"REGULATION IN AN ERA OF CHANGE"
REMARKS OF BROOKSLEY BORN, CHAIRPERSON
COMMODITY FUTURES TRADING COMMISSION
FOURTH INTERNATIONAL DERIVATIVES CONFERENCE
June 5, 1997
It is a pleasure to be among such a distinguished group of international regulators and industry participants and to speak at the meeting of the Futures Industry Association and the Futures and Options Association. Sweeping change is occurring in the world's financial markets and in the efforts to oversee them. I would like to address two particular issues this change poses: first, the significant changes in financial regulation that a number of jurisdictions are currently considering or undertaking; and second, the changing nature of international regulatory cooperation.
We meet at a time of great change in financial services regulation in several countries with major markets. The U.K. has just announced very significant changes to its financial regulatory structure. The U.S. and other countries such as Japan and Australia are actively considering how best to restructure and to modernize their regulation of financial services. In addition, numerous emerging market jurisdictions are considering how best to regulate newly created markets in their countries.
The discussions of change should not be viewed as an indictment of the existing systems of regulation in our countries. Rather, the proposals for regulatory change reflect an attempt to respond to significant changes in the businesses and markets being regulated. If regulators are not responsive to technological developments, business changes and market evolution, we will have failed in maintaining an effective regulatory system and will burden innovation and financial market growth with regulatory inefficiencies and outmoded regulatory structures.
We are all well aware of the forces that are driving this process of regulatory reevaluation and change -- the globalization of our markets, integrated trading activities and risk-management needs of globally active market users and market intermediaries, technology changes of the information age and the increasing pace of market innovation. Moreover, market crises -- such as the 1989 Chicago sting operation, the London tin crisis, the stock market crash of 1987, and the massive losses of Barings Plc. and Sumitomo Corporation to name a few -- have been catalysts for regulatory change.
Although they have chosen different paths to reform, policymakers in various countries are trying to respond to the changes taking place in the markets. In the U.K., the 1985 White Paper on Financial Services increased access to U.K. markets and led to the enactment of the 1986 Financial Services Act establishing a "two-tier" regulatory and self-regulatory framework. Last month, the U.K. initiated radical market reforms to integrate into one entity -- the Securities and Investments Board -- the supervision of banks, securities firms and insurance companies and the functions of many self-regulatory organizations. Thus, in a relatively short time frame -- from 1985 to 1997 -- the UK has moved to a single, all-embracing financial regulator.
In contrast to the UK's unitary approach, the Wallis Committee in Australia has recommended the creation of a "risk- based" regulatory model with three separate agencies: a market conduct and disclosure regulator, a prudential regulator of financial entities and intermediaries, and a Payments Systems Board with the Bank of Australia to implement policies to improve payments system efficiency and to oversee clearing streams.
Japan announced reform measures last year intended to enhance the Tokyo market in its role as one of the "big three" financial centers in the world, along with London and New York. Japan is increasing access to its markets, expanding the range of permissible investments, opening up competition by financial intermediaries by liberalizing commission structures, and improving oversight of securities firms. The Ministry of Finance has been working with the Tokyo Stock Exchange and the Osaka Stock Exchange to enhance customer fund protection and to move toward a system of fund segregation already in place in the commodity markets. These reforms, however, will not affect the product-based approach to regulatory responsibilities under the current Japanese structure.
In Switzerland, recent legislation has granted the Swiss Banking Commission new regulatory powers, strengthening federal regulation of financial institutions and diminishing reliance on self-regulation.
In the United States, we too are considering changes in our financial services regulatory structure. One major question is whether and to what extent we should maintain the Glass-Steagall Act's traditional separation of banking and securities functions. Last month, the Clinton Administration proposed an overhaul of the Act's restrictions that would permit banks to venture directly into the securities area and also raised the possibility of permitting banks to conduct non-financial businesses, subject to certain limitations.
At the Commodity Futures Trading Commission we have been examining our regulations to determine whether they are unduly burdensome or require updating. This effort has already resulted in some significant streamlining in the way we regulate our markets. For example, we recently created a "fast track" process by which our exchanges may obtain CFTC approval of new contracts on an expedited basis. Certain contracts may now be approved within 10 days and others within 45 days. This development exemplifies the type of regulatory reform that many nations are currently undertaking: on the one hand, it reduces regulatory burdens on our exchanges and other regulated entities; on the other hand, it preserves important public interests and fulfills the Commission's oversight responsibilities.
