Congressional Hearings
STATE, FOREIGN OPERATIONS AND RELATED PROGRAMS APPROPRIATIONS FOR FISCAL YEAR 2019
Congressional Hearings
SuDoc ClassNumber: Y 4.AP 6/2
Congress: Senate
CHRG-115shrg89104827
| AUTHORITYID | CHAMBER | TYPE | COMMITTEENAME |
|---|---|---|---|
| ssap00 | S | S | Committee on Appropriations |
[Senate Hearing 115-]
[From the U.S. Government Publishing Office]
FINANCIAL SERVICES AND GENERAL GOVERNMENT APPROPRIATIONS FOR FISCAL
YEAR 2019
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TUESDAY, JUNE 5, 2018
U.S. Senate,
Subcommittee of the Committee on Appropriations,
Washington, DC.
The subcommittee met at 3:33 p.m., in Room SD-138, Dirksen
Senate Office Building, Hon. James Lankford (Chairman)
presiding.
Present: Senators Lankford, Boozman, Kennedy, and Van
Hollen.
SECURITIES AND EXCHANGE COMMISSION
STATEMENT OF HON. JAY CLAYTON, CHAIRMAN
OPENING STATEMENT OF SENATOR JAMES LANKFORD
Senator Lankford. Good afternoon, everyone. The
subcommittee will come to order.
Welcome to today's hearing on the fiscal year 2019 budget
request for the Securities and Exchange Commission (SEC) and
the Commodity Futures Trading Commission (CFTC). Today we have
SEC Chairman Jay Clayton, CFTC Chairman Christopher Giancarlo.
Thank you both for being here today, by the way, and for the
extensive preparation that you did.
SEC's mission is to protect investors, maintain fair,
orderly and efficient markets, and facilitate capital
formation. To accomplish these objectives, SEC requests $1.658
billion for fiscal year 2019, a $6 million increase over the
fiscal year 2018 enacted amount. SEC's funding is derived from
fees paid by national securities exchanges and associations and
results in no direct appropriations. However, these fees are
ultimately passed on to U.S. investors, retirement savers,
market participants, and the subcommittee has the
responsibility to ensure that they are all spent wisely.
Chairman Clayton, your leadership of the SEC coincides with
the rapidly changing environment for investors. The Commission
is formulating responses to new threats, including
cybersecurity, misconduct affecting retail investors, as well
as new opportunities including innovative platforms and
promoting investor access to information.
This hearing is timely as I continue working with my
colleagues on additional reforms to facilitate capital
formation. I look forward to working with you and hearing your
thoughts on legislative changes that would be most helpful to
small and mid-sized businesses.
CFTC's mission is to foster open, transparent, competitive,
and financially sound markets. To facilitate oversight of the
Nation's swaps futures and options markets, CFTC requests
$281.5 million for fiscal year 2019, a $32.5 million increase
over the fiscal year 2018 enacted amount.
Chairman Giancarlo is at the helm with global reform
efforts towards swaps data reporting and significant
developments in financial technology.
SEC and CFTC as Federal market regulators are charged with
establishing a regulatory environment for investors and market
participants that fosters innovation, market integrity, and
ultimately confidence. And that is not simple to do all three
of those. So I appreciate your trying to keep the balance.
We are interested in hearing more about your efforts to
defend against cyber threats to investors and financial market
infrastructure, as well as to ease regulatory burdens. Your
jobs have become even more challenging in the rise of automated
trading, constant technological innovation, including areas
such as financial technology, or fintech, and the need to
operate in markets undergoing digital transformation.
I appreciate both of you being here and your preparation.
Mr. Clayton, your written statement was slightly shorter
than ``War and Peace,'' but not much shorter than that. You
gave us a tremendous amount of information, and I appreciate
you laying all of that out. It was very, very helpful.
Mr. Giancarlo, yours read more like a fiction novel. You
had so many great illustrations and ideas in it.
So I appreciate the two pieces of fine literature in your
written statements and look forward to the oral testimony in
the moments ahead. I thank you both for doing this.
I would turn to my colleague, Senator Van Hollen, for his
opening remarks.
STATEMENT OF SENATOR CHRIS VAN HOLLEN
Senator Van Hollen. Thank you, Mr. Chairman, and thank you
for your leadership, Chairman Lankford.
As you can see, our Ranking Member, Senator Coons, was
unable to make it today, but he wanted to extend his best
wishes to both of you and his thanks to both of you.
And I share lots of the concerns about issues that were
raised by the Chairman.
I thank both of you for being here, look forward to hearing
more about your budgets. Both of you have very important
responsibilities in your different oversight capacities, and we
want to make sure we have the resources available for you both
to do your jobs. And so I will have some questions related to
your oversight responsibilities, but in terms of an opening
statement, just welcome and I look forward to hearing from both
of you.
Senator Lankford. Thank you.
I was going to mention actually Ranking Member Coons on
this as well is under the weather, and I can assure you he
would much rather be here than where he is, as far as feeling
miserable right now. But thank you both for being here and we
will follow up. He will have questions for the record. Then we
will do some follow-up on it in the moments ahead.
Mr. Clayton, why do you not go ahead and begin first with
your testimony? We will be glad to be able to receive your
testimony now.
SUMMARY STATEMENT OF HON. JAY CLAYTON
Mr. Clayton. Thank you, and I will try and give the
abridged version.
Chairman Lankford, Senator Van Hollen, Senator Kennedy,
thank you for the opportunity to testify before you today about
the President's fiscal year 2019 budget request for the SEC.
I am also pleased to be joined by my colleague, CFTC
Chairman Giancarlo. We have worked closely together over the
past year on a number of issues to improve and strengthen our
markets.
On behalf of my fellow commissioners and the 4,500 women
and men at the SEC, I would like to thank this subcommittee for
its support. Congress' recent fiscal year 2018 funding for the
agency will enable the SEC to make significant investments in
furtherance of our efforts to modernize our information
technology infrastructure and improve our cybersecurity risk
profile. I recognize the vote of confidence that you have shown
in the SEC, as does our staff. I am committed to ensuring that
the agency is a prudent steward of this appropriation.
In my interactions with our staff, it is always clear that
they recognize and are motivated by the fact that tens of
millions of Americans are invested in our securities markets.
The daily touchstone for the SEC staff is the long-term
interests of these Americans. In turn, we believe serving these
interests furthers America's interests.
Our fiscal year 2019 request of $1.658 billion for SEC
operations will enable the SEC to continue its work in a number
of areas with a focus on five important components that I will
highlight in a moment.
I will start with a few threshold matters.
First, the request will enable us to start lifting our
hiring freeze and support approximately 100 new hires to
address current priorities.
Second, the budget request relies on the SEC having
continued access to the reserve fund to invest in information
technology.
Third, the SEC's funding is deficit neutral, and any
amounts appropriated to the agency will be offset by
transaction fees.
Let me focus on the five components.
First, information technology (IT) and cybersecurity. With
regard to technology and cybersecurity, Congress' enacted
fiscal year 2018 appropriation, and our fiscal year 2019
request, will allow the SEC to make improvements to modernize
our information technology infrastructure and improve our
cybersecurity risk profile. In short, we will use the fiscal
year 2018 and fiscal year 2019 funding to advance the
implementation of our multiyear IT strategic road map.
Second, capital formation. In facilitating capital
formation, we have made progress, but I believe the SEC can and
should do more to enhance capital formation in our public and
private capital markets and particularly for mid-sized, small,
and emerging companies. Please be assured that as we develop
initiatives aimed at promoting access to capital markets, we
will also seek to maintain and enhance investor protection. The
request will also provide additional resources for staffing of
the new Office of the Advocate for Small Business Capital
Formation.
Third, protecting Main Street investors. Protecting Main
Street investors and preserving their access to investments and
opportunities is at the heart of the work of numerous divisions
and offices at the Commission. In April, the Commission voted
to issue for public comment a comprehensive package of rule
making and interpretation designed to address retail investor
confusion and improve their relationships with investment
professionals. Our rulemaking package would significantly
enhance retail investor protection by preserving access in
terms of both availability and cost to a variety of types of
investment services and investment products. Our rulemaking is
designed to serve our Main Street investors, and I hope that we
will hear from them during the comment process.
Just yesterday, I had the opportunity to speak with Main
Street investors in Houston, Texas, and gained additional
valuable insight into what they expect from their relationships
with investment professionals. These interactions, along with
our experience applying and enforcing our securities laws, are
essential to crafting a final rule that, one, aligns investor
expectations with legal standards and, two, provides Main
Street investors with access to a variety of investment
services at a reasonable cost.
Fourth, enforcement, compliance, and inspections. Over 50
percent of our workforce is devoted to enforcement, compliance,
and inspections, and our 11 regional offices are primarily
devoted to these areas. Our Enforcement Division is committed
to protecting our markets and investors, especially from fraud
that impacts the most vulnerable. Our budget request will allow
for critical investments in our ability to protect investors by
supporting key enforcement priorities, including expanding the
work of our new Cyber Unit and our new Retail Strategy Task
Force. The budget request will also allow for further advances
in our examinations of market participants, including
investment advisors. We increased our examination of investment
advisors by more than 40 percent in fiscal year 2017 to
approximately 15 percent of all SEC-registered investment
advisors. But we are always seeking improvements in this area.
Fifth and finally, trading and markets. Our trading markets
are constantly evolving, expanding, and demanding continuous
effort to identify emerging issues and risks. And we strive to
ensure that as technology changes, our regulations drive
efficiency, integrity, and resilience. Our request will allow
our Division of Trading and Markets to expand the agency's
depth of expertise in vital areas such as equity and fixed
income market surveillance, analysis, clearing agency
oversight, broker-dealer operations, cybersecurity, and
electronic trading.
Finally, our request supports our participation in the
GSA's competitive procurement process for a successor lease for
our New York regional office.
In closing, I would like to again thank the subcommittee
for its continued support of the SEC, its mission, and its
staff.
I look forward to answering any questions you may have.
[The statement follows:]
Prepared Statement of Hon. Jay Clayton
Chairman Lankford, Ranking Member Coons and Senators of the
subcommittee, thank you for the opportunity to testify today on the
President's fiscal year 2019 budget request for the U.S. Securities and
Exchange Commission (SEC).\1\
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\1\ The views expressed in this testimony are those of the Chairman
of the Securities and Exchange Commission and do not necessarily
represent the views of the President, the full Commission or any
Commissioner.
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It is an honor to appear before this Committee again with my
colleague, Commodity Futures Trading Commission (CFTC) Chairman
Christopher Giancarlo. Over the past year, we and the staff of our
agencies have collaborated on a number of issues to strengthen our
markets, including improving our swaps and security-based swap markets.
We also are coordinating our efforts to address issues raised by
cryptocurrencies, initial coin offerings and related products.\2\
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\2\ See Jay Clayton and J. Christopher Giancarlo, Regulators are
Looking at Cryptocurrency, Wall St. J. (Jan. 24, 2018), available at
https://www.wsj.com/articles/regulators-are-looking-at-cryptocurrency-
1516836363?mod=searchresults&page=1&pos=2.
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To begin, I would like to thank the Members of this Committee for
your support of the SEC, its personnel and its mission to protect
investors, maintain fair, orderly and efficient markets and facilitate
capital formation. Congress's recent funding for the agency, with
additional funds for information technology, will provide the SEC with
the ability to make significant investments in fiscal year 2018 in
furtherance of our efforts to modernize our information technology
infrastructure and improve our cybersecurity risk profile. This funding
also will allow us to make advances in each part of our tripartite
mission.
I recognize the vote of confidence that you have shown in the SEC
as does our staff. We all appreciate it. I am committed to ensuring
that the agency is a prudent steward of this appropriation.
I also look forward to working with each of you on the agency's
fiscal year 2019 request during the congressional appropriations
process.
our mission, our perspective and the importance of our capital markets
to america
Since joining the SEC last May, I have been increasingly impressed
by the SEC staff's professionalism and dedication to serving American
investors, issuers and other market participants. I would also like to
thank my fellow Commissioners--Kara Stein, Michael Piwowar, Robert
Jackson, Jr. and Hester Peirce--for their commitment to the Commission
and for working to address a host of issues for the benefit of U.S.
investors and our capital markets.
With a workforce of over 4,500 staff in Washington and across our
11 regional offices, the SEC oversees, among other things (1)
approximately $82 trillion in securities trading annually on U.S.
equity markets; (2) the disclosures of approximately 4,300 exchange-
listed public companies with an approximate aggregate market
capitalization of $30 trillion; and (3) the activities of over 26,000
registered entities and self-regulatory organizations. These registered
entities include, among others, investment advisers, broker-dealers,
transfer agents, securities exchanges, clearing agencies, mutual funds
and exchange-traded funds (ETFs) and employ over one million people in
the United States.
These statistics are significant on their face. They are even more
significant when viewed in comparison to world markets and demonstrate
the importance of our capital markets to America and the American
people. Of the world's 100 largest publicly traded companies, 53 are
U.S. companies, representing 62 percent of the total market
capitalization of those top 100 companies. The U.S. population is
approximately 4.4 percent of global population. Our relative
contribution to global economy is a remarkable, long-term achievement
that has been driven, to a significant extent, by our capital markets.
More importantly, at least 51 percent of U.S. households are invested
directly or indirectly in our capital markets.\3\ This level of retail
investor participation stands out against other large industrialized
countries. They want to replicate it because such broad investor
participation in our capital markets is a significant competitive
advantage for our economy, and our capital markets have made many
Americans' lives better. But this level of investor participation
should not be taken for granted and has been a decades- long endeavor
between the SEC and market participants.
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\3\ See Jesse Bricker et al (2017), ``Changes in U.S. Family
Finances from 2013 to 2016: Evidence from the Survey of Consumer
Finances,'' Federal Reserve Bulletin, vol. 103 (September), available
at https://www.Federalreserve.gov/publications/files/scf17.pdf; see
also Rel. No. 34-83063, Form CRS Relationship Summary; Amendments to
Form ADV; Required Disclosures in Retail Communications and
Restrictions on the use of Certain Names or Titles (Apr. 18, 2018) (for
statistics except the mutual fund data); 2017 Investment Company Fact
Book (ICI, 57th ed. 2017) (mutual fund statistics).
