AREGULATORY REFORM: LOOKING BACK, LOOKING AHEAD@
REMARKS OF BROOKSLEY BORN
COMMODITY FUTURES TRADING COMMISSION
FUTURES INDUSTRY ASSOCIATION=S
INTERNATIONAL FUTURES INDUSTRY CONFERENCE
Boca Raton, Florida
March 19, 1998
I always appreciate the opportunity to address the members of the Futures Industry Association. Those of you who were here last year may recall that my remarks then frankly expressed the Commodity Futures Trading Commission=s serious concerns about legislative proposals to deregulate the futures markets. This year, I will address the Commission=s own efforts at regulatory reform, which address many of the same issues raised by those legislative proposals.
Let me preface that discussion, however, by reiterating the closing message of last year=s speech. I asked you to consider Ajoining 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.@ My concluding words were, Aworking together, we can move into the 21st century with a dynamic, strong industry, ready to face the changes and challenges of the future.@
The Commission may not always agree with you on the exact route we should be taking, but we are committed to the same ultimate destination -- a strong, sound and successful U.S. futures industry. I believe there is no better way to illustrate the Commission=s commitment to your success than by reminding you of the major regulatory reform initiatives that have been proposed, or have become effective, in just the 12 months since last year=s FIA conference. Some of these efforts are a direct response to issues raised in last year=s proposed legislation, some were suggested by industry representatives, and still others are the result of our own staff=s review.
Shortly after last year=s FIA conference, on April 7, 1997, new Afast-track@ procedures became effective providing for quicker Commission processing and approval of new contract market designations and exchange rule changes. That same month, amendments to simplify our reporting rules also took effect, with the result that large traders now are required file a Form 40, Statement of Reporting Trader, only upon request of the agency, rather than having to file a new form each year.
April was also the effective date of the first of several actions relating to electronic communication -- a new rule allowing FCMs to file financial reports with the Commission electronically. This was followed in subsequent months by three more initiatives. The first allows CPOs and CTAs to file disclosure documents with the Commission electronically. The second permits FCMs and other regulated persons to communicate with consenting customers electronically -- for example, by delivering trade confirmations and monthly statements by E-mail in lieu of paper documents. The third initiative authorizes CPOs and CTAs to deliver disclosure documents to consenting customers through electronic media.
In September 1997, we proposed new rules whereby FCMs and IBs would no longer be required to provide mandatory risk disclosure materials to sophisticated traders. Final rules were published on February 20th of this year and will become effective on April 21st. These revisions will speed up the account opening process for sophisticated customers.
December of last year saw two major proposals. On the 19th, we published proposed rules that would allow exchanges to permit futures-style margining of option contracts. On the 30th, we published a concept release seeking comments on various alternatives for easing restrictions on the circumstances under which an FCM could hold segregated customer funds in foreign currency or in a location outside the U.S. The express purpose of the release was Ato avoid inhibiting transnational commodity futures activities or causing undue costs or operational inconvenience, without increasing risks to market participants.@ The Commission=s staff are currently reviewing the comments received on these proposals.
In January of this year, the Commission issued three more significant regulatory reform proposals. On January seventh, we published a proposed rule to permit post-execution allocation of bunched orders of sophisticated customers where the CTA or investment adviser has obtained the customer=s consent. Previously, in May 1997, we had approved an NFA Interpretation permitting streamlined procedures for allocating customer orders bunched for execution in advance by CTAs.
On January 22nd, we published proposed rules to establish specific procedures for filing requests for no-action, exemptive and interpretative letters. The proposal was the result of a thorough review of the entire no-action process and is intended to give structure to the process, to provide greater guidance to requesters, and make to the process more transparent to all interested parties.
