Thank you for that kind introduction. I appreciate the invitation to join you again this year to share some thoughts on the work of the CFTC – both the projects that have kept us busy during the past year, and where our attention is likely to be focused during the year ahead.
First, though, I want to acknowledge my fellow Commissioners Walt Lukken, who is here as a panelist and participant, and Mike Dunn, who is keeping the fires burning at the CFTC back in Washington. There is no doubt that my job at the CFTC has been made immeasurably easier by the expertise and judgment brought to bear by my fellow Commissioners, not to mention the outstanding staff at the agency.
Indeed, as practitioners who conduct business with the Commission on a regular basis, I know that you are all familiar with our outstanding and experienced professional staff. Their commitment and dedication to the CFTC, especially during the tight budget times of recent years, represent the best in public service.
The Past Year
Around the time I appeared before you last year, the CFTC had, among others, three major projects on its plate. Specifically, we were: 1) reviewing the process by which foreign boards of trade provide access to U.S. traders; 2) considering whether to make any changes to our Commitments of Traders Reports in light of the increasing participation of commodity index funds in U.S. futures markets; and 3) studying the state of self-regulation in today’s brave new world of highly competitive, de-mutualized, and publicly-traded futures exchanges. I am pleased that each of these projects has been brought to closure.
1. Policy Statement Concerning Foreign Boards of Trade
Chronologically, the first completed was our Policy Statement regarding foreign boards of trade. This Policy Statement affirmed the use of the flexible staff no-action process for reviewing requests by bona-fide foreign exchanges, operating under a regulatory scheme based on objectives equivalent to those in this country, to provide U.S. participants with direct access to their electronic trading systems.
Importantly, though, we also enhanced the existing process in two key respects. First, we will insist upon going beyond good intentions and seek affirmative evidence of the foreign regulator’s ability to obtain – and willingness to share – critical market information with the CFTC. And second, the Policy Statement addresses circumstances where the trading of foreign products may have adverse effects on contracts traded on a U.S. futures market, or compromise the ability of the CFTC to carry out its regulatory responsibilities.
While the no-action process has been a resilient one, our Policy Statement updates this longstanding practice in light of today’s increasing globalization and technological advances. The Policy Statement achieves four important objectives: 1) it makes clear the CFTC’s continuing recognition of the need to respond flexibly to the demands by market users for access to global markets and products; 2) it furthers the Congressional intent expressed in the CFMA to facilitate cross-border transactions by removing or lessening unnecessary legal and practical obstacles; 3) it avoids inadvertently inhibiting technological innovation or the ability of the U.S. futures industry to compete abroad; and 4) at the same time, it maintains our unyielding commitment to U.S. customer and market protections.
2. Supplemental Commitments of Traders Report
Just a few weeks after issuing our Policy Statement, we announced that beginning this year, the CFTC would publish a weekly Supplemental Commitments of Traders (“COT”) report on 12 agricultural commodities. The new report shows aggregate futures and options positions of “index traders,” who also have been described as “non-traditional hedgers” and who represent a growing desire to seek exposure to commodities as an asset class.
The need for this new supplemental report arose from the increasing diversity among futures participants. This greater diversification in the marketplace is best illustrated by the proliferation of commodity-linked products, including the development of commodity-based indices. The total investment in commodity-linked products by pension funds, hedge funds and other institutional investors has been estimated to exceed $100 billion.
This growth, though, raised a concern that the COT reports had not kept pace with market developments. Some urged greater transparency of distinctions among market participants in the COT reports. The Commission took those concerns to heart, and decided to begin reporting commodity index trading separately in order to better reflect what’s really going on in the marketplace.
We recognize, though, that some of you (or your clients) fear that this enhanced transparency may come at the cost of compromising the confidentiality of proprietary trading information. It is our job as regulators to balance such competing interests. Overall, we are confident that traders’ identities are sufficiently protected by the threshold requirement that there must be at least 20 reportable traders in any given market before the CFTC will publish COT data for that market. Releasing this data in aggregate form should not compromise the confidentiality of the positions of any given trader.