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Our staff recognizes, and is motivated by, the fact that tens of
millions of Americans are invested in our securities markets and have
to make personal investment decisions--both direct decisions such as
which stocks, bonds, mutual funds, ETFs and other securities to
purchase and indirect investment decisions such as which broker-dealer
or investment adviser to hire. Many other Americans are also invested
in our markets through pension funds and other intermediaries. The
touchstone for the SEC staff is the long term interests of these
Americans. They benefit from investment opportunities, fair and
efficient markets and, importantly, investor protection. In turn, we
believe serving these interests furthers America's interests.
Over the course of my first year at the Commission, I have held
town halls at each of our 11 regional offices and with each one of our
divisions and offices. These sessions have demonstrated unequivocally
that the women and men of the SEC place the long term interests of our
Main Street investors first.
Earlier this year, the President designated April as National
Financial Capability Month, ``affirm[ing] the importance of financial
literacy and highlight[ing] the need for all Americans to plan for
their futures.'' \4\ The designation reiterates the importance of
financial literacy and retirement planning--a message that rings
especially true at the SEC because educating investors is a vital part
of our core mission. We engage and interact with the investing public
on an ongoing basis through a number of channels, including through our
investor education programs and through the publication of alerts on
our Investor.gov website. Our Office of Investor Education and Advocacy
provides information and resources to investors, stressing the
importance of saving and investing, researching their investment
professionals and being aware of the potential indicators of fraud.\5\
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\4\ Presidential Message on National Financial Capability Month
(Mar. 30, 2018), available at https://www.whitehouse.gov/briefings-
statements/presidential-message-national-financial-
capability-month/.
\5\ See Press Release 2018-88, The SEC Has an Opportunity You Won't
Want to Miss: Act Now! (May 16, 2018), available at https://
www.sec.gov/news/press-release/2018-88.
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Recently, we launched a new tool designed to enable investors to
research whether their financial professional or others offering them
investments have a judgment or order entered against them in an
enforcement action.\6\ The SEC Action Lookup for Individuals--or SALI--
provides Main Street investors with additional information they can use
to protect themselves from being victims of fraud and other misconduct.
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\6\ See Press Release 2018-78, SEC Launches Additional Investor
Protection Search Tool (May 2, 2018), available at https://www.sec.gov/
news/press-release/2018-78.
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My fellow Commissioners and I also participate in investor
education and outreach efforts with military servicewomen and men,
seniors and other retail investors. Next week, all five of us, along
with staff from across the agency, will be in Atlanta for an investor
town hall where Main Street investors can hear directly from, and share
feedback with, the Commission on issues important to them.\7\
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\7\ See Investing in America: The SEC Comes to You, available at
https://www.sec.gov/investing-america.
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In charting the course of the SEC, I have noted several guiding
principles that have been borne out by my interactions with the men and
women of the Commission staff and America's Main Street investors.\8\
These principles are embodied in the day-to-day efforts of all
divisions and offices, particularly, and worthy of continued emphasis,
with regard to focusing on the long term interests of Main Street
investors. I have followed these principles in developing a streamlined
Regulatory Flexibility Act rulemaking agenda. While the number of items
on the short term portion of the agenda is lower than in years past, it
does not mean that work at the Commission is slowing down. Rather, this
change is rooted in a commitment to increased transparency and
accountability regarding rulemaking priorities in an endeavor to be
direct with Congress, investors, issuers and other interested parties
about what rules the agency intends to pursue and the Commission has a
reasonable expectation of completing in the coming year.\9\
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\8\ See Remarks at the Economic Club of New York (July 12, 2017),
available at https://www.sec.gov/news/speech/remarks-economic-club-new-
york; The principles are (1) the SEC's tripartite mission--protect
investors, maintain fair, orderly and efficient markets and facilitate
capital formation--is its touchstone; (2) our analysis starts and ends
with the long-term interests of the Main Street investor; (3) the SEC's
historic approach to regulation is sound; (4) regulatory actions drive
change, and change can have lasting effects; (5) as markets evolve, so
must the SEC; (6) effective rulemaking does not end with rule adoption;
(7) the costs of a new rule now often include the cost of demonstrating
compliance; and (8) coordination is key.
\9\ Over the past 10 years, the Commission has completed, on
average, only a third of the rules listed on the near-term agenda. As
examples, 18 rules were listed as to-be-adopted in 2008, and 32 rules
were listed in the same category for 2016; in each case, about 27
percent of the rules were adopted in each year.
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our fiscal year 2019 budget request
Our fiscal year 2019 budget will allow the agency to build on its
recent efforts in overseeing the U.S. markets and its market
participants, protecting American investors, further promoting economic
growth and being better prepared to tackle unanticipated issues that
arise. Our request of $1.658 billion for SEC operations represents a
modest increase above fiscal year 2018's enacted level of $1.652
billion. This level will enable the SEC to continue its work in a
number of areas, with a focus on several important components that I
will highlight further below, including: (1) leveraging technology and
enhancing cybersecurity and risk management; (2) facilitating capital
formation across our markets; (3) protecting Main Street investors
through multiple channels, including focusing on our most vulnerable
investors, markets that are fertile ground for fraud and market
integrity efforts such as combating insider trading, market
manipulation and accounting fraud; (4) maintaining effective oversight
of changing markets; and (5) supporting our leasing efforts.
The SEC's request for fiscal year 2019 would enable us to start
lifting the hiring freeze that has been in place since late in fiscal
year 2016. Our budget request would support restoring 100 positions,
approximately one-quarter of the positions that became vacant during
our hiring freeze, to address current critical priority areas and
enhance the agency's expertise in key areas, including the Division of
Enforcement (17), the Office of Compliance Inspections and Examinations
(24), the Division of Trading and Markets (16), the Division of
Investment Management (7), the Division of Economic and Risk Analysis
(4), the Office of Information Technology (16) and the Advocate for
Small Business Capital Formation (5), among others. These 100 positions
would result in SEC staffing at approximately the same level as in
fiscal year 2014. The fiscal year 2019 budget request also relies on
the SEC having continued access to the Commission's Reserve Fund to
fund information technology improvements, including those related to
cybersecurity.
The SEC's funding is deficit-neutral. Any amount appropriated to
the agency will be offset by transaction fees. The current transaction
fee rate is just over one cent for every $1,000 in covered securities
sales. The SEC also has been a net contributor to the U.S. Treasury in
ways that are not directly related to our appropriations. By law,
companies pay a fee to the SEC at the time they register securities for
sale. For fiscal year 2019, the fee rate will be set at a level
sufficient to collect $660 million. A portion of these collections will
be put into the Reserve Fund, which the agency devotes to information
technology improvements, while the remaining funds will be deposited in
the general fund of the U.S. Treasury.
leveraging technology, cybersecurity and risk management
Congress's enacted fiscal year 2018 appropriation and our fiscal
year 2019 request will allow the SEC to make investments to modernize
our information technology infrastructure and improve our cybersecurity
risk profile. The agency plans to use its fiscal year 2018 and fiscal
year 2019 resources to advance the implementation of our Office of
Information Technology's multi-year IT strategic roadmap to further our
mission through advanced data analytics, digital workflows and other
tools to maximize efficiency, effectiveness and security. Key IT
priorities for fiscal year 2018 and fiscal year 2019 include:
1. Investing in information security to improve monitoring,
protect against advanced persistent threats and strengthen risk
management;
2. Retiring antiquated ``legacy'' IT systems to improve our
cybersecurity posture while also saving agency funds;
3. Expanding data analytics tools to facilitate earlier detection
of potential fraud or suspicious behavior and better identify high-risk
registrant activities deserving examination; and
4. Modernizing the EDGAR electronic filing system to make it more
secure, more useful for investors and less burdensome for filers.
In particular, cybersecurity at the Commission itself continues to
be a priority area. No organization can guarantee that it will be able
to withstand all cyberattacks, particularly in an environment where
threat actors may be backed by substantial resources. Nevertheless, we
must continuously work to remain on top of evolving threats when it
comes to securing our own networks and systems against intrusion. This
is especially true when protecting mission critical systems as well as
systems dealing with sensitive market and other data involving
personally identifiable information. This means regularly evaluating
progress, pursuing improvements and making it a priority to invest
sufficient resources so our systems keep up with the ever-changing
threat environment. This also means regularly exploring alternatives
that will allow us to further our mission while reducing the
sensitivity of the data we collect. This may include, for example,
taking in market-sensitive data on a delayed basis where feasible.
Because of the increasing importance of these issues, shortly after
joining the Commission, I initiated an assessment of the SEC's overall
cybersecurity risk profile and preparedness. This initiative is ongoing
and includes an assessment and uplift of the agency's cybersecurity
risk profile, including the identification and review of all systems,
current and planned, that hold sensitive market data or personally
identifiable information. As part of this process, we have engaged
outside experts that are in the process of reviewing our systems and
data. More broadly, the agency is evaluating its cybersecurity risk
governance structure. This has resulted in the establishment of a
senior-level cybersecurity working group, a review of our incident
response procedures and additional planned enhancements to promote the
management and oversight of cybersecurity across the Commission's
divisions and offices. We have also established internal incident
response exercises and have continued to interact on cybersecurity
efforts with other government agencies and committees, including the
Department of Homeland Security, the Government Accountability Office
and the Financial and Banking Information Infrastructure Committee.
Another important step to strengthen our cybersecurity and risk
management efforts is my announcement of a new position, the Chief Risk
Officer, to coordinate the SEC's efforts to identify, monitor and
mitigate risks across our divisions and offices. Last week, we
announced an Acting Chief Risk Officer as part of our efforts to
maintain a robust program for identifying and addressing risks to the
agency's mission while we continue our search to fill this new position
on a permanent basis.\10\ I also have authorized the hiring of
additional staff and outside technology consultants to aid in our
efforts to protect the security of our network, systems and data.
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\10\ See Press Release 2018-98, SEC Names Julie A. Erhardt Acting
Chief Risk Officer (May 31, 2018), available at https://www.sec.gov/
news/press-release/2018-98.
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Beyond our overall assessment of the SEC's cybersecurity risk
profile, last September I disclosed a prior intrusion of the SEC's
EDGAR system. We have ongoing investigations--conducted by our Office
of the General Counsel, Office of Inspector General and Division of
Enforcement--aimed at helping us understand what transpired, including
with respect to the scope of the incident. I am focused on getting to
the bottom of the matter and, importantly, using the information gained
from the investigations to strengthen our cybersecurity efforts moving
forward. I am committed to keeping the Committee informed of the
ultimate findings and conclusions of our internal review into the EDGAR
intrusion.
While our investigations are not complete, we have taken various
steps to reinforce the security of our EDGAR system, including
conducting a detailed penetration test of the EDGAR environment, a
security review of EDGAR's code to proactively identify and remediate
vulnerabilities and additional security enhancements to the
architecture of the EDGAR system.
Further, I directed staff to conduct a review of the sensitive
personally identifiable information we gather through SEC forms in an
effort to make sure we do not take in more of such information than we
need to carry out our mission. With the support of my fellow
Commissioners, one recent result of this effort has been to eliminate
the requirement for filers of certain forms to continue to provide us
with their social security numbers, foreign identity numbers or date or
place of birth. With respect to these forms, the Commission's action
reflected a conclusion that we would be able to achieve our regulatory
objectives without taking in this sensitive personally identifiable
information. These are the types of analyses and questions we will
continue to consider as we think about data collection use and security
at the agency.
Uplifting the agency's cybersecurity program will remain a top
priority during fiscal year 2019. Our request would support investment
in tools, technologies and services to protect the security of the
agency's network, systems and sensitive data. It would also enable
funding of multi-year investments to transition legacy information
technology systems to modern platforms with improved embedded security
features. The fiscal year 2019 request would provide additional staff
positions to enable the SEC to expand its cybersecurity protections,
particularly with regard to incident management and response, advanced
threat intelligence monitoring and enhanced database and system
security, and to focus on the security of specific systems. The fiscal
year 2019 request also would permit the SEC to hire additional staff
positions under the Chief Risk Officer to strengthen and advance the
agency's risk management capabilities.
facilitating capital formation
The U.S. capital markets have long been the deepest, most dynamic
and most liquid in the world. They provide businesses with the
opportunity to grow, create jobs and furnish diverse investment
opportunities for investors, including retail investors, pension funds
and other retirement accounts. Our markets have provided the U.S.
economy with a competitive advantage and American Main Street investors
with better investment opportunities than comparable investors in other
jurisdictions. We should strive to maintain and enhance these
complementary positions, including by being mindful of emerging trends
and related risks.
In executing the SEC's tripartite mission, we have sought to
promote an environment conducive to capital formation while ensuring
that our markets and our investors remain well protected. Over the past
year, our Division of Corporation Finance (Corporation Finance) has
carried out several key initiatives, with a particular emphasis on
capital-raising opportunities.
Corporation Finance announced that it would accept voluntary draft
registration statement submissions for certain securities offerings,
including for initial public offerings (IPOs) and offerings within 1
year of an IPO, for review by the staff on a non-public basis. This
expanded policy builds on the confidential submission process
established by the Jumpstart Our Business Startups (JOBS) Act. We
believe this approach provides a meaningful benefit to companies and
investors without in any way diminishing investor protection, and a
number of companies have already pursued this path.
The Commission also proposed amendments, as required by the Fixing
America's Surface Transportation (FAST) Act, to modernize and simplify
certain disclosure requirements in Regulation S-K and related rules and
forms in a manner that reduces the costs and burdens on registrants
while continuing to provide all material information to investors.
Corporation Finance also is developing recommendations for the
Commission on amendments to the ``smaller reporting company''
definition, which would expand the number of issuers eligible to
provide scaled disclosures.
While progress has been made, I believe the SEC can and should do
more to enhance capital formation in our public and private capital
markets and, particularly, for small and emerging companies. Fewer
emerging companies are choosing to enter the public capital markets
than in the past, and, as a result, investment opportunities for Main
Street investors are more limited. There has been much debate about the
causes and policy implications of this trend, but from my perspective,
having a broader portfolio of public companies, especially those at the
earlier stage of their growth cycle, ultimately will have positive
impacts for our Main Street investors. Because it is difficult and
costly for Main Street investors to invest in private companies, they
will miss out on the growth phase of these companies to the extent they
go public less frequently and later in their life cycle. Additionally,
companies going through the SEC public registration and offering
process often come out better companies on the other side of an IPO,
providing net benefits to the company and our capital markets. While
there is not a silver bullet to counter the negative trend in the
number of U.S. public companies, we will continue working to enhance
capital formation opportunities without sacrificing the important
investor protections our public company disclosure system has provided
for over 80 years.
