When President Barack Obama nominated Gary Gensler last year to be chairman of the Commodity Futures Trading Commission (CFTC), skeptics questioned whether a former Goldman Sachs Group partner who served in the Clinton administration’s Treasury Department when it refused to regulate over-the-counter derivatives in the late 1990s could be trusted to head a major financial regulator. “We need an independent leader who will help create a new culture in the financial marketplace and move us away from the greed, recklessness and illegal behavior which has caused so much harm to our economy,” Independent Senator Bernie Sanders proclaimed in opposing the nomination.
After a year on the job, Gensler is still getting flak, but not from the usual suspects. The banker-turned-regulator has won over most of his congressional skeptics with his strong advocacy of tighter regulation. As Congress has moved forward on a broad financial reform bill in recent months, Gensler has tirelessly campaigned for tough new rules for the $615 trillion derivatives market. He wants as much of the business as possible to be conducted on regulated exchanges and processed through central clearinghouses that would impose collateral and margin requirements on dealers. He also wants to ensure that all derivatives dealers be subject to supervision. In addition, Gensler has sought to extend the CFTC’s authority to impose position limits on oil futures, to prevent speculation from driving up energy prices.
It’s a measure of Gensler’s performance that his main critics today are not in Congress but in his former industry, which contends that new regulations will drive up the cost of hedging activity for corporate America and drive financial activity into offshore markets.
Gensler shrugs off the complaints and insists that his job is to serve the interests of Main Street, not Wall Street. The CFTC needs to play an activist role in enforcing transparency in futures markets so that companies and investors can hedge risks at the lowest possible cost, he asserts.
“I believe we benefit from a regulated market economy,” he says in a recent interview at his Washington office. “We need to lower risk and increase transparency. End users benefit from transparency. Transparency is not costly.”
The CFTC boss hailed the Senate’s passage of a reform bill last month, saying it promised to bring “comprehensive oversight to the unregulated over-the-counter derivatives market.” And as members of the House and Senate began meeting to reconcile competing reform proposals and draw up final legislation, which President Obama is expected to sign this summer, Gensler sought to blunt industry lobbying efforts aimed at widening exemptions in the new derivatives rules for trades with end users, such as corporations seeking to hedge fuel or commodity costs. “Every exemption for financial companies creates a link in the chain between a dealer’s failure and a taxpayer bailout,” Gensler, 52, told bankers and analysts at a financial services conference in New York earlier this month.
The new attitude at the CFTC represents a stark departure from the laissez-faire ethos of the precrisis years. “Gensler is trying to make sure all futures markets are stable, since the futures markets, including derivatives, were designed to be hedging vehicles in order to boost liquidity,” says Michael Greenberger, a professor at the University of Maryland School of Law and a former director of the Division of Trading and Markets at the CFTC under Brooksley Born, who sought unsuccessfully to regulate derivatives in the late 1990s. “They are not capital-building vehicles designed to hit home runs.”
Gensler’s commitment to reform is not the result of any recent Damascene conversion. As a senior aide to former Democratic senator Paul Sarbanes, he played a large role in writing 2002’s Sarbanes-Oxley Act on corporate governance, in response to the Enron Corp. and WorldCom scandals earlier this decade. He also co-authored a book, The Great Mutual Fund Trap, that recommended most individuals invest in index funds rather than actively managed mutual funds — a notable position, considering the fact that his twin brother, Robert, is portfolio manager of the $700 million T. Rowe Price Global Stock Fund.
Gensler says that, far from making him an apologist for the securities industry, his 18 years at Goldman taught him plenty about the need for proper regulation.
“Swap dealers and Wall Street have a profit motive. They are looking to maximize their revenues and compensation,” he explains. “That is different from our obligation to taxpayers and the public. This is not a surprising debate.”
The stakes involved are huge. Like most global regulators, Gensler believes that unregulated derivatives activity played a major role in the financial crisis, including the near-collapse of American International Group in September 2008. But those products are also one of Wall Street’s most lucrative business lines and have been a major factor behind the restoration of profits at the big banks.
U.S. commercial banks had a record $22.6 billion in derivatives trading revenues in 2009, with interest rate and foreign exchange products accounting for nearly 90 percent of revenues, according to the Office of the Comptroller of the Currency. The five largest U.S. traders of derivatives are JPMorgan Chase & Co., Bank of America Corp., Goldman Sachs, Morgan Stanley and Citigroup, according to OCC data. Just five banks — JPMorgan, BofA, Goldman Sachs, Citigroup and Wells Fargo & Co. — accounted for 97 percent of the $212.8 trillion notional amount of derivatives held in the U.S. banking system. According to Fitch Ratings, the five largest credit default swap dealers are JPMorgan Chase, Goldman Sachs, Barclays, Deutsche Bank and Morgan Stanley.
