"The CFTC's International Initiatives in a
REMARKS OF BROOKSLEY BORN
COMMODITY FUTURES TRADING COMMISSION
BEFORE THE EXCHEQUER CLUB
WEDNESDAY, DECEMBER 17, 1997
I am pleased to be here today at the Exchequer Club to share with this
distinguished group some observations on how the Commodity Futures
Trading Commission ("CFTC"), the Federal agency charged with
regulation of futures and derivatives markets, seeks to achieve its
goals of ensuring market integrity and customer protection in an era
of increasing market globalization.
This subject is particularly timely. The recent volatility that has shaken world equity and currency markets has demonstrated more vividly than ever before that the markets are inextricably linked through related products and common market participants. Therefore, events that occur in one market can and frequently do cause global regulatory concerns. The shocks to the world financial system caused by the collapse of Barings Plc. in 1995 and the dramatic losses incurred by the Sumitomo Corporation in 1996 illustrate that this is true for derivatives markets as well as securities markets.
The CFTC, a small regulatory agency, quietly has become a leader in encouraging international action to address the issues of systemic risk posed by our linked markets and in encouraging worldwide adoption of higher regulatory standards. In my remarks today, I would like to review with you some of the recent international initiatives of the CFTC. Those initiatives are designed:
to enhance international supervisory cooperation and emergency procedures;
to establish concrete standards of best practices that set international benchmarks for regulation of futures and derivatives markets;
to improve the quality and timeliness of international information sharing; and
to encourage jurisdictions around the world to remove any legal or practical obstacles to achieving these goals.
The Commission has also expanded the opportunities for international regulators to participate in these initiatives by working to eliminate any inadvertent barriers to such participation.
Following the collapse of Barings Plc., a UK firm which traded on numerous world futures markets including those in Singapore, Japan, Hong Kong and the UK, the CFTC co-chaired a meeting in Windsor, England with the UK Securities and Investments Board ("SIB") -- which has since been renamed the Financial Services Authority ("FSA"). That meeting, and the resulting Windsor Declaration, set in motion a series of international initiatives at both the regulatory and the market level intended to enhance the resilience of the financial marketplace against shocks or stress caused by such defaults. These initiatives included:
I. the development of procedures to coordinate and to respond to a market crisis;
II. initiatives to increase transparency of market protections and procedures, including proposals for the strengthening of protections accorded customer funds deposited for investment or safekeeping; and
III. initiatives to encourage the development by all markets of default procedures intended to isolate risks to the defaulting firm and to restrict potential impact on other firms or markets.
In an era where exchange member firms and market participants typically trade on multiple exchanges, no one regulator or market authority will have the information necessary to evaluate the risks to its markets. For example, at Barings, a rogue trader with high exposures in Singapore claimed that his positions in the Japanese markets were risk reducing, but there was no regulatory mechanism available to any regulator to verify this claim. A notable accomplishment resulting from the Windsor meeting which addressed this concern was the signing in March 1996 at Boca Raton, Florida of the Declaration on Cooperation and Supervision of International Futures Exchanges and Clearing Organizations, an arrangement under which the occurrence of certain triggering events affecting an exchange member's financial resources or exposures prompts the sharing of information among regulators. The Declaration, which has been signed by 23 regulators to date, and a similar companion agreement among self-regulatory organizations, which has been executed by 65 exchanges and clearinghouses, facilitate the identification of large exposures by firms that could have a potentially adverse effect on multiple markets.
Similarly, in November 1996, following the revelations of huge losses at Sumitomo and the related adverse effects on the global copper markets, the CFTC and the UK SIB, along with the relevant Japanese authorities, the Ministry of International Trade and Industry ("MITI") and the Ministry of Agriculture, Forestry and Fisheries ("MAFF"), co-sponsored an international regulators' conference in London on physical delivery markets in international commodities. The London conference focused on the special problems that physical delivery markets pose for regulators and considered how contract design, market surveillance and international information sharing can reduce the potential for, and assist in the management of, manipulation and other market disruptions. The 17 countries participating in that meeting issued a Communiqué agreeing on certain basic principles of regulation and on a year-long work program.
That effort culminated on October 30 and 31, 1997. Representatives of regulators from 16 jurisdictions responsible for supervising commodity futures markets participated in a conference in Tokyo, Japan, jointly chaired by the CFTC, the Japanese MITI and MAFF and the UK FSA, and announced the completion of the work program contained in the London Communiqué issued in November 1996. At the end of the meeting, the regulators issued a Tokyo Communiqué which, among other things, endorsed two guidance papers, one on best practices for the design and/or review of commodity contracts and another on market surveillance and information sharing. The guidances represent the first occasion on which regulators responsible for overseeing commodity derivatives markets have agreed to international standards for the supervision of these markets.
By creating international best practices standards, we hope to establish world-wide regulatory benchmarks which can help each regulator to assess how its standards and practices compare with the benchmarks and to consider possible regulatory improvements. We anticipate that market authorities -- both regulators and markets -- will refer to the standards of contract design as reflecting an international consensus as to the elements that should be considered in order to reduce the possibility that a commodity contract may be susceptible to manipulation or other disorderly conditions.
