I appreciate the Futures Industry Association inviting me to talk with you this afternoon. FIA under John Damgard’s leadership has been a good friend over the years.
As John mentioned, I was recently confirmed by the Senate and sworn-in as a Commissioner of the Commodity Futures Trading Commission. The nomination and confirmation process took a year and a half from start to finish and its intrusiveness is enough to make a proctologist blush. But I feel fortunate and blessed to be before you today and in this position to serve the public.
Despite having lived in Washington, D.C. for the past nine years, I consider myself a Midwesterner. I was born and raised 17 miles southwest of here in the suburb of Darien, Illinois. I moved to Indiana during my teens and ended up at Indiana University, where I studied finance at the Kelly School of Business. Upon graduating from Indiana, I went on to receive my law degree from Lewis and Clark Law School in Portland, Oregon. I returned to Chicago after law school to take the bar exam, which I thankfully passed and remain a member of today.
In 1993, I moved to Washington, D.C. and began my career in government service with Senator Richard Lugar of Indiana as a legislative aide handling financial and tax matters. For those who are fortunate enough to know him, I am very blessed to have had such a mentor. In the Lugar office, I learned, not only the Senate process, but also how fairness, integrity, and midwestern sensibilities can shape important policy decisions. Throughout the years, I have tried to emulate these decision-making qualities in my work.
In 1997, I began to cover issues relating to the futures and derivatives markets for Chairman Lugar on the Senate Agriculture Committee. In 2000, I was assigned to work on the Commodity Futures Modernization Act (CFMA). My approach to advancing this legislation involved openly engaging staff, both Democrats and Republicans, as well as regulators and industry members in an attempt to build a consensus among them. I believe that this “open door” approach left those involved with this legislation – even those opposed to it – with the belief that the final product was developed in a fair manner. I continue to adhere to this style.
Despite several revisions to its statute throughout the years, the primary mission of the Commodity Futures Trading Commission has remained constant. The CFTC is charged with protecting the public and market users from fraud, preventing commodity price manipulation, and fostering open, competitive and financially sound futures and options markets.
This mission remains as vital today as it did when the CFTC was created. With sputtering confidence in our financial markets caused in part by corporate misdeeds and, as yesterday solemnly reminds us, our global war on terrorism, it is imperative that the Commission be a diligent but calming force.
Being a graduate of Indiana University, I like basketball analogies. Every fan knows that a good referee can raise the level of competition in a basketball game. The referee’s presence reassures both teams that the outcome of the game has been reached in a just and fair manner. Likewise, appropriate regulatory oversight and enforcement, especially during times of economic stress, serve to re-vitalize markets by reassuring the public and market participants that the rules of the game are being followed.
However, it is equally important to understand that when fouls are not being committed, referees and regulators should allow the competition itself to determine the outcome. Participants in our markets must have the freedom to compete, to innovate and to take risks if the U.S. economy is to grow and prosper. Free markets must determine winners and losers, not regulators.
This is a difficult but necessary balance to achieve, but one that the CFTC must attain. President Bush’s Budget Director Mitch Daniels has termed this approach “smarter regulation.” It is the idea that regulatory action should always be tailored to effectively meet public goals without burdening individuals with unnecessary costs. The “smarter regulation” approach does not necessarily mean more regulation or less regulation. There will be times when the evidence, analysis, and public sentiment justify a greater regulatory involvement. When this is the case, I will support regulatory action. At other times, the opposite will be true. But in either event, regulators are obligated to weigh the costs to the public as well as the benefits of implementing regulations, and to do so in a timely, informed and open manner. I commit to you today that this will be my decision-making model during my tenure at the CFTC.
No one political party can lay sole claim to the “smarter regulation” approach. It was the Clinton Administration together with the Republican Congress that brought this approach to the futures industry in the form of the Commodity Futures Modernization Act of 2000.
The overwhelming motive behind the legislation was to resolve the “legal certainty” problem that had plagued the over-the-counter derivatives market for years. The CEA as originally enacted contained a “death penalty” provision in which any product deemed to be an off-exchange futures contract could be declared illegal and void by a court of law. This quirk in the law--together with some saber rattling by the CFTC’s former Chair--threatened the entirety of the multi-trillion dollar over-the-counter derivatives market.
To address this problem, in November 1999 the President’s Working Group on Financial Markets, which consisted of the Treasury Secretary Laurence Summers, Federal Reserve Board Chairman Alan Greenspan, SEC Chairman Arthur Levitt and CFTC Chairman Bill Rainer, proposed clarifying the jurisdiction of the CFTC by excluding certain over-the-counter derivatives from its jurisdiction. In determining whether the CFTC should have oversight authority, the PWG looked to whether products were being traded by retail customers, whether products were susceptible to manipulation and whether the participants were not otherwise regulated. The PWG believed that if these characteristics were not present, there was no public value in providing the CFTC with oversight that either was redundant or failed to meet its public mission.