ENFORCING THE NEW REGULATORY REFORM RULES and containing risks in the sprawling derivatives markets will be a demanding job, but Gensler is used to meeting big challenges.
He attended the University of Pennsylvania and earned both a BS in economics and an MBA from the Wharton School in just four years. Fresh out of school, he joined Goldman at the tender age of 21 in 1979 — in the same month, coincidentally, that Lloyd Blankfein went to work for J. Aron & Co., a trading firm later bought by Goldman. He rapidly climbed the investment banking ladder and became the firm’s then-youngest-ever partner when he was just 30.
His personal life has been no less challenging. Gensler has been a single parent of three teenage daughters since his wife, photo collagist and filmmaker Francesca Danieli, died of breast cancer in 2006. He lives outside Baltimore, where he grew up and where his father still runs a small vending supply business, and commutes daily to his office in Washington.
On a recent afternoon Gensler had to cut short an interview because he had a scheduled call with one of his daughters’ schools. Notwithstanding the demands on his time, he still manages to indulge his taste for extreme athletics. He has run nine marathons, including the JFK 50 Mile ultramarathon in northern Maryland, although he has scaled back his running since joining the CFTC. Each year he goes mountain climbing with his oldest daughter; they are currently deliberating this year’s choice.
At Goldman, Gensler began working in the mergers and acquisitions group, specializing in media companies. In 1990 he advised the National Football League on its landmark $36 billion broadcasting-rights deal with five television networks. During the 1990s he spent three years in Tokyo as head of currency trading and fixed income before returning to New York to serve as co-head of finance.
In 1997, Gensler gave up his multimillion-dollar job and partnership to serve as assistant secretary of financial markets at the Treasury under then-secretary Robert Rubin, a former Goldman co-chairman. At Treasury, Gensler helped the government pay down debt as it moved from deficits to surplus, worked to quell the Asian and Russian debt crises and, as he moved up to undersecretary in 2000, helped shape legislation that encouraged investment in low-income communities.
Gensler’s role in two presidential working groups and the controversial Commodity Futures Modernization Act of 2000 served as a lightning rod for his critics during his confirmation battle last year. In 1999 a working group that examined leverage in the financial system after the 1998 blowup of the Long- Term Capital Management hedge fund said that some consideration should be given to directly regulating derivatives dealers, but it stopped short of actually recommending such a step. In testifying that year before the House subcommittee on risk management, research and specialty crops, Gensler said there were important differences between exchange-traded derivatives and OTC derivatives “that may justify different regulatory approaches.”
He was also part of the working group on financial markets that talked about the need for electronic trading and clearing of OTC derivatives. The group, however, explicitly opposed regulating derivatives dealers that were not affiliated with banks, broker-dealers or futures commission merchants, asserting that they constituted a small share of the overall market. Ultimately, the final language of the commodity futures act exempted OTC derivatives from regulation.
Gensler’s perceived role in the decision to exempt derivatives prompted Sanders and Democratic Senator Maria Cantwell to hold up his nomination as CFTC head for several months last year. (His closeness to Bill and Hillary Clinton was reinforced when he worked hard on the latter’s presidential bid. After Clinton dropped out of the race, Gensler poured his efforts into the Obama campaign, commuting to Chicago three days each week and helping to garner support for the candidate from some 300 chief executive officers.)
Sanders and other critics have asserted that the government’s hands-off regulatory stance toward derivatives planted the seeds of the global financial crisis. They contend that a lack of transparency and regulation of the market for credit default swaps, and the inability of counterparties to stand behind their transactions, led to the implosion of AIG.
Gensler insists that the criticism of his supposed role a decade ago is mistaken. He contends that he recused himself from all discussions of derivatives in his first year at Treasury because of his ties to Goldman, which was lobbying against tighter regulations. By the time he got involved with the issue in 1999 and 2000, he says, the administration’s policy had been effectively set by Rubin and his successor, Lawrence Summers.
“There’s a big difference between being part of a team that is supporting a cabinet and the president and being an independent regulator,” he says of his role at Treasury, adding, “We all evolve.”
