Good afternoon. It is a pleasure to appear before you. I want to thank the Futures Industry Association for hosting this conference, as well as the hospitality afforded by FMC Chairman Sundareshan to me and other guests this week.
First, let me say that our deepest sympathies are with the people of India in the wake of the Mumbai terrorist attacks. Sadly, both our countries are all too familiar with the grave challenges that terrorism poses to states, economies, peoples and democratic parties. But our countries also have in common a mature and stable democracy that gives us the underlying strength to rise above the challenge of isolated terrorist acts. This fundamental commitment to democracy, central to both our nations, also makes the United States and India natural partners in the business world.
This is evident at this conference. An impressive number of people have traveled half-way across the globe to attend. This is testament to the exciting opportunities that the U.S. business community finds in India.
Economic growth in India has been nothing short of explosive. Since 1994, India has maintained an average rate of growth of GDP of nearly 7%, and the rate of growth appears to be accelerating – exceeding 9% in the first quarter of 2006 on an annual basis. Within twenty years, India’s economy is expected to be one of the three largest in the world in purchasing power parity terms.
In the financial services arena, growth has been equally remarkable. The National Stock Exchange of India is now the third largest stock exchange in the world in terms of total transactions, and the Bombay Stock Exchange ranks number five in overall volume of transactions. The market capitalization of these two exchanges has tripled in the last six years. India, with nearly 6,000 publicly-listed companies, has approximately the same number as on the two major U.S. stock exchanges combined.
With respect to derivatives, of the world’s 20 largest derivatives exchanges, the National Stock Exchange is one of the fastest growing, and is the tenth largest exchange when ranked by futures volume only. Indian exchanges are a world leader in single stock futures, trading futures on 118 individual stocks with total volume 35 times greater than in the United States. Trading in equity derivatives has increased dramatically since their introduction in India in the year 2000. Total equity futures contracts traded grew from 114,000 the first year to 155 million in 2005-2006, with volume increasing from $633 million to $1.15 trillion during that same period.
As impressive as these statistics are in their own right, even more important is that they are indicative of broader changes that lie ahead. India stands poised to reap the benefits of the wave of technological innovation and financial globalization that is knitting together industries and economies across the continents.
We operate today on a global platform with technology that makes it possible for futures contracts to be traded anywhere, anytime; for an exchange to offer products and services to traders in multiple jurisdictions; and for contracts to be listed on one exchange and cleared on the other side of the world. Global futures volume has increased four-fold during just the last five years. The rapidly-changing demands of today’s international marketplace are spawning dynamic new cross-border initiatives, and virtually borderless transactions, which present tremendous opportunities for countries that are prepared to take advantage of them.
But if we are to succeed in harnessing the opportunities that globalization can afford us, we must remain faithful to certain fundamental precepts. This afternoon, I would like to touch on how we in the United States have approached these issues during the dramatic industry changes of the past decade. These approaches may have some applicability as you continue to press forward in your own way to develop your capital markets, including commodities, futures, and derivatives.
Specifically, let me touch on three subject areas. First, competition and innovation; second, vigorous enforcement; and third, international cooperation.
While our approaches in each of these areas may be new, these issues are not. In fact, some of them can be found in the writings of Kautilya, an adviser to King Chandragupta, who ruled Northern India around 300 BC (just a few years before wheat contracts started trading on our exchanges in Chicago). In the Arthasastra, a wide-ranging 15-part treatise about the role of government in maintaining the well being of the country, Kautilya recognized the importance of trade and access to markets for the economic development of his country. To paraphrase, he wrote,
• The Director of Trade should not create a restriction as to time or the evil of a glut in the market in the case of commodities constantly in demand. . . . [Rather] he should encourage the import of goods produced in foreign lands by [allowing] concessions...
While Kautilya understood the benefits of access to markets, he was not blind to the realities of the marketplace. For he also warned that government needs to protect society from the unscrupulous:
• The [King] should prevent thieves who are not known as thieves such as traders, artisans, actors, mendicants, jugglers and others from oppressing the country.
To be sure, the world has changed in ways unimaginable in Kautilya’s times. I also recognize that Kautilya was not a free-market advocate. Nonetheless, Kautilya’s general words of wisdom about how access to markets contributes to economic prosperity, and the role that government can play in contributing to that access, remain relevant today. By adhering to these timeless precepts, we can foster lasting economic prosperity for years to come.
