Questions about who ought to be the next chairman of the Federal Reserve have occupied lots of attention in Washington in recent months. But the lesser-known Commodity Futures Trading Commission is about to get a new chairman as well. Gary Gensler, who has headed the agency since 2009, is leaving at the end of the year, and his replacement certainly will have his work cut out for him.
The CFTC, long-time regulator of the futures markets, saw its mandate expand considerably under Dodd-Frank. The agency became the primary regulator of swaps, a type of derivative that had previously traded over-the-counter and outside the purview of market regulators like the SEC and CFTC. At the enthusiastic urging of Chairman Gensler, Congress crafted a complex regulatory web for swaps and the companies that sell and use them. The CFTC cranked out thousands of pages of rules in a successful effort to win the gold medal for most Dodd-Frank deadlines met. In the process, the CFTC cast aside its former careful and restrained demeanor in favor of a bull-headed, self-aggrandizing approach.
The large volume and rapid pace of rulemaking during Chairman Gensler's tenure does not mean that the incoming chairman can sit back, relax, and watch the new regulatory infrastructure do its magic. To the contrary, the new chairman will reap the consequences of a regulatory regime rushed into place. Many of those consequences remain to be uncovered by unwitting market participants, but some have already come to light. Recently, for example, requirements related to the registration of swap execution facilities embedded in a single footnote of a 130 page rulemaking notice engendered industry and agency panic. As the implications came to light, the CFTC was forced into providing a last-minute extension. Another unintended consequence of the CFTC's rules is that some firms have ditched swaps in favor of futures, which are subject to a tried, true, less onerous, and less costly regulatory framework than swaps.
Yet another possible unintended consequence could be that US swap users will be shunned by foreign firms seeking to avoid the long arm of CFTC regulations. Rather than relying on foreign regulators to handle transactions within their borders, the CFTC has tried to expand the universe of transactions to which US rules apply. The CFTC holds out the promise of "substituted compliance" with foreign rules. That piecemeal approach still falls short of respectful deference to foreign regulators that are working in good faith alongside the US under an international commitment to implement derivatives reforms.
The CFTC's poorly crafted rules are the product of bad housekeeping practices. One such practice is the reluctance to work productively with other regulators here and abroad, but its internal rulemaking processes are broken too. The agency has shown a marked disinterest in understanding-as its governing statute requires it to do-the likely costs and benefits of its rules. Instead of undertaking serious analysis, it checks the cost-benefit analysis box with sweeping statements about benefits and narrow attempts to identify costs.
The CFTC also has gotten into the habit of relying on so-called no-action letters to fix problems after rules are finalized. These invariably last-minute letters provide conditional, temporary relief from rules: if firms take the steps laid out in the letter, the staff of the CFTC promises not to recommend that the commission bring an enforcement action against them. These late-night missives, which are typically conditioned on a specific set of compliance obligations, function as de facto rules. Unlike rules, no-action letters don't get run through the salutary public comment or formal commission approval processes.
President Obama is likely to name his nominee for the CFTC any day now. Getting through public vetting and confirmation hearings will be just the beginning of a long road of challenges. Only someone who is willing to critically rethink the agency's recent decisions and procedures for making them should step up to take the reins of the CFTC.