On January 26th, we published another concept release, this one dealing with non-competitive off-floor transactions. Proposals discussed in the release would enable exchanges to permit certain non-competitive transactions to be executed off-floor, but still subject to the rules of the exchange. For example, an exchange could adopt rules allowing sophisticated market participants privately to negotiate the terms of large transactions and then to report the trades to the exchange. The release also seeks comment on issues relating to exchanges of futures for physicals, exchanges of futures for swaps, exchanges of futures for options, and basis trading.
Just this week, the Commission has issued proposed amendments to our Part 10 rules, which deal with procedures in administrative enforcement actions brought under the Commodity Exchange Act. The proposed amendments would improve the overall fairness and efficiency of the administrative process and would facilitate the Commission=s use of the authority it was given in the Futures Trading Practices Act of 1992 to impose restitution as a sanction. The Commission also has requested comment on a proposal to repeal the short option value charge in our net capital requirements.
If you have not already done so, I would urge you to review these proposals and to share your views with us through the comment process. The CFTC does not take lightly its obligation to seek input from the industry and the public, and neither do I. In that context, I recently assumed the Chair of the Commission=s Financial Products Advisory Committee, which includes among its members a broad cross-section of futures industry representatives. The details of several of these regulatory reform proposals were topics of discussion at the February 25th meeting of that committee.
In addition to proposals that have already been published, there are a number of other initiatives in the pipeline. The Commission is reconsidering its approach to net capital requirements and taking a closer look at a value-at-risk model. Commission staff are currently working with the industry to analyze VAR issues in detail. Another reform, urged by the NFA and the Managed Futures Association, would allow CTAs to report their performance based on notional funds. Staff in the Division of Trading & Markets are currently working on a draft Federal Register release requesting comment on that issue.
The Commission also has before it several proposals that will require us to tackle some complex issues related to electronic trading. For example, there is an application pending for designation of an Internet-based electronic market in cattle futures, known as FutureCom. We also have received an application for designation of an electronic contract market in government securities on the New York Cotton Exchange. In addition, we are considering issues related to the location in the U.S. of terminals for trading on foreign electronic exchanges. We plan to publish a concept release requesting comment on whether certain U.S. activities of foreign electronic exchanges should subject them to Commission regulation.
Looking to a broader international regulatory perspective, during 1997 the Commission led a cooperative effort to establish international principles for the supervision of commodity futures markets. These efforts culminated with the October 31, 1997 adoption of Guidelines setting international best practices standards for market surveillance, for information sharing, and for contract design and approval. These first-ever international standards for regulating commodity markets represent a crucial measure in protecting U.S. markets from events in foreign markets, as well as a significant step toward leveling the global regulatory playing field.
In July 1997 the Commission created a new Office of International Affairs to focus its efforts on international regulation of futures markets. Moreover, two weeks ago the Commission announced the establishment of a CFTC Global Markets Advisory Committee to be chaired by Commissioner Barbara Holum. The new advisory committee will facilitate industry input into our international activities. Among the issues to be included on the committee=s agenda are Aavoiding unnecessary regulatory or operational impediments faced by those doing global business ... setting appropriate international standards for regulation of futures and derivatives markets and intermediaries ... [and] achieving continued global competitiveness of U.S. markets and firms ...@
In summary, these recent actions demonstrate two things. First, the Commission really does listen to the concerns of U.S. exchanges, commodity professionals and market users. Second, within just the past 12 months, the Commission has responded to those concerns through a number of significant actions, aimed at both streamlining domestic regulation and enhancing the regulation of foreign markets.
Let me turn now to the next step in the CFTC=s regulatory reform process -- a planned concept release dealing with the treatment of over-the-counter derivatives. The last major Commission actions concerning OTC derivatives took place in early 1993 when the Commission exempted certain swaps and hybrid instruments from most provisions of the Commodity Exchange Act.