In taking this tack, the PWG was using the “smart regulation” framework. As I mentioned before, this approach does not presume more or less regulation. And in fact, the PWG found that there were certain markets needing more regulation and others needing less. For example, the PWG found that the CFTC should have jurisdiction over off-exchange retail foreign currency transactions. Since the enactment of this recommendation as part of the CFMA, the CFTC has successfully brought 18 foreign currency fraud cases, filling a regulatory gap that had been rife with bucket shops and abusive retail practices.
Applying the same “smart regulation” rationale, the CFTC designed a tiered regulatory framework for on-exchange futures contracts. Products that were more susceptible to manipulation and were offered to the retail public, such as agricultural futures contracts, would be more heavily regulated. Those instruments that were less susceptible to manipulation and were offered only to sophisticated investors would benefit from a lighter regulatory touch. Ultimately, this regulatory reform proposal along with the PWG’s findings on over-the-counter derivatives became the first two legs of the Commodity Futures Modernization Act.
As many in the audience know, the third leg of the CFMA lifted the ban on security futures products and provided a joint regulatory framework for allowing the trading of these instruments. The fruits of this labor are about to be unveiled. Tomorrow is the effective date of the last joint rules necessary to allow domestic trading of security futures products. So far, three futures exchanges have notice-registered with the SEC to trade these products, and I expect there will be at least one securities exchange that will notice register with the CFTC in the not-too-distant future.
I want to congratulate both the SEC and CFTC, as well as NFA and other industry members who contributed to these efforts, in putting together what seemed like an impossibility: a joint regulatory structure. I worked in the Senate when this process began in 1999, and you could hardly get the two agencies to talk to each other, let alone agree on something. However, since that time, both agencies, to their credit and benefit, have learned about each other’s industries and regulatory methodologies. As a result of these efforts, I believe that the regulatory structure that is in place is a good one and one that will provide this product with an excellent opportunity to succeed.
I am pleased to point out that this regulatory structure allows the industry to choose its regulators in certain circumstances. I believe that choice is an important characteristic of the smarter regulation approach. As long as the public interest is being served, regulatory choice is a healthy way to ensure competing agencies do their jobs in the most effective manner possible. Inevitably, this comparison will cause the CFTC, as well as the SEC, to improve the way it conducts business. I believe this to be healthy, and I look forward to this measurement.
The last major section of the CFMA worth noting, and the one that has received a great deal of attention of late, is the section dealing with the over-the-counter energy and metal markets. The CFMA exempted energy and metal derivatives from CFTC oversight, except that it provided the CFTC with anti-fraud and anti-manipulation authorities over products traded on bilateral markets and provided additional regulatory authorities over these products when traded on a multilateral exchange. Congress provided the CFTC with limited authorities in this area because these were institutional markets--thought to be deep and liquid--that the CFTC had never regulated in the past.
Subsequent events have severely challenged our underlying assumptions of these energy markets and have caused us to rethink this position. The collapse of Enron has focused the nation’s attention on the business of energy trading and the laws that govern them. Investigations by regulators have uncovered the prevalent practice of wash trading by energy firms who have allegedly made these trades without economic justification. There are also allegations in the press of trading schemes that appear to border on fraud and market manipulation. The widespread nature of these allegations has harmed the entire energy trading sector. The press has reported that the once-robust trading desks at many energy companies have all but shut down. At the same time, we’ve witnessed the dramatic devaluation of energy stocks due to a combination of credit problems, low trading volume, and falling investor confidence. Indeed, faced with the undesirable choice of bankruptcy or a fire sale of assets, energy markets appear to be in jeopardy of drying up completely.
Accordingly, I believe that additional regulatory involvement would benefit these markets--not only to prevent and deter illicit behavior but also to bring participants back to these important markets. As I noted earlier, smarter regulation doesn’t necessarily translate into “more” or “less” regulation—it means using the best economic and scientific data we have to develop responsible regulation to protect the public interest—period. And if ever a situation called for the application of our best efforts, this is one of those times. I’m looking forward to an open dialogue with Congress, with other federal regulators, and with industry participants to come up with the best “smart regulation” approach possible in this area.
In Indiana, we have a saying that “farmers are capitalists on the way up and socialists on the way down.” Some may say the same for politicians and regulators, especially during these economic times. However, smart regulation reminds us to tailor our actions carefully to meet our public goals. I want to make perfectly clear that, while I do see the need to thoughtfully address the energy situation, I do not support opening up the carefully crafted “legal certainty” provisions contained in the CFMA that excluded certain financial instruments from the CFTC’s jurisdiction. This important statutory change, which was overwhelmingly supported in the Administration, Congress and industry alike, remains as important today as it did when enacted. Former CFTC Chairman Bill Rainer noted to me recently that the real story that has not been reported in the press concerning the recent problems in the over-the-counter markets is that no one has attempted to void their obligations by claiming their over-the-counter contract was an off-exchange futures contract. I believe this to be the most important yet overlooked success of the CFMA debate, and one that we can proudly attribute to “smart regulation”.
Thank you for the opportunity to speak with you today—I look forward to a productive tenure at the CFTC. I appreciate your hospitality.
Last Updated: July 16, 2007