.
We consistently reject reasoned comments from industry professionals
with little justification in our cost benefit analysis to support those
rejections.
I have been hopeful for the past year that things would change when we
started finalizing rules, and especially the rules that are so integral to the
new regulatory framework, but things have not changed.
I am no longer optimistic; I do not believe that these rules have a chance
of withstanding the test of time but instead believe that this Commission
_____________________________________________________________

will be consumed over the next few years using our valuable resources to
rewrite rules that we knew or should have known would not work when
we issued them.
March 7, 2012

_____________________________________________________________

NUMBER 5

7 March 2012
Technical features of the Legal Entity Identifier (LEI)

The FSB LEI Expert Group has made significant progress in identifying
the key issues and developing framework solutions to be presented in the
report to the FSB Plenary by the end of April, to enable the Board to meet
the G-20 mandate provided at the Cannes Summit.

Work is proceeding intensively under five workstreams - each having its
own mandate and deliverables:

- governance;
- operational model;
- scope, confidentiality and access;
- funding; and
- implementation and phasing.

The Expert Group is supported by an Industry Advisory Panel composed
of 34 representatives from different sectors and regions to help provide
important industry input into the global public-private LEI initiative.

The Expert Group is determining the regulatory interests that must be
protected within the framework of the global LEI system and is
continuing to review the resulting regulatory requirements for the LEI
that form a key component of the G-20 mandate.

The FSB has, however, decided to provide early clarity on two technical
points. This clarity is provided in order to give early guidance to industry,
to help with expected forthcoming proof of concepts and to provide initial
direction on the work of the Expert Group.
_____________________________________________________________

At the same time, this early guidance is subject to final confirmation as
the Expert Group completes its work.

First, the Expert Group has agreed that a 20-character alphanumeric code
is a good basis for the global LEI code.

Second, the Expert Group is continuing to review the LEI eligibility
criteria as well as the reference data that the regulatory community views
as essential and, consequently, would require to be associated with the
identifier.

In the first round of discussion, the Expert Group agreed that the
following six data elements will all form part of the minimum set of
reference data attributes that will be required by the regulatory
community on the launch of the LEI:

- The official name of the legal entity;

- The address of the headquarters of the legal entity;

- The address of legal formation;

- The date of the first LEI assignment;

- The date of last update of the LEI;

- The date of expiry, if applicable.

It should be noted that this limited minimum set of the reference data is
the product of the first round of regulatory discussions.

As the Expert Group completes its work, it expects to propose additional
elements both for reference data attributes, and for the audit trail of
changes and updates to the LEI, in order to meet various regulatory
needs.

Work continues on all other aspects of the LEI framework with the aim of
completing an internal report to the agreed deadline.
_____________________________________________________________

This report will provide concrete recommendations on the protection of
public interests and structures sought in the LEI system.

The final report will be published in due course.

_____________________________________________________________

NUMBER 6

Interesting developments

Mario Draghi, President of the ECB,
Vítor Constâncio, Vice-President of the ECB,
Frankfurt am Main, 8 March 2012

Important parts
Ladies and gentlemen, the Vice-President and I are very pleased to
welcome you to our press conference. We will now report on the outcome
of today’s meeting of the Governing Council.
Based on our regular economic and monetary analyses, we decided to
keep the key ECB interest rates unchanged.
The information that has become available since the beginning of
February has confirmed our previous assessment of the outlook for
economic activity.
Available survey indicators confirm signs of a stabilisation in the euro
area economy.
However, the economic outlook is still subject to downside risks. Owing
to rises in energy prices and indirect taxes, inflation rates are now likely to
stay above 2% in 2012, with upside risks prevailing.
Nevertheless, we expect price developments to remain in line with price
stability over the policy-relevant horizon.
The underlying pace of monetary expansion remains subdued, consistent
with contained inflationary pressures over the medium term.
Looking ahead, we are firmly committed to maintaining price stability in
the euro area, in line with our mandate.
To this end, the continued firm anchoring of inflation expectations – in
line with our aim of maintaining inflation rates below, but close to, 2%
over the medium term – is of the essence.