Since then, a lot has happened. The OTC derivatives market has grown dramatically. For example, the most recent market survey by the International Swaps and Derivatives Association (ISDA) shows that the notional value of transactions reported by ISDA members for the first half of 1997 increased 46 percent over the previous six month period and brought the notional value of outstanding contracts to an astounding $28.7 trillion dollars. Even allowing for the fact that the amount at risk in a derivatives transaction represents only a small proportion of the notional value -- about three percent according to the General Accounting Office -- that still adds up to over $860 billion at risk in OTC derivatives worldwide. In addition to growing in size, the OTC derivatives market also has grown in diversity, with the development of a multitude of new products and increased interest in new market mechanisms.
At the same time, a series of large, well-publicized losses over the last few years has focused a spotlight of industry, regulatory and public attention on potential problems in the OTC markets. While it is difficult to quantify OTC derivatives losses, a 1997 GAO Report provides a rough idea of the scale of the problem. It catalogues 360 end-user losses between 1987 and 1997 totaling an estimated $11.4 billion. In most cases, the end-users suffering those losses were entities that would be considered sophisticated investors.
In addition, the Securities and Exchange Commission has published a rulemaking proposal which would establish a regulatory regime for certain OTC derivatives dealers. The CFTC is concerned that the SEC proposal could come into conflict with the requirements of the Commodity Exchange Act and could create gaps and inconsistencies in the regulatory treatment of instruments traded by OTC derivatives dealers. This concern, and the need to make a timely response to the SEC=s request for comments, contributed to the CFTC=s decision to announce the concept release while our preparation of it was still underway.
The genesis of the concept release, and the Commission=s attitude concerning regulatory cooperation with the SEC on its proposal, can be summed up in the following statement from our comment letter to the SEC:
The growth and maturation of the OTC derivatives market, the magnitude of the losses suffered by derivatives users and dealers, and new developments in the market such as the growing desire for clearing operations, have resulted in the CFTC=s decision to examine its approach to the market. The SEC=s proposal to regulate the market underscores the appropriateness of the CFTC=s decision and the need for coordination and cooperation between the two agencies.
The other thing I would like to emphasize about the CFTC=s concept release is simply that the most important word in the document is the word Aconcept.@ This will be a conceptual document that will not propose specific rule changes. This release will raise some difficult and controversial issues. The Commission will be putting those issues on the table with an open mind and with no preconceived notions. I hope the Futures Industry Association and its members will approach those issues in the same spirit and will give us thoughtful comments on the issues that the release will put forward.
Just what will those issues be? It would be premature to go into much detail because the document is not yet finalized, and none of the Commissioners, including myself, has signed off on it. However, I can give you a brief preview of a few of the issues that will be covered. These include the following:
$ In light of the evolution of the swaps market, do the terms of the Commission=s 1993 swaps exemption need to be revised and, if so, how?
$ Should the definition of a hybrid instrument set out in the Commission=s 1993 exemption of such instruments be modified and, if so, how?
$ Should the Commission propose sales practice standards for OTC derivative instruments within its jurisdiction and, if so, what should those standards be?
$ What is the appropriate regulatory regime for swaps clearing facilities?
Let me conclude this preview of the OTC derivatives concept release by quoting another excerpt from our comment letter on the SEC proposal. This language, which was endorsed by all the Commissioners, describes the purpose and intent behind the concept release as follows:
The concept release will request comment on how best to achieve an appropriate balance between the need to ensure that U.S. entities have the opportunity to remain competitive in the global financial marketplace and the need to maintain adequate regulatory safeguards. After receiving public comment and consulting with the industry, the users of OTC derivatives instruments, relevant regulatory authorities, and other interested parties, the CFTC will be in a position to address new developments in the OTC derivatives markets and to satisfy its obligations to protect derivatives end-users and the public while fostering innovation and avoiding unduly burdensome regulation.
I hope these remarks have conveyed the Commission=s sincere commitment to regulatory reform and to a strong, sound, and successful U.S. futures industry. We would welcome additional suggestions for regulatory reform and streamlining. With your help, we can create a regulatory regime that will serve our markets and market participants well in the next millennium. Thank you.