"THE DANGERS OF DEREGULATION"
REMARKS OF BROOKSLEY BORN, CHAIRPERSON
COMMODITY FUTURES TRADING COMMISSION
BEFORE THE FUTURES INDUSTRY ASSOCIATION'S 22ND ANNUAL INTERNATIONAL FUTURES INDUSTRY CONFERENCE
Boca Raton, Florida
March 13, 1997
I am pleased to have the opportunity to be with you today, and I am sure it will come as no surprise that I intend to speak on the proposed legislation pending in Congress to amend the Commodity Exchange Act. In the Commission's view, it is entirely appropriate to reexamine the Commodity Exchange Act to determine whether it continues to be effective and efficient in regulating our markets, and I commend Congress for doing so. Those markets have changed radically over the years, and the Act may well require amendment to reflect those changes. I appreciate the effort undertaken by Congressman Ewing and Senators Lugar, Leahy and Harkin to address these difficult and important issues.
The Commission has endorsed a number of thoughtful provisions in the pending Senate bill. In addition, two weeks ago the Commission adopted regulatory changes that accomplish the goals of the contract designation and rule approval provisions of that bill. We are also engaged in discussions with the Treasury Department in an effort to arrive at a consensus concerning clarification of the Act's Treasury Amendment provision. The Commission remains committed to working with Congress to craft legislation that modernizes the Act while protecting the public interest.
However, the Commission strongly opposes the professional market exemption in the pending bills, which would lead to pervasive deregulation of our futures exchanges. Federal oversight of the futures exchanges would be eliminated as long as exchange trading was limited to certain so-called "appropriate persons." These traders would include small businesses, proprietorships, partnerships, pension funds, mutual funds, and commodity pools of individual investors, as well as large institutions. The exchanges estimate that approximately 90 percent of their current trading volume is on behalf of such appropriate persons. Therefore, it is likely that simple exchange rule changes could convert them into professional markets subject to no federal oversight.
The professional markets exemption would create U.S. futures exchanges with less government regulation than any other significant futures exchanges in the world. For a decade, the Commission has played a vital role in encouraging other countries to adopt necessary regulatory regimes for their futures exchanges, and they are doing so. The bills -- if enacted -- would send a signal that the U.S. is no longer willing to act as a world leader in setting the standards to protect the economy and the public from the risks these exchanges pose. Indeed, the bills would allow exchange trading with far less governmental oversight and regulation than the London Metal Exchange at the very same time that the United Kingdom is strengthening its regulatory protections to prevent a reoccurrence of the Sumitomo Corporation debacle.
The deregulation of exchange trading possible under the professional markets exemption would eliminate federal power to protect against manipulation, fraud, financial instability and other dangers. The bills preserve CFTC jurisdiction to bring fraud and manipulation cases after the fact. But that limited authority would provide only the illusion of protection since the Commission would be stripped of regulatory tools designed to prevent those abuses from occurring and to detect them when they do occur.
The Commission's market surveillance over the 11 U.S. futures and option exchanges would be eliminated, as would requirements such as speculative position limits, large trader reporting, and exchange recordkeeping. Thus, the Commission would not have the data to analyze aberrational price movements on the markets, including suspected price manipulation. Exchanges would not be subject to the current legal standards relating to their contracts, rules or governance. Standards for trading on these markets such as the requirements of open and competitive trading, open pricing and audit trail would also be abolished.
The Commission supervises 64,000 commodity professionals who trade on the floors of the exchanges or deal with customers. If these persons were to trade only on the exempted professional markets, the standards applicable to them, including registration, fitness standards, risk disclosure to customers, recordkeeping and sales practice standards, would be abolished, leaving customers -- and the markets themselves -- without meaningful governmental protection. Even large institutions can be the victims of fraud and other abuses on these markets, as the Commission's case docket amply demonstrates.
Statutory and regulatory standards relating to the financial integrity of the markets and their participants would also be eliminated. The standards abolished would include segregation of customer funds, net capital requirements, financial reporting, margining of accounts and special bankruptcy protections. In sum, the bills would eliminate seventy years of government protection of the integrity of our markets.