Our fiscal year 2019 budget request will further enable the staff
to develop and present to the Commission rulemaking initiatives aimed
at promoting firms' access to capital markets to generate economic
growth while continuing to foster important investor protections. The
resources provided by the fiscal year 2019 request also would enable
Corporation Finance to further assist companies that seek to raise
capital through IPOs, follow-on or exempt offerings and to implement
other important capital formation initiatives.
Additionally, the fiscal year 2019 request will provide additional
resources for staffing of the Office of the Advocate for Small Business
Capital Formation (Advocate). We are in the advanced stages of our
efforts to hire the Advocate, whose mission is to be a resource and
voice for small businesses and their investors by providing assistance,
conducting outreach to better understand their concerns and making
recommendations to the Commission and Congress regarding potential
improvements to the regulatory environment. I look forward to the
benefits that the Advocate will provide to the Commission, issuers and
investors.
protecting main street investors and our markets
In early 2017, as I moved through the confirmation process, it
became apparent that a wide range of market participants, including
retail investors and various Members of Congress, believed that
standards of conduct for investment professionals (e.g., investment
advisers and broker-dealers) was a matter where Commission action,
including coordination with our fellow regulators, would be both
appropriate and timely. In June 2017, I issued a request for
information, seeking input from the public on a range of potential
issues. Since then, I have also had scores of meetings with investors,
consumer groups, industry participants and others across the full
spectrum of these issues.
In particular, the candid comments of retail investors we met with
in Missouri, Montana, Illinois and California, as well as those who
travelled to New York for a roundtable, on what they expect, and do not
expect, from investment professionals resonated with me in considering
the appropriate course of action. These interactions, including
consultations with my fellow Commissioners and staff, led me to the
conclusion that the Commission should lead--but not dictate--in this
area in order to (1) address investor confusion regarding the roles of,
and the differences between, broker-dealers and investment advisers,
(2) establish standards of conduct that meet reasonable investor
expectations and adequately address conflicts of interest, and (3)
minimize the effects of regulatory complexity, both more generally and
as a result of the Department of Labor's application of the fiduciary
rule to a portion of the market.
In April, the Commission voted to issue for public comment a
comprehensive package designed to address retail investor confusion and
potential harm in their relationships with investment professionals.
Our rulemaking package would enhance retail investor protection while
preserving access, in terms of both availability and cost, to a variety
of types of investment services and investment products.
I have included my overview of the rulemaking package as an
appendix to my testimony but will provide a brief synopsis.\11\ First,
to meet reasonable investor expectations and address conflicts of
interest, we are enhancing the standard of conduct for broker-dealers.
We are also reaffirming--and in some cases clarifying--the standard for
investment advisers. Under proposed Regulation Best Interest, a broker-
dealer, when making a recommendation of a securities transaction or
investment strategy to a retail customer, will be required to act in
the best interest of that customer at the time the recommendation is
made, including the broker-dealer being prohibited from placing their
financial or other interest ahead of the interest of the retail
customer. To add clarity for all participants, the proposal provides
that the best interest duty is discharged if the broker-dealer complies
with a disclosure obligation, a care obligation and two conflict of
interest obligations. Under current standards, by contrast, broker-
dealers are permitted to recommend to their retail customer a product
that is suitable but worse for the customer than another product that
the broker-dealer offers--because the first product makes the broker-
dealer more money. Let me be clear: our proposed Regulation Best
Interest would address this concern.
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\11\ See also The Evolving Market for Retail Investment Services
and Forward-Looking Regulation--Adding Clarity and Investor Protection
while Ensuring Access and Choice (May 2, 2018), available at https://
www.sec.gov/news/speech/speech-clayton-2018-05-02.
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How would this new duty be discharged? First, broker-dealers would
need to disclose material facts relating to their relationship with the
customer. Second, broker-dealers would need to enhance their current
compliance framework to meet the demands of a more rigorous best
interest standard. Third, and most important, broker-dealers would need
to eliminate, or mitigate and disclose, material conflicts of interest
related to financial incentives. Disclosure alone would not suffice.
The new broker-dealer best interest obligation draws from the
principles applicable to an investment adviser's fiduciary duty. The
close relationship is made clear when the proposed Regulation Best
Interest is reviewed against the standards applicable to investment
advisers. To address confusion regarding the standards applicable to
investment advisers, we issued a proposed interpretation reaffirming--
and in some cases clarifying--that duty as part of the rulemaking
package. With respect to an investment adviser's fiduciary duty, let me
be clear, because I believe there is substantial confusion in the
marketplace. An investment adviser must seek to avoid conflicts of
interest and at a minimum make full and fair disclosure of material
conflicts. But it misstates the law and could mislead investors to
suggest that investors currently have a legal right to conflict-free
advice from an investment adviser.
Second, the rulemaking package would address concerns that retail
investors are confused about their relationship with an investment
professional. For example, they may mistakenly engage the services of a
broker-dealer when, if they were to make a fully informed choice, their
preferences would better match those of an investment adviser. Our
proposal (1) would require broker-dealers and investment advisers to
clearly state what they are, (2) would prohibit stand-alone broker-
dealers and their financial professionals from using the terms
``adviser'' or ``advisor'' as part of their names or titles, and (3)
introduce a new short-form disclosure, no more than four pages, to help
people identify the services that their financial professional
provides, certain conflicts of interest to which they are subject, the
fees the investor will pay, and the legal standards of conduct that
apply when dealing with their clients or customers. Put bluntly, we
want investors to understand who they are dealing with (e.g., what
category their investment professional falls into) and, then, what that
means and why it matters (e.g., how their investment professional is
compensated).
We have been thinking about these issues for over 20 years and
about this rulemaking for nearly a year. I urge commenters to review
the rule thoroughly, and then engage with us on it during the 90 day
comment period. In order to provide as much opportunity for that
engagement as possible, I also announced several investor roundtables,
including in Atlanta, Houston, Denver, and Miami, to hear directly from
those the rule is designed to serve--Main Street investors.\12\
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\12\ See Statement on Public Engagement Regarding Standards of
Conduct for Investment Professionals Rulemaking (Apr. 24, 2018),
available at https://www.sec.gov/news/public-statement/public-
engagement-standards-conduct-investment-professionals-rulemaking.
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The fiscal year 2019 request would restore seven staff positions
within the Division of Investment Management (Investment Management),
which plays a critical role in protecting retail investors through its
regulation of investment advisers, mutual funds, variable insurance
products and ETFs, among other products. The resources would be used to
enhance Investment Management's monitoring and disclosure programs, as
well as advance key investor-focused rule-writing priorities, such as
standards of conduct for investment professionals.
Additionally, a vigorous enforcement program is at the heart of the
Commission's work to protect investors and maintain the integrity of
the securities markets. Our Division of Enforcement (Enforcement) has
the frontline responsibility of safeguarding our capital markets and
American investors, and their dedication and expertise is focused on
detecting and pursuing fraud and other misconduct where they may occur.
Enforcement is focused on protecting all investors--without favor for
account size, geography or other measures of priority--in its efforts
to investigate and bring charges against violators of the Federal
securities laws. Successful enforcement actions impose meaningful
sanctions on securities law violators, deter wrongdoing and, most
important, have the maximum impact of returning dollars to harmed
investors, especially Main Street investors, as well as preventing harm
to those investors in the first instance.
During the past year, Enforcement has continued to focus on key
areas where misconduct can harm investors, undermine confidence and
impair market integrity. This includes such critical areas as retail
investor fraud and investment professional misconduct, insider trading,
market manipulation and accounting fraud. In furtherance of these
initiatives, Enforcement enhanced its focus and expertise through the
establishment of a Retail Strategy Task Force and a new specialized
unit, the Cyber Unit.\13\ The Retail Strategy Task Force's charge is to
develop effective strategies and techniques to identify, punish and
deter misconduct that most affects everyday investors. The Cyber Unit
centralizes, leverages and builds upon the considerable expertise that
the Commission has developed in several rapidly developing areas. The
Cyber Unit focuses its efforts on the following key areas: (1) hacking
to obtain material, nonpublic information and trading on that
information; (2) market manipulation schemes involving false
information spread through electronic and social media; (3) violations
involving distributed ledger technology and initial coin offerings
(ICOs); (4) misconduct perpetrated using the dark web; (5) intrusions
into online retail brokerage accounts; and (6) cyber-related threats to
trading platforms and other critical market infrastructure.
---------------------------------------------------------------------------
\13\ Press Release 2017-176, SEC Announces Enforcement Initiatives
to Combat Cyber-Based Threats and Protect Retail Investors (Sept. 25,
2017), available at https://www.sec.gov/news/press-release/2017-176.
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Our fiscal year 2019 request would allow for critical investments
in our ability to protect investors by restoring 17 positions for
Enforcement to support key enforcement priorities, including expanding
the work of the Cyber Unit and the Retail Strategy Task Force.
Another critical tool for the SEC to carry out its mission is our
National Examination Program (NEP), led by our Office of Compliance
Inspections and Examinations (OCIE). The SEC conducts risk-based
examinations of registered entities, including broker-dealers,
investment advisers, investment companies, municipal advisors, national
securities exchanges, clearing agencies, transfer agents and FINRA,
among others. Our examination program is one of many areas where we
have focused on doing more with our available resources. Recently,
through the reallocation of resources, advancements in OCIE's use of
technology and other efficiencies, OCIE increased its examination of
investment advisers by more than 40 percent in fiscal year 2017 over
fiscal year 2016--to approximately 15 percent of all SEC-registered
investment advisers.
Although this has been a very positive step, more needs to be done
to continue to increase investment adviser examination coverage levels,
while at the same time being careful to avoid decreasing examination
quality. To that end, our fiscal year 2019 request would restore 24
positions within the SEC's NEP, including six additional staff for its
Technology Controls Program, which monitors critical securities market
infrastructure for significant cyber events and outages. I believe this
area will continue to warrant close attention, and I have shared these
views with other regulators, particularly in areas where we have
overlapping responsibilities and oversight.
We will also continue to explore additional efficiencies and
improvements to our risk-based examination program. One way to help us
achieve our goals is through the continued use of data analytics. We
have developed tools that can scan arrays of data fields to help us
analyze and identify potentially problematic activities and firms,
allowing us to make better decisions concerning which registered
entities to examine and appropriately scope those examinations, among
other things.
effective oversight of our changing markets
One of the few certainties of trading markets is that they
continually evolve and expand, while at the same time becoming more
interrelated. Over the last decade, technological advancements and
other developments have significantly altered the operations of our
securities markets. These dramatic changes in our markets demand the
Commission's continuous effort to identify emerging issues and risks in
our markets and to strive to ensure that, as technology changes, our
regulations continue to drive efficiency, integrity and resilience. The
Division of Trading and Markets (Trading and Markets) serves as the
SEC's first line in advancing our mission of maintaining markets that
are fair, orderly and efficient through its work to regulate the major
securities market participants and infrastructure.
While much attention is paid to activity in our equity markets and
the $82 trillion in securities traded annually there, it is possible
that even more dramatic market changes are occurring in our fixed
income markets. These markets are massive--and growing. For example:
--The U.S. corporate bond market has experienced significant growth
since the early 2000s. Issuance in the corporate bond market
has hit record highs 5 years running.\14\ In 2016, there were
nearly 1,400 issues, amounting to $1.5 trillion, of corporate
bonds, and there was over $8.5 trillion of corporate bonds
outstanding.\15\ By comparison, in 2006 there was over $4.8
trillion of corporate bonds outstanding.\16\
---------------------------------------------------------------------------
\14\ See A Financial System That Creates Economic Opportunities:
Capital Markets, Report to President Donald J. Trump, U.S. Department
of the Treasury (Oct. 2017) at 85, available at https://
www.treasury.gov/press-center/press-releases/Documents/A-Financial-
System-Capital-Markets-FINAL-FINAL.pdf.
\15\ See 2017 SIFMA Fact Book at 23-24, 31, available at https://
www.sifma.org/wp-content/uploads/2016/10/US-Fact-Book-2017-SIFMA.pdf.
\16\ See id. at 31.
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--Growth in the U.S. corporate bond market has also outpaced growth
in U.S. equities: between 2006 and 2016 the value of corporate
bonds outstanding rose by about 76 percent, while equity market
cap rose by 40 percent.\17\
---------------------------------------------------------------------------
\17\ See id. at 58.
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--The municipal bond market is large and vital and has experienced
significant growth in recent years. By the end of 2016,
municipal bond issuers had approximately $3.8 trillion bonds
outstanding, up 17 percent from the end of 2006.\18\
---------------------------------------------------------------------------
\18\ See id. at 31.
The fixed income markets are critical to our economy and,
increasingly, Main Street investors, yet over the years less attention
has been paid to their efficiency, transparency and effectiveness
relative to the equity markets. To address these issues, the Commission
recently broadened its review of market structure to include increased
attention our fixed income markets. We established a new Fixed Income
Market Structure Advisory Committee (FIMSAC), which has already had two
public meetings and recently provided a recommendation for a pilot
program to study the market implications of changing the reporting
regime for block-size trades in corporate bonds.
Over the last year, we also have continued to engage on issues
related to our equity markets. The Commission recently proposed a pilot
program based on a recommendation from the Equity Market Structure
Advisory Committee (EMSAC) to study the effects that transaction-based
fees and rebates may have on--and the effects that changes to those
fees and rebates may have on--order routing behavior, execution quality
as well as market quality more generally. I believe the data generated
by a pilot program of this type would help inform the Commission, as
well as market participants and the public, about any such effects and
thereby facilitate a data-driven evaluation of the need for regulatory
action in this area.
While the EMSAC's charter expired in January 2018, the staff is
organizing targeted roundtables among market participants on discrete
equity market structure issues, which will feature experts
representative of a broad diversity of viewpoints. These meetings will
provide further opportunities for discussions about critical issues
affecting our equity markets. In April, we held our first roundtable
focused on market structure issues for thinly-traded exchange-listed
securities--an important issue as smaller companies, the securities of
which are often relatively illiquid, play an essential role in our
economy and may be the larger companies of tomorrow. We should continue
to examine whether the current equity market structure--which is
uniform for all companies, large and small, liquid and illiquid--meets
the needs of all types of companies.