_____________________________________________________________

Over recent months, a wide range of additional non-standard monetary
policy measures has been implemented by the Eurosystem.
These measures, including in particular two three-year longer-term
refinancing operations, were decided upon against the background of
exceptional circumstances in the last quarter of 2011.
The first impact of these measures has been positive.
Together with fiscal consolidation and stepped-up structural reforms in
several euro area countries, as well as progress towards a stronger euro
area economic governance framework, they have contributed to a
significant improvement in the financial environment over recent months.
We expect that the three-year longer-term refinancing operations will
provide further support for the ongoing stabilisation in financial markets
and, in particular, for lending activity in the euro area.
All our non-standard monetary policy measures are temporary in nature.
Furthermore, all the necessary tools to address potential upside risks to
medium-term price stability are fully available.
Let me now explain our assessment in greater detail, starting with
the economic analysis.
Real GDP contracted by 0.3% in the euro area in the fourth quarter of
2011.
According to recent survey data, there are signs of a stabilisation in
economic activity, albeit still at a low level.
Looking ahead, we expect the euro area economy to recover gradually in
the course of this year.
The outlook for economic activity should be supported by foreign
demand, the very low short-term interest rates in the euro area, and all the
measures taken to foster the proper functioning of the euro area financial
sector.
However, the remaining tensions in euro area sovereign debt markets and
their impact on credit conditions, as well as the process of balance sheet
_____________________________________________________________

adjustment in the financial and non-financial sectors, are expected to
continue to dampen the underlying growth momentum.
This assessment is also reflected in the March 2012 ECB staff
macroeconomic projections for the euro area, which foresee annual real
GDP growth in a range between -0.5% and 0.3% in 2012 and between 0.0%
and 2.2% in 2013.
Compared with the December 2011 Eurosystem staff macroeconomic
projections, the ranges have been shifted slightly downwards.
This outlook remains subject to downside risks. They notably relate to a
renewed intensification of tensions in euro area debt markets and their
potential spillover to the euro area real economy.
Downside risks also relate to further increases in commodity prices.
Euro area annual HICP inflation was 2.7% in February 2012, according to
Eurostat’s flash estimate, slightly up from 2.6% in January.
Looking ahead, inflation is now likely to stay above 2% in 2012, mainly
owing to recent increases in energy prices, as well as recently announced
increases in indirect taxes.
On the basis of current futures prices for commodities, annual inflation
rates should fall again to below 2% in early 2013.
Looking further ahead, in an environment of modest growth in the euro
area and well-anchored long-term inflation expectations, underlying price
pressures should remain limited.
The March 2012 ECB staff macroeconomic projections for the euro area
foresee annual HICP inflation in a range between 2.1% and 2.7% in 2012
and between 0.9% and 2.3% in 2013. In comparison with the December
2011 Eurosystem staff macroeconomic projections, the ranges for HICP
inflation have been shifted upwards, notably the range for 2012.
Risks to projected HICP inflation rates in the coming years are seen to be
still broadly balanced, with upside risks in the near term mainly
stemming from higher than expected oil prices and indirect tax increases.

_____________________________________________________________

However, downside risks continue to exist owing to weaker than
expected developments in economic activity.
The monetary analysis indicates that the underlying pace of monetary
expansion remains subdued.
The annual growth rate of M3 was 2.5% in January 2012, up from 1.5% in
December 2011.
Loan growth to the private sector also remains subdued. However, its
annual rate (adjusted for loan sales and securitisation) picked up slightly
in January to 1.5% year on year from 1.2% in December.
The annual growth rates of loans to non-financial corporations and loans
to households (adjusted for loan sales and securitisation) stood at 0.8%
and 2.1% respectively in January.
The volume of MFI loans to non-financial corporations declined only
slightly in January, following the pronounced decline in December. By
contrast, the flow of loans to households in January was positive.
Following the signs of improvement in the financial environment, it is
essential for banks to strengthen their resilience further, including by
retaining earnings.
The soundness of banks’ balance sheets will be a key factor in facilitating
an appropriate provision of credit to the economy.
To sum up, the economic analysis indicates that price developments
should remain in line with price stability over the medium term.
A cross-check with the signals from the monetary analysis confirms this
picture.
Looking ahead, in order to deliver a favourable environment for
sustainable growth and to support confidence and competitiveness, the
Governing Council stresses the urgent need for governments to make
further progress towards restoring sound fiscal positions and
implementing the structural reform agenda.
Regarding fiscal consolidation, many governments in the euro area are
making progress. Continuing with comprehensive fiscal consolidation
_____________________________________________________________

and complying with all commitments remains essential. In this respect,
the 2012 European Semester should be used to enforce rigorously the
reinforced fiscal surveillance mechanism.
Equally important are structural reforms to increase the adjustment
capacity and competitiveness of euro area countries and to strengthen
growth prospects and job creation.
In this area, more progress is desirable.
The Governing Council strongly welcomes the European Commission’s
Alert Mechanism Report on macroeconomic imbalances and expects the
proposed in-depth country reviews to actively support the reform
processes under way in euro area countries.
We are now at your disposal for questions.
***

