Division of Economic Analysis
One of the Commission's principal responsibilities is to assure that futures markets operate competitively, free of manipulation or congestion, and serve the risk-shifting and price-discovery needs of the U.S. and world economies. Division of Economic Analysis (DEA) programs – Market Surveillance, Market Analysis, and Market Research – focus on these objectives. DEA periodically examines the effectiveness of its programs and seeks to institute revisions that reduce the costs of compliance.
New Contract Listing and Rule Review Procedures. During FY 2000, the Commission proposed a far-reaching and fundamental change to its procedures for listing new futures contracts offered by U.S. exchanges. This change responds to U.S. futures exchanges’ concerns that their ability to list new contracts without delay is important to their continued competitiveness, particularly with foreign exchanges. Specifically, the Commission adopted procedures allowing an exchange to list new contracts one day after the exchange files a notice with a certification that the contract meets the Commission’s requirements. The certification, in conjunction with the fast-track procedures for approval of new contracts adopted previously by the Commission, ensure that the benefits of new contracts can be brought to the marketplace as soon as possible.
On July 15, 1999, the Commission published proposed rules that would further streamline its procedures for reviewing exchange rules. The CFTC proposed to allow additional categories of exchange rule amendments to be approved automatically, upon adoption by the exchange, and to permit such amendments to be submitted to the Commission in a single, weekly, summary filing rather than in individual submissions. For certain other rules, the review time would be reduced to three days. The proposed rules also reorganize, in a clearer and more accessible format, the Commission's rules on expedited approval procedures for proposed rule amendments to contract terms and conditions.
These amendments build on the fast-track procedures for approval of changes to the terms and conditions of existing contracts previously adopted by the Commission. The Commission has also proposed alternative procedures to allow exchanges to implement changes to the terms and conditions upon a certification that the Commission’s requirements are satisfied. These provisions are designed to help ensure that the benefits of amended contracts are made available to market participants in an expeditious manner.
Listing of New Products. In FY 2000, the Commission approved 29 new futures and option contracts. Of the 29 contracts approved, two were approved under 10-day fast-track provisions and 13 were approved under 45-day fast-track provisions. In addition, exchanges filed 23 new contracts for listing under the Commission’s certification procedures, which permits exchanges to certify their own contracts and list them prior to receiving Commission approval.
Agricultural Trade Options. The Commission completed a review of its rules for agricultural trade options and on November 30, 1999, adopted amendments intended to provide greater flexibility in contract design and to streamline the registration process for agricultural trade option merchants. Agricultural trade options are off-exchange options on specified domestic agricultural commodities offered to producers, processors or merchandisers in connection with their business. In order to make agricultural trade options simpler and more flexible for users, the Commission amended its rules to permit cash settlement of the options. Under the prior rules, an agricultural trade option, if exercised, had to result in physical delivery of the underlying commodity. The Commission also streamlined the registration requirements for agricultural trade option merchants and their sales agents. Finally, the Commission simplified the information required in disclosure statements and reduced the overall reporting and recordkeeping requirements.
In order to serve the vital price discovery and hedging functions of futures and option markets, exchanges must list products for trading that are not readily susceptible to manipulation and they must have an appropriate ongoing oversight program. Appropriate contract design minimizes contracts’ susceptibility to manipulation or price distortion, and analyses of the terms and conditions of contracts to ensure that they meet the Commission’s rules and policies is a key element of the Commission’s market surveillance effort. The Market Analysis subprogram reviews new contracts as well as rule changes of economic significance to existing contracts to ensure that contracts are in compliance with statutory and regulatory anti-manipulation requirements. The reviews foster markets free of disruptions or price manipulations and provide the Commission and other interested parties essential information about the markets to conduct effective surveillance and to address regulatory and public interest issues. In this regard, deficiencies in the terms and conditions of futures and option contracts increase the likelihood of cash, futures, or option market disruptions and decrease the economic usefulness and efficiency of the contracts.
New Futures and Option Contracts. During FY 2000, the staff completed economic reviews of 29 new futures and option contracts: 17 applications for approval of new futures contracts and 12 applications for approval of new option contracts. In addition, staff reviewed 23 filings under the certification listing procedures. Highlights of the new contracts are as follows.
