COMMODITY FUTURES TRADING COMMISSION
COMMITTEE ON AGRICULTURE, NUTRITION AND FORESTRY
UNITED STATES SENATE
MAY 14, 1998
Mr. Chairman and Members of the Subcommittee:
I am pleased to appear today on behalf of the Commodity Futures Trading Commission (CFTC or Commission) to discuss the Commissionís program to ensure that it and the futures industry will be technologically prepared for the Year 2000. The CFTC has long been aware of the potentially debilitating effect that lack of adequate Year 2000 preparation could have on the futures industry.
The CFTC is a small independent agency with a mandate to oversee the economic utility of futures and option markets, encourage their competitiveness and efficiency, and protect market participants. The Commission has direct regulatory responsibility over eleven futures exchanges, six clearing associations, the National Futures Association (NFA), and more than 60,000 registrants. Commission registrants include, among others, approximately 227 commodity brokerage firms referred to as futures commission merchants (FCMs), 1,556 introducing brokers (IBs), 1,364 commodity pool operators (CPOs) and 2,630 commodity trading advisors (CTAs). In addition to these firm registrants, the Commission also regulates approximately 54,883 individual floor brokers, floor traders and associated persons.
In my testimony today I shall first discuss what the CFTC is doing to ensure that its own systems will be Year 2000 compliant. Next, I shall describe the Commissionís program to encourage the Year 2000 compliance by the futures industry. Finally, I shall discuss how the CFTC is joining in national and international efforts to address concerns that the failure of systems in one industry or in one part of the world could endanger systems elsewhere.
THE COMMISSIONíS INTERNAL SYSTEMS
The Commission has been preparing its internal computer systems for compliance since it became aware of the need for Year 2000 readiness in 1993. In that year, the Chicago Mercantile Exchange announced plans to begin trading certain contracts with expiration dates occurring after December 31, 1999. With that announcement, Commission staff began an analysis of the CFTCís systems to determine their ability to process Year 2000 dates.
The Commission relies on two mission-critical mainframe systems to conduct its regulatory oversight, the Integrated Surveillance System (ISS) and the Exchange Database System (EDS). The ISS supports Commission staff in carrying out the daily monitoring of futures and option trading to detect potential problems and trends in the marketplace. This system basically provides continuously updated data concerning holders of large futures and option positions. The EDS is used by Commission staff to conduct trade and market investigations. The system provides access to all data regarding transactions on every CFTC-regulated exchange.
After the Chicago Mercantile Exchange announced its plans to begin trading contracts with a Year 2000 expiration date, the Commission modified the ISS and EDS and tested them for Year 2000 compliance. Since 1994, the systems have been processing Year 2000 data successfully. Thus, the Commissionís mission-critical systems have been fully Year 2000 compliant for several years.
Other Internal Systems
Coincident with making changes to the Commissionís mission-critical systems, we made several strategic decisions that have facilitated our preparation for the Year 2000. First, we adopted a policy requiring that all new systems development work must include design specifications and test plans to insure Year 2000 compliance. Second, as part of our long-range strategic systems planning process, we analyzed the growing computing requirements of the Commission and the technological alternatives available for meeting those requirements and concluded that we should migrate from our mainframe environment to a client-server environment. That decision, which is consistent with the requirements of OMB circular 96-02, has enabled us to take advantage of the most current hardware and software products available in the marketplace -- products whose design criteria have included requirements that they are Year 2000 compliant.
The Commission is reliant on automated systems to conduct its essential work. That reliance has resulted in regular hardware, software and communications equipment upgrades. In 1996, for example, in anticipation of the increased desktop processing requirements of client-server systems we were developing, we began modernization of the personal computers (PCs) in use at the Commission. This effort resulted in the installation of Year 2000 compliant Pentium computers for ninety-five percent of Commission staff. The remaining staff will receive these Pentium computers this summer.
In the course of relocating our headquarters office in the fall of 1995, we upgraded our internal network facilities to accommodate the anticipated growth in data traffic which would result from our adoption of a client-server architecture. In the summer and fall of 1996, we performed a similar upgrade to the communications equipment which connects our six office locations. All of that new equipment has been upgraded to be Year 2000 compliant.
In April 1997, we conducted a comprehensive inventory of the Commissionís hardware and software and reviewed our existing plans for upgrades in the coming year. We found that we were likely to reach Year 2000 compliance in advance of the then-existing target dates specified by OMB for government systems.
