ORAL TESTIMONY OF BROOKSLEY BORN
COMMODITY FUTURES TRADING COMMISSION
ON H.R. 467
SUBCOMMITTEE ON RISK MANAGEMENT AND
SPECIALTY CROPS OF THE COMMITTEE ON AGRICULTURE
U.S. HOUSE OF REPRESENTATIVES
APRIL 15, 1997
Mr. Chairman and members of the Subcommittee, thank you for inviting me to present the views of the Commodity Futures Trading Commission on H.R. 467, a bill to amend the Commodity Exchange Act. I request that my written testimony be included in the record of the hearing. With me here today are three of the other Commissioners, John E. Tull, Jr., Barbara Pedersen Holum and David D. Spears. Our fifth Commissioner, Joseph B. Dial, is in Asia representing the Commission in meetings with futures industry participants and government regulators there. My testimony represents the unanimous view of all of us.
The Commission commends Chairman Ewing's introduction of H.R. 467. Rapid changes in the futures and option markets in the United States necessitate periodic review of the Act and of the Commission's regulations to ensure that they continue to serve the important missions of maintaining the fairness, integrity and competitive strength of the markets and protecting market participants and the public from manipulation, fraud, and other abuses.
The Commission is committed to reducing unnecessary regulatory burdens while at the same time preserving important public interest protections. It has recently adopted a number of amendments to streamline its regulations including improvements that obviate the need for certain of the bill's provisions.
The Commission, at the invitation of former Chairman Roberts, has proposed modest amendments to the Act which would significantly enhance the Commission's enforcement powers. Those proposed amendments to the Act are not currently included in H.R. 467, and we urge this Committee to consider their inclusion.
The Commission opposes the provisions of H.R. 467 in their current form. They could result in the pervasive deregulation of our futures and option markets and thus would pose grave dangers to the public interest. These changes would radically alter the regulatory system that has allowed our futures markets to become the strongest and most respected in the world and could leave those who use and rely on the integrity of our markets exposed and unprotected. However, the Commission remains committed to working with this Subcommittee, the futures industry and the agricultural and commercial interests that use the futures markets to craft legislation that modernizes the Act while protecting the public interest and providing market participants with strong, safe and transparent futures markets.
I will focus my oral comments on a single aspect of the bill -- the professional markets exemption as it would apply to exchange markets -- and refer you to the Commission's written testimony for a description of the Commission's serious concerns about the other provisions of the bill.
The professional markets exemption could lead to widespread deregulation of our futures exchanges by eliminating federal oversight as long as exchange trading was limited to entities with $1 million net worth, including small businesses, proprietorships, pension funds, mutual funds, insurance companies, and commodity pools of individual investors, as well as large institutions. The exchanges estimate that approximately 90 percent of the trading volume on their markets currently is on behalf of such entities. We believe that simple rule changes on the part of U.S. exchanges could convert them into professional markets subject to no meaningful federal regulation under the bill's provision.
This legislation would create U.S. futures exchanges with less government regulation than any other significant futures exchanges in the world and would render them vulnerable to problems experienced abroad, such as the Sumitomo and Barings debacles. For more than a decade, the Commission has played a vital role in encouraging other countries to adopt necessary regulatory regimes for futures exchanges, and they are doing so. The bill would send a signal that the U.S. no longer is willing to act as a world leader in protecting the economy and the public from the risks these exchanges pose.
The deregulation of exchange trading possible under the professional markets exemption would greatly restrict federal power to protect against manipulation, fraud, financial instability and other dangers. The bill would do so just at the time that agricultural producers have an increased need for the risk management tools provided by futures exchanges because of the elimination of government price supports. The bill preserves Commission jurisdiction to prohibit fraud and manipulation, but that limited authority might provide only an illusion of protection since the Commission would be stripped of its 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 could be eliminated by the bill, including requirements such as speculative position limits, large trader reporting, and exchange recordkeeping. Thus, the Commission would be unable to analyze aberrational price movements on the markets, including possible price manipulation, such as those involving potatoes in the 1970's, silver in the 1980's, equity indices in 1987 and 1989, soybeans in 1989, cattle in 1994 and 1995, and copper, heating oil and wheat last year.
In addition, exchanges would not be subject to the current legal standards relating to their futures contracts, rules or governance. Standards for trading in these markets, such as the requirements of competitive trading, open pricing and audit trail, would be eliminated.
The Commission currently supervises 64,000 commodity professionals who trade on the floor of the exchanges or deal with customers. The standards applicable to them, including registration, fitness standards, risk disclosure to customers, and sales practice standards, would be abolished, leaving customers without meaningful governmental protection.
Statutory and regulatory standards relating to the financial integrity of the markets and its participants would also be eliminated. These standards include segregation of customer funds, net capital requirements, financial reporting, margining of accounts and special bankruptcy protections.
Although the Commission strongly opposes the elimination of exchange regulation envisioned in H.R. 467, it would welcome an opportunity to work with the exchanges, the futures industry and the commercial users of the exchanges to fashion a reduced level of regulation for some markets. As part of its effort to reduce unnecessary regulatory burdens, the Commission established a pilot program exempting professional exchange markets from a number of regulatory requirements in November 1995. The Commission believes that such a pilot program would provide the necessary experience to determine the appropriate regulatory regime for professional exchange markets and has asked the exchanges for suggestions for improving the program. To date, no exchange has opted to participate in that program or has offered suggestions for improvement short of total deregulation.
The exchanges have said that they should be able to operate in the same unregulated environment as the over-the-counter markets. It has yet to be established that regulatory differences have placed exchange trading at a significant competitive disadvantage. Moreover, exchange trading involves important public interest considerations which require a higher level of regulation than over-the-counter markets. Exchange trading creates a concentration of financial risk not present in customized, bilateral, over-the-counter transactions between sophisticated traders and therefore poses a more serious systemic threat to our economy. While both the over-the-counter and exchange markets provide hedging opportunities to commercial interests, the strong public interest in protecting the price- discovery and price-basing functions uniquely performed by exchanges distinguishes them from most over-the-counter markets. Trillions of dollars of commercial transactions are based on futures market prices. The prices established by the futures exchanges affect what we all pay at the grocery store and at the service station, what we pay for our silverware, our copper plumbing and our lumber.
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 greatest power to hurt us all by their attempts at manipulation, by causing price distortions or by financial irresponsibility. To demonstrate this point, I need only refer to the financial repercussions from the collapse of Barings Plc., the effect on the price of copper by Sumitomo Corporation's trading, Metallgesellschaft's enormous loss in the oil market, and the Hunt brothers' attempt to manipulate the world market in silver. Moreover, the FBI and CFTC investigations of trading on the Chicago exchanges in 1989 showed that large institutions as well as unsophisticated traders can be defrauded on the floor of the exchanges.
The U.S. exchanges are the strongest, most dynamic and most innovative in the world. Their volume of trading has more than doubled in the past decade -- an increase of 130% since 1986. The Chicago Board of Trade -- the world's largest futures market -- had a record year in 1996, with a 26% increase in its profits. Indeed, 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.
The exchanges have argued that self-regulation would be adequate to protect their markets. Self-regulation by the exchanges is certainly an important aspect of our regulatory system. Nonetheless, the Commodity Exchange Act currently sets the legal standards for that self-regulation, and those standards would be eliminated under the professional markets exemption. In their place would be left only the commercial self-interest of the exchanges. Such self-interest alone is insufficient to maintain the integrity of our markets and to protect their users, as the Commission's ongoing regulatory efforts and the Commission's enforcement docket demonstrate.
Thank you. I would be pleased to answer any questions you may have.