Contract design, however, is merely part of an overall market
regulation approach, and accordingly, the regulators issuing the Tokyo
Communiqué also endorsed standards of best practices for market
surveillance and information sharing. Among other things, the guidance
on market surveillance and information sharing recommends that
regulators should have access to information about the exchange
positions of large traders. Also, they should have access to such
traders' related cash and over-the-counter positions in order to
be able to assess fully the risk of such traders' positions to the
Significantly, the regulators at the Tokyo meeting agreed that they should move beyond the mere adoption of statements and expressly committed that they would seek the removal of domestic legal or other barriers to ensure access to the information that permits them to detect and to deter abusive practices and disorderly conditions in the markets, including information on concentrations of positions and the overall composition of the market. This commitment is significant because many regulators need new or expanded powers in order to attain this goal.
The best practices guidances adopted in Tokyo demonstrate an international consensus on how to regulate commodity derivatives markets and a commitment on the part of regulators to enhance their regulatory effectiveness. They also form a framework within which increasing harmonization of regulation may develop. In a world of global markets, the safety of our economy depends on improved regulation around the world. Our exchanges deserve a level competitive playing field in which foreign markets are subject to effective regulation. Market participants should also be free to use markets around the world without the burdens of unnecessary regulatory complexity and diversity. It is true that differences in regulatory approaches will continue, reflecting different cultures and legal systems. However, it is incumbent on regulators to work toward harmonization so that regulation does not unnecessarily impede market access, investment decisions and economic innovation.
The Tokyo Communiqué also encouraged regulators to participate in and to make use of the arrangements for sharing large exposure information which are set out in the Boca Declaration. However, we recognized that restrictive language in the Declaration made it impossible for certain regulators of commodity markets to join in that arrangement. Accordingly, the CFTC and the UK FSA, as co-chairs of the Windsor Declaration, successfully led an effort to amend the Declaration. We are pleased to report that on October 31, 1997, the Japanese MITI and MAFF were the first regulators to execute the amended Declaration, thus becoming the first Japanese market regulators to enter into a formal multilateral arrangement for information sharing. Their entry into this arrangement is a welcome and important addition to the global network of information exchange established by the Declaration.
The Sumitomo incident provided the first concrete test of the information sharing arrangements in the Boca Declaration when the CFTC asked the UK's SIB for information. The Declaration's information sharing arrangements worked, but they could have worked more efficiently. The SIB and the CFTC discussed issues regarding the relevancy and scope of information requested, which initially slowed the exchange of information.
In response to this experience, the CFTC and the UK FSA jointly proposed a practical solution to the Technical Committee of the International Organization of Securities Commissions ("IOSCO"). Our solution was to settle issues of relevancy in advance by developing guidance on the types of information which regulators should be prepared to share under a variety of market scenarios.
This work was taken forward within IOSCO where the CFTC helped to draft a guidance within an IOSCO working group. The guidance developed includes actual lists of questions that regulators could be expected to ask each other during various market crises. The guidance was adopted by the IOSCO Technical Committee at its recent meeting in Taipei in November. Moreover, the guidance had immediate practical use; several members of IOSCO stated that they had relied upon the draft guidance during the October market volatility.
The Commission also took steps this year that resulted in IOSCO's interpreting its membership criteria to allow specialized commodity regulators to become associate members. As a result, MITI and MAFF of Japan became members of IOSCO in November. This action ensures that the regulators of important commodity markets participate fully in the ongoing development of global regulatory standards.
Cooperation by national regulators in an increasingly international market environment is not an option; it is a necessity. To emphasize the CFTC's commitment to assuring that our regulatory regime stays abreast of global change, in July of this year the Commission established for the first time an Office of International Affairs. We hope that the new Office will enhance the CFTC's ability to meet the challenges posed by the globalization of financial markets in three important ways:
I. to respond quickly to market crises that have global systemic implications;
II. to remain an effective supervisor in a global marketplace;
III. to eliminate unnecessary impediments to global business.
Our new Office of International Affairs will play a key role in an
evolving process of the harmonization of regulation which facilitates
market innovation and access while maintaining needed customer and
In advancing these international initiatives, the Commission has not encountered any pressure from other countries to accede to lower regulatory protections as the price for achieving international consensus. On the contrary, we have experienced wide support internationally for raising the level and quality of regulation worldwide. This attitude reflects an international recognition that a regulatory regime featuring strong protections is essential to maintain investor confidence in markets and that confidence fosters liquidity.
Our futures markets are widely recognized as the strongest and most competitive markets in the world. The success and growth in U.S. futures markets are derived in large part from the world-wide perception that US exchanges are fair, liquid and transparent -- characteristics that have been developed under the regulatory scheme of the Commodity Exchange Act. Emulating the success of the US markets, other countries have developed their own futures and option markets during the past decade, and many of those countries look to the U.S. regulatory scheme as the world model. The success of the Commission's international initiatives depends upon the international recognition of the critical importance of maintaining high levels of market and customer protections. The CFTC plans to continue to play an active role in fostering this emerging international regulatory consensus.