Also, I am pleased to announce that yesterday the CFTC opened the way for futures brokers to make use of electronic media in communicating with their customers. The Commission's new guidance permits futures brokers to deliver monthly statements, trade confirmations and other account statements solely by electronic media to customers who consent to electronic transmission in lieu of receiving paper documents. It is time to recognize that the Internet and other forms of electronic communication may perform these functions as well as or better than the U.S. mail. This step should increase the timeliness of information flows and benefit brokers as well as customers by enabling them to reduce their administrative costs. This initiative is only the most recent of a series of actions by the Commission to assure that our regulatory program, the regulated industry, and futures customers reap the benefits of technologi cal advances.
There is also legislation pending before our Congress to amend the Commodity Exchange Act, the law governing futures and option trading in the U.S. These bills could have a wide-ranging impact on our exchange-traded and over-the-counter derivatives markets. The Commission strongly opposes certain of the proposals contained in this legislation. There are three areas in particular in which the bills could dramatically reduce federal government oversight of our markets and, in my view could expose these markets to unnecessary risks:
First, the bills contain a provision exempting so- called professional futures exchange markets from nearly all federal oversight as long as exchange trading is limited to entities with $1 million or more of net worth. The deregulation of exchange trading possible under this exemption would greatly restrict government power to prevent and to detect manipulation, fraud, and financial instability in these markets.
Second, the proposed legislation would exempt most trading in futures and options on foreign currency and government securities on the over-the-counter market and on exchange markets as long as they excluded some element of the general public. Such trading would be free from all federal regulation and customer protections.
Third, the proposed legislation would create statutory exemptions from most of the Commodity Exchange Act's protections for all over-the-counter derivatives trading among entities with at least $1 million of net worth. Prohibitions against fraud and manipulation would be preserved.
These three provisions in the pending legislation could have a significant negative impact on the integrity of our financial markets. The CFTC is committed to working with Congress, the futures industry and all financial market participants to craft legislation that modernizes the Commodity Exchange Act, but at the same time protects the public interest and the integrity of our markets.
Regardless of the path taken by particular regulatory reform efforts -- whether the UK's unitary approach, the risk-based reforms in Australia, or the continuing product-based regulation in Japan -- each country is assessing the appropriate level and methods of regulation based on changed local and global conditions. Over time, countries have developed different regulatory schemes to ensure that markets operate effectively, free from manipulation and fraud, and that customers are treated fairly. Not surprisingly, therefore, the eventual regulatory reforms adopted in each country may vary, depending on such factors as each nation's history, culture, legal customs, and the needs of its markets.
It is too early to make any pronouncements as to which of these reform efforts will be implemented and will prove successful in responding to current developments in the global marketplace. However, reform will not succeed unless it has as its central mission the protection of the investing public and the preservation of market integrity. In order to achieve these goals, policymakers and regulators must ensure that they take into account the interests and views not only of regulated entities such as the markets and financial services intermediaries, but also the interests and views of the users of the markets and the public at large.
No matter what approach each jurisdiction takes to the reform of regulation in its domestic markets, international cooperation and coordination must continue to move forward. Cooperation by national regulators in an increasingly global financial environment is not an option; it is a necessity. In this regard, the Commission is particularly pleased with the close cooperative relationship established between the US and the UK regulators.
The failure of Barings Plc., followed in quick succession by the dramatic losses incurred in Sumitomo Corporation's copper trading, are two recent dramatic events demonstrating the complexity and interrelationship of financial supervision in a global marketplace. Markets today are linked through products and market participants. Events in one market can and do create regulatory concerns in multiple jurisdictions.
In a global market environment, the effective supervision of futures markets requires that regulatory authorities cooperate by sharing relevant supervisory information. In a world of multinational financial firms, it is unlikely that any one regulator will have the ability and resources adequately to supervise all the participants in its markets. Moreover, the likelihood of repercussions from disruptions in other jurisdictions has accelerated the need for and extent of international cooperation.
International regulatory cooperation has evolved to accommodate the changing regulatory and commercial landscape. In the 1970's regulators concentrated on addressing fraudulent activities occurring on a cross-border basis. Consequently, early efforts focused on entering bilateral memoranda of understanding or nonbinding statements of intent to cooperate in enforcement cases.