Nevertheless, we also accepted the recommendation that we publish the supplemental COT report as a two-year pilot program involving a limited number of commodities. This will permit the CFTC to monitor developments and assess whether the balance has indeed been appropriately struck. In addition, it also will enable us to study market receptivity and utility, and evaluate the feasibility of adding additional product categories.
3. Acceptable Practices Concerning SRO Conflicts of Interest
Finally, the CFTC concluded its three-year study of self-regulation and self-regulatory organizations (“SROs”) in the futures industry by issuing Acceptable Practices under Core Principle 15 of the Commodity Exchange Act. The Acceptable Practices address the structural conflict of interest inherent in today’s exchange operations. Exchanges must respond to a highly competitive environment; generate profits; advance commercial interests; and serve multiple membership, ownership, customer, and other constituencies – all the while remaining responsible for their self-regulatory obligation to protect the public interest.
The cornerstone of these new Acceptable Practices is the focus on the role of truly independent directors in the governance system of futures self-regulatory organizations. They include a new definition of “public” director that raises the standard for director independence by excluding exchange members and other “insiders” from consideration; only those persons who are unburdened by commercial ties to the exchange may qualify as a “public” director under this definition.
The Acceptable Practices also set a new minimum 35% standard for public director representation in the boardroom, effectively raising the bar for U.S. futures exchanges. In addition, they firmly place key regulatory functions and responsibilities under the oversight of a regulatory watchdog, the Regulatory Oversight Committee, comprised exclusively of public directors.
Collectively, these new Acceptable Practices will strengthen the system of checks and balances in SRO governance and ensure that U.S. futures exchanges fairly and effectively fulfill their self-regulatory responsibility to minimize conflicts of interest. Good governance is the first line of defense against corporate misconduct. The Commodity Exchange Act mandates that exchanges be more than just good corporate citizens; they must also be keepers of the public trust, and as such, must be models of good governance.
But the issuance of these Acceptable Practices is not the end of the road. Self-regulation is not a static concept. The Acceptable Practices represent minimum standards necessary to obtain safe harbor treatment.
Certain exchanges, such as those that are large subsidiaries of publicly-traded companies, may be best served by a larger number of public directors, and better able to attract them. I encourage the larger, public exchanges to act voluntarily to set a 50% public director board as the appropriate goal. The greater impact that these exchanges bring to bear on the national economy warrants a more substantial public voice in their governance and decision making.
Independent of these Acceptable Practices, SROs must continually and vigorously fulfill their obligations to enforce their own rules and ensure adequate funding to support effective surveillance and examination programs. This duty applies equally to exchanges and to member-funded SROs such as the National Futures Association. Anything less puts at risk the public trust and confidence that the futures industry has worked so hard to develop and preserve.
The Year Ahead
The need for each of these three projects from the past year – the Policy Statement concerning foreign boards of trade, the decision to publish a supplemental COT report concerning index-related trading, and the Acceptable Practices concerning SRO conflicts of interest – was a direct result of the incredible growth and competition in the futures industry (both domestic and international) that was ushered in by the Commodity Futures Modernization Act in 2000.
That growth and competition are likely to continue unabated in the year ahead. But the challenge they pose for the CFTC is not going to be resolved in further policy statements or reports. Rather, the challenge now becomes even harder – to adapt to trading, traders, and products that no longer fit neatly into the regulatory compartments of the past. The CFTC, like industry participants themselves, must adapt its activities to reflect today’s market realities. Three examples – globalization, the energy markets, and “product convergence” – illustrate the point.
First, globalization. Worldwide futures and options volume has nearly tripled in just the last five years. Today’s international marketplace is spawning dynamic new cross-border initiatives and virtually borderless trading. Cooperation among international regulators is imperative to address the complicated issues associated with this cross-border trading.