Transcript of the questions asked and the answers given by
Mario Draghi, President of the ECB, and Vítor Constâncio,
Vice-President of the ECB
Question: Two questions, as permitted. One: I have heard or many heard
your message clearly about LTROs, the temporary measure and the
temporary nature of it, but for those who have not heard it, can you tell us
about the chances of a third LTRO or something further down the line?
And the second question, maybe along the same lines: how concerned or
upset were you by that leaked letter from the Bundesbank or, more
notably, from Jens Weidmann and, in that context also, how concerned
are you that the ECB is not necessarily speaking with one voice at a time
when it is most critical?
Draghi: On your first question: the LTRO, both operations, I would say,
are an unquestionable success.
The risk environment has improved enormously, markets have reopened,
both senior and secure markets, covered bond markets, and even the
interbank market – although still limited to the short term and to national
boundaries – has also started working a little better.
_____________________________________________________________

Certainly, we see many signs of a return of confidence in the euro.
So-called real money investors have, to some extent, come back. We see
the presence of money market funds, which were the first to take flight
from the euro a year and a half ago.
We see again pension funds, we see investment funds – so, all in all, we
see that great progress has been achieved. I don’t really need to spend
much more time on this; you only need to compare the situation in
November of last year with that today.
Let me also add that this is not only the effect of the LTRO, but also of the
serious reform effort that has been undertaken by several governments in
the euro area and of the improved governance of the whole euro area; here
I am referring especially to the fiscal compact.
But basically, the LTRO had the powerful effect of removing what is
called “tail risk” from the environment.
Now I think the ball is in the court of governments and other actors,
especially banks, to continue their reforms, to repair their balance sheets
so that they – especially banks – can actually support the recovery.
The LTRO has created a situation where these efforts can certainly be
undertaken, but certainly neither governments nor banks nor the other
key actors ought to be complacent.
On the other issue, let me say what I say all the time: I think we all – when
I say “we”, I mean the Governing Council – we all have to do the right
things and we have to do them together.
So let me first, incidentally, say that my personal and professional
relationship with Jens is excellent. So that is one thing I want to say.
I would also like to add that nobody, contrary to what some journals,
newspapers and magazines have said, nobody is isolated in the
Governing Council.
And the Bundesbank especially is not isolated, and there are several
reasons for this, besides its being a very important central bank.

_____________________________________________________________

As I have had many opportunities to say, I really cherish the culture and
the tradition of the Bundesbank, of maintaining price stability. I think we
all collectively owe a lot of what we have learned about the stability
culture to the Bundesbank and to Germany.
But now we are all custodians of stability, there is not one specific
custodian of the stability culture. We all share the same view, the same
ideals. So I think that ought to be kept in mind.
The other thing that is related to the letter – and, incidentally, I don’t
think that the leak came from Jens himself, I am certain that it was not
him – is that the substance, the content of that letter is present in all our
minds: the possible risks of our monetary policy, the complications –
which are largely communication-related, I would say – created by the
use of additional credit claims, and the TARGET2 balances as well.
We always say that it is normal in a monetary area to have TARGET2
balances.
We say that it is within the Treaty, that these balances are a normal
product, especially when interbank markets don’t function. But it is also
true that these TARGET2 balances reveal structural differences and
structural weaknesses in some parts of the euro area, and this is therefore
not something that can be ignored.
We ought to think about it and reflect on it. And I think that on this, we
completely share these views. Finally, let me say: we are all in the same
boat. And I think that there is nothing to be gained by fighting or arguing
publicly outside the Governing Council.
Question: First, last month you said that you didn’t even discuss interest
rates at your monetary policy meeting. Did you discuss them this month?
Second, based on the latest information that you might have, how
confident are you that the Greek private sector involvement (PSI) will be a
success?
And finally, you said in Mexico that a special bank lending survey is being
conducted to assess the impact of the first LRTO. Could you perhaps tell