Today, Gensler is an unabashed regulatory hawk. He says it is time to move from a derivatives market in which a handful of big banks dominate trading and tightly control pricing information, toward a more open, exchange-based marketplace in which all participants can benefit from transparency. He also believes derivatives dealers should have to meet capital standards and margin requirements, to help lower risk.
The CFTC head wants dealers to bring all of their standardized derivatives transactions onto regulated exchanges or electronic trading systems and to clear such trades in regulated clearinghouses. Although acknowledging that customized derivatives can’t be forced onto exchanges or through clearinghouses, he insists that dealers should be subject to comprehensive regulation for these transactions as well. Such reforms are essential to preventing a repeat of the crisis surrounding AIG, whose massive exposure to credit default swaps nearly brought down the entire global financial system and prompted a $180 billion U.S. government bailout.
“Central clearing would greatly reduce the size of dealers as well as the interconnectedness between Wall Street banks, their customers and the economy,” Gensler said in a March speech at the Women in Housing & Finance conference in Washington. “The more transparent a marketplace, the more liquid it is, the more competitive it is and the lower the costs for corporations that use derivatives to hedge their risks.”
Gensler has argued his case in repeated appearances before congressional committees and in meetings with and letters to individual legislators.
In December the House of Representatives passed a reform bill giving the CFTC responsibility for regulating OTC derivatives and requiring that standardized contracts be traded on exchanges and processed by clearinghouses. Custom-tailored contracts that avoid the exchange and clearing requirement would still have to be reported to a swap repository or the CFTC. The bill would exempt transactions involving nonfinancial end users, such as airlines and energy companies, from collateral and margin requirements, an exemption Gensler had opposed.
The University of Maryland’s Greenberger believes the bill would have been much weaker had it not been for Gensler’s lobbying of key lawmakers. “He had a lot to do with constraining exemptions in the House bill,” Greenberger says. Adds Mark Young, a partner at the Washington office of law firm Kirkland & Ellis and a former CFTC lawyer, “Gensler lost the battle but won the war.”
The Senate version of financial reform, which was shepherded through the upper chamber last month by Christopher Dodd, chairman of the Senate Committee on Banking, Housing and Urban Affairs, would impose somewhat tighter restrictions on derivatives. The bill contains more-specific language limiting the exemption from clearing requirements for nonfinancial end users.
More controversially, the bill also includes a provision that would require big banks to spin off their derivatives businesses. That measure is opposed by the Obama administration and is expected to be discarded by a Senate-House joint committee that is working to reconcile the two bills and draw up final legislation by July.
For Gensler, the key to the negotiations is the end-user exemption. He argues that the exemption should be defined as narrowly as possible and apply only to legitimate corporate hedging activity. Such entities account for only 9 percent of the market for interest rate swaps, the largest segment of the derivatives market, according to the Basel-based Bank for International Settlements. The vast bulk of the market is dominated by interdealer trades or transactions between dealers and financial entities such as hedge funds and insurance companies. That massive trading activity is the key source of risk in the financial system today, Gensler contends.
“As long as financial entities remain interconnected through their derivatives, one entity’s failure could mean a run on another financial entity and a difficult decision for a future Treasury secretary,” he told a financial conference in New York early this month. “It is essential that financial reform does not allow loopholes that leave interconnectedness in the system. Such exemptions will only come back to haunt us in the future.”
Gensler’s industry critics have stepped up their own lobbying in a bid to blunt the scope of the legislation. They argue that many swaps and other derivatives trades are unique and don’t lend themselves to standardization, and therefore cannot be traded on an exchange. They also contend that margin requirements will increase the cost of hedging, which ultimately will be passed on to consumers.
In February the Coalition for Derivatives End-Users urged the Senate to include the same broad end-user exemptions as the House bill, in a letter that said, “The loss of these important risk management tools would be detrimental to businesses, the economy, and job creation.” An earlier letter, signed by about 150 major corporations and trade groups, including the Business Roundtable, the U.S. Chamber of Commerce and the National Association of Manufacturers, warned that tight restrictions on derivatives would place “an extraordinary burden” on end users and be “at cross purposes with the goals of lowering systemic risk and promoting economic recovery.”
With their lobbying, industry groups hope to win the widest possible exemption from collateral and margin requirements in the final legislation.
Any measure that obliges energy utilities to centrally clear their derivatives trades “would tie up cash which could be used for capital projects, environmental upgrades and developing new clean energy — goals of the administration,” says Daniel Dolan, vice president of policy research and communications at the Electric Power Supply Association.