U.S. Agency Notes. The Commission approved the Chicago Mercantile Exchange (CME) and Cantor Financial Futures Exchange (CFFE) five-year and ten-year U.S. agency notes futures and option contracts. The Chicago Board of Trade (CBOT) filed these same products under the certification procedures. These are the first contracts based on Freddie Mac and Fannie Mae instruments. These innovative contracts are designed to provide a risk management tool to help businesses protect against market rate risk. These contracts are the first physical-delivery debt contracts based on notes that were not issued by the U.S. Treasury or a foreign government.
Barge Freight Rates. The Commission designated the Merchants Exchange of St. Louis, a new exchange, as a contract market in Illinois Waterway Barge Freight futures and St. Louis Harbor Barge Freight futures. These contracts are the first futures contracts that require the delivery of a service, namely, barge transportation from the Illinois Waterway and St. Louis to New Orleans area grain export locations. The contracts are intended to provide buyers and sellers of barge freight with a means of managing rate risk.
Cottonseed Oil. The Minneapolis Grain Exchange (MGE) submitted cottonseed futures and futures option contracts pursuant to the certification procedures. These contracts are the first contracts based on cottonseed to be traded. The contracts offer a risk management tool for cottonseed producers, cottonseed mills, and milk producers.
U.S. Equity Indexes. The Commission approved the CBOT Dow Jones Utility Average, Dow Jones Transportation Average, and Dow Jones Composite Average futures and option contracts; the CME Fortune e-50 futures and option contracts; and the Commodity Exchange, Inc. (COMEX), Eurotop 300 futures and option contracts. These contracts provide institutional portfolio managers with additional means of hedging risks associated with U.S. equity portfolios.
Currency and Currency Cross-Rates. The New York Cotton Exchange (NYCE) filed currency and currency cross-rate contracts under the certification procedures. These contracts include the Euro/Australian dollar cross-rate, Australian dollar/Canadian dollar cross-rate and Canadian dollar/Japanese yen cross-rate futures and option contracts, and the U.S. dollar/Swedish krona and U.S. dollar/Norwegian krona currency futures and option contracts. In addition, the New York Futures Exchange (NYFE) filed a U.S. dollar/Canadian dollar currency futures option contract under the certification procedures.
Dairy and Livestock Products. The Commission designated FutureCom, Inc., a new electronic exchange, as a contract market in cash-settled live cattle futures and option contracts. The futures contract is the first cash-settled futures contract based on the value of cattle of slaughter weight. In addition, the Commission designated the CME as a contract market in Class IV milk futures and options. The CME also submitted several new contracts under the certification procedures, including E-mini lean hog futures and options, E-mini feeder cattle futures and options, lean hog index options, and feeder cattle index options. The E-mini hog and cattle contracts (the sizes are one-half the size of the exchange’s existing lean hog and feeder cattle contracts) will be traded exclusively on the exchange’s Globex electronic trading system. They are designed to enhance the hedging opportunities for smaller livestock producers. The lean hog and feeder cattle index options expire in those months that currently are not listed for trading under the existing lean hog and feeder cattle futures contracts, with any exercised options being cash settled based on the same cash price series that is used to cash settle the exchange’s existing lean hogs and feeder cattle futures contracts.
Regional Electricity Contract. The Commission approved this fiscal year the New York Mercantile Exchange (NYMEX) MidColumbia electricity futures contract. This contract provides electricity market participants with risk management tools to respond to the evolving electricity cash market in the Pacific Northwest region of the U.S.
Oriented Strand Board. The Commission approved the CME’s regional oriented strand board (OSB) contracts based on the four major OSB trading and distribution areas in the U.S. These areas are the North Central, South Eastern, South Western, and Western regions of the U.S. Regional differences exist in the supply and demand for OSB, which result in pricing differences in the cash market. This is due to regional variations in OSB end-use applications in the various regional markets, and, most importantly, limitations on the available shipping capability between regions. These contracts are designed to meet the specialized hedging needs of firms for the lumber industry that produce, store, or consume in the OSB.
Rule Changes. During FY 2000, the staff completed economic reviews of 100 rule amendment packages for existing futures and option contracts. Nine of the rule changes were submitted for review and approval under fast-track procedures. Of the 100 economic reviews processed this fiscal year, 93% were completed within 45 days (the fast-track review period) and 22% were completed within 10 days of submission.
Significant rule changes approved this year include:
The conversion of the NYCE U.S. dollar index contract to physical delivery from cash settlement.
