CFTC Commissioner Daniel Berkovitz recently spoke to the FIA Commodities Symposium, in Houston, Texas, about the reduction of systemic risks and the strengthening of market integrity under the Dodd-Frank Act. He gave the usual disclaimer, that the views he expressed in this address were his own not those of the Commission. Still, they are worth the attention of anyone interested in how the derivatives markets in the United States function.
Berkovitz maintains that in general the effect of Dodd-Frank and its implementing regulations has been positive: “our financial markets are safer and more resilient” than they were before.” Almost 89% of interest-rate swaps and 96% of broad index credit default swaps are cleared through a central clearinghouse, for example. Nearly 98% of all swap transactions involved at least one registered swap dealer. These numbers testify to the institutionalization of buffering roles without the system.
The swap trading rules, in particular, have “led to more competition, more electronic trading, better price transparency, and lower spreads for swaps traded on regulated platforms,” Berkovitz said.
Unfortunately, there are continuing grounds for concern and more work to be done. Although there is as quoted above “more competition” as measured by bid-ask spreads etc., there are fewer competitors. Berkovitz doesn’t really delve into the paradox this juxtaposition of claims presents. He moves rather quickly to a discussion of the reduction of choices for end-users, and the obligation of the CFTC to address that going forward.
In this line, he advocates “expanding the floor trader provision in the swap dealer definition.” This is a change to existing rules, consistent with the statutory language, that would allow proprietary trading firms to trade on swap execution floor traders without registering as dealers. Berkovitz says that floor traders who “solely provide liquidity on electronic trading platforms and do not solicit or negotiate with customers like a traditional swap dealer” should be accommodated.
Berkovitz also addresses at some length the fraught matter of speculative position limits. The philosophical stance behind Dodd-Frank is that trading activity driven by the need to hedge operational positions is healthy and should be encouraged, but speculative trading can become excessive and should be limited. Berkovitz accepts this distinction, saying that “meaningful position limits are critical to preventing manipulation or distortion of the price discovery process due to excessively large speculative positions.” He cites three instances where excessive speculation has created such distortion: the Hunt Brothers’ efforts to corner the silver market in 1980; the Ferruzzi soybean crisis of 1989; and the Amaranth shock in the natural gas market in 2006.
A Dissenting View
On these points, Craig Pirrong begs to differ. Pirrong, professor of finance at the University of Houston, also known in the econoblogosphere as the “Streetwise Professor,” devoted a post on June 13 to a debunking of what he calls Berkovitz’ “valiant, but failed defense” of Dodd-Frank, and especially of speculative position limits.
Pirrong doesn’t believe that there is any problem to which position limits are a solution. He finds each of the three examples that Berkovitz cites unpersuasive. The Hunts are “ancient history” and are too exceptional to justify rules-creation at all; the Ferruzzi squeeze came about precisely because of the position limits then in existence, not because of the absence of such limits; and the Amaranth debacle was less than has been made of it, and would not have been prevented by position limits in any case.
Speaking more generally, Pirrong undermines the distinction between hedgers and speculators that is behind the relevant Dodd-Frank provisions, observing that the most likely power manipulators are long hedgers—the very folks that the Act’s framers saw as the good guys deserving of exemptions.