The Senate bill, unlike the House bill, would not permit deregulation of futures markets in certain domestic agricultural products, presumably on the grounds that it would be too dangerous to do so. The Commission believes that futures markets in other products -- energy, metals, tropical agricultural products, and financial instruments -- deserve the very same level of regulatory protection. Furthermore, the Commission is extremely concerned about whether it would be able effectively to regulate and to protect markets in agricultural products that would trade side-by- side on the same exchange with totally unregulated markets.
In the current debate about the professional markets exemption, it has been overlooked that the Commission is committed to the principle that professional exchange markets are entitled to a lower level of regulation than markets open to the general public. We recognize that sophisticated institutional traders do not require the same degree of protection as unsophisticated and inexperienced individuals. As part of its ongoing effort to eliminate unnecessary regulatory burdens, the Commission established a pilot program exempting professional exchange markets from a number of regulatory requirements in November 1995. To date, no exchange has opted to participate in that program. The Commission believes that such a pilot program would provide the necessary experience to determine an appropriate level of regulation for professional exchange markets. I want to reiterate my invitation for any exchange to come in and to provide the Commission with suggestions for improving the pilot program. We remain open to a dialogue with the industry on the issue of reduced regulation at the same time that we stoutly oppose the elimination of regulation.
The exchanges have said that they should be able to operate in the same unregulated environment as the over-the-counter markets -- a result that the pending legislation would likely achieve. However, exchange trading involves important public interest considerations which require a higher level of regulation than over-the-counter markets. Exchanges create a concentration of financial risk not present in bilateral over-the-counter transactions and therefore pose a more serious systemic threat to our economy. While both exchanges and the over-the-counter markets perform a vital public service in providing hedging opportunities, there is also a strong public interest in protecting the price-discovery and price-basing functions uniquely performed by exchanges. The prices established by the futures exchanges affect trillions of dollars of commercial transactions and ultimately the retail prices for many commodities. This price- discovery function requires protection even if particular sophisticated traders do not. That is why Congress created the CFTC and provided it with powers to protect the public interest in these markets.
Merely restricting participation in the futures markets to large institutions is insufficient to protect these important public interests and cannot justify abandoning the protections of the Act. In fact, it is the large institutions which have the power to do the greatest harm to the markets through attempts at manipulation, price distortions, and financial irresponsibility. To demonstrate this point, I need only refer to the effect on the price of copper by Sumitomo Corporation's trading, the financial repercussions from the collapse of Barings Plc., Metallgesellschaft's enormous loss in the oil market, and the Hunt brothers' attempt to manipulate the world market in silver.
The U.S. exchanges are the strongest, most dynamic and most innovative in the world. Their volume of trading in 1996 was the second highest in history, and the Chicago Board of Trade set a new trading record as the world's largest exchange. The CBOT has recently announced profits for 1996 of $19 million, or a 26 percent increase over its 1995 profits. The Chicago Mercantile Exchange continues to be the second largest exchange in the world. In the past decade, trading on U.S. exchanges has more than doubled -- an increase of 130%. During fiscal year 1996, U.S. exchanges launched 92 new contracts approved by the Commission. In fact, exchange trading in the U.S. has thrived under our current regulatory system, which has assured market participants around the world that our markets are fair, safe and transparent.
While the U.S. exchanges point to the decrease in their share of world futures trading, that is a function of the recent creation of new futures exchanges in countries around the world in emulation of the U.S. success. Most of that foreign trading relates to local cash markets and does not compete directly with U.S. futures contracts. Despite the rapid growth of foreign markets in the past decade, U.S. trading volume has continued to grow at a healthy rate during the same period.
While the over-the-counter derivative market has also grown quickly over the past decade, it is clear that that market complements futures exchange markets as well as competing with them, by providing large institutions with a choice of custom- designed bilateral instruments as an alternative to standardized contracts without counterparty credit risk. Traders on the over- the-counter market often hedge their resulting exposure on an exchange and thus do bring business to the exchanges.