Changes to the circuit breaker provisions of the CME and KCBOT NASDAQ 100 and ISDEX stock index contracts to treat the 10% circuit breaker price limit as a “speed bump” until a general circuit breaker trading halt is disclosed.
Revisions to the CBOT grain, soybeans, soybean products, gold, and silver futures contracts to increase maximum daily price fluctuation limits.
Changes to the CBOT rough rice futures contract to increase the quality standards for deliverable rough rice by reducing the maximum permitted number of kernels of stained and light stained rice and prohibiting the delivery of heat-damaged rice.
Modifications to the MGE durum wheat futures contract reducing the quality requirements for delivery wheat, including reducing the minimum test weight and protein content for such wheat.
Futures prices are widely quoted and disseminated throughout the U.S. and abroad. Business, agricultural, and financial enterprises use futures markets for pricing information and for hedging against price risk. The participants in commercial transactions rely extensively on prices established by the futures markets. Moreover, the prices established by the futures markets directly or indirectly affect all Americans. They affect what we pay for our food, clothing, and shelter. Since futures and option prices are susceptible to manipulation and excessive volatility, and, since producers and users of the underlying commodities can be harmed by manipulated prices, preventive measures are necessary to ensure that market prices accurately reflect supply and demand conditions.
CFTC surveillance economists monitor all actively traded futures and option markets to detect and prevent price manipulation. They routinely review the positions of large traders, futures and cash price relationships, and supply and demand factors to detect threats of price manipulation.
The Market Surveillance staff works closely with the exchanges and other government agencies to deal with any potential market threats that may develop. The staff apprises the Commissioners and senior CFTC staff of potential problems and significant market developments at weekly surveillance briefings so that the Commission is prepared to take prompt regulatory action when warranted.
Financial Markets. During FY 2000, Market Surveillance staff closely monitored the financial futures and cash markets as the domestic equity indices continued to rise at an extraordinary pace and experienced periods of considerable volatility. In this period, the U.S. economy continued to experience very strong economic growth, relatively low inflation, strong gains in worker productivity, subdued wage pressures, strong corporate earnings growth, and an appreciating U.S. dollar. However, early in FY 2000, there was increasing concern that the rapid growth in the economy was not sustainable without causing increased inflationary pressures. Strong employment gains and high levels of consumption spending threatened to create imbalances relative to the production capacity of the economy. In response to these developing imbalances, the Federal Reserve Board raised the target for the Federal Funds rate, in six increments, to 6.50 percent. The actual and anticipated tightening of monetary policy put upward pressure on interest rates, especially at the short end of the yield curve. The large U.S. budget surplus reduced the need for issuance of debt and funded a buy-back of government securities in the intermediate to long end of the yield curve. These factors caused an unusual inversion of the Treasury yield curve. These developments, as well as a change in the contract specification of the nominal yield on futures contracts for U.S. Treasury notes and bonds (from eight percent to six percent), increased the complexity of staff surveillance of these interest rate futures markets. In addition, staff closely monitored trading in new contracts in Agency notes.
Early in FY 2000, as interest rates rose, investors poured money into technology stocks, believing that they were less dependent on borrowed capital and that their growth prospects made small changes in interest rates insignificant. This caused a sharp divergence in the performance of so called "old economy" versus "new economy" stocks. During the first half of FY 2000, Nasdaq 100 index futures prices rose by more than 100 percent while futures on the S&P 500 index and the Dow Jones index were up far less. Beginning in April, Nasdaq stocks experienced a sharp correction as investors reacted to the high valuations of technology stocks by moving into relatively cheaper “old economy” stocks. During this period, price volatility was extraordinarily high in equity indices and in futures and options on those indices. Interest rates peaked in mid May, as economic data began to show signs of a slowdown in economic growth. Concerns about further increases in interest rates by the Federal Reserve Board abated, at least in the short run. However, as FY 2000 came to a close, equity indices were pressured by new concerns that corporate earnings would be less than expected, especially in computer-related industries, and by weakness in the euro currency, which adversely affected corporate profits. In addition, rising energy prices created the potential to increase production costs and spill over into core inflation and to reduce corporate profits. Staff conducted heightened surveillance of equity futures markets and prepared special analyses of these events. Staff also shared information with other financial regulators.