Our fiscal year 2019 request would allow Trading and Markets to
recruit 16 additional professionals to expand the agency's depth of
expertise in vital areas such as equity and fixed income market insight
and analysis, clearing agency oversight, broker-dealer operations,
cybersecurity and electronic trading. The request would also provide
resources to continue the staff's work with the FIMSAC and its
important work to evaluate, and for the Commission to take, appropriate
measures to enhance the efficiency, transparency and effectiveness of
fixed income markets.
leasing
One final, important component of the SEC's funding needs for
fiscal years 2018 and 2019 is to support the leasing of office space.
In addition to the funds requested to support our operations, the SEC
is requesting funds in fiscal year 2019 necessary to participate in the
General Services Administration's (GSA's) competitive procurement
process for a successor lease for the SEC's New York Regional Office.
As with the SEC's headquarters lease procurement that Congress funded
in fiscal year 2018, in accordance with its standard process, GSA has
requested that the SEC set aside the funds that might become necessary
to cover construction and related costs should the SEC need to move
from its current building. None of these funds would be used for the
operations of the SEC, and the agency has proposed appropriation
language that provides a mechanism whereby any unused portion of these
funds would be refunded to fee payers.
conclusion
Thank you again for the opportunity to present the President's
fiscal year 2019 budget request and for your support of the Commission.
I appreciate the opportunity to work with the Committee to ensure that
the SEC has the resources needed to fulfill our important mission to
protect investors, maintain fair, orderly and efficient markets and
facilitate capital formation. I look forward to answering any of your
questions.
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
Senator Lankford. Thank you.
Mr. Giancarlo.
----------
COMMODITY FUTURES TRADING COMMISSION
STATEMENT OF HON. J. CHRISTOPHER GIANCARLO, CHAIRMAN
Mr. Giancarlo. Thank you, Chairman Lankford, Senator Van
Hollen, Senator Kennedy, and Members of the subcommittee. I
appreciate the opportunity to appear today along with SEC
Chairman Jay Clayton who has become an important regulatory
counterpart to us at the CFTC.
For more than a century, Americans have relied on U.S.
derivative markets to stabilize the cost of living. These
markets allow farmers and ranchers to hedge production costs
and delivery prices. They are the reason shoppers enjoy stable
prices not only in the supermarket but in all matter of
consumer finance from auto loans to household purchases.
Derivative markets influence and set the price of availability
of heating in homes, energy used in factories, interest rates
borrowers pay on home mortgages, and returns workers earn on
retirement savings.
And not just consumers. More than 90 percent of Fortune 500
companies use derivatives to manage commercial or market risk
in their worldwide business operations. Derivatives allow the
risks of variable production costs such as the price of raw
materials, energy, foreign currency, and interest rates to be
transferred from those who cannot afford them to those who can.
In short, derivatives serve the needs of society to help
moderate price, supply, and other commercial risks to free up
capital for economic growth, job creation, and prosperity.
While often derided in the tabloid press as risky, derivatives,
when used properly, are tools for efficient price discovery and
risk transfer and risk reduction. It has been estimated that
the use of commercial derivatives added 1.1 percent to the size
of the U.S. economy between 2003 and 2012.
American derivative markets are the world's largest, most
developed, and most influential. Many key agricultural,
mineral, and energy commodities are priced in U.S. derivative
markets. So are key financial products like interest rates and
foreign exchange that take friction out of the global economy's
system of floating exchange rates.
The United States is the only major economy to have a
regulatory agency specifically dedicated to derivative market
regulation, and that is the CFTC. And the agency is recognized
around the world for its depth of expertise and breadth of
capability.
This regulatory competency is one of the reasons why U.S.
derivative markets continue to serve the needs of participants
all around the globe. Well regulated U.S. derivative markets
give the American economy a competitive advantage, and that is
dollar pricing of the most important global commodities. And
these markets underpin the U.S. dollar as the world's primary
reserve currency.
Now, this advantage is well recognized by competing
economies around the world. Earlier this year, the Shanghai
International Energy Exchange allowed non-Chinese market
participants to trade its yuan-denominated crude oil contract
for the first time. A few weeks later, China opened its yuan-
denominated iron ore contract to international traders, and
there is also talk about allowing international market
participants to trade Chinese futures contracts in fuel oil,
copper, and even soybeans.
The opening of Chinese futures markets to international
participation is part of a long-term strategy to expand China's
influence over the pricing of key industrial, agricultural, and
other commodities. This has competitive implications for the
United States. We can be complacent no longer about the
historical primacy of our derivative markets. We must make sure
that U.S. markets are unrivaled in their openness, orderliness,
and liquidity.
And to do so, they must continue to be well regulated by an
adequately funded U.S. regulator. Good regulation is our
competitive advantage. The CFTC must have suitable resources to
continue to supervise the world's most open, transparent,
competitive, innovative, and financially sound derivative
markets in the world. Full funding of the CFTC's budget request
will support its mission to serve this vital national interest.
Our fiscal year 2019 budget, which I promise you, Chairman,
is not fiction, reflects the true needs of a policy-setting and
civil law enforcement agency. It is bare bones, no waste,
fiscally conservative, and mindful of taxpayer dollars. It is
based on a rigorous review of the agency's functions and
expenditures. It broadly assesses key areas of market
innovation and financial technology, cybersecurity,
cryptocurrencies and assets, econometric capability,
clearinghouse supervision, monitoring of systemic risk, and
vigorous enforcement.
I humbly ask, Senators, for the tools to do our job to
oversee the markets that Americans rely on each day. With the
proper balance of sound policy, regulatory oversight, and hard
work, America's deep, liquid, and sensibly regulated derivative
markets will continue to meet the challenges of increased
global competition in a new digital world to ensure a healthy
U.S. economy where our citizens can flourish.
Thank you.
[The statement follows:]
Prepared Statement of Hon. J. Christopher Giancarlo
introduction
Thank you, Chairman Lankford, Ranking Member Coons, and Members of
the subcommittee. I appreciate the opportunity to appear before you
today, along with my fellow colleague from the Securities and Exchange
Commission (SEC), Chairman Jay Clayton.
For more than a century, Americans have relied on U.S. derivatives
markets to stabilize the cost of living. These markets allow farmers
and ranchers to hedge production costs and delivery prices so that
consumers can always find plenty of food on grocery store shelves. They
are the reason why American consumers enjoy stable prices, not only in
the supermarket, but in all manner of consumer finance from auto loans
to household purchases. Derivatives markets influence the price and
availability of heating in American homes, the energy used in
factories, the interest rates borrowers pay on home mortgages, and the
returns workers earn on their retirement savings.
And not just consumers. More than 90 percent of Fortune 500
companies use derivatives to manage commercial or market risk in their
worldwide business operations.\1\ These markets allow the risks of
variable production costs, such as the price of raw materials, energy,
foreign currency, and interest rates, to be transferred from those who
cannot afford them to those who can.
---------------------------------------------------------------------------
\1\ See International Swaps and Derivatives Association, 2009 ISDA
Derivatives Usage Survey, ISDA Research Notes, No. 2 (Spring 2009), at
1-5, available at https://www.isda.org/a/SSiDE/isda-research-
notes2.pdf.
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Even Americans not actively participating in commodity derivatives
markets are affected by the prices generated by them. Commodity
derivatives markets provide a critical source of information about
future harvest prices. For example, a grain elevator uses the futures
market as the basis for the price it offers local farmers at harvest.
In return, farmers look to exchange prices to determine for themselves
whether they are getting fair value for their crop. The U.S. Department
of Agriculture (USDA) uses that same information to make price
projections, determine volatility measures, and make payouts on crop
insurance.\2\
---------------------------------------------------------------------------
\2\ E.g., USDA, Informational Memorandum: PM-17-012, 2017 Crop Year
(CY) Common Crop Insurance Policy and Area Risk Protection Insurance
Projected Prices and Volatility Factors; Malting Barley Endorsement
Projected Price Component and Volatility Factor; and Hybrid Seed Price
Endorsement--Hybrid Seed Corn Prices (Mar. 1, 2017), available at
https://www.rma.usda.gov/bulletins/pm/2017/17-012.pdf.
---------------------------------------------------------------------------
In short, derivatives serve the needs of American society to help
moderate price, supply and other commercial risks to free up capital
for economic growth, job creation and prosperity. While often derided
in the tabloid press as ``risky,'' derivatives--when used properly--are
tools for efficient risk transfer and mitigation. It has been estimated
that the use of commercial derivatives added 1.1 percent to the size of
the U.S. economy between 2003 and 2012.\3\
---------------------------------------------------------------------------
\3\ The Milken Institute found the following economic benefits to
the U.S. economy from derivatives: ``[b]anks' use of derivatives, by
permitting greater extension of credit to the private sector, increased
U.S. quarterly real GDP by about $2.7 billion each quarter from Q1 2003
to Q3 2012; [d]erivatives use by non-financial firms increased U.S.
quarterly real GDP by about $1 billion during the same period by
improving their ability to undertake capital investments; [c]ombined,
derivatives expanded U.S. real GDP by about $3.7 billion each quarter;
[t]he total increase in economic activity was 1.1 percent ($149.5
billion) between 2003 and 2012; [b]y the end of 2012, employment had
been boosted by 530,400 (0.6 percent) and industrial production 2.1
percent.'' See Apanard Prabha et al., Deriving the Economic Impact of
Derivatives, Milken Institute, at 1 (Mar. 2014), available at http://
assets1b.milkeninstitute.org/assets/Publication/ResearchReport/PDF/
Derivatives-Report.pdf.
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American derivatives markets are the world's largest, most
developed, and most influential. Many of the world's most important
agricultural, mineral, and energy commodities are priced in U.S.
dollars in the U.S. derivatives markets. Dollar pricing of the world's
commodities provides a tremendous advantage to American producers in
global commerce, an advantage well recognized by competing economies
abroad.
American derivatives markets are also the world's best regulated.
The United States is the only major country in the Organization for
Economic Co-operation and Development to have a regulatory agency
specifically dedicated to derivatives market regulation: the Commodity
Futures Trading Commission (CFTC). The CFTC has overseen the U.S.
exchange-traded derivatives markets for over 40 years. The agency is
recognized for its principles-based regulatory framework and
econometrically-driven analysis. The CFTC is recognized around the
world for its depth of expertise and breadth of capability.
This combination of regulatory expertise and competency is one of
the reasons why U.S. derivatives markets continue to serve the needs of
participants around the globe to hedge price and supply risk safely and
efficiently. It is why well-regulated U.S. derivatives markets continue
to serve a vital national interest--Dollar pricing of important global
commodities.
In short, America's well-regulated derivatives markets are a
national advantage in global economic competition. However, we must not
take this advantage for granted. In order for U.S. derivatives markets
to remain the world's best, U.S. markets must remain the world's best
regulated. To be the best regulated, U.S. derivatives markets must have
an adequately funded regulator. The CFTC must have adequate resources
to continue to serve its mission to foster open, transparent,
competitive, and financially sound U.S. derivatives markets that remain
the envy of the world.
Today, I look forward to discussing the CFTC's resource
requirements.
budget request
The fiscal year 2019 budget submitted by the Commission reflects
the true needs of a policy setting and civil law enforcement agency
that has the duty to ensure the derivatives markets operate effectively
and the public is protected from harm. As the workload of the CFTC has
increased dramatically--exponentially--and globally--over the last 4
years, we have been flat-lined in our budget--at $250 million in three
of those years--and actually experienced a budget reduction of $1
million this year. Even with the cuts to our budget, it is still
incumbent upon us to evolve into a 21st century regulator because the
demands on our agency from the markets don't stop as a result of budget
cuts. In fact, those demands constantly increase.
In order for the CFTC to fulfill its duty to oversee these vital
derivatives markets in fiscal year 2019, the Commission is requesting
$281.5 million and 716 full-time equivalents (FTE). This is an increase
of $32.5 million and 46 FTE over the resources provided in the fiscal
year 2018 enacted budget \4\ and is the same level of funding that the
Commission requested in fiscal year 2018.
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\4\ Consolidated Appropriations Act, 2018, Public Law 115-141.
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The Commission's budget request for fiscal year 2019 reflects and
builds on the efforts commenced in 2018. The budget request of $281.5
million is the level of funding necessary to fulfill the CFTC's
statutory mission.
The CFTC budget request is bare-bones, no waste, fiscally
conservative, and mindful of taxpayer dollars. It is based on a
rigorous analysis of each of the agency's functions and expenditures.
As with fiscal year 2018, we built the 2019 budget based upon the real
needs of the Commission. Each dollar of this budget serves a specific
purpose in pursuit of the agency's mission.
During the budgeting process, we identified ways that the agency
could be more efficient. Today, we are implementing changes necessary
to realize those efficiencies. Departments are being reorganized and
streamlined to increase productivity and provide long-term cost
savings. We have also successfully negotiated the return of an entire
floor of vacant office space in Kansas City back to our landlord. It
will result in significant savings over the remaining life of the
Kansas City lease. Going forward, we are committed to working with the
General Services Administration in connection with all of the CFTC's
regional office leases upon their expiration.
In all matters of agency budgeting and expenditure, we seek to
carry out the mission to foster open, transparent, competitive and
financially sound markets, free from fraud and manipulation, in a way
that best fosters broad-based economic growth and prosperity while
respecting the American taxpayer through careful management of our
agency resources.
There are areas where the modest increase in the agency's budget
that has been requested is necessary to fulfill the CFTC's statutory
mission.
21st century financial markets
Today, we meet at a tipping point. The future is devouring the
past, forging a new agenda, and threatening to move ahead of
regulators, financial institutions, and government. That is why we need
21st century regulation for a 21st century world.
Technology is leading us into a world that is much different than
the world we knew 5 or 10 years ago, much less when the Commission was
created in 1975. Much of our world today--from information to
journalism to music to manufacturing to transportation to commerce to
agriculture, even legal services--is undergoing a digital
transformation. It therefore should be no surprise then that our
financial markets are going through the same digital revolution.
Technology is impacting trading, markets, and the entire financial
landscape with far-ranging implications for capital formation and risk
transfer. These technologies include machine learning and artificial
intelligence, algorithm-based trading, data analytics, ``smart''
contracts valuing themselves and calculating payments in real-time and
distributed ledger technologies, which over time may come to challenge
traditional market infrastructure.