The exchanges have argued that self-regulation would be adequate to protect their markets. It is certainly true that self- regulation by the exchanges is currently a critically important aspect of our regulatory system. The Commission could not adequately regulate these markets with its limited resources absent the enormous contribution to the regulatory effort by the exchanges and the National Futures Association.
Nonetheless, the Act currently sets the standards for that self-regulation, and those standards would be eliminated by the professional markets exemption. In their place would be left only the commercial self-interest of the exchanges. The Commission's oversight role over the exchanges and its supervisory role over commodity professionals remain absolutely necessary to the effectiveness of the regulatory regime. Self-regulation alone is insufficient to maintain the integrity of our markets, as the Commission's ongoing regulatory efforts with the exchanges and the Commission's enforcement docket demonstrate.
When Congress enacted the Futures Trading Practices Act of 1992 in the wake of the 1989 FBI-CFTC sting on the floors of the Chicago exchanges, Senator Leahy expressed his hope that the 1992 Act would restore confidence and integrity to our futures markets. He explained that the Act provided "a code of conduct that every honest trader could live by." Senator Lugar characterized the Act as designed "to instill greater investor confidence" in the markets. If the 1992 Act was designed to instill greater confidence in the markets, what will the 1997 proposal do if it removes not only the very protections enacted in 1992 but also the statutory provisions enacted to protect the markets and market participants during the past seventy years?
If the futures exchanges were to establish markets without government oversight as permitted by these bills, every commodity professional in this room would need to ask, "Who will have the confidence to trade on these markets?" For example, would the exporter who wants to hedge its foreign currency risk use our markets? Would pension fund managers be willing to risk our citizens' retirement funds in these markets?
Traditionally, the Futures Industry Association has played a very constructive role in legislative deliberations concerning the Commodity Exchange Act and has helped to reconcile differing views within the industry. The FIA and the Commission have frequently worked closely together, and I hope they will continue to do so. Currently, however, the FIA is taking a position on the professional markets exemption of the bills that is diametrically opposed to that of the Commission. While it should not be surprising that the regulator and the members of its regulated industry should have different views on changes to our governing statute, it does surprise me that the FIA -- whose members depend so heavily on the integrity of the futures markets and investor confidence in them -- has supported the removal of the regulatory protections that have made our markets the safest and most transparent in the world.
In its Senate testimony, the FIA endorsed centralized professional markets that would not be subject to the protections of the Commodity Exchange Act "in any way." The FIA supported an environment where any exchange or other entity that wished to establish a centralized market for professional traders would be free to operate according to its own rules or no rules at all. The FIA even urged that the manipulation and fraud prohibitions of the Act should not apply to such markets. By advocating the elimination of prohibitions, the FIA has gone even further than the futures exchanges in support of a laissez faire marketplace governed by a single rule -- caveat emptor or "let the buyer beware."
For those FIA members who want to set up their own "in-house" futures markets, the prospect of operating in an essentially lawless environment might naturally have some appeal. But what about commodity professionals who earn their livings trading on U.S. exchanges and who benefit from the knowledge of their customers that the U.S. regulatory framework protects them from fraud and manipulation? What will become of the reputation of our markets if they are governed strictly by self-interest?
The U.S. has had more than 70 years of successful futures market regulation -- regulation that has produced the most competitive, most dynamic and most innovative futures markets in the world. In its place, we are asked to trust that the self- interest of private market participants will protect not only those participants but the marketplace as a whole. However much free market economists may applaud a laissez faire approach to futures markets, this approach would be at best a profoundly dangerous experiment, placing the future of our futures markets in jeopardy. I urge you to pause and consider the dangers that deregulation poses in the long term for the future of this industry.
Consider as an alternative joining with the Commission in an effort to modernize and to streamline the regulatory regime we administer to eliminate unnecessary regulatory burdens and to increase the Commission's efficiency. We would welcome your help and participation in this effort. Working together we can move into the Twentyfirst Century with a dynamic, strong industry, ready to face the changes and challenges of the future.