Perhaps the biggest and most active opponents of Gensler and those seeking more restrictions on derivatives are the banks and investment banks that dominate the trading of swaps — and are very aggressively guarding their turf. The International Swaps and Derivatives Association, which represents participants in the privately negotiated derivatives industry, argues that banks need the ability to customize transactions for their individual needs or for those of their customers. The group supports transparency and the use of central counterparty clearing facilities for standardized derivatives but opposes any requirement that they be traded on exchanges. “It is not clear to us why a cleared trade should be exchange traded,” says Robert Pickel, the group’s executive vice chairman. “Exchange trading has nothing to do with reducing systemic risk. Clearing does. Legislation should be appropriate for institutions that pose systemic risk.”
The Futures Industry Association, a dealer body, warns that tough regulation risks driving the derivatives business into less-regulated markets offshore. “A barrel of oil is in demand 24 hours, seven days, all over the world,” says John Damgard, the group’s president. Market participants “will trade where it makes the most sense.”
The idea that tougher regulations could merely push derivatives activity into more–loosely regulated markets overseas is something even Gensler’s supporters take seriously. “It is an issue we need to think about very carefully,” says Bart Chilton, one of the CFTC’s three Democratic commissioners.
Gensler is confident that he is well within the new international consensus on regulatory reform and that the proposed U.S. rules won’t be rendered useless by industry arbitrage. The recent debt crisis in Greece could be a game changer. In March, German Chancellor Angela Merkel called for more scrutiny of derivatives trading, and European Commission President José Manuel Barroso has said he would consider imposing a ban on naked credit default swaps, or taking a CDS position without having an interest in the underlying debt.
“The recent chill winds blowing through Europe, including the discovery that derivatives were used to help mask Greece’s fiscal health, remind us of the need to bring derivatives under regulation,” Gensler tells II.
The CFTC chief’s campaign to tighten regulation does not stop with derivatives. He has targeted other areas for reform, with the aim of making sure the markets work as well as they can for the public.
One of his top goals is to gain authority for the CFTC to establish position limits in a wide variety of markets that he believes have been destabilized at times by excessive speculation. The commission currently can set and enforce position limits only on certain agricultural products.
In January the agency proposed setting position limits on the trading of four major energy commodities: oil, natural gas, gasoline and heating oil. These rules would exempt bona fide hedging transactions, which are conducted by commercial users, and certain risk management transactions by swap dealers.
The proposals arose from complaints that speculators — ranging from hedge funds to index investors — drove up the prices of some energy commodities in the first half of 2008, when the price of oil surged to a record of nearly $150 a barrel before dropping sharply. “This increase in speculative activity is closely correlated with the increased volatility of oil prices, which has caused so much harm,” said Richard Hirst, senior vice president and general counsel for Delta Air Lines, in testimony at the CFTC last year.
The issue is so sensitive that last August reclusive billionaire hedge fund manager John Arnold made a rare public appearance at a CFTC hearing to argue against position limits for natural gas. Arnold said that although the commission should have oversight of all financially settled contract positions, hard limits on financial contracts would push trading activity away from exchanges and into the OTC market, exacerbating volatility, reducing liquidity and increasing costs for commercial hedgers.
Jill Sommers, one of the CFTC’s two Republican commissioners, warns that imposing position limits would drive activity into overseas markets. “Until there is global cooperation on position limits, it is not prudent for us to move forward on our market,” Sommers tells II. “It will hurt our exchange-traded market.”
In March the CFTC held discussions about instituting position limits on metals, but the agency hasn’t come up with any proposals yet. Gensler says he would like to see the agency set position limits on agricultural products not covered by existing laws and impose separate limits on so-called massive passive investors such as index funds and exchange-traded funds, which can wield tremendous influence on futures markets.
The commission is currently reviewing industry comments on its proposals for extending position limits to other commodities markets; formal rules could follow as early as later this year. “If we do that, it will define the type of regulator we want to be,” says commissioner Chilton.
Gensler has no doubt about the kind of regulator he wants to be, and although he has scored no major policy victories yet, he’s not discouraged. As he puts it, “I’m not into scorecards.”
As one of the administration’s strongest and most consistent advocates of regulatory reform, Gensler has already made his mark. His activism has brought newfound respect and attention to an agency that until recently was seen as having little bark and even less bite.
“He still has a lot to do,” says the University of Maryland’s Greenberger. “But when the final chapter is written on the Obama administration, Gensler will stand out as the leading light of financial reform.”