It is no surprise that these technologies are having an equally
transformative impact on U.S. derivatives markets. One thing is
certain: ignoring these changes in the market would be profoundly
imprudent. They will not go away. Rather, the rate of change will
accelerate.\5\ Nor is ignorance a responsible regulatory strategy. We
cannot respond in a reactive way--chasing to catch up with technology.
We must be proactive with a regulatory and statutory framework that is
ahead of the curve, gives clarity and coherence to this often complex
technology, and anticipates its evolution. The same technology can give
us advantages in market regulation.
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\5\ See, e.g., Tyler Wells Lynch, Moore's Law and the Future of
Information Technology,
Reviewed, Sept. 3, 2013 (Moore's Law claims that the number of
transistors that can fit into a single microchip, or integrated
circuit, doubles roughly every 18 months), available at http://
www.reviewed.com/features/moore-s-law-and-the-future-of-information-
technology.
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Our task, as market regulators, is to set and enforce rules that
foster innovation while promoting market integrity and confidence. To
do so, we must have the resources and tools to keep pace with rapid
evolution of the markets we oversee. Our budget request provides those
resources and tools.
Among other things, our requested budget will also allow us to
address market-enhancing innovation and financial technology (FinTech).
LabCFTC is the focal point of the CFTC's efforts to engage with FinTech
innovation for the benefit of the American public. It helps us keep
pace with changes in our markets, and proactively identify emerging
regulatory opportunities, challenges and risks. We have situated
LabCFTC within the CFTC's Office of the General Counsel. This allows
LabCFTC to leverage the expertise of the CFTC's legal team to manage
the interface between technological innovation, regulatory
modernization, and existing rules and regulations.
LabCFTC has hosted innovators across the Nation, ranging from
startups to established financial institutions to leading technology
companies. These outreach efforts are designed to make the CFTC more
accessible to FinTech innovators, and to serve as a platform for
informing the Commission's understanding of emerging technologies. The
information gathered in these meetings also provides important insights
to CFTC staff on market innovations that may influence policy
development.
In fact, through its engagement with--and study of--innovative
technologies, LabCFTC was recently able to recommend new virtual
currency surveillance tools to our Enforcement division. Our
Enforcement team has been able to avail itself of this new technology
and is now able to enhance certain surveillance and enforcement
activities. This important development helps underscore the value of
LabCFTC, and its effort to ensure that we are prepared to be a 21st
century digital regulator.
In addition to LabCFTC's domestic activities, the Commission
continues to proactively work with international regulators on FinTech
applications to coordinate approaches and to share best practices. In
February of this year the CFTC and the UK's Financial Conduct Authority
(FCA) entered into an arrangement to collaborate and support innovative
firms through each other's FinTech initiatives--LabCFTC and FCA
Innovate. This is the first FinTech innovation arrangement for the CFTC
with a non-U.S. counterpart. We believe that by collaborating with the
best-in-class FCA FinTech team, the CFTC can contribute to the growing
awareness of the critical role of regulators in 21st century digital
markets.
cyber security
Cyber security is critically important to protecting infrastructure
and financial markets around the world. In fact, it may well be the
most important single issue facing our markets today in terms of market
integrity and financial stability.
As market leaders and regulators, we must take every step possible
to thwart cyber-attacks that have become a continuous threat to U.S.
financial markets. Responding to this threat must take priority
requiring more of our resources in fiscal year 2019. Our understanding
of the cyber threat must develop in pace with the constant evolution of
the threat itself. As we learn, we must engage in discussions with the
DCOs about their cyber defenses and threat resiliency and recovery. It
is through the oversight and examination of systems safeguards that the
Commission helps to ensure that DCOs are prioritizing cyber security
activities. With this budget request, the CFTC will be able to better
undertake its duties to oversee cyber defense capabilities in the
markets we regulate.
The same vulnerabilities hold true in the case of futures
commission merchants where customer accounts hold records and
information that requires protection. We as an agency will work hard to
ensure that regulated entities live up to their responsibility to
ensure their IT systems are adequately protected from attacks and
customers are protected.
As an agency, the Commission is faced with growing pressure to
protect terabytes of data and maintain compliance with the Federal
Information Security Modernization Act and Office of Management and
Budget mandates. Protecting our information comes with a price. Some of
the requested funding will enable us to enhance our internal cyber
security including implementing additional cyber attack sensors and
defenses to further protect the market data we collect.
oversight of virtual currencies
In fiscal year 2018, certain exchanges self-certified several new
contracts for futures products for virtual currencies. These
innovations impact the regulatory landscape and with this budget
request, the Commission will invest more in new technologies and tools
that support important surveillance and enforcement efforts.
Under the CEA, Commission regulations, and related guidance,
exchanges have the responsibility to ensure that their Bitcoin futures
products and their cash-settlement process are not readily susceptible
to manipulation, and DCOs have the responsibility of risk management to
ensure that the products are sufficiently margined. The CFTC has the
authority to ensure compliance with both. In addition, the CFTC has
legal authority over virtual currency derivatives in support of anti-
fraud and manipulation including enforcement authority in the
underlying markets.
Recently, CFTC staff issued an advisory \6\ giving registered
exchanges and clearinghouses guidance for listing virtual currency
derivative products. The guidance will help ensure that market
participants follow appropriate governance processes with respect to
the launch of these products. It clarifies CFTC staff's priorities and
expectations in its review of new virtual currency derivatives to be
listed on a designated contract market or swap execution facility, or
to be cleared by a DCO. The advisory should help exchanges and
clearinghouses effectively and efficiently discharge their statutory
and self-regulatory responsibilities, while keeping pace with the
unique challenges of emerging virtual currency derivatives.
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\6\ CFTC Staff Issues Advisory for Virtual Currency Products, May
21, 2018.
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The CFTC has been in close communication with the SEC with respect
to policy and jurisdictional considerations, and in connection with our
recent enforcement cases. We have also been working with the U.S.
Treasury and the Financial Stability Oversight Council. In addition, we
have been in communication with our foreign counterparts through
bilateral discussions and through international bodies like the
International Organization of Securities Commissions.
economic modeling and econometric capabilities
The budget request, if met, would boost the CFTC's ability to
monitor systemic risk in the derivatives markets by increasing both its
analytical expertise and its capacity to process and study the
voluminous data provided by market participants since the passage of
the Dodd-Frank Act. These investments will allow for the expansion of
sophisticated quantitative and econometric analyses that are necessary
for risk modeling, stress tests, and other stability-related
evaluations, especially with respect to central counterparty
clearinghouses. These analyses will, in addition, enhance the quality
of CFTC policy development, rulemaking and cost-benefit considerations.
agency reform and the kiss project
Since becoming Chairman, I have made efforts to normalize
operations and practices, and found opportunities to reinvest and
maximize current resources. That means a return to greater care and
precision in rule drafting; more thorough econometric analysis; and a
reduced docket of new rules and regulations to be absorbed by market
participants.
The KISS initiative launched last March included a review of rules
and processes, and the invitation for public comment to collect ideas
on how the CFTC can be a more effective regulator. The effort has
produced a tiered list of significant actions that will lessen
regulatory burdens.\7\ Recently, the agency unanimously approved an
amendment replacing the complex and confusing lettering for defined
terms with a simple alphabetical list.\8\ The replacement will remove
unnecessary complexity from our rules and should help make regulatory
compliance less burdensome.
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\7\ Michael Gill, Chief of Staff, U.S. Comm. Fut. Trading Comm'n,
Remarks at the National Press Club, CFTC KISS Policy Forum, Washington,
D.C. (Feb. 12, 2018), available at https://www.cftc.gov/PressRoom/
SpeechesTestimony/opagill2.
\8\ J. Christopher Giancarlo, Chairman, U.S. Comm. Fut. Trading
Comm'n, We're Making Government Function More Efficiently for Taxpayers
and Market Participants (Feb. 15, 2018), available at https://
www.cftc.gov/PressRoom/PressReleases/pr7696-18.
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Internally, we have embraced the administration's Reform Plan
concept and have implemented in-depth organizational reviews to ensure
that the agency is staffed to provide the most effective services to
the American taxpayer. This ongoing effort has already borne results.
We are now leveraging knowledge gained from enforcement actions and
surveillance efforts to enable the provision of more efficient and
timely consumer education materials to the public. The Primer on
Virtual Currency, Bitcoin webpage, and podcasts are just a few of the
initiatives resulting from these efforts.
swaps reform
We now have more than 4 years of U.S. experience with the current
CFTC regulatory framework for swaps and have learned from its varied
strengths and shortcomings. Four years provides a significant sample
size to evaluate the effects of these reforms and their implementation.
Based on a careful analysis of that data and experience, we are in
position to address flaws, recalibrate imprecision and optimize
measures in the CFTC's initial implementation of swaps market reform.
At the end of April, I released a White Paper on swaps reform
called ``Swaps Regulation Version 2.0.'' The White Paper was co-
authored with Bruce Tuckman, the CFTC's Chief Economist. This White
Paper analyzes the range of academic research, market activity, and
regulatory experience with the CFTC's current implementation of swaps
reform. It explores and considers a range of improvements to the
current reform implementation that is pro-reform, aligned to
legislative intent, and better balances systemic risk mitigation with
healthy swaps market activity in support of broad-based economic
growth.
increased examinations of clearinghouses
The Commission expects the number of derivatives clearing
organizations (DCOs) to continue to increase in fiscal year 2019, with
many expanding their business to other products and other jurisdictions
around the world. As the number of DCOs increase, the complexity of the
oversight program will increase. It is imperative that the Commission
strengthen its examination capability to enable it to keep pace with
the growth in the amount of swaps cleared by DCOs pursuant to global
regulatory reform implementation. As the size and scope of DCOs have
increased, so too has the complexity of DCO's risk management programs
and liquidity risk management procedures. In addition, increased
funding will enable the Commission to enhance its financial analysis
tools used to aggregate data and evaluate risk across all DCOs.
enforcement
The day after the White House announced its intention to nominate
me as CFTC Chairman, I spoke to hundreds of industry executives at the
annual Futures Industry Association Conference. I issued a warning to
those who may seek to cheat or manipulate America's derivatives
markets. I said, ``[t]here will be no pause, let up or reduction in our
duty to enforce the law and punish wrongdoing in our derivatives
markets. The American people are counting on us.'' \9\ Through robust
enforcement of our laws and regulation, we will continue to send a
clear signal to the marketplace about our seriousness in punishing bad
behavior and compensating victims.
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\9\ J. Christopher Giancarlo, Chairman, U.S. Comm. Fut. Trading
Comm'n, CFTC: A New Direction Forward, Remarks of Acting Chairman J.
Christopher Giancarlo before the 42nd Annual International Futures
Industry Conference in Boca Raton, Florida (Mar. 15, 2017), available
at http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-20.
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In the past several months the CFTC has filed a series of civil
enforcement actions against perpetrators of fraud and market abuse
involving virtual currency. These actions and others to follow confirm
that the CFTC, working closely with the SEC and other fellow financial
enforcement agencies, as well as with criminal enforcement agencies,
will aggressively prosecute those who engage in fraud and manipulation
of U.S. markets for virtual currency.
In the fiscal year that ended September 30, 2017, the CFTC brought
numerous significant actions to root out manipulation and spoofing and
to protect retail investors from fraud. The CFTC also pursued
significant and complex litigation, including cases charging
manipulation, spoofing, and unlawful use of customer funds.
As of this morning, the Commission has filed 13 manipulative
conduct cases in 2018--the most manipulation cases the CFTC has ever
filed in a single year, which was last year (12 cases).
But it is not just about the numbers; it is about making our
markets safer and removing bad actors from the marketplace. We believe
that to adequately deter future misconduct, we must prosecute not just
the companies responsible, but also the individuals involved in the
wrongdoing. We also believe that, to maximize deterrence, we must work
with our criminal law enforcement partners to ensure that wrongdoers
face not just civil liability, but also the prospect of criminal
prosecution and time in jail.
In January 2018, the CFTC filed manipulation and spoofing cases
against six individuals in coordination with the Department of Justice
(DOJ) and the Federal Bureau of Investigation, which brought criminal
charges against the same individuals. This constitutes the largest
coordinated prosecution with the criminal authorities in the history of
the CFTC. These prosecutions were equally significant for DOJ: in a
press statement, the Assistant Attorney General characterized it as
``the largest futures market criminal enforcement action in Department
history.'' \10\
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\10\ Acting Assistant Attorney General John P. Cronan Announces
Futures Markets Spoofing Takedown (Jan. 29, 2018), available at https:/
/www.justice.gov/opa/speech/acting-assistant-
attorney-general-john-p-cronan-announces-futures-markets-spoofing.
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I also pledged last year that the agency would look to benefit from
cooperation with civil and criminal capabilities of other Federal and
State regulators and enforcement agencies. We have been making good on
that pledge. Two weeks ago, I signed an important agreement, marking a
milestone in the area of U.S. Federal and State financial fraud
detection and prosecution. That was a memorandum of understanding (MOU)
between the CFTC and individual State securities commissions will focus
our collective resources to better uphold the law.\11\
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\11\ CFTC, NASAA Sign Agreement for Greater Information Sharing
Between Federal Commodities Regulator and State Securities Regulators.
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This MOU establishes protocols and procedures, for the access, use,
and confidentiality of information and treatment of non-public
information in the course of law enforcement. It creates a framework
for cooperation that will result in:
--Leveraging State and Federal resources to support enforcement
actions;
--Enhancing the impact of enforcement efforts and their deterrent
effect;
--Encouraging the development of consistent and clear governmental
responses to violations of the Commodity Exchange Act;
--Preventing the duplication of efforts by multiple authorities; and
--Facilitating vital exchanges of information and communications
between the Commission and State Securities Administrators.
Complementing its enforcement efforts, the CFTC has also
strengthened its Whistleblower Program, and provided whistleblowers
additional incentives to report wrongdoing to the CFTC. In May 2017, to
further protect whistleblowers, the CFTC added protections prohibiting
employers from retaliating against whistleblowers and from taking steps
that would impede would-be whistleblowers from communicating with the
CFTC about possible misconduct. In the near future, the CFTC also
anticipates issuing its largest ever whistleblower awards. These
incentives are working. In fiscal year 2017, the Commission received a
record number of whistleblower reports--nearly twice as many as in any
other year, and fiscal year 2018 is on track to receive nearly twice as
many as in fiscal year 2017.