Since that time we have replaced all remaining non-Pentium PCs and installed Windows 95 and Microsoft Office 97 as our standard desktop software in our headquarter office and in our two largest regional offices. Similar upgrades will be completed in our other regional offices by June 1998. By June 1998, we also expect to complete the replacement of our network server hardware. At that time, all of our PCs, network hardware and communications infrastructure will be Year 2000 compliant.
With regard to our network Operational System (OS) software, we are currently using both Windows NT server OS and Banyan VINES OS. While the Windows NT server OS is Year 2000 compliant, the Banyan VINES OS is not. However, a Year 2000 compliant version is scheduled to be available by June 30, 1998. Although our strategic plan is to migrate the remaining network services for which we employ VINES (file, print and security services) to Windows NT by March 15, 1999, our contingency plan for this area is to upgrade to the Year 2000 compliant version of VINES if necessary.
On January 20, 1998, the Office of Management and Budget (OMB) issued Memorandum 98-02 announcing changes in government-wide goals for Year 2000 compliance. OMB established "a new target date of March 1999 for implementing fixes to all systems Ė both mission critical and non-mission critical. OMB has also established a new date of September 1998 for completion of renovation and January 1999 for completion of validation." OMB further directed that "agencies must have contingency plans for those systems that are not expected to complete implementation by March 1999."
Only a few tasks remain to make all internal Commission computer systems Year 2000 compliant. With one exception, the Commission anticipates achieving the OMB target dates. The current version of the CFTCís financial management system (FMS), the mainframe-based system which is used by our Office of Financial Management to manage our budget, is not Year 2000 compliant. Commission staff currently are evaluating a Year 2000 version of the current mainframe system as well as a number of alternative systems that could perform this function long term. We anticipate that a Year 2000 compliant replacement system will be selected by June 30, 1998, and will be in place and operational by June 30, 1999. Nonetheless, the Commission has a short-term contingency plan for this activity and, if necessary, will upgrade to the Year 2000 compliant version of the FMS and continue to operate the system on the Commission's mainframe computer until June 30, 2000, at the latest. Toward this end, OMB has granted the Commissionís request for an extension through June 30, 2000, to comply with its mandate to close our mainframe data center. This would allow the Commission an additional year to implement the selected long-term alternative system, should it be necessary to employ the contingency plan.
A few minor software applications in use at the Commission utilize software products that are not Year 2000 compliant. These applications support administrative processes such as tracking travel expenditures, staffing levels and other non-critical recordkeeping activities. We are identifying all such systems and will make necessary adjustments by March 31, 1999.
We are looking at our other internal systems. We have identified all equipment in use (e.g., telephone systems, pagers, and copiers) that contain embedded technology. We are in the process of contacting the manufacturers and/or vendors of this equipment to determine its Year 2000 readiness and will repair or replace these items as necessary. We have verified that the telephone system used at the headquarters office is Year 2000 compliant. The voice mail system associated with it will be upgraded prior to March 31, 1999, for Year 2000 compliance with a software patch that is currently available. The voice communication hardware and software in the other regions are currently being assessed, and non-compliant systems will be replaced by March 31, 1999.
The Commission currently relies on some external systems over which we have little control. For example, we rely upon the Department of Agriculture National Finance Center (NFC) for payroll and personnel processing. The NFC has announced plans to achieve Year 2000 compliance in all of its systems during FY 1998. We are working closely with the NFC as it moves toward that goal by participating in testing the new systems. However, if delays occur, or if the project goal otherwise appears to be in jeopardy, the Commission will develop a contingency plan in early FY 1999, such as outsourcing services to another government agency. The Commission also relies on several external systems operated by OMB, the Office of Personnel Management and the Department of the Treasury. Staff currently are contacting those entities to ascertain the Year 2000 status of systems used by the Commission.
The Commission leases private office space at all of its locations. Staff are currently contacting each of our landlords to discuss Year 2000 readiness of all building facilities and equipment.
