COMMODITY FUTURES TRADING COMMISSION
HOUSE COMMITTEE ON APPROPRIATIONS
SUBCOMMITTEE ON AGRICULTURE, RURAL DEVELOPMENT,
FDA, AND RELATED AGENCIES
MARCH 4, 1999
Mr. Chairman and Members of the Subcommittee, I am pleased to appear before you this morning to discuss the President's fiscal year ("FY") 2000 budget request for the Commodity Futures Trading Commission ("CFTC" or "Commission"). In my testimony today, I will provide the Subcommittee with an overview of the proposed budget for FY 2000, discuss the need for additional resources for the Commission's programs and update you on highlights of FY 1998.
REQUEST FOR APPROPRIATIONS IN FISCAL YEAR 1999
The President's FY 2000 budget request for the Commission is $67.7 million. That sum represents $6.7 million more than the amount appropriated to the Commission for FY 1999. Included in the increase is approximately $4.7 million which is necessary for the Commission to maintain current services and operations. The remaining $2.0 million increase would support the addition of 41 full-time equivalent ("FTE") staff years, a seven percent increase in staffing. The budget request would provide the Commission with the resources needed effectively to perform its legislative mandate under the Commodity Exchange Act ("CEA" or "Act").
OVERVIEW OF FUNDING LEVELS AND OPERATIONAL EFFECTS
The Commission has a statutory mandate to oversee the nation's futures and option markets, including on- and off-exchange transactions in futures and options. The Commission is responsible for ensuring the economic utility of these markets by guarding the integrity of the markets, protecting customers from fraud and other trading abuses, monitoring the markets to detect and to prevent price distortions and manipulation, and encouraging the competitiveness and efficiency of the nation's futures exchanges. Through effective oversight regulation, the CFTC enables the futures markets better to serve their vital functions in the nation's economy, price discovery and hedging.
The Commission also oversees 62,000 commodity professionals who trade on the floor of the exchanges or represent customers. Our goal is to ensure that these firms and individuals meet standards of fitness, maintain financial integrity, use proper sales practices and provide adequate risk disclosures to their customers.
For well over a century, futures transactions have enabled producers, merchandisers and processors of agricultural commodities to protect against adverse price movements. Subsequent innovations expanded markets to include contracts for other physical commodities such as metals and energy products. In recent decades, the derivatives industry has developed new on- and off-exchange futures and option products that have given financial institutions and others tools to protect against currency fluctuations, equity index variations, and interest rate changes. The proven utility of these derivative transactions has resulted in phenomenal growth in trading volumes.
Examples of this growth and the great expansion of the Commission's oversight and regulatory responsibility include the following:
Increased exchange trading volume: The CFTC supervises all trading of futures and option contracts on U.S. futures exchanges. The commodity futures and option markets have experienced dramatic growth. Exchange futures and option trading has increased by over 100 percent in the last decade (from 295 million to 630 million contracts). In the last year alone, the number of futures and option contract transactions grew from almost 555 million in 1997 to 630 million in 1998, an increase of 12 percent. The Commission's regulatory program encourages this healthy growth by assuring market participants around the world that our markets are safe, fair and transparent.
Growth of over-the-counter derivatives: The CFTC exercises oversight of some portions of the rapidly growing and evolving over-the-counter market in derivative instruments. The CFTC works with other U.S. financial regulators and with the international regulatory community to address disclosure and market integrity issues in the global market. This enormous market, currently estimated to have a notional value well in excess of $70 trillion world-wide, has emerged in the past decade.
Growing managed funds: The CFTC regulates commodity pool operators ("CPOs") and commodity trading advisors ("CTAs"). Funds committed to professional management for futures trading have grown exponentially, from $115 million in 1975 to over $39.9 billion today. This area of financial investment includes a growing number of pension and mutual funds. The Commission has worked with industry groups and other regulators to improve and to simplify disclosure requirements, which allow customers to make informed investment decisions.
Rapid innovation: The CFTC approves contracts traded on futures and option exchanges and rules of such exchanges and the National Futures Association ("NFA"). Since 1986, the CFTC has approved over 500 new contracts for trading on exchanges. Many of these innovative contracts have brought new market users within CEA protection for the first time. The CFTC has worked closely with both the exchanges and industry representatives to assure that new contracts will create hedging opportunities and enhance price discovery and price basing of the underlying commodities.
Expanded Congressionally mandated responsibilities: The CFTC's authority and responsibilities have grown substantially since the Commission was created in 1975. For example, Congress passed the Futures Trading Practices Act of 1992, giving the CFTC a number of new responsibilities to ensure market integrity. Ongoing activities include enforcing heightened audit trail standards for exchanges and improving the CFTC's own oversight and enforcement programs. In 1995 Congress reaffirmed these obligations by adopting a reauthorization of the Commission through fiscal year 2000.