The Commission takes its enforcement efforts very seriously and
prides itself on being a premier Federal civil enforcement agency
dedicated to deterring and preventing manipulation and other
disruptions of market integrity.
Full funding of our budget request will allow us to continue to
carry out our mission in the area of enforcement.
rule harmonization
Soon after Chairman Clayton was sworn in as SEC Chairman, we began
discussing ways to ensure that our respective agencies are working
together in areas where our regulatory interests are complimentary or
overlapping. Now, almost 8 years after the Dodd-Frank Act officially
required the CFTC and SEC to ``consult and coordinate . . . for the
purposes of assuring regulatory consistency,'' \12\ I am pleased to say
that both agencies are undertaking an active and cooperative review of
our Dodd-Frank regulations. With the helpful assistance of Commissioner
Quintenz, CFTC staff has been actively engaging with our SEC
counterparts--and jointly with outside stakeholders--to identify areas
ripe for further alignment. Our agencies are also working to finalize
an updated information-sharing agreement that will help us further our
collaborative efforts in the swaps and FinTech age. I believe that
Congress and the American people expect regulators to communicate and
coordinate closely on issues where our regulatory interests are
complementary or overlapping. I am optimistic this review process will
lead to regulatory changes that will enhance our oversight efforts
while reducing unnecessary complexities and lessening costs for both
regulators and our shared market participants.
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\12\ Section 712(a) of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, Public Law 111-203 (July 21, 2010).
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foreign competition
As you may know, in the first quarter of this year, the Shanghai
International Energy Exchange launched a yuan-denominated crude oil
contract allowing non-Chinese market participants to trade for the
first time in Chinese commodity markets. Early in the second quarter,
China opened a yuan-denominated iron ore contract to international
traders. There is also talk of China allowing international market
participants to trade Chinese futures contracts in fuel oil, copper and
even soybeans.
China is the world's largest consumer of oil and fuel and a major
global purchaser of iron ore for its world leading steel production.
The opening up of China's domestic futures markets to international
participation is part of a long term strategy by the Chinese government
to expand China's influence over the pricing of key industrial
commodities.
The development of Chinese commodity futures markets as viable
regional price benchmarks for key industrial commodities has
competitive implications for the United States. We cannot be complacent
about the historical primacy of our derivatives markets. Our best
response for U.S. commodity market participants and, indeed, for global
markets, is to ensure that derivatives markets in the United States are
unrivaled in their openness, orderliness, and liquidity. This requires,
of course, that the regulation of U.S. markets continue to be of the
highest quality.
To achieve this regulatory objective, U.S. derivatives markets must
have an adequately funded regulator. The CFTC must have suitable
resources to continue to serve its mission to foster open, transparent,
competitive, and financially sound U.S. derivatives markets that remain
the envy of the world. Full funding of the CFTC's budget request will
allow it to fulfill its mission to serve this vital national interest.
conclusion
Members of the subcommittee, we meet one day after the anniversary
of the ``miracle at Dunkirk,'' the rescue of the British and French
forces trapped and then improbably evacuated in 1940. That may be the
single most important event of the Second World War, enabling Europe to
hold on until America entered the war.
Like many of you, I was struck by the recent movie about Winston
Churchill, ``Darkest Hour.'' Faced with the threat of catastrophe,
Churchill told the nation, ``We shall not fail or falter; we shall not
weaken or tire . . . Give us the tools, and we will finish the job.''
When those tools came (and they did come), they were American tools
that got the job done.
We need the tools to do our job of protecting the markets that
Americans rely on each day. With the proper balance of sound policy,
regulatory oversight, and hard work, America's deep, liquid, and
sensibly regulated derivatives markets will allow us to meet the
challenges of the future and ensure a healthy U.S. economy where our
citizens can flourish.
Thank you.
Senator Lankford. Thank you both very much on this.
I am going to defer my questions to the end to give time
for other Members to be able to step in earlier on this. So,
Senator Van Hollen.
Senator Van Hollen. Thank you, Mr. Chairman.
Again, welcome to both of you.
Mr. Commissioner Clayton--Chairman Clayton, I have got a
question related to conduct and appropriate conduct by members
of the SEC because there were some recent alarming reports with
respect to an exchange between one of the commissioners,
Commissioner Piwowar, and Citibank.
And my first question to you is, would you agree that it
would be inappropriate for a member of the SEC to suggest that
the way a regulated entity was treated depended on the position
that entity took on a business decision outside the purview of
the SEC?
Mr. Clayton. Senator, we interact with a number of market
participants. What I can tell you is how I approach those
interactions and that is in a very open, fair, and transparent
way.
Senator Van Hollen. I am not suggesting otherwise, Mr.
Chairman, with respect to any conduct.
I will cut right to the chase. There were reports. Senator
Kennedy and I are both in the Banking Committee. As you know,
Citigroup as a matter of policy said to its retailers that they
should not be using Citigroup services to sell weapons that had
not gone through a criminal background check, where the buyer
was under 21. And it has been reported--I assume you have read
the reports--that one of the commissioners, Commissioner
Piwowar, met with Citigroup at their request on a derivatives
regulation issue, and in the course of that conversation,
Commissioner Piwowar chewed them out for the position Citigroup
had taken on this issue outside the purview of the SEC.
And so my question to you is, are you aware of those
reports? Do they concern you? And have you asked the Inspector
General to determine whether or not that was a violation of SEC
conduct and rules?
Mr. Clayton. Senator, I am aware of those reports. I have
not asked the Inspector General to investigate those reports,
and I do not think that this is the appropriate forum to get
into that. But I understand your comments and your concerns.
Senator Van Hollen. I appreciate that. My concerns are
shared by a number of our colleagues, and I think you will be
receiving a letter in your capacity as chairman. But we are
also going to be asking the IG to take a look at this because
regulatory bodies should not be using their authority to try to
assert the personal opinions of the members. And I think we
share that view. I just want to give you a heads-up on that
issue. This has nothing to do with anything you did or said in
your personal capacity, but I just wanted to raise it with you
because the integrity of the process, whether it is CFTC, SEC,
any regulatory commission, is that they should not be using the
power they have over regulated entities on issues outside their
jurisdiction. We may all disagree with the policy position
Citigroup took, but I do not think we should disagree on using
that leverage.
CYBERSECURITY
Let me ask you a question on cybersecurity. And we have had
this exchange in the Banking Committee. I know you are
concerned about the issue of timely disclosure by entities
under the jurisdiction of the SEC that have been hacked. We
have talked about Equifax in the Banking Committee.
As I am sure you are aware, a report from the White House
Council of Economic Advisors back in February actually
identified concerns at the SEC specifically. I just want to
read from their report. Quote: The effectiveness of the SEC's
2011 guidance is frequently questioned. There are concerns that
companies under-report events due to alternative
interpretations of the definition of ``materiality.''
This is a concern I share. I was somewhat disappointed to
see the regulations coming out from the SEC I think in April
after this February report that simply sort of adopted the 2011
recommendations that were criticized in the SEC report. And I
wonder if you would be willing to take another look at this
with us because the Equifax example is one that I think shows
that there is a problem when materiality can be so loosely
defined that different folks under your regulatory purview have
vastly different interpretations.
Mr. Clayton. I understand everything you have said. It is a
complex issue. Let me try and address a few things.
First, you will note that we brought a very significant
enforcement action in this regard against the company formerly
known as Yahoo for their failure to disclose in this area. It
was clear that the information that they had was material and
should have been disclosed.
Second, I think an issue that we have talked about in the
past is trading during the period of time that a company
identifies an issue, it is clearly important--let us use the
word ``material'' for sake of argument--and then it is
disclosed. I am very willing to work with you on that issue
because, as I have testified in the past, I think it is good
corporate hygiene that during that period, senior officers
should not be trading in securities whether they themselves
know or do not know of this event. In that area, I am willing
to work with you.
Senator Van Hollen. I appreciate that. Forgive me, Mr.
Chairman. That is after the company itself has already
determined materiality between that time and disclosure. But
there is still a lot of ambiguity over what constitutes
materiality.
I would only point out that with respect to OMB, a Federal
agency, there are clear guidelines for their timeline for
reporting hacks, for example, into the Office of Personnel
Management system that we saw a couple years ago.
So I think we should have a little clearer definition of
what constitutes materiality in the context of these cyber
breaches.
Senator Lankford. Great.
Senator Kennedy.
Senator Kennedy. Thank you, Mr. Chairman.
Chairman, Chairman, welcome.
Chairman Clayton, when an American corporation, including
but not limited to a broker-dealer, violates the securities
laws of another country, are we made aware of that? Do they
have to report their violation to you?
Mr. Clayton. Generally those other countries do not have
statutes that would require their enforcement authorities to
notify the Commission.
Senator Kennedy. What about the American corporation that
violated the foreign law? Do they have to tell you?
Mr. Clayton. Is there an absolute obligation to tell us? I
do not believe so. Are there disclosure obligations that they
have that would trigger a requirement to make a disclosure?
Yes. And as a matter of policy, do American public companies
that have a foreign enforcement problem contact us to let us
know? They generally do and they should.
Senator Kennedy. Have you heard of a company called Real
Gold Mining, Limited that was suspended from trading on the
Hong Kong Stock Exchange? Does that ring a bell?
Mr. Clayton. Senator, that company does not ring a bell,
and I want to be careful not to talk about any pending
enforcement actions.
Senator Kennedy. Well, Hong Kong fined an American
corporation, Citigroup, $7.26 million for misleading statements
during the IPO of Real Gold Mining, Limited. And Real Gold
Mining, Limited ended up being suspended from trading on the
Hong Kong Stock Exchange. Do we know if any American investors
were hurt?
Mr. Clayton. Senator Kennedy, I do not know about that
specific situation. But I can tell you that if there was fraud
on a large foreign stock exchange, it is likely that directly
or indirectly an American investor has been harmed.
Senator Kennedy. Well, would you look into this? I mean,
$7.26 million is quite a fine. And I do not know the facts of
the case. I read about it in the ``Wall Street Journal.'' But I
would be interested to know that if Citigroup or other
corporations violate the securities laws of another country,
how we go about determining in a global economy whether
American investors were injured as well.
Mr. Clayton. Your question, including as a policy matter,
is a very good one. American investors, estimates vary, have at
least $9 trillion invested outside the United States. One of
the things that is important to me is what are we doing at the
SEC to ensure that when that money goes outside the United
States, investors are getting protections that are similar to
what they expect at home. I can tell you that the SEC and the
CFTC work closely together mostly through the International
Organization of Securities Commissions (IOSCO) but also through
the Financial Stability Board (FSB) with that in mind because
American investors send a lot of money outside the United
States.
Senator Kennedy. Well, if your Inspector General goes to
work on the issues that the distinguished Senator talked about,
I would also like him to look into why, because of the greed of
a handful of companies, in 2008 it caused the entire banking
system and almost the world economy to crash. Not a single
solitary member of senior management went to jail. You might
ask him to take a look at that too.
I would like the thoughts of both of you about the Volcker
Rule. I will hush. We got 34 seconds. If you could just tell
me--I know there are changes being made. We have not had a
recession since 2008. Are we making changes too quickly? I am
not saying we are. I am just asking your opinion. Mr. chairman.
VOLCKER RULE
Mr. Giancarlo. Thank you for the question. We monitor
markets very, very carefully. Just last week, when Italian
bonds went into a mini-crisis, we saw a real strain in those
markets. In February, when the VIX, Volatility Index, when
interest rates had the prospect of rising in that index, we saw
a strain in the markets. And what we observe is not an
abundance of high-level market-making. Banks have moved out of
the market. And one of the reasons is the Volcker Rule. And one
of the reasons is a presumption, not in the way it is written
in the law, but the way it has been adopted by the agencies, a
presumption that activity is proprietary trading unless proven
to be market-making. And that is an odd presumption.
The change that our agencies proposed are to remove some of
the bias against market-making. I think that is healthy for
markets. The core principle, however, remains.
Senator Kennedy. Because there is a blurred line between
proprietary trading and market-making.
Mr. Giancarlo. Right.
You know, I spoke to Paul Volcker about this a year and a
half ago, and he admitted. He said, look, the Volcker Rule is
an easy concept but it is hard to do in practice. In other
words, let us separate proprietary trading, which banks should
not do with depositors' money, from market-making, which is a
legitimate function. But he admitted that getting the
separation right is a challenge.
What was done in the first crack here was to put in a
presumption that things are impermissible proprietary trading.
By removing the presumption, we are still keeping the
prohibition on impermissible proprietary trading using
depositors' funds. And I think that is the right thing.
So it will be said that what has been proposed is a
rollback and going back to the crisis days, but it is really
not. It is really a very measured moderate response, and I take
it as a good sign that Marty Gruenberg from the FDIC supports
the proposal that was put forward by at least our agency
yesterday.
Senator Kennedy. Thank you, Mr. Chairman.
Senator Lankford. Before I move to Senator Boozman,
Chairman Clayton, would you respond on the Volcker Rule as
well? Both of you have been asked about it. I know that will be
a question. Then I am going to come straight to Senator
Boozman.
Mr. Clayton. Sure. Let me just supplement what Chairman
Giancarlo said, which is this is a very complex area, important
area, but an area with a great diversity of firms involved.
What I am very happy with is that we are taking the small and
medium-sized financial institutions which are--tell me if I
have this right--less than 5 percent of trading activity, in
fact, and we are taking a tiered approach instead of a one-
size-fits-all approach. I think that is wholly appropriate in
this area. I think that the compliance burden that fell on
those institutions that are the small and mid-sized banks was
greatly out of proportion with their trading activity. Other
than that, I am fine with everything Chairman Giancarlo said.
Senator Lankford. Thank you.
Senator Boozman.
Senator Boozman. Thank you, Mr. Chairman.
And thank both of you all for being here. We really do
appreciate your hard work and your guidance in these areas.
RULE 30E-3
Before I get into my questions, Chairman Clayton, I
understand the SEC adopted the rule 30e-3 earlier this morning.
I appreciate the Commission taking into account real concerns
that my constituents and stakeholders not only in Arkansas but
across the country had with the rule and your efforts to
address some of the issues.
