Remarks of Commissioner James E.
Commodity Futures Trading Commission
National Cattlemen's Beef Association
Annual Convention and Trade Show
Live Cattle Marketing Committee
Charlotte, North Carolina
February 13, 1999
I am delighted to be with you here this morning, and I thank you for the opportunity to talk with you about issues we are currently facing at the CFTC, and that are of significant interest and import to your membership. As you know, things are changing at the CFTC: the Chair has announced that she will be living at the end of her term, Commissioner Tull will be leaving the Commission at the end of this month, and the President has recently made a new nomination to the Commission. At the very least, one can say that there will be leadership changes at the Commission in the near future. However, please be assured that we will endeavor to provide a seamless continuation of public service at the CFTC, and that your interests, and the interests of all market participants, will be heard and considered as we tackle the major issues before us.
Many of you already know who I am and where I come from, but let me give a little background about myself for those of you I have not yet had the opportunity to meet. I, along with my three brothers, grew up on my family's cattle operation in Florida. For the last ten years, I have worked as the Executive Vice President of the Mississippi Cattlemen's Association and Beef Council, and consequently, I tend to look at things from the producer's point of view. I, like you, am proud of my agricultural background, and of the values and work ethic it has provided. I think that it's important for you to know that I did not grow up wanting to be a CFTC Commissioner; in fact, I tried to turn it down, but Senators Lott and Cochran would not take "no" for an answer.
I bring to the Commission a free market philosophy that is pro-competition and pro-business, and, although I often find myself in the minority, I still ascribe to the belief that our government should be run by and for the people. Although some in Washington seem to think this is an antiquated idea, I call it time-honored and time-tested, and I hold to the conviction that in "governing best by governing least," we foster those ideals which allow our businesses, our farms, and our financial services to retain their primacy in the global marketplace. Because of the beliefs I've just described, I can make a commitment to you: just as I commend and encourage those in the private sector for thinking "outside the box" and for being innovative and creative in their business activity, I can pledge to you that in my tenure as a Commissioner at the CFTC, I will think "outside the Beltway" in making decisions regarding appropriate regulation of those activities.
As you know, the Commission is facing yet another reauthorization. Although this often elicits groans from those involved in the process, I am looking at it as an opportunity: indeed, I believe that Congress has the occasion now to address and resolve several key concerns of both regulators and regulatees. Let me take a few minutes to address some of those topics, as well as some other current regulatory issues.
FutureCom has applied to the CFTC to become an Internet-based futures exchange, where participants can actually trade contracts electronically, directly on the Internet rather than through an intermediary. While this represents a sea change in the way risk management tools have traditionally been transacted, it's clear that electronic trading is part of the future for all of us, and, indeed, I think this is only the first among many such efforts that we will see in the years to come. Let me say that I commend Bill O'Brien for his innovative thinking and his entrepreneurship; but as he will tell you, when you're breaking new ground, sometimes the soil can be pretty hard.
I certainly support the concept of multiple investment/hedging options for producers and other industry participants; furthermore, I believe all participants should have a level playing field in this area to encourage pure competition. And, in accordance with my earlier comment to you about thinking "outside the Beltway," I recently convened a meeting of CFTC staff and FutureCom in order to help facilitate progress on the regulatory side; and I believe that it was a productive meeting. This type of innovative thinking raises some regulatory issues regarding the guidelines of the Commodity Exchange Act, and will probably need to be addressed in CFTC reauthorization. In the meantime, I will continue to exhort CFTC staff to encourage, not impede, creative market thinking. As responsible regulators, we should work with the Congress to address regulatory challenges, therefore encouraging visionary ideas.
Dual trading refers to the practice of trading on the floor of an exchange for both one's customers and oneself. As you know, in the Futures Trading Practices Act of 1992 (FTPA), Congress directed the CFTC to implement dual trading prohibitions in certain markets. Several exchanges petitioned the Commission for exemptions from this prohibition, and for the past several years the Commission and exchanges have been working on these petitions. We all understand the reason for Congress including this in the FTPA. However, that was ten years ago. Times have changed dramatically since then: electronic trading has become a reality in the marketplace and will become more widespread in the coming years; and exchanges have, across the board, made major improvements to their audit trail systems. The Commission is in the process of final review of the Chicago exchanges' petitions, and I expect and hope that those will be voted on in the near future. While I won't prejudge the issue, I will certainly review the exchanges' systems as a whole, and will make my decision accordingly.
Agricultural Trade Options (ATOs)
An agricultural trade option is an agreement giving the agricultural producer the right to deliver his or her commodity in the future for a set price. The producer is not obligated to deliver and may simply choose to "walk away" from the option contract. In return for this right, the producer pays a fee, usually called the option premium. Agricultural trade options would not be traded on a commodity futures exchange, but directly between commercial parties.