Growing internationalization of the markets: Futures and option markets are becoming increasingly global, further increasing the complexity of the CFTC's oversight responsibilities. The agency must respond promptly and effectively to international developments, such as the collapse of Barings Plc. and the manipulation of copper prices by Sumitomo Corporation. The agency has ongoing responsibilities to ensure that its regulatory framework is capable of responding to the domestic implications of problems arising anywhere in the world. It has become a leader in encouraging international cooperation and improvement of futures and option regulation abroad.
Technology developments: The exchanges, commodity professionals and users of the markets are turning to newly developed technologies to cope with the huge growth in this industry. Likewise, the CFTC has had to augment its staff as well as its hardware and software to keep pace with the growth in the markets. Technology also poses regulatory challenges to the CFTC, including the need to police futures and option trading advice and sales offered illegally via the Internet.
During the past five years, both the Administration and Congress have recognized the need for additional resources at the CFTC to maintain effective oversight over the growing and evolving futures and option markets. Accordingly, the CFTC has received increased appropriations to maintain current service levels from year-to-year, to provide additional resources to the Commission's Division of Enforcement and to permit investments in technology to increase the Commission's ability to conduct adequate market surveillance.
The proposed increase in funds for FY 2000 is necessary to enable the Commission to keep pace with the rapid growth in volume and the profound changes resulting from novel transactions, new trading systems, new market practices, advances in technology, and the globalization of the markets. The additional resources would be dedicated primarily to maintaining an effective enforcement, surveillance and oversight presence in these rapidly changing and growing markets. In addition, the Commission must remain responsive to technological developments, business changes, and market evolution so as not to burden innovation and financial market growth with regulatory inefficiencies and outmoded regulatory structures. The Commission began a comprehensive regulatory review and reform initiative in FY 1997, which is ongoing and will continue into FY 2000. Without the requested additional resources, the Commission would not be suitably equipped to carry out effective enforcement, market surveillance and regulatory reform.
Much of the requested increase will be dedicated to the Division of Enforcement, which will receive an allocation of sixteen additional FTE staff years. That allocation of resources would make the Division's employment level the strongest since FY 1992. The addition of these staff years would enable the Commission, through the Division, to meet increasing demands.
The additional FTEs will be devoted to investigation and prosecution of matters involving fraud, quick-strike cases, and large, complex cases, including manipulation cases. The Division's flexible organizational structure will allow the Enforcement program to devote necessary staff to respond appropriately to such cases without detracting from a strong enforcement presence across the industry.
The Division of Trading and Markets would receive 13 FTE staff years under the FY 2000 budget. The Division of Trading and Markets has taken the lead in developing many of the regulatory reform initiatives that have been undertaken or are being considered by the Commission. A number of those initiatives are discussed in the Commission's highlights of FY 1998 described below. Additional resources are needed to develop innovative regulatory approaches to address new product developments, market linkages, and trading mechanisms and to assure that clearing organizations, firms holding customer funds, and other commodity professionals operate safely and consistently with the public interest. The resources will also enhance Commission oversight of contract market standards and practices.
The Commission's FY 2000 budget request also would add seven FTE staff years to further the Commission's market surveillance efforts. These FTEs are necessary to conduct surveillance on the expanding number of diverse and innovative futures and option markets being developed by the exchanges and on the electronic exchanges that are emerging to compete with traditional exchanges.
For the first time in recent years, the FY 2000 budget proposal would add three FTE staff years to the Office of the General Counsel. A number of issues will contribute to the increased workload of the Office of the General Counsel, notably the continued development of innovative financial instruments and products and the ongoing global expansion of futures trading, particularly in the areas of after hours and electronic trading.
The final two additional FTE staff increases will be provided to the Commission's Executive Direction and Support. One position would be allocated to the Commission's Office of the Secretariat and a second would be allocated to the Office of Financial Management for contract and procurement oversight.
The requested increase in funding and staffing will strengthen the Commission and will increase its ability to oversee the growing and vital futures and option markets that are critical to our nation's economy.
HIGHLIGHTS OF FISCAL YEAR 1998
In May 1998, the Commission issued an order instituting proceedings, making findings, and imposing remedial sanctions upon Sumitomo Corporation of Japan ("Sumitomo"). In the order, which accepted an offer of settlement in which Sumitomo neither admitted nor denied the findings, the Commission found that Sumitomo engaged in a scheme to manipulate the price of copper. The Commission ordered Sumitomo to cease and desist from further violations of the Act and to pay a total of $150 million. Of that amount, $125 million was paid as a civil monetary penalty immediately. The penalty is believed to be the largest civil monetary penalty ever imposed by an agency of the United States government. The remaining $25 million was placed in escrow for a period of up to four years to provide restitution to persons injured by the unlawful conduct of Sumitomo. Those monies are expected to be paid out as restitution to private persons pursuant to settlement orders awaiting final approval by the courts.