1. Competition and Innovation
First, there is the fundamental precept of competition and innovation in products and services. Ultimately, the public benefits from lower transaction costs, broadened product diversification, and market liquidity. Far from being a zero-sum game, competition expands the playing field and growth opportunities for all markets – to the benefit of market participants and the general public alike.
In the U.S., competition in the futures industry was strongly enhanced when our Congress enacted the Commodity Futures Modernization Act, or CFMA, in the year 2000. In recognition of the need to enable derivatives markets to keep pace with rapidly developing technological advances and demands for new products, the CFMA replaced the prior “one size fits all” regulatory model with a flexible, practical, principles-based model for exchanges. U.S. exchanges also were given the authority to approve new products and rules through a self-certification process without prior CFTC approval, which encouraged innovation and enabled exchanges to act quickly in response to fast-changing market conditions.
Since the CFMA was adopted, there has been a seven-fold increase in the rate of new product listings by U.S. exchanges. Nine new contract markets and nine new derivatives clearing organizations have been approved by the CFTC. Electronic trading has soared to approximately 60 percent of total volume this year, and that percentage is steadily increasing. The competition, product innovation, and increasing use of technology fostered by the CFMA offers the prospect of continued growth in the futures markets, in the form of new trading venues, new trading strategies, new risk management tools, and new customers.
The CFTC has taken the same approach with respect to global competition as well. From its earliest years, the CFTC has shaped its cross-border policy based on the notion that we all benefit as more choices are made available to market participants, as competition between exchanges is enhanced, and as the efficient movement of capital across the globe is facilitated.
A good illustration of this approach is our practice of permitting bona fide foreign boards of trade to provide direct electronic access to their U.S. members without requiring registration as a U.S. exchange. Today, 17 markets from 12 non-U.S. jurisdictions have received such permission, subject to access to books and records, submission to U.S. jurisdiction, and effective information sharing and cooperative surveillance arrangements.
The CFTC also has been increasing the range of foreign products available to U.S. investors. For example, the Bombay Stock Exchange’s Sensex Index futures contract has been approved for trading in the United States, as is the case with the National Stock Exchange’s Nifty Fifty Index futures contract.
In India, as many of you are aware, exchange-traded futures were banned as recently as the 1960s, and even in the 1970s, futures markets were limited to trading only seven “non-essential” commodities. However, in the past ten years, both of India’s financial market regulators, the Forward Markets Commission and the Securities and Exchange Board of India, undertook bold reforms to increase access to Indian markets.
For example, the FMC created three national exchanges, which helped establish a concentrated source of liquidity for most physical commodities. Equally important, the FMC lifted restrictions on the types of commodity futures that could be traded. From just seven “non-essential” agricultural commodities such as cotton and jute being traded in the futures markets at the millennium, there are now more than 80 commodities listed on India’s commodities exchanges, though not all of them trade actively.
In a similar vein, the SEBI created transparent commissions that were no longer embedded in the price of securities. Almost immediately, brokerage fees dropped from approximately 2.5 percent to 0.5 percent per trade. This is not dissimilar to the May 1, 1975 “Mayday” when the U.S. abolished fixed commissions, nor to the similar transition to fully negotiable commission rates that occurred with the London “Big Bang” in 1986 and in Tokyo in 1999.
More recently, we have watched with interest as the Indian government has resisted proposals to curb futures trading in certain agricultural commodities, following allegations in the Indian press blaming such trading for enhanced volatility and an increase in prices. As those of you who know the CFTC are aware, we in the United States have faced similar pressures from time to time.
Government regulators must be ever-vigilant for possible manipulation of futures markets, and we must, of course, be fully prepared to punish acts of market manipulation whenever they occur. That said, we also must resist the temptation to take actions that may stifle competition in our markets, even when it may be politically expedient to do so. As regulators, it is not our place to pick winners or losers. Nor is it our function to design or engineer the manner in which markets should respond to competitive pressures.
Rather, we must help foster a market environment that invites competition and innovation. As with all other free markets, innovation in the futures markets will draw out the best products, providers, and business methods. This will increase the overall liquidity of these markets, enhance efficiencies, and promote the use of the markets for their vital price discovery and risk management functions.