Energy Markets. In September 2000 crude oil, heating oil, and gasoline cash and futures prices reached their highest levels since the Gulf War. International crude oil stocks and stocks of petroleum products declined sharply in response to reduced oil production by OPEC members and other major oil producers and due to increased demand emanating from strong economic growth in the U.S. and other regions of the world. Heating oil and gasoline prices were affected by the escalation of crude oil prices and by the strong demand for these products. In the summer, gasoline prices also were affected in some regions by the implementation of Phase II of the Reformulated Gasoline Program, as specified by the Clean Air Act of 1990. CFTC Market Surveillance staff carefully monitored the expirations of all crude oil, heating oil, and gasoline futures contracts over this entire period.
Natural gas prices also reached record highs in both cash and futures markets. Low storage levels during the summer months, caused by strong demand for the generation of electricity, led to increased concern about the adequacy of natural gas supplies heading into the winter. Very hot summer weather in the southern and western portions of the country led to the consumption of large quantities of natural gas to meet the increased demand for air conditioning. Market Surveillance staff reviewed the expirations of natural gas futures to assure that the actions of large traders did not exacerbate an already tight supply and demand balance for natural gas.
Precious Metals Markets. Platinum and palladium futures and cash prices rose to record high levels this year. During a period of strong industrial demand for these metals, particularly from automobile and electronics manufacturers, world supplies were drawn down to very low levels due to reduced and delayed Russian exports. The Tokyo Commodity Exchange (TOCOM) took extraordinary action in February 2000 to substantially constrain trading in that exchange's palladium futures contract after prices advanced from the mid $400 dollar range in early January to $800 in late February. CFTC Market Surveillance staff contacted Japanese regulators and TOCOM officials to determine whether the factors leading to the regulatory action on TOCOM also posed a threat to the NYMEX palladium futures contact. Close contact also was maintained with NYMEX staff regarding the palladium and platinum futures expirations, and large traders were contacted regarding positions carried into contract expiration.
Livestock Markets. Pork belly futures on the CME were characterized by extremely small deliverable supplies throughout the 1999-2000 marketing season. Since numerous traders held positions going into contract expiration that exceeded deliverable supply, Market Surveillance staff initiated frequent contacts with large traders and CME surveillance staff during each expiration. Several live cattle futures expirations also required special surveillance attention as traders with large long positions maintained sizeable positions late into the delivery month. Frequent contacts with large traders and exchange staff resulted in orderly liquidations of these markets.
Large Trader Reporting. The Commission implemented its re-engineered market surveillance computer system, replacing the mainframe-based computer system. During FY 2000 and FY 2001, the Commission will complete development of this new system by improving its operational speed, particularly in the regional offices, and by enhancing the quality of the system in a number of areas.
During FY 2000, the Commission worked with the brokerage firms that were filing reports manually to assist them in converting to a new system of electronic filings via the Internet. As a result of that effort, all large trader reports are now being filed electronically. This avoids the need to have staff enter the data manually. In May 2000, the Commission raised the reporting levels for 23 commodities to reduce the amount of data that is required to be reported to the Commission by brokerage firms and individual traders.
The Market Research staff conducts research on major policy issues facing the Commission; assesses the economic impact of CFTC regulatory changes on the futures markets and other sectors of the economy; participates in the development of Commission rulemakings; provides expert economic support and advice to other Commission divisions; and conducts special market studies and evaluations.
During FY 2000, the Market Research staff provided technical support to Division of Enforcement on a number of cases regarding fraud in precious metals and energy trading. In addition, the staff testified in several cases requiring expert information on the economic functions and uses of futures contracts.
The Market Research staff continued to provide economic input into the analysis of commodity exchange and Commission regulatory initiatives. Market Research staff participated actively in the development of policies concerning new derivatives instruments and trading mechanisms in futures markets. Staff also continued to study the impact of existing and alternative executive procedures in futures markets. For example, the staff examined the economics of block trading and undertook a study of liquidity and volatility of S&P 500 futures versus the liquidity of e-mini S&P 500 futures. Market Research staff performed cost comparisons of electronic exchanges versus floor-based exchanges and evaluated economic functions of single stock futures and the performance of single stock futures in foreign countries.
Market Research staff also examined economic issues relating to exchange-proposed amendments to existing futures and option contracts and to applications for new futures contracts. Market Research staff, in cooperation with Market Analysis staff, completed a congressionally mandated study of price limits and milk futures price volatility. Staff members continue research on alternative risk measurements, stress tests, and risk-based capital requirements.