Futures Association Role Raises Doubts About Swaps Regulation

If the Commodity Futures Trading Commission receives the funding it's asking for, the once-niche National Futures Association will be given an unprecedented role in overseeing major banks' activities in the swaps and futures markets.

If, as is entirely possible, the CFTC fails to get its funding, the NFA's authority will likely be even greater.

"The CFTC's responsibilities are going up at a time when resources are going to be more scarce," the NFA's president, Daniel Roth, recently said on a CFA Institute conference call. "The less it gets in its allocations, the more responsibility it may try to shift toward the self-regulatory sphere."

As regulators scramble to implement the Dodd-Frank Act, the NFA offers a glimpse of the vast amount of work yet to be done in registering firms, collecting data and enforcing the law. Under Roth, the NFA has hired two officials to plan dealer registrations, oversee the design of data tracking and surveillance systems and develop standard conventions among industry players used to trading on disparate systems.

The NFA's main advantage as a regulator body, it is widely agreed, is its ability to raise funds through industry fees and outsourced compliance services.

"We have always told the CFTC we will accept any responsibilities they give us," said Lawrence Dykeman, an NFA spokesman.

The potential breadth of the NFA's role has some market observers worried: While well regarded, it has not traditionally regulated major banks and dealers, raising concern that making it the front-line regulator for the massive swaps industry might be too much to ask.

"The NFA was the default regulator for small futures merchants," said Michael Greenberger, a former director of trading and markets for the CFTC. "Now you're saying they're going to be responsible for the TBTF ['too big to fail'] institutions."

Greenberger is concerned that giving a self-regulatory body so much responsibility might allow dominant industry players to weaken how Dodd-Frank derivatives regulation is implemented. Former CFTC Chairman Brooksley Born raised similar concerns in June testimony to Congress.

"There has never been a history of self-regulatory organizations being strong if the principal regulator isn't strong," he said.

Greenberger's take echoes the comments of CFTC Chairman Gary Gensler, who has spent the past several months walking a fine line between insisting that the CFTC can carry out its mission without the 50% funding increase it's requested and suggesting that "we won't have people to answer their telephones," as he told the Senate Appropriations Committee in May.

The CFTC's budget request would bring it to $308 million and 983 employees by 2012. Given Congressional Republicans' attempts to cut its funding, the CFTC's ability to get those funds is uncertain. While the CFTC is ultimately responsible for regulating the swaps market, Gensler said the commission has been working with NFA officials "to determine what duties and roles they can take on."

The NFA has been discussing its potential role with regulators and industry groups since shortly after Dodd-Frank's passage, although the two officials heading the planning came on more recently. Ed Dasso, the association's new vice president of market regulation, joined in March from a role heading up compliance for the Intercontinental Exchange's over-the-counter derivatives market and will oversee swaps execution facilities.

Jamila Piracci, a former attorney for the Federal Reserve Bank of New York and Mayer Brown's structured credit derivatives practice, joined the NFA in July. She will oversee NFA registration and examinations, including auditing.

Both new hires are working on what could be called the prerequisites to regulation. Piracci's focus has been establishing an industry advisory committee and designing a provisional registration system for swaps dealers. Procedures for examinations, auditing and enforcement will come after the CFTC finalizes its rules and the NFA registers dealers.

"We are, like the market, having to play this a little bit by ear," Piracci said.

Dasso has spent time with a small team designing computer systems to track trading, which is necessary for regulators to audit trading. While he currently oversees a compliance team of 14, they cover the full range of futures exchanges that the NFA has historically tracked. "Full time there's myself and another individual working on the Swap Execution Facility issue from the compliance perspective," he says, though an information systems team is responsible for the data collection planning. "Our initial push is the technology portion of it." Expectations of consolidation in the number of entities that provide swap execution facilities complicates the question of how large a staff Dasso will eventually need, he says. While 20 potential swap entities have signed nondisclosure agreements and provided initial funding for some of the NFA's efforts there's no way of telling how many of them will ultimately sign on or stay in business.

Dasso and Piracci agreed that answering enforcement questions is still a ways off, as is a resolution of the role the CFTC's budget will allow it to play in the process. The general framework will likely be along the lines of that used by other self-regulatory organizations like SIFMA, with the government relying on the NFA almost entirely to conduct day-to-day registration and data-tracking. The CFTC would be expected to play a slightly greater role in overseeing ongoing monitoring and compliance, and would likely play its biggest role in handling enforcement and matters involving significant misconduct. Budgetary considerations would likely play a major role in determining the extent of its involvement in enforcement. "If funding wasn't to the level they needed, they'd still have an enforcement department, and they'd still be able to take the larger cases themselves to federal court," Dasso said.

Piracci said she expected the CFTC would play at least as much of a role in relation to her team's work. Any trepidation about the role the NFA would play, she predicts, will be dispelled with time. "I understand that this is not an organization that comes up in the daily lives of most people on the OTC derivatives side," she says. "The industry is moving into an entirely different era, and we will rise to that."