However, I still have concerns that the 30e-3 rule that was
approved today, an opt in rather than an opt out for paper
reports, will have far-reaching consequences for many of my
constituents that are elderly, many that do not have reliable
access to broadband Internet or simply want hassle-free paper
reports. I think that the technology is getting there, but as
you travel through rural America, it is still a huge problem
for some.
Mr. Clayton. I recognize those concerns. Our staff
recognized those concerns. And the rule that was approved is, I
would say, a substantial departure from what had originally
been proposed. We have a 2-year phase-in period. The earliest
that a fund complex or company could switch to an opt in to
paper is 2021, and that is only after they have provided
extensive notice and opportunity for their investors to choose.
This is also part of an overall assessment of investor
experience that we are going through. So we think that this is
the right move, but we do not think it is one that should be
done hastily. And we think that we should be providing the very
constituents that you mentioned every opportunity to continue
to receive reports as they receive them today in paper.
WELL-REGULATED DERIVATIVES MARKETS
Senator Boozman. Thank you very much.
Mr. Giancarlo, in your testimony, you mentioned the
Shanghai International Energy Exchange launched yuan-dominated
crude oil and iron ore contracts allowing non-Chinese market
participants to trade in Chinese commodity markets for the
first time. Can you talk to us a little more about the
importance for farmers and end users for the commodities that
they trade to be priced in U.S. dollars and not other
currencies?
Mr. Giancarlo. Indeed. You know, I have spent a lot of my
past 4 years on the Commission meeting with the farmers that
use our products. And I will often point out to them. I say, do
you understand that compared to farmers all over the world, you
have one advantage that you probably do not think about, but it
is an enormous advantage? And that is, most of your production
is priced in U.S. dollars. When you compete against an
Argentinean wheat grower or an Australian wheat grower, their
production is priced in dollars, not in their native currency.
That is a tremendous advantage.
We are the world's largest food producer. We are becoming
the world's largest energy producer. The largest consumer,
however, is China, the largest consumer of energy products, the
largest consumer of iron ore for purposes of their world-
leading steel production, the largest consumer of soybeans. I
understand China consumes 60 percent of the world's soybeans.
So they are sitting there saying we are the largest
consumer. Why are we paying in dollars for these core
commodities? And so it is part of their grand strategy to
become the world's leading economic power to see the transfer
of the pricing mechanism of these core materials, these core
commodities that they consume from dollars into their currency.
Now, that may be decades away, but these steps that they are
taking in the last few weeks are very much part of that
strategy. We should no longer take for granted that for now and
for all time, these commodities that we produce and lead the
world in production will remain priced in dollars for all
eternity. There is nothing in that.
The one advantage we have, I believe, is not only being a
large producer, we have the best regulated markets. The price
mechanism that is set in Chicago and New York for these
commodities is overseen by our agency. And I truly believe we
are the world's best regulator at this. There are real
deficiencies in the way other regimes go about regulation,
including in China. And we saw, when there were problems in
their market a year or so ago, their very heavy-handed approach
to addressing those problems was not the approach we take. We
take a much more well-informed and appropriate, principle-based
approach. And I think that is one of the reasons why the
pricing mechanism is here, one of the reason why the world
looks to U.S. markets to price these core commodities.
Senator Boozman. So in not taking this for granted, you
mentioned the ability that we have to run a very orderly
system. Are there other things that we need to be doing along
that line?
Mr. Giancarlo. Look, I do not think we can stop China from
offering these products around the world. I do not think we can
do anything to stop the amazing growth of their economy. It is
their right to do that, and they are doing some brilliant
things.
What we can do is just what we do but even better. And I
think one of those advantages--and I said in my opening
testimony good regulation is a national competitive advantage.
And I think that is why I humbly ask that our budget request be
fulfilled so that we can continue to do what we do but do it
even better.
Senator Boozman. Very good. You make a good point. Thank
you, sir.
FISCAL YEAR 2019 BUDGET REQUEST
Senator Lankford. Thank you.
Let me keep going with that theme of your budget request, a
$32.5 million increase on it. Do you consider this bringing up
to the level that you think it should be and is this
sustainable? Is this a 1-year bump? Is this bringing it up to a
new level? What are your expectations for the next several
years on budgeting?
Mr. Giancarlo. Thank you for that.
As you know, Chairman, we have been flat-funded----
Senator Lankford. You have for several years.
Mr. Giancarlo [continuing]. For several years, and in fact,
decreased last year.
This increase of roughly 13-14 percent will bring us to a
level that had we seen incremental increases during that time,
we would be there. Should you see fit to fund our full request,
I do not see similar requests of that magnitude going forward.
I see incremental increases going forward. So our request is
really to address some of the challenges we have had over the
last few years and some of the cuts we have had to make in
technology, in supervisors. We have some real, quite mission-
critical shortfalls in cyber examiners, in technologists, areas
where we really should not be falling behind, and where we have
been. We are effectively in a hiring freeze and have been for
several years, and as attrition works its way through the
Agency, you know it is very uneven. In some critical areas, we
have not been able to backfill, and we need to do that. So this
funding will bump us up to where we need to be, and then I see
incremental increases thereafter.
Senator Lankford. Do you see the increased funding--let us
just take the technology side of it--on equipment in technology
or in personnel in technology?
Mr. Giancarlo. Both. So technological skills are in short
supply, and the people you need for cyber--the going bid for
their services is enormous. So to fill those positions is
critically important. It is a combination of skilled people and
competent technology. Again, once we catch up, then our needs
going forward should be incremental.
Senator Lankford. For the SEC, the same issue on
technology. What do you expect as far as modernization efforts?
Mr. Clayton. Well, as I mentioned, I thank you for the
additional funding that we needed to lift not only our
cybersecurity game but effectively our advancement or, if you
want to say it in the negative way, our retirement of legacy
systems. Part of cybersecurity and good cyber hygiene is not
only what is my cybersecurity protection, but it is also
rolling off your legacy systems that were built with less
protections and replacing them. And we are able to do that. I
think we are in a good place, but I want to be clear. When I
say we are in a good place, we are in a good place from funding
because I know where to put the dollars. We are improving our
cybersecurity risk profile, but we have work to do and I expect
it to be a continuing journey.
Senator Lankford. So one of the things that you and I have
talked about is not just cybersecurity and the right software,
right hardware, right personnel and process, but also how much
information do you really need to be able to hold. That becomes
the threat on it. Obviously, with the breach of the Edgar
system before, it raises new questions.
So where are you as far as what information you really need
to have accessible at that point?
Mr. Clayton. Let me put that into two categories.
Senator Lankford. Sure.
Mr. Clayton. Personally identifiable information, PII.
Following the breach, we did a review of the PII that we take
in, and we have eliminated taking it in in areas where we do
not need it. And we continue to approach that issue, and I
expect to continue to approach that issue in the same way. We
are not going to take that kind of retail investor information
in unless we need it to fulfill our mission.
More general market information, the same approach. Like we
discussed, why would the Commission create a risk unless we
need it to fulfill our mission. So we are looking at the market
information and the company information that we take in that is
non-public. Does the Commission need it? Do we need it at the
time we are taking it? Because over time, the value of that
information to, for lack of a better term, ``bad guys''
diminishes. So we are looking at those issues as well.
Senator Lankford. Let us talk a little bit about staffing
changes. You mentioned quite a bit as far as staffing changes
in different key areas. Which area or office, as you look at
the priorities of adding 100 different positions basically back
in, becomes the top priority for you? So when you are talking
about we have got a lot of priorities, this one goes first,
where does that land for you?
Mr. Clayton. Let me give you four, if you do not mind, four
top priorities.
First, we talked about IT. There are a few positions there
that we want to fill.
Let me go to the programmatic ones. Enforcement and
inspections.
In enforcement, we have probably had the most significant
attrition. I know that we can add value there.
Inspections, the number of investment advisers that are
operating has increased. Therefore, our obligation to continue
to inspect them has increased. The Commission is doing a lot
with risk-based inspections, but we also need smart, competent
people to do it.
Lastly is in trading and markets. As I have talked about,
our markets have evolved a great deal. I want to make sure that
we have the people in place. I will give you an example. Fixed
income is moving from what I will call human oral trading to a
great deal more of electronic trading. I want to make sure that
we have the people who can cover that transition. It is a
transition that is akin to what has happened in the equity
markets but it is not going to be the same. And we need some
expertise in that area as well.
Senator Lankford. So the challenges you have is the IG went
back and evaluated, a very not-fun evaluation on human capital
management and pressed on SEC. This was the quote. SEC lacks
assurance that its hiring specialists have the necessary skills
to hire and promote the most qualified applicants in accordance
with key principles of an effective control system.
I know you have seen that and this has already been a work
in process. But with adding an additional 100 people,
especially in high-end areas like that, how do you feel at this
point about hiring specialists and those individuals that are
managing human capital?
Mr. Clayton. I am going to give you what may sound like a
simplistic answer but it is one that I really believe in. Good
people hire good people.
Senator Lankford. I would agree. That is not overly
simplistic. That is good common sense.
Mr. Clayton. I think we have good people in place in those
programmatic divisions that I mentioned.
Senator Lankford. Is that a transition from what the IG was
concerned about before?
Mr. Clayton. Chairman, I do not know if that is a
transition, but I have a great deal of confidence that the
people who are now heading those divisions know how to identify
talent, and I am going to leave them to do it.
Senator Lankford. Fair enough.
Let me if there are other Senators who have a second round
of questions. Senator Kennedy? All right.
I have got a stack of a second round here that I want to go
ahead and jump into.
PERSONNEL NEEDS
Mr. Giancarlo. Senator Lankford, may I just actually answer
the question you asked my colleague, Jay Clayton, about
personnel----
Senator Lankford. Sure.
Mr. Giancarlo [continuing]. Where we are looking for it?
In our request, we request 46 FTEs, and I would just like
to break those down for you to help you understand how we think
about staffing.
I put our needs into three buckets: a third, a third, a
third.
The first third are personnel for what I call prevention.
Senator Kennedy talked about the last crisis. We think about
what a future crisis might look like and think about how we can
do something about prevention so it does not happen, not that
we have a crystal ball. But when we think about prevention, we
think about it in two areas. One is cyber and one is in our
clearinghouses. You know, one of the effects of Dodd-Frank was
to supersize our clearinghouses with swaps clearing. How do we
get ahead in that? And it is vitally important we have the
examiners to do the exams and to go into the detail. So maybe
we find a problem before it becomes a crisis. In the areas of
cyber, we desperately need to add additional personnel to do
quality cyber exams of cyber defenses in our global
clearinghouses and our futures exchanges and observe what their
other defenses are as well.
And then a second bucket is how do we be more forward-
looking. And that is where we really need more technologists to
understand the way our markets are going digital by the minute
and economists to understand the dynamics of algo trading and
other impacts on the marketplace.
And then the last third is to just fill in gaps that have
emerged over the last 4 years of flat funding and a hiring
freeze. Just to give you an example, we have not had a full
Commission for 4 years now, but we face the prospect very soon
of having a full Commission, once two new commissioners arrive.
Those commissioners will need to be staffed. Those staffs will
come out of our budget. Just as our budget has gone down for
fiscal year 2018, we may have two new commissioners arrive that
we will need to staff up. So just filling in the gaps there,
and there are other areas as well.
So that is our 46 FTE budget proposal. Thank you for giving
me the opportunity to explain it.
Senator Lankford. No, no. Glad to. Thanks for the insight
on that.
SWAPS REGULATION VERSION 2.0
Help me understand a little bit. You put out a white paper
on swaps regulation and swaps reforms that is pretty sweeping
to be able to take a look at and say where could we go and what
does this really mean in implementing issues and margins and
all kinds of things. Walk us through that and what would be the
financial needs as far as staffing around that as well?
Mr. Giancarlo. Thank you for that.
You know, I am maybe a bit of a rare breed. When Dodd-Frank
was passed, I actually publicly stated I thought Title VII
worked. I said Congress got that part right, the swaps reforms.
And I said that after 14 years in the swaps industry. I knew
firsthand the shortcomings in the market structure. I also knew
how the market worked and I knew what worked well. And so I was
a keen observer of how the CFTC and other Federal agencies
implemented Title VII. And at the time, I wrote a white paper
in 2015 laying out areas where I thought the agency got it
right and areas where--and I thought now coming in as chairman,
it was time to update that and reflect on what I have now seen.
We have got 4 years of experience with our swaps reforms at the
CFTC.
Again, I still believe Congress got it right, and I think
in some cases, the agency has been extraordinarily successful
in its work. So the clearing mandate, implemented by my
predecessor by two, Gary Gensler, has worked extraordinarily
well. But that has led to second order impacts. We have
supersized some of the world's clearinghouses. What are the
impacts of supersizing those clearinghouses? How do we oversee
them? How, in the event of a crisis, do we make sure they are
able to recover, or if they are not able to recover, how are
they then resolved and how are all their accounts put back into
good order? So we address that in this white paper.
The swaps reporting mandate, was I think actually the most
important mandate to come out of Dodd-Frank, and yet 10 years
after the crisis, 8 years after Dodd-Frank was passed, we still
do not have a clear and composite picture of the counter-party
credit risk of one financial institution to another because of
its swaps book. How can we make that swaps reporting a reality
so we can actually use it to signal whether risk is building up
in the system? And I lay out ideas for that as well.
In the area of swap dealer capital, one of the big problems
I believe in the swaps reforms--they are actually biased
against swaps. And part of the problem there is that we
continue to rely on the notional amount of swaps, which is why
when people talk about the swaps market, they talk about it in
hundreds of trillions. We recently introduced some research
through our Office of Chief Economist that says when you
actually net that down, the swaps world looks a lot like other
large markets like the U.S. Treasury market and not like some
gargantuan marketplace. It actually falls into a logical
proportion to other key global markets. And once it is put into
proportion, maybe then we can have regulations that reflect its
actual size and not fears about it overwhelming the global
economy. So that is what we tried to do in this.
It is very much a forward-looking work. It does not lay out
things to be implemented next month or next week, but it lays a
forward path to what I think is a balanced and healthy approach
to swaps regulation, one that is not biased against derivatives
which, as I explained in my opening remarks, are very important
to the U.S. economy. I think our leadership in the global swaps
market underpins the U.S. dollar as the world's reserve
currency, and I think we need to maintain that edge, but we
need to do it in a balanced, thoughtful, intelligent, and well
regulated fashion.