The CFTC will continue to pursue a multi-faceted approach to international regulatory cooperation, which starts first and foremost with information sharing. A prime example is the Memorandum of Understanding, or “MOU,” that the CFTC entered into with the United Kingdom’s Financial Services Authority last November regarding inter-market surveillance of cross-border products. This MOU established an enhanced framework for our two agencies to share information essential to the oversight of trading in linked contracts on U.K. and U.S. derivatives exchanges.
In the enforcement context, gaps between nation-based regulators and the anonymity of the Internet are friends to wrongdoers the world over. Our cooperative enforcement efforts to combat these fraudsters occur bilaterally and also multilaterally in forums such as the International Organization of Securities Commissions (“IOSCO”), with whom we entered into a multilateral MOU with two dozen other nations. The IOSCO multilateral MOU sets a new international benchmark for enforcement cooperation, as it enables regulators to exchange essential information to investigate cross-border derivatives violations.
Beyond information sharing, though, oversight of global trading that is premised on international regulators relying on the home market supervision of others, as appropriate, is only as strong as its weakest link. Regulators on each side of any cross-border relationship must have the tools – and, just as importantly, the training – to assure that they can properly protect their markets.
Toward that end, the CFTC has been a leader in international standard-setting bodies such as IOSCO, working to develop regulatory “best practices” and “benchmarks” to help foster the highest international regulatory standards. The CFTC also has been active in setting up relationships with its counterparts overseas to provide training and technical assistance.
In just the past several months, we have entered into an arrangement for regulatory cooperation and technical assistance with the Forward Markets Commission of India, and sent a delegation to Beijing, to provide technical assistance to the China Securities Regulatory Commission. The latter delegation also included a representative from a U.S. futures exchange, and I cannot emphasize enough the importance of industry participation in international technical assistance efforts.
In the year ahead, we envision our international work at the CFTC consisting primarily of this type of day-to-day regulatory cooperation, as opposed to further policy statements or rulemakings. Only through international cooperation – information sharing, standard setting, and technical assistance – can we assure industry access to cross-border opportunities while fully maintaining market and customer protections.
2. Energy Markets
On the domestic front, the CFTC similarly is adapting to trading activity that is bursting traditional boundaries in the energy sector. Major players are trading in physical, OTC derivatives, and futures energy markets simultaneously. Competition is keen, with price discovery contracts on fully-regulated exchanges being challenged by exempt commercial markets that list comparable contracts.
The increasing interrelationship between trading in physical, financial and futures contracts in the energy sector has caused some to voice concern that traders may be engaging in activity in one market in order to improperly influence prices in another. This has impacted the work of the CFTC in three respects.
First, we are working more closely with our colleagues at the Federal Energy Regulatory Commission (“FERC”). In light of the anti-manipulation authority that Congress provided FERC in the Energy Policy Act of 2005, those involved in trading natural gas may find themselves fielding inquiries from both agencies. To streamline parallel investigative efforts, the two agencies have entered into an MOU regarding information sharing and the confidential treatment of energy trading data. This MOU will facilitate the work of each agency to assure the price integrity of markets for energy products within the scope of its own jurisdictional mandate. In the year ahead, we will continue to work closely with our sister agency to address issues of concern, each respectful of the governing statutory authority of the other to avoid overlapping action that could create competitive imbalance or disrupt the proper functioning of the markets.
Second, we have issued rules implementing our statutory authority to obtain information from electronic energy markets such as the Intercontinental Exchange (“ICE”). The CFTC has utilized this authority to request trader position data on an ongoing basis related to ICE natural gas contracts that are directly linked to contracts on the New York Mercantile Exchange (“NYMEX”). This enhances our surveillance of the NYMEX contracts by providing a better window into this marketplace.