These initial efforts proved remarkably successful. A recent check of an IOSCO database on the Internet indicated the existence of over 224 bilateral arrangements involving 50 jurisdictions. These arrangements have proven extremely useful. For example, in fiscal year 1996 there were approximately 190 instances in which the CFTC requested information from a foreign regulator and 65 instances in which a foreign regulator requested information from us.
The recent market events involving Barings and Sumitomo forced regulators to move beyond cooperation in the enforcement area in order to protect their domestic financial marketplace against shocks or stress on the system caused by extraterritorial events. Barings gave birth to the March 1996 Declaration on Cooperation and Supervision, which has been signed by 20 regulators to date, and its companion agreement among self- regulatory organizations, which has been executed by 62 exchanges and clearinghouses.
Following the Sumitomo incident, the CFTC and the SIB, along with the relevant Japanese authorities, the Ministry of International Trade and Industry and the Ministry of Agriculture, Forestry and Fisheries, co-sponsored an international regulators conference in London in November 1996 on physical delivery markets. The conference focused on the special problems that physical delivery markets pose for contract design, market surveillance and international information sharing. The 17 countries participating issued a Communiqué agreeing on certain basic principles of regulation and on a year-long work program. Earlier today, the London conference co-chairs reported on the progress to date and released the results of our survey describing current regulatory practices in the participating countries. We are working toward the development of international "best practices" standards in contract design, market surveillance and information sharing to be released at a meeting in October 1997 in Tokyo.
These efforts demonstrate the commitment of regulators from around the world to cooperate. By creating international best practices standards, we will establish world-wide regulatory benchmarks, which can help each domestic regulator to assess how its standards and practices compare with the benchmarks and to consider possible regulatory improvements.
International regulators are also working to ensure that information sharing will occur quickly and efficiently. The Sumitomo incident provided the first concrete test of the information sharing arrangements in the March 1996 Declaration. The Declaration's information sharing arrangements worked, but they could have worked more efficiently. Given the competition between the London and New York copper markets, it is not surprising that invocation of the Declaration's information- sharing provisions initially raised questions whether the inquiries were motivated by competitive reasons rather than supervisory concerns. Moreover, time was spent in discussion of the scope of information legitimately necessary.
To address these problems, the CFTC and the SIB jointly proposed to the IOSCO Technical Committee a project to provide guidance on the types of information which may need to be shared in a particular market event. The market events to be covered include a firm financial crisis such as Barings, a major market move such as the 1987 stock market crash, and price distortions or unusual volatility in a particular market, such as the Sumitomo situation. Agreeing in advance upon the type of information which may be required should facilitate information- sharing when such an event occurs. IOSCO is also concluding a round of self-assessments by participating jurisdictions of the usefulness of these information-sharing arrangements.
The implementation of the Declaration and the London Communiqué bring me to my last topic for this afternoon, the growing need and trend toward regulatory convergence. We have learned that information sharing arrangements are futile if needed information is not available in the first instance. For example, some markets do not generate information on large exposures. In other cases customer position information may be obtained by market authorities but not shared with other regulators due to blocking, financial privacy, or secrecy laws. As international cooperation continues to increase in response to market factors, a certain degree of regulatory standardization will be inevitable and beneficial. All jurisdictions that wish to obtain information from their fellow regulators will need to generate and share similar information with those regulators.
Moreover, the need to streamline burdensome regulatory requirements will also play an important role in harmonizing regulatory schemes. The US and the UK, for example, have approved a generic risk disclosure statement, which can be used by participants in either jurisdiction. Indeed, the multinational participants in our markets require and deserve international regulatory harmonization to facilitate their business operations and to reduce the burdens of conforming to many differing national regulatory schemes. International regulators have a responsibility not only to streamline and modernize our domestic regulatory programs, but also actively to pursue the elimination of unnecessarily regulatory divergence on an international level.
Obviously, financial regulation will not reach a level of complete global harmonization any time soon. Very different regulatory approaches have led to equally successful results, and no one system will work in all jurisdictions. Regulatory diversity within a framework of internationally accepted parameters may well enhance regulatory innovation and tend to foster experimentation leading to improved supervision and reduced regulatory costs.
Times of change are also times of challenge. Although regulatory change in the United States and internationally is necessary to keep up with changes in the marketplace, our true challenge is to reform regulation while preserving the important interests in market integrity and customer protection that have been the foundation for our regulatory schemes. We must build upon the regulatory foundations that have served us well in the past to develop modernized regulatory regimes to take us into the Twenty-first Century.