DE MINIMIS
Senator Lankford. So you have also put out a recent
conversation on registration as a swaps dealer to an $8 billion
notional value rather than a $3 billion. Walk us through the
why and the what and what do you think is the effect of that?
Mr. Giancarlo. When this original rubric was set in place,
the $8 billion, then falling to $3 billion, there was actually
very little data. I would say it was an educated guess by the
agency. Now we have years of data, and have done a very, very
thorough analysis. And what we have found is that if the $8
billion were to fall to $3 billion, we would only gather less
than 1 percent more swap dealing activity. The fact of the
matter is that we probably would not gather it because that
dealing activity is done by small, local power utilities,
agricultural co-ops, small regional banks. And in the last 4
years, I have met with many of them, and they all tell me if
that level drops down to $3 billion, they will drop their
dealing activity from 7.9 to 2.9 because they cannot bear the
cost of becoming a swap dealer. It was estimated recently that
the cost of being a swap dealer is over $300 million per
entity, and these small power utilities cannot do that. And so
the cost-benefit analysis of capturing potentially another less
than 1 percent and imposing those costs just did not make
sense. All we would be doing is rewarding the large Wall Street
banks that can afford that $300 million to be a swap dealer. We
would be hurting these small, local liquidity providers and
helping the large banks.
Senator Lankford. So how often does that $8 billion amount
need to be revisited?
Mr. Giancarlo. So what we adopted yesterday on a two-to-one
vote of the Commission is a proposed rule to keep the level at
the $8 billion and not drop it down to $3 billion. And as I
said yesterday, I believe that is right. I think it is right
for the U.S. economy. I think it is the right level. We will
still be registering the Wall Street banks, and at the end of
the day, it was the Wall Street Reform Act. It was not the
Small Business Reform Act.
Senator Lankford. My question is if we do not revisit that
on a regular cycle, then as time goes on, you are capturing
more and more small businesses that do not need to be engaged
in that.
Mr. Giancarlo. We should, indeed, revisit that on a regular
cycle using up-to-date data.
Senator Lankford. Do you have a plan on how that should be
or a recommendation on how often that should be revisited?
Mr. Giancarlo. We did it after 4 years. I think that gave
us a good outcome. Now, we have not set that as a regulatory
objective, but I think something like that, maybe every 5
years, might be the right time period.
Senator Lankford. Thank you.
CRYPTOCURRENCY
Let me ask you something simple for both of you. What are
we going to do on cryptocurrencies? This is not complicated at
all. What is the plan? What is the direction? What is the
staffing need that you have and the regulatory authority that
is needed?
Mr. Clayton. Let me divide it into two buckets:
cryptocurrency as--or crypto-asset--we will call it a currency
as a replacement or substitute for the dollar, the yen, and
then what we call ICOs, initial coin offerings, a crypto-asset
that is a security.
The ones that are the substitutes--the SEC does not
regulate. We regulate securities transactions and persons who
issue and trade in securities. Both of us have mentioned that
that space is a space where there is no direct regulation of
those cryptocurrencies. And it makes sense that there is not
because these were all sovereign-backed. Now we have a
purported substitute for the sovereign-backed currencies. There
is not a specific regulatory framework in place. There is anti-
money laundering. There are a number of other statutes that
would touch on this, but no comprehensive body of regulation.
We need to watch this space for that and many other reasons.
Mr. Giancarlo. I will tell you the last 18 months for
Chairman Clayton and I in the area of cryptocurrencies has been
what the Grateful Dead called a ``Long Strange Trip.'' We had
to come up to speed awfully quick in this area that was
developing very fast in Chairman Clayton's case, in the SEC's
case, to make the world understand that unregistered ICOs would
not be tolerated. And I think that message has been delivered
loud and clear. In the case of the CFTC we will work within our
unique statute which allows for self-certification by our self-
regulatory organizations of cryptocurrency derivatives which
have been launched. We have now put out recent guidance on the
standards that we will look at when we review those self-
certifications. We have had to get up to speed very quickly,
but I do think as we sit here today, within the CFTC's area and
its jurisdiction, within our jurisdiction, we now have our
principles expressed and understood.
But there is that area that Chairman Clayton mentions that
I think is the area of concern and that is the cash exchanges.
The cash exchanges for these cryptocurrencies is an area where
we do not have direct regulatory oversight. And that is an area
where there is a lot of talk right now as to what is the right
way forward. There is potentially a Federal role. The States
are exploring what their role is. Certainly some States like
New York have developed a cryptocurrency license. Others are
looking at this. And I think a general conversation should be
had as to whether a 50-State approach or a Federal regulatory
approach is the right way to go. But I think we do need to
bring our best minds together around the issue of where and how
do we go forward. As we see more and more of them. What do they
look like, and what is the right role for regulation and at
what level of our Federal and State regulatory regime.
Senator Lankford. So what do you need from us? Because you
all still have a connection on whether it is initial coin
offerings or whether it is fraud or whether it is money
laundering or any number of things that are in that space. What
is it that you need at this point as far as legislatively?
Mr. Giancarlo. We need our budget fulfilled, Senator.
Senator Lankford. That would be helpful.
Mr. Giancarlo. Part of our budget is for technologists, and
one of the areas--when we are approached with a self-
certification, the resources we devote to make sure we are
ready when they are ready to launch is a real strain on our
resources. And we do not have a choice. We cannot say to a
self-certification this meets our requirements but we do not
have the budget, therefore it cannot go forward. That is not a
basis on which we can deny it. We have to do what we have to
do. So the budget allocation is critically important for the
CFTC.
Senator Lankford. Okay.
Chairman Clayton, anything you want to add?
Mr. Clayton. I will just say--and thank you, Chairman
Giancarlo--that in the securities space where we are talking
about crypto-assets that are securities, ICOs, our laws are
clear. You either conduct a good private placement following
the private placement rules that are well established or you
register with the SEC and conduct a public offering, including
with financial statements and all the requirements of a public
offering. We have allocated resources to ensuring that people
do that, and we will enforce those laws. It is an area that I
watch in terms of assets that we need. I think we are good for
now, but I am watching that space.
Senator Lankford. Fair enough.
INITIAL PUBLIC OFFERINGS (IPOS)
Let me flip topics on you real quick as well, Chairman
Clayton, and that is dealing with IPOs and trying to encourage
more opportunities for more people to be able to get at the
market. My concern that I watch is the smaller number of IPOs,
let us say, in the last 10 years, the growth of the activist
investor, and is that encouraging or discouraging public
opportunities to be able to enter into the market, or does that
continue to limit dollars in smaller and smaller hands because
if you have activist investors and other complexity in the
market, then it is easier to go get private capital than it is
to go out in the public, which again centralizes wealth again?
So the question really for you is where are we on some of
the rules on dealing with activist investors, what power that
they have, the percentages and the rules? Is there anything
that you are starting to be able to examine to say is this the
right model, the right look to be able to consider?
Mr. Clayton. Chairman, I share your concern about the
relative size of our public equity markets and therefore the
relative size that our retail investors have to participate in.
Are we reducing the opportunities for retail investment? And as
you said, if all of the good investment opportunities--that is
an exaggeration. If many of the good investment opportunities
are in the private space, the people who have access to the
private space are generally our most wealthy, not the middle
class. That troubles me. I want to encourage the growth of our
public capital markets.
Your specific question around activists and governance. In
the last decade, the governance dynamic of our public companies
has changed significantly as a result of a number of factors.
The result is--I am not saying it is a good thing or a bad
thing--shareholders have more direct access and more immediate
effect on the governance of public companies. Items that were
reserved for the board of directors are now more greatly
influenced by shareholders. That has effects.
Senator Lankford. Is that based on just a new functioning
of an older rule or a new rule?
Mr. Clayton. New rules, new market dynamics, concentrations
of holdings, as well as direct access to governance by
shareholders, which has increased the ability of shareholders
to affect decisionmaking. My view is we should recognize that,
take a pause, and ask ourselves--things have changed--have they
changed for the better? There are arguments on both sides, but
we should recognize that things have changed.
Senator Lankford. Right. And that is something that you are
currently evaluating to be able to see, gather data to be able
to help make a decision on our proposed rule.
Mr. Clayton. Yes. That is our job.
STANDARDS OF CONDUCT FOR INVESTMENT PROFESSIONALS
Senator Lankford. Let me ask about another rule that is
sitting out there, the Standards of Conduct for Investment
Professionals, a nice little thousand pages that is out there,
shorter than your written testimony, by the way.
[Laughter.]
Senator Lankford. That is a big piece of it.
Mr. Clayton. And to think my mother could not get me to
write a paper.
[Laughter.]
Senator Lankford. Listen, all of your folks--it was
extremely not only well written but a lot of great information
there.
So this whole issue about trying to protect small savers
and families that are trying to get started, this is a big
issue because again it goes back to the middle class and people
that are just starting out to try to invest. This is no simple
rule because this affects how people will be able to save for
their own retirement or try to invest when they are just
getting started out, when they are setting aside $10 a month
rather than people that are aside $10,000 a month on the other
end of the spectrum. Give us a feel of where this goes right
now from this proposed rule.
Mr. Clayton. It is no simple rule. But what we are trying
to do is for the type of person you talked about, make it
simpler. There are two types of relationships with investment
professionals we have in this country. There is an investment
advisor type relationship, which is a portfolio-based I will
say longer-term, more general relationship. Then there is a
broker-dealer relationship which is a transaction-based, more
episodic, in-the-moment relationship.
We believe that in both cases the investment professional
cannot put their interests ahead of the client. But that means
different things in those contexts because we should recognize
that, one, you are having a longer-term relationship over a
greater aspect of someone's investment. In the other, it is
shorter-term. Both of these models have served us well. They
can be improved and they can be clarified. So we want to keep
them, improve them, and clarify them, and that is what we are
trying to do.
Specifically, we want our retail investors to be able to
have a candid conversation with their broker-dealer or their
investment advisor about how they are getting paid, what their
incentives are, and what that encourages them to do so that
they can make more informed choices and they can be better
protected. That is what we are trying to do.
Senator Lankford. Give us a guess on the timing.
Mr. Clayton. We have allowed for a 90-day comment period. I
am sure we will take that full comment period. We are doing
investor testing. We are doing investor town halls. Let me just
take this opportunity to say we want to hear from investors as
to what they want because my objective is to align the law and
the practice with investor expectations. What does a reasonable
investor expect, and let us see if we can align the law and
practice with that. So we are going to take at least the 90
days. But you know what? I am not going to take forever because
this issue has been out there a long time, and I think it is
time to bring a focal point for the many regulators in this
space.
Senator Lankford. Thank you.
Mr. Giancarlo, any final comments, anything you want to
add?
MARKET INTEGRITY
Mr. Giancarlo. Well, we have a different area. But what I
hear from Chairman Clayton is this focus on where the rubber
meets the road of people's retirements and how they allocate
money, how they speak to their professionals, what they expect
in return in terms of their needs being put first. And in very
many ways, our approach to markets, although again we do have
different approaches historically in the approach of our
agencies--our approach, though, is still the same thing, is
what is the experience of America's producers when they are
going to find--price discovery, to find out what their crop--
what they should be getting for it at the elevator. Do they
trust the price coming out of the Chicago Merc or NYMEX or
others? Do they know that that price is going to be a fair
price when it is reasonably settled? The reason why the world
relies on prices coming out of our markets is because they
believe they are deep, they are liquid, they are efficient. We
must never take that for granted.
Then the final thought is I hear Chairman Clayton talk
about that marketplace that we took for granted for years of
how enterprises were financed first through private equity and
eventually into the public markets. It worked so well. It was
the envy of the world. And it built the great companies like
Apple and Sysco and others, all these great firms that dot the
landscape that we rely on. They all came to fruition through
that process. Did we take it for granted? Have we allowed it to
be gummed up? Do we need to fix something?
And I worry about taking for granted our own price
discovery markets that set the world price for commodities. We
must not take those for granted as well because other countries
see them, and they want them for themselves. We must not take
them for granted. We must do everything possible all the time
to keep refreshing. What are we good at? How do we keep being
good at that? Those are vital national interests. We need to
retain them.
Senator Lankford. I would agree.
By the way, I did jokingly talk about your opening
statement earlier. It is an inspiring piece of literature. You
start out with a great American story and telling the story,
and it ended with Dunkirk, if I recall correctly. And so the
information that you provided and the inspiration was helpful.
Mr. Giancarlo. As we celebrate the anniversary of World War
II, a great uncle of mine, my mother's cousin, died at the
Battle of Bastogne. And I think about that all the time. When
people give their service to their country, they give the
ultimate service. We in public service--we do not face that
type of peril, but it is vitally important that we take it as
seriously as they did and deliver for our fellow citizens, as
they did as well.
Senator Lankford. I would concur.
Chairman Clayton, any final statements?
Mr. Clayton. I want to thank Chairman Giancarlo and my
other fellow Federal regulators, not just our coordination
around the Volcker Rule but the coordination over the past year
in trying to assess where markets are going, where the
vulnerabilities are, and just make us better. I really
appreciate the cooperation we have, and I appreciate the
cooperation we have with the Federal Reserve, the Federal
Deposit Insurance Corporation, and the Office of the
Comptroller of the Currency. So thank you.
Senator Lankford. I would tell you the American economy is
benefiting from good leadership at this point as well. We have
one of the lowest unemployment rates that we have had in
decades now. So the job market is accelerating. The stories
that we hear frequently right now from my home are trying to
look for employees rather than employees looking for work. It
is a very different story than where we were 10 years ago. And
both of you have a tremendous responsibility within our
economy, being able to keep a good, balanced, stable economy
that continues to be able to provide jobs to people in the days
ahead. So thank you for the continuing work. There is much
still to be done in this process to make sure we have some
regulatory certainty that maintains a growing, vibrant economy.
If there are no further questions and comments from either
of you gentlemen, the hearing record will remain open until
next Tuesday, June 12, for the subcommittee Members to submit
statements or questions for the record for either of the
witnesses.
CONCLUSION OF HEARINGS
Thank you both for being here.
The subcommittee hearing is adjourned.
[Whereupon, at 4:40 p.m., Tuesday, June 5, the hearings
were concluded, and the subcommittee was recessed, to reconvene
subject to the call of the Chair.]
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