In addition, the Division in FY 1998 continued to file cases alleging fraud in the offer and sale of various off-exchange instruments, including precious metals contracts and foreign currency contracts marketed to the general public. The Division also pursued cases against firms and individuals using fraudulent advertising and solicitations.
The Division also continued its investigation of individuals and entities in connection with hedge-to-arrive ("HTA") contracts and in FY 1998 filed an additional complaint. More recently in FY 1999, the Division issued two new complaints relating to HTA activities from 1995-1996, and one of these cases was settled. No further HTA cases are anticipated at this time.
One of the Commission's top priorities in FY 1998 and continuing into FY 1999 has been to modernize and to streamline its regulatory framework. Much of the Commission's regulatory regime dates back to its early years as an agency. The explosive growth and change in our markets as well as revolutionary technological developments have necessitated a comprehensive review of the Commission's regulations. The Commission must ensure that its rules adapt to changes in the marketplace and continue to provide an effective level of regulation and public protection. Toward that end, the Commission has proposed or adopted a number of regulatory reform initiatives in the last year, some of which I would like to highlight here today.
The Commission also issued concept releases seeking public comment on
the following significant regulatory issues:
Each of these releases illustrates profound changes occurring in the futures markets and the need for the Commission and Congress to grapple with difficult and rapidly evolving regulatory and statutory issues.
In FY 1998, the Commission reviewed and approved 58 applications for new futures and option contracts 27 futures contracts and 31 option contracts. Of the 58 designation applications, 38 were processed under the new CFTC fast-track procedures. Several of the approved contracts represent innovative approaches designed to meet specialized hedging needs of producers and firms. For example, the Commission approved futures and option contracts submitted by the New York Mercantile Exchange ("NYMEX") based on coal produced in the US Central Appalachian region. Also, the Commission approved bankruptcy index futures and option contracts and Russian ruble futures and option contracts submitted by the Chicago Mercantile Exchange ("CME").
AGRICULTURAL TRADE OPTIONS
Effective June 15, 1998, the Commission removed the longstanding ban on trade options on the agricultural commodities enumerated in the CEA. Since then, staff have prepared educational materials on the new regulatory scheme for these market instruments and have met with agricultural trade groups to discuss the program's rules.
Agricultural options (both on- and off-exchange) were traded in the United States at least from the time of the Civil War until the 1930s. However, concerns about fraudulent sales practices, failure to perform over-the-counter obligations, and the use of exchange-traded options to manipulate the prices of agricultural commodities prompted numerous industry and government efforts to limit or eliminate trading in agricultural options. In 1936, Congress banned all sales of options on certain agricultural commodities listed in the CEA. In 1982, Congress lifted the 1936 statutory ban, allowing the Commission to permit options on certain agricultural commodities listed in the Act. The Commission permitted exchange trading in these agricultural options in 1984. There have been deep divisions within the agricultural community on whether the ban on off-exchange agricultural options should be lifted.
During the summer of 1997, the Commission sought public comment on the issue of lifting the ban on agricultural trade options. The Commission heard statements by interested parties at field meetings held in Bloomington, Illinois and Memphis, Tennessee.
On November 4, 1997, the Commission published a notice of proposed rulemaking in the Federal Register, which proposed to remove the prohibition on off-exchange trade options on certain agricultural commodities pursuant to a three-year pilot program. The Commission received 448 comments on the proposed rules.
After carefully considering the comments, the Commission adopted interim final rules on April 16, 1998. In doing so, the Commission stated its intent to reexamine the rules during and at the conclusion of the three-year pilot program. The interim rules permit only those entities that are cash market participants in the commodity to offer to buy or sell such options on that commodity. Vendors of such options are required to: 1) become registered as agricultural trade option merchants ("ATOMs"); 2) report to the Commission on their transactions (subsequently delegated to the National Futures Association); 3) provide their customers with disclosure statements; and 4) safeguard their customers' premiums. The rules also exempted individuals or entities which meet a substantial financial requirement. Finally, the Commission removed the prohibition on the offer or sale of exchange-traded options on physical agricultural commodities. Members and staff of the Commission have indicated that they would be open to proposals to revise the pilot program and we understand that industry representatives currently are working on such a proposal.
