Written Testimony of
Commissioner James E. Newsome
Commodity Futures Trading Commission
U.S. House of Representatives
Committee on Agriculture
Subcommittee on Risk Management,
Research and Specialty Crops
May 18, 1999
Thank you Mr. Chairman and members of this distinguished subcommittee. I am pleased to be here to testify before you today, and I thank you for the opportunity to discuss issues relating to reauthorization of the Commodity Futures Trading Commission. I applaud your efforts to gather information and data regarding modernization of the Commodity Exchange Act, as I believe that this reauthorization period provides a unique opportunity for Congress to make necessary changes to the Act that will benefit the industry and market participants, as well as provide clearer guidelines for appropriate regulation by the Commission.
There are several topics that I will offer today for your review, but I would like to begin by stressing two overarching principles that I believe are critical in this analysis: providing legal certainty and decreasing regulatory burdens should be the key elements in any review and amendment of the Act. In order to accomplish this, we need to listen to industry participants regarding the effects of regulation on the day-to-day matters of financial and agricultural risk management and price discovery, and respond accordingly. We as public servants are charged with protecting the interests of the public, and we cannot do justice to that obligation unless and until we listen carefully to those most directly affected by our actions. 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 cooperate with members of this Committee to develop a regulatory scheme that discourages fraud and manipulation, but encourages innovation, technology, fair competition, and sound business practices.
In addition, I believe there is a significant corollary issue to the goal of decreasing regulatory burdens that should be considered. It goes without saying that businesses will seek to operate in the most efficient fashion; accordingly, if the opportunity presents itself to avoid
regulatory costs by operating outside the borders of the United States, many businesses will make the logical decision to take advantage of that opportunity. Therefore, I believe it is critically important to engage in sensible cost/benefit analyses in making regulatory decisions, as some of those determinations be of limited utility, and may simply move businesses and dollars out of our economy. (Indeed, I believe in some cases that has already occurred.) Not only that, overly burdensome regulation has the effect of moving those entities outside the sphere of our policy-making authority. In other words, with the exodus of business beyond our borders goes the ability of the United States to continue to make policy determinations that affect the global economy. I do not want to overstate the matter, however, given current technological advancements, I firmly believe that we as law makers and enforcers must be acutely sensitive to this issue in order to maintain the primacy of our markets as world-wide leaders and innovators.
I join with you in the desire to identify areas I believe have suffered from regulatory overreaching, confusion, or misunderstanding; and, indeed, I have already begun the process of taking steps to initiate changes that can be made under our current regulatory authority to decrease regulatory burdens and promote legal certainty. In that vein, I recently convened a meeting with representatives from the three largest futures exchanges in the United States. I asked them to come to this meeting ready to discuss concrete, practical initiatives that we can undertake promptly to address their regulatory concerns. I was extremely gratified with the outcome of that meeting, and have accumulated a significant list of projects that I believe the CFTC can and should act on in an expeditious manner. Furthermore, I plan to continue to exhort staff and industry to work together to review these issues to determine in what areas we can make significant inroads in decreasing unnecessary regulatory burdens.
Along those lines, let me say I believe that regulatory reform should be industry-driven. It is clear to me that market discipline and adherence to best-practice standards can achieve better enforcement of fundamental market integrity concerns than can any amount of overlaid regulation. Accordingly, I advocate stripping away unnecessary, costly regulation, and at the same time maintaining the ability to ensure forceful, swift prosecution and significant punishment for those outliers who commit core violations of the Act. I believe that more reliance on private sector discipline and better use of public regulation fosters these interests and I look forward to hearing from market participants and users to tell us how they envision achieving these goals. I am glad to see that this subcommittee will hear from them this week as well.
With regard to modernization of the CEA, there are several areas of regulatory reform that under current authority cannot be addressed at the agency level—issues that require Congressional review, analysis and disposition. I would like to focus the remainder of my remarks on highlighting general themes and specific topics for your examination. Let me reiterate that, in my opinion, the end result of such review should be regulation that fosters efficient and liquid markets, enhances the ability of market participants to innovate and compete effectively, and does not create artificial and costly barriers to trade and competition. Ultimately, I believe the CFTC should concentrate on what Congress intended us to do when it created the Commission in 1974, that is, protect participants against fraud and manipulation and ensure safe, sound, and competitive markets.
Electronic Trading Issues
During the past year, I have been struck by the number of issues that in some way involve electronic trading; it is clear that we are witnessing a sea change in the way markets work. For example, who would have thought ten 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 ten more years? I believe it is critically important that the CFTC have the flexibility to be innovative from a regulatory standpoint regarding those within industry who are creative and visionary, and we must work with the Congress in determining how much flexibility the Commission needs to address the changing technological environment. Given this regulatory agility, the Commission can encourage, and not impede, those who think outside of the traditional box.
As I have stated before, I believe the intense interest in this topic is fueled by two issues: first, the rapidly increasing globalization of the futures and options markets in particular and financial markets in general; and secondly, the tremendous advances in electronic trading technologies and activity. The lower transaction costs and the inherent benefits regarding oversight of electronic trading systems make them an attractive complement or alternative to traditional trading methods. However, at the time of the promulgation of the Act and regulations, it obviously was not possible to contemplate such incredible changes in the way markets today effect transactions and conduct business. Accordingly, I think Congress needs to