As most of you know, there has been a long history of on-again, off-again options trading, both on- and off-exchange, and that, in large part, provides the basis for the circumstances we find ourselves in today. Since 1974, there has been a gradual lessening of the regulatory prohibitions on trading commodity options, the last of which has been the lifting of the off-exchange agricultural trade options ban. The Commission lifted the ban in April 1998 with the introduction of a 3-year pilot program. The pilot program was the result of long and intensive study and review at the Commission and with various agricultural interests.
I was not at Commission during creation of pilot program, but support the concept of additional risk-management tools. I am concerned, however, about the usefulness of the pilot program under current rules, and think the chairman of this live cattle marketing committee, Mr. Paul Hitch, summed it up best at the CFTC Agricultural Advisory Committee meeting last August. He said since we [CFTC] had the pilot program open for a few months and had yet to have anyone register, that we "might have perfected a hemorrhoid transplant. There is a world of potential donors, but there are no willing recipients out there."
In fact, the pilot program was launched over 9 months ago, but as yet there have been no applications for participation. I have met with industry participants in Chicago, Minneapolis, Kansas City, New York, and there appears to be common areas of concern regarding the program: overburdening paperwork requirements, the exemption level, the lack of cash settlement ability, and registration issues.
All producers must protect themselves against downside price risk, given the Freedom to Farm Act, increased market volatility, and most recently, exceptionally low commodity prices. Most producers do not use the futures market (only about 10 percent according to one study). However, exchange-traded options have become increasingly popular (trading volumes grown about 62% over last 5 years according to Futures Industry Association estimates).
Given these dynamics, I believe that we must find a way to create a product that is attractive to the agricultural sector, both producers and agribusinesses, while ensuring the preservation of market integrity, given the changing structure of agriculture. ATOs are one alternative, but several things will have to change before the program will have a chance to succeed. The Commission must first create a program that is attractive, not only to farmers and ranchers, but also to local elevators and other processing facilities. In order to achieve such a goal, the process must be industry-driven. Industry knows best what it needs and what will actually work. To that end, Commissioner Spears and I are meeting with industry participants to draft needed changes to the ATO program.
I believe that if the ATO program is successful, the exchanges would see new business generated through the ATOM's need to hedge their risk-- risk incurred when selling trade options to agricultural producers. I am committed to working with you in order to make this program a success. I believe that the more risk-management tools available to industry, the higher the level of competition, and the better the products will ultimately be. I am still optimistic about the potential of ATOs to become a viable risk-management tool in the future; however, if ATOs are not the answer, then we need to work together to determine what is.
On July 24, 1998, the Commission published a concept release regarding the placement of foreign board of trade terminals in the United States. In effect, this would allow foreign boards of trade to have access to US customers, with lessened regulatory requirements. A major concern about this matter is the issue of fair competition--the argument is that if we allow foreign terminals to be set up over here, then a US exchange should be able to set up terminals in foreign jurisdictions, with similar regulatory treatment. I share this concern and feel that equal access should be granted to our exchanges. Commission staff is currently putting together final rules for consideration by Commissioners, and I hope that this will move along expeditiously.
Future Regulatory Challenges
The Commission must work with the Congress in determining how much flexibility the Commission needs to address the changing technological environment. Who would have thought 10 years ago that we would be considering trading over the Internet? Who knows what technological advancements in futures and options trading will be presented to us in 10 more years? These are issues in which both Chairman Lugar and Chairman Combest have expressed an interest, and most likely will be taken up during the reauthorization process.
Importantly, I believe we must decrease the regulatory burden on our domestic exchanges in order for them not only to continue to compete and prosper but to remain global leaders. The Commission must have the flexibility to be innovative regarding those within the industry who are creative and visionary. Finally, industry input will be critical in this process; experience and common sense tell me that if market participants can agree on basic issues, then Congress will respond.
Senator Lugar pledged to begin reauthorization hearings early this year. Many members of Congress have expressed concern regarding actions taken by the CFTC over the last year, particularly with the Commission's Concept Release concerning the Over-The-Counter (OTC) Derivatives Market, and believe these issues should be addressed in reauthorization process.
There is talk of more specifically defining the jurisdiction of the CFTC, which could possibly lead to a reduction in CFTC authority or some are even suggesting merging the CFTC with the SEC. The Senate and House Agriculture Committees will hold a symposium later this month on the Commodity Exchange Act and issues of importance for the upcoming reauthorization. I am sure that several proposals will be introduced or re-introduced during this discussion.
I believe that whatever action is ultimately taken by the Congress, the agricultural emphasis can and should be maintained in a clearly defined way, given the role commodity markets play in the risk-management arena. I also feel that, as responsible regulators, the Commission must be responsive to not only industry, but also to the Congress as we work through reauthorization. We must work with members of the Agriculture Committee to develop a regulatory scheme that discourages fraud and manipulation; that doesn't impede, but rather encourages innovation, technology, fair competition, and sound business practices.
Thank you for the opportunity to be here; I look forward to working with you in the years to come.