DELIVERY SPECIFICATIONS FOR CHICAGO BOARD OF TRADE FUTURES CONTRACTS
In December 1996, the Commission voted unanimously to notify the Chicago Board of Trade ("CBOT") under section 5a(a)(10) of the Commodity Exchange Act (Act) that the delivery terms of the CBOT corn and soybean futures contracts no longer accomplished the statutory objectives of "permit[ting] the delivery of any commodity . . . at such point or points and at such quality and locational price differentials as will tend to prevent or diminish price manipulation, market congestion, or the abnormal movement of such commodity in interstate commerce." On November 7, 1997, the Commission issued a Final Order to the CBOT changing and supplementing the delivery specifications of its corn and soybean futures contracts. By submission dated March 20, 1998, the CBOT proposed revisions to the November 7, 1997 Final Order. The Commission on May 7, 1998, adopted the proposed revisions.
ELECTRONIC TRADING DEVELOPMENTS
The Commission is faced with an increasing number of important issues concerning the impact of technological changes on methods of transacting business on futures exchanges. The Commission has had before it three different issues related to developments in electronic trading. First, the Commission approved an application from the Cantor Financial Futures Exchange ("CFFE") to be designated as a contract market for the computer-based trading of US Treasury bond, and ten-, five-, and two-year note futures contracts. The CFFE is the first U.S. designated exchange on which there is only electronic trading.
A second issue before the Commission involves the placement of foreign boards of trade terminals in the United States. The Commission issued a concept release on July 24, 1998, to solicit the views of the public on important questions concerning whether foreign boards of trade should be permitted to place their computer terminals in the US without being subject to designation as a US contract market and, if so, what requirements and conditions should apply.
Finally, the Commission is addressing the application of Futurecom, Ltd., a Texas limited partnership owned by the Texas Beef Group, to be designated as the first Internet-based futures exchange. Futurecom has applied for designation as a contract market in cash-settled live cattle futures and options and technology stock index futures.
The Commission's current regulatory provisions exempting certain types of over-the-counter ("OTC") derivatives from certain provision of the CEA were adopted more than five-years ago. The Commission issued a concept release in May 1998 seeking public comment on whether its current regulatory structure applicable to OTC derivatives should be modified in any way.
In addition, the Commission is participating in the President's Working Group on Financial Markets' studies on hedge funds and the OTC derivatives market. The Commission staff has conducted and compiled the results of an international survey of regulations governing OTC derivatives activity.
YEAR 2000 COMPUTER COMPLIANCE INITIATIVES
The Commission has been working since 1994 to prepare for the Year 2000 to ensure that its own systems are Year 2000 compliant. In addition, the Commission has worked with the futures exchanges and the National Futures Association ("SROs") to execute a comprehensive and multifaceted approach to assist the futures industry in achieving Year 2000 compliance. The actions taken include: 1) sending questionnaires to SROs and registrants; 2) specifying Year 2000 responsibilities for SROs, registrants, and auditors; 3) working with the American Institute of Certified Public Accountants (AICPA) to develop agreed-upon procedures to assess programs to ensure Year 2000 readiness; and 4) fostering testing and contingency planning preparations. The Commission is working closely with the Futures Industry Association ("FIA") to monitor industry testing of connectivity and clearing functions. Such testing will continue throughout the industry in 1999. The Commission also participates in the President's Council on the Year 2000 Conversion, as well as other domestic and international industry groups addressing the Year 2000 problem.
SEXUAL HARASSMENT TRAINING
Sexual harassment is a problem faced by employees and employers nationwide. As a result, many organizations have taken steps to eliminate harassment in the workplace and to increase awareness of the various types and impact of inappropriate gender-based conduct.
In response, the Commission recently adopted a new sexual harassment policy. The new policy was provided to all employees and was featured as part of Commission-sponsored mandatory sexual harassment training.
The Commission's authorization for appropriations expires on September 30, 2000. Thus, legislation to reauthorize the Commission is likely to be acted on during the 106th Congress. The process began recently with a symposium on February 25 and 26, 1999, co-hosted by Senator Richard Lugar, Chairman of the Senate Committee on Agriculture, Nutrition and Forestry, and Representative Larry Combest, Chairman of the House Committee on Agriculture. The Commission looks forward to working with all of the members of the authorizing and appropriating committees with an interest in the Commission on this major legislative effort for the 106th Congress.
Separately, the CFTC has been monitoring the progress of the recently reintroduced Financial Services Act of 1999 (H.R. 10). During Congressional action in the 105th Congress on the bill, the Commission was joined by several exchanges in expressing concerns that the legislation could create conflicts between the federal banking, securities and derivatives laws. We are pleased that this year's legislation includes a savings clause for the Commodity Exchange Act that has been endorsed by the Commission.
The Commission appreciates this opportunity to report to the Subcommittee on its accomplishments of the past year and to reiterate its commitment to fulfilling its Congressional mandate to oversee the United States futures and option markets. As we look ahead to FY 2000, the Commission seeks additional appropriations to enhance its enforcement efforts, to improve its surveillance abilities, and to build on the Commission's ability to respond to a rapidly changing derivatives market.
Thank you. I would be happy to answer any questions you may have.