2. Vigorous Enforcement
Let me turn to the second precept of vigorous enforcement. Markets function best when the rules are consistently and fairly enforced. With open access, increased competition among exchanges and firms, and borderless transactions, it is essential that regulators be equipped to detect, and prepared to act against, wrongdoers. Indeed, times of explosive market growth and innovation are precisely the times when an aggressive enforcement presence may be most necessary.
Because market abuse that interferes with the price discovery process adversely affects all Americans, even those who are not trading, the CFTC has a zero-tolerance policy for those who engage in false reporting or manipulative conduct. Nor will we ever lose sight of another core enforcement priority: targeting those who take advantage of retail customers, the most vulnerable participants in the futures markets.
The CFTC has been very aggressive in its enforcement efforts – whether shutting down boiler-room operations that are defrauding the public, working with other governmental authorities to lock up criminals, or pursuing corporate malfeasance as part of the President’s Corporate Fraud Task Force. Such robust law enforcement serves as a powerful deterrent to wrongful activity and represents an important component of the CFTC’s overall regulatory program.
In India, there are proposed revisions to the FMC’s existing statutory authority that would create new structures for the FMC to regulate India’s commodity markets. Among other things, the proposal would enhance the FMC’s registration powers, authorize the FMC to create regulations, and significantly add to the penalties that the FMC can impose on wrongdoers. Such authorities are similar to powers the U.S. Congress has given to the CFTC; these are critical tools that we have utilized to address market integrity and customer protection concerns.
Laws must be clearly crafted to ensure that appropriate redress is available on behalf of aggrieved parties in the event of wrongdoing or malfeasance. Whether in the United States or in India, the single most effective way to ensure continued market success is to protect its most vital asset – public confidence.
3. International Cooperation
The final precept I want to talk about concerns international cooperation – particularly as it relates to information sharing among regulators and market authorities. Cross-border information-sharing plays an integral role in the effective surveillance of global markets that are increasingly linked by products, participants, and technology. Information-sharing arrangements are critical to combat cross-border fraud and market abuse, address financial risks posed by market participants, and exchange expertise on market oversight and supervision.
As technology increasingly reduces the significance of national borders in the world’s financial markets, regulators have a heightened burden – and a more difficult task. While markets and clearinghouses may reside under the jurisdiction of separate regulatory authorities, transactions on one market can raise important market and customer protection concerns for others. However, no one market authority will necessarily have jurisdiction over all key aspects of an international trading arrangement, nor will it have access to all the information that may be needed to obtain a comprehensive view of the market in question.
It is vitally important, therefore, that supervisory authorities continue to maintain information-sharing arrangements, exchange technical assistance with their counterparts overseas, and participate in international standard-setting bodies. The CFTC has entered into myriad bilateral and multilateral information-sharing arrangements with our fellow regulators in other countries, including India.
Specifically, the United States has an information-sharing arrangement in place with SEBI, and both India and the United States are signatories to the IOSCO multilateral Memorandum of Understanding that sets a new international benchmark for enforcement cooperation. I am honored to be able this week to execute a Memorandum of Understanding with the Forward Markets Commission so that the CFTC can provide technical assistance and cooperation with the FMC as it does with SEBI.
The goal of such international cooperation is not to stymie the increased efficiencies that technology and globalization bring to the futures markets. Rather, it is to enable regulators to rely on each other, as appropriate, and effectively share information in order to streamline industry access to cross-border business opportunities, while fully maintaining market and customer protections.
In closing, at this compelling time, as futures markets continue to become increasingly global, technology and market demand will promote even greater linkages around the world. Our continued adherence to the timeless precepts of competition and innovation, vigorous enforcement, and international cooperation is essential for these opportunities to serve as a catalyst for market growth and prosperity in each of our countries.
Thank you again for your invitation to speak, and for your patience in listening. I look forward to the rest of what promises to be an interesting and productive conference.
 See Kautilya’s Arthasastra: A Neglected Work in the History of Economic Thought, by Kishor Thanawala, appearing in Ancient Economic Thought, Vol. 1 Rutledge (1997), edited by B.B. Price.
Last Updated: April 2, 2007