THE COMMISSIONíS PROGRAM RELATING TO THE FUTURES INDUSTRY
The Commissionís regulation of the futures and options markets relies heavily on the activities of self-regulatory organizations (SROs) -- the exchanges and the National Futures Association (NFA) -- which exercise regulatory responsibilities relating to their members subject to Commission oversight. The Commission believes that, although the Year 2000 problem calls for intense regulatory focus, this task can best be accomplished through the pre-existing framework of regulation by SROs coupled with Commission oversight. The SROs have responsibility for ensuring their own Year 2000 compliance and for encouraging that of their members. The Commission, in conjunction with the SROs, has executed a comprehensive and multifaceted approach to assist the futures industry achieve Year 2000 compliance. The actions taken include sending questionnaires and letters to SROs and registrants requesting detailed information regarding their Year 2000 actions; specifying Year 2000 responsibilities for SROs and registrants; fostering the industryís development of systems and interfaces testing; making clear that a lack of Year 2000 preparation could constitute a violation of Commission regulations; and requiring special Year 2000-related reports and audit procedures.
In January 1997, the Commission sent letters to all SROs emphasizing the gravity of the potential Year 2000 problem and requesting information about their plans to address it. See Attachment A. The purpose of this step was to increase industry awareness of the potential problem and to prompt an assessment of systems for Year 2000 readiness. The responses indicated that most SROs already were engaged in assessing their systems, although the pace and methods varied.
In November 1997, the Commission issued an advisory entitled "Year 2000 Computer Problem." See Attachment B. The advisory identified the minimum phases of "a sound Year 2000 preparedness plan" to include: (1) identification of systems that are Year 2000 vulnerable; (2) update of the systems; (3) extensive testing; and (4) contingency planning in the event of malfunction of any part of the system. These phases are, and continue to be, the matrix for the Year 2000 planning of the Commission and the futures industry.
The advisory informed FCMs and IBs of their duty under Commission regulations to report "material inadequacies" in their Year 2000 activities to the Commission and their designated SRO. The advisory also informed CPOs and CTAs that they must disclose all material information relating to their Year 2000 preparedness to pool participants and clients. The Commission stressed that industry participants are responsible for inquiring whether each entity on which they rely for any part of their operation, such as a service bureau, is actively involved in bringing its systems into Year 2000 compliance and for conducting testing to ensure that system interdependencies have been addressed adequately.
Also in November 1997, the Commission requested that the Joint Audit Committee (JAC) add a Year 2000 component to the yearly inspection of FCMs and IBs by SROs. The JAC comprises senior representatives from the SROs -- the exchanges, the clearinghouses, and NFA -- who are responsible for conducting audits of their members, including yearly audits of FCMs, and for other surveillance activities. The Commission directed that JAC auditors review the Year 2000 plan of the registrants for which they are responsible and ascertain that those registrants adhere to their Year 2000 preparation schedule.
In March 1998, the JAC and NFA sent a Year 2000 questionnaire requesting exchange and non-exchange member FCMs, among other things, to identify the highest management level responsible for their Year 2000 project, to describe its staffing and budget and to provide details regarding its scope. See Attachment C. Most responses to this questionnaire have been received and the evaluation process has begun. In April 1998, NFA sent a similar questionnaire to IBs, CPOs, and CTAs. The responses are due May 15. The responses to questionnaires will be used to monitor individual firmsí progress in their Year 2000 preparations.
Also this Spring, the Commission sent comprehensive follow-up letters to SROs requesting a detailed accounting of their internal and external Year 2000 activities. See Attachment D. The information requested includes details regarding implementation and testing of internal and external systems; the scope, methodology and timeliness of system performance verification or certification; and the internal and external contingency plans being developed by each SRO. Responses to this request are due in mid-May. CFTC staff plan to meet with each SRO to discuss its response to the Commissionís letter and the results of its review of membersí responses to the questionnaires.
Most recently, on April 28, 1998, the Commission issued an advisory entitled "Year 2000 Problem Ė Reporting and Disclosure Requirements." See Attachment E. The advisory provides clear guidance to Commission registrants concerning the basis for reporting and disclosure obligations. It lists numerous steps that must be accomplished at the planning, scheduling, staffing and approval and control levels. Any material failure to meet the noted steps would constitute a "material inadequacy" under Commission regulations. The Commissionís regulations require that material inadequacies must be reported by an FCM, IB, or its auditor to the relevant SRO and to the Commission. Similarly, a CPO or CTA must disclose material information in a disclosure document for customers or investors required by Commission regulation and reviewed by the NFA. The advisory makes clear that a failure to meet Year 2000 goals would be required disclosure. Further, it stresses the necessity for involvement in Year 2000 planning by the highest level of management such as the board of directors.
