CFTC Commissioner Giancarlo places the blame for market illiquidity squarely on regulation

CFTC Commissioner Giancarlo, speaking at the 2015 ISDA Annual Pacific Conference, let go a ripping over-the-top condemnation of banking regulations and its impact on market liquidity. He pulled no punches, sounding a lot like Republican presidential hopefuls preaching to their base. Was that the right tone to strike?

The speech, “Top-Down Financial Market Regulation: Disease Mislabeled as Cure” (October 26, 2015), addressed several issues: market liquidity, margin on uncleared swaps, automated trading, and cyber security. We will only look at the liquidity issue.

Commissioner Giancarlo took direct aim at the Fed’s research that, by and large, downplays the liquidity concerns.

“…While some central bankers express skepticism over a lack of quantitative evidence of illiquidity, there is real concern among those with actual financial market responsibility and knowledge, including financial market regulators and important market participants…”

We agree with Giancarlo that Wall Street traders can no longer afford to provide liquidity, unable to leverage their own inventories and ability to hold securities. Wasn’t this the job of the stock market specialist too? Maintaining orderly markets by buying when there were only sellers and visa-versa? The world has shifted to “as agent” trading and that adds to volatility.

“…Traditionally, large global money center banks served to reduce such market volatility by buying and selling reserves of securities or other financial instruments to take advantage of short-term anomalies in market prices. Their balance sheets served as market “shock absorbers” in times of market turbulence…”


“…Throughout these recent sharp volatility episodes, banks appear to have been unable to step in aggressively to provide additional trading liquidity…”

This is where the Commissioner lays blame on regulation. No sugar coating it here.

“…A major – though not exclusive – cause of the reduced bank trading liquidity and volatility spikes in financial markets is the new regulatory policies that U.S. and overseas prudential banking regulators imposed in the wake of the financial crisis. Policies such as the Basel III capital requirements and leverage ratios, the Volcker rule’s ban on bank proprietary trading, the CFTC’s flawed derivatives trading rules, low de minimis levels for swap dealer registration, restrictive position limits proposals and unending edicts from global shadow regulators like the Financial Stability Board prioritize capital reserves over investment, balance sheet surplus over market making, trading friction over efficiency and safety over opportunity…”

And now the inevitable – has all this regulation created something worse than the original problem?

“…The question must be asked whether the regulatorily driven retreat of major banking institutions from active trading in financial markets is the disease of which it purports to be the cure…”

While we don’t really buy some of the Fed’s arguments that liquidity has not entirely left the building (see our posts here, here, here, here, and here), Giancarlo’s speech seemed bombastic. Sure, there were lots of footnotes making reference to articles and research on disappearing liquidity – some of which we have cited ourselves – but if the tone in person was anything like how it read, it must have been some show.

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