Third, we continue to pursue a vigorous enforcement program to deal with those who break the rules at the expense of market integrity. During the last four fiscal years, the CFTC has filed actions charging more than 50 defendants with false reporting, attempted manipulation, or manipulation in the energy markets. To put those numbers in perspective, during the 20 years prior to fiscal year 2002, the CFTC had filed only two energy cases involving these violations. Our recent energy cases are based on established CFTC cash market enforcement authority that has been clearly recognized by the courts (if not by some of those in this room). The CFTC will continue to aggressively pursue those who willfully engage in false reporting or manipulation – market abuses that interfere with price discovery and, as such, adversely affect all Americans.
In the year ahead, I expect our work in the energy area to continue to focus on the day-to-day performance of these three mission-critical functions – interagency cooperation, surveillance, and enforcement.
3. “Product Convergence”
Finally, the increasingly competitive futures environment that was ushered in by the CFMA, together with an advanced use of new technologies, has fostered a period of tremendous product innovation and creativity in this country. Since the CFMA was enacted, there has been a twelve-fold increase in the rate of new product listings by U.S. futures exchanges, from 43 new futures and options contracts in 2000 to 543 new contract filings in 2006. Many of these contracts are innovative or based on new commodities, including futures on ethanol, pollution allowances, weather, and freight rates (but still not onions!).
The creativity of these new product offerings reminds us of the benefits of well-functioning futures markets. Product innovation enhances efficient risk management and broadens and deepens the markets by opening up new avenues for participation by the public.
Just this week, for example, the CFTC approved the Chicago Mercantile Exchange’s new credit event derivatives, which are designed to provide a more transparent, liquid and easy means of acquiring protection against the risk of bankruptcy. These contracts also will introduce the benefits of exchange-traded products – standardization, liquidity, and transparency – to the fastest-growing segment of the OTC derivatives market.
Yet, this creativity and innovation in product design can lead to a degree of “product convergence” requiring careful line-drawing of the jurisdictional responsibilities between government agencies. Creative new products may not neatly fit into the “futures” or “security” category. Such products may technically fall on one side of the line, yet be economically equivalent to products on the other side of the line. As such, these products may potentially implicate the legitimate supervisory interests of other regulators.
When faced with a similar dilemma years ago with single stock futures, the SEC and the CFTC signed the Shad-Johnson accord, which prevented the trading of such products for decades – assuredly not the model for dealing with today’s issues. We must resist the temptation to take actions that may stifle competition in our markets. Our charge must be to adapt the regulatory structure to fit the marketplace, not to force the marketplace to fit the regulatory structure.
Today, with an ever-growing line of exotic products on the horizon, there is a need for new thinking in this area – and greater coordination between different regulators implementing their respective public mandates. Toward that end, I expect that the year ahead will see the CFTC working closely with other regulators – and with industry – to encourage product innovation and to endeavor to eliminate legal uncertainty while at the same time assuring that critical public and market protection issues are addressed.
There must, of course, be no seams in regulatory coverage. But nor should there be undue burdens or competitive imbalances from subjecting innovative products to regulation under fundamentally different statutory regimes. We would hope to proceed in a manner consistent with the CFTC’s longstanding view that the regulator’s role is not to pick winners or losers, but rather to foster the flexible and nimble regulatory environment envisioned by the CFMA – in short, a regulatory environment that encourages fair and vigorous competition.
In the areas of globalization, energy markets, and “product convergence” the CFTC will make every effort to confront the thorny challenge of reconciling very different legislative frameworks that apply to different markets, different agencies, and different countries. In tackling that challenge, the CFTC will pursue the same objectives that animated its major projects of the past year: 1) promoting competition and innovation by proactively taking down unnecessary barriers, and avoiding artificial legal constraints, to trading in our markets; and 2) at the same time, fulfilling our mandate under the Commodity Exchange Act to protect the public interest and to enhance the integrity of, and public confidence in, U.S. futures markets.
We look forward to receiving the benefit of the support, experience, and expertise of each of you as we strive to meet that challenge. I would be happy to take your questions.
Last Updated: April 2, 2010