The Futures Industry Association, a WashingtonĖbased trade association representing FCMs, markets users and various service providers, is in the process of organizing extensive Year 2000 compliance testing to be performed commencing in June of this year. The CFTC is currently participating in meetings concerning the FIAís coordination of industry testing and intends to monitor closely the results of the testing. During the testing period, from June of this year until the first quarter of 1999, transactions will be simulated for four key dates: December 31, 1999, January 3 and 4, 2000, and February 29, 2000, which is a leap day.
Point-to-point testing, which will focus on the links between an exchange and a memberís back office, is scheduled to begin in June 1998. In September and November 1998, a full clearing cycle will be conducted for a limited group of industry participants. All participant firms will run a full dayís processing cycle, including trade submission and reporting. Industry-wide testing is expected to occur in the first quarter of 1999. The Commission is encouraging exchanges to make testing mandatory for their members.
The Commission is now intensifying its requests for specific contingency planning on the part of firms and SROs. These procedures, for example, could provide for substitute processes, the authority to initiate them, and the necessary staffing to implement them. The information being gathered through questionnaires, reports, and audits, plus future test results, will form a factual basis for such planning.
So far I have addressed the Commissionís efforts to ensure that it is prepared for the Year 2000 and that the U.S. futures industry likewise will be ready to meet this challenge. Other dimensions of the problem also are of concern to the CFTC. The operation of the futures industry depends on the performance of other U.S. private sectors, such as the banking industry. Furthermore, the growing global linkages of markets and market participants make the domestic futures industry vulnerable to failures abroad.
The CFTC is taking an active part in discussions among parties that share these concerns. The Commission is a member of the Presidentís Council on Year 2000 Conversion. The Councilís mission is to monitor federal agency efforts throughout the Year 2000 conversion process and to coordinate the outreach by federal agencies to those outside the government to increase awareness of the Year 2000 problem. The Council also attempts to anticipate the effect on the U.S. of systems failures and to help with contingency planning.
The Commission also participates in meetings of the Presidentís Working Group on Financial Markets Year 2000 Issues. The Working Group is made up of the Secretary of the Treasury, the Chairperson of the CFTC, the Chairman of the Federal Reserve Board of Governors, and the Chairman of the Securities and Exchange Commission; other financial regulators such as the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Federal Reserve Bank of New York, the Office of Thrift Supervision, the National Economic Council, and the Council of Economic Advisors also participate. The meetings permit representatives to keep each other informed of their Year 2000 initiatives and generally to share information, ideas and solutions.
As a member of the International Organization of Securities Commissions (IOSCO), the CFTC is also working actively in the international forum. In November 1997, IOSCO surveyed securities and futures regulatory agencies worldwide to assess Year 2000 awareness and planning. IOSCO has recently sent a new survey that focuses on testing and contingency planning. As foreign regulatory authorities progress in addressing Year 2000 problems, we anticipate increasing international discussion and cooperation in this area, and the Commission is committed to working to minimize the exposure of U.S. futures markets and participants to Year 2000 malfunctions abroad.
The Commission and the futures industry already have made a concerted effort to prepare for the Year 2000, and much progress has been made. The Commission fully intends to maintain the highest priority for its Year 2000 program. The Commission plans to focus its continuing Year 2000 activities on evaluating the information collected from SROs and firms in the questionnaires, audits, and ad hoc reports I previously discussed and on evaluating the results of testing that will commence shortly. Those sources should provide meaningful data for a timely assessment of Year 2000 readiness, including the identification of firms that appear likely to experience problems due to insufficient or untimely preparations. The firms so identified will be the subject of intensive follow-up by the SROs responsible for overseeing their activities and by the Commission as necessary. Both the Commission and the SROs have authority to restrict or to terminate the activities of a registrant that experiences difficulties, and the Commission is studying the circumstances under which this should be done in the event of a Year 2000 deficiency.
The Commission also believes that coordination within the industry, across industries and internationally must continue to be a vital part of its Year 2000 preparation. To this end, the Commission will continue to take an active part in the coordinating committees and task forces that are influential in increasing Year 2000 awareness and fostering planning and coordination.
No amount of effort and planning can ensure that there will not be some business whose work is interrupted because of a Year 2000 malfunction. However, the Commission is actively working to ensure that parties over which it has jurisdiction are making appropriate efforts to bring about as smooth a turn into the next millennium as is reasonably achievable.