_____________________________________________________________

us what the results are and whether you are actually intending to publish
that survey?
Draghi: In answer to your first question, no, we did not discuss interest
rate changes.
As for the Greek PSI, the operation is unfolding as we speak, and so it
would be completely inappropriate for me to comment on it.
Lastly, the bank lending survey I referred to in Mexico is an ad-hoc survey
for internal use and we do not plan to publish it immediately.
However, it certainly shows that from the very, very negative trends in
credit and money that we saw in the last three to four months of last year –
for the first time in history and the history of the euro, the absolute level of
M3 declined for three consecutive months and the volume of loans to the
private sector, non-financial corporations, also declined for two
consecutive months – there has been a modest pick-up in credit and bank
lending since the first LRTO.
Question: Two questions relating to the same subject. Did the Governing
Council discuss the issue of a possible restructuring of the Anglo Irish
Bank’s promissory notes?
And second, do you think that such a restructuring or any kind of
concession on the promissory notes would help Ireland to return to the
bond markets next year as planned and would also perhaps help the Irish
government in its quest to pass the referendum on the fiscal compact?
Draghi: On your last question, let me say that I am really confident that
the referendum will pass and that the fiscal compact will be approved,
because Ireland is probably one of the programme countries that has
made most progress, under conditions that have been very harsh.
And, in spite of these conditions, it has really delivered. We are also aware
that there are certain fragilities that need to be taken care of.
On your first question, we didn’t discuss it. It is being examined, but it
was not part of the Governing Council’s discussions.

_____________________________________________________________

Question: On the topic of growth, you mentioned that you expect a
gradual recovery over the course of this year. Can you give us an idea as to
where the ECB sees the sources of this growth coming from? If you look
at austerity, higher oil prices, rising unemployment, none of these things
seem to bode well for a recovering economy? Can you give us a sense of
how you all assess where this growth is going to come from?
Second, back to the letter and the issue with the Deutsche Bundesbank,
one thing that it seems to raise is the fact that these debates within the
ECB aren’t really published in any kind of way, e.g. meeting minutes or
vote counts. Now that you are President of the ECB, would you maybe
consider making these internal debates public – even without mentioning
names – so that they do not create such a drama when they do become
public?
Draghi: Before I answer your two questions, let me say that I read
everything that you write very carefully. You recently wrote a piece on the
risks that are in the ECB’s balance sheet because of the LTRO.
In that article, you compare the size of the balance sheet, which is now
around 3 trillion euro or something to GDP and conclude that the
expansion has been greater in the euro area than in the United States or
the United Kingdom. I am dealing with this now because I have also seen
this mentioned elsewhere.
Now, one has to look at the balance sheet for what it is. The comparison
of the overall amount does not really relate to the issue of whether risks
have increased or not.
The Eurosystem has a very large volume of assets that have nothing to do
with monetary policy, e.g. gold, foreign exchange reserves, among other
things.
If you compare the ECB’s balance sheet with that of the Federal Reserve
System or the Bank of England, the latter are very lean, they do not have
the same volume of assets.
You have to make the comparison in terms of the additional risks caused
by the two LRTOs. You have to compare the ratio of monetary policy
instruments to GDP in the three different areas of the world.
_____________________________________________________________

If you do that, the ratio is actually 15% for the ECB, 19% for the Federal
Reserve System and 21% for the Bank of England.
Therefore, at the present time, to say that the risks for the ECB’s balance
sheet are higher than those for Federal Reserve System and the Bank of
England is not correct.
The same conclusion can be reached if you look at the rates of change.
The balance sheets of the other major central banks have expanded in a
short period of time by much more than that of the ECB. That was a point
I wanted to make, because it also clarifies some of the concerns that have
been expressed in various quarters, not only in the Wall Street Journal.
Now, in answer to your questions, the recovery in growth is going to be
very gradual.
But there are reasons for that: foreign demand, the very low level of short
and medium-term interest rates, and the extraordinary improvement in
the risk environment, which if it is maintained, is probably going to be the
main factor that we can count on. There are also the structural reforms.
We have always assumed that structural reforms have an impact on
growth in the long term, but that is not always true for all reforms.
There is first of all a signalling effect, there is a confidence effect, but in
the case of some reforms, there are also some reforms that have an impact
on growth, even in the short term.
With regard to your last question on transparency, I think it is stretching
it a bit to say that if there are leaks, you need to be more transparent. In
any case, the ECB is very transparent.
We have regular press conferences, we have hearings in parliament, we
have press releases, we have publications – we are transparent.
It must also be kept in mind that we are not – either politically or
economically – in the same situation as the United States or the United
Kingdom, namely we are not one country. To some extent, you want to
keep the deliberations of the Governing Council as separate as you can
from the national identity of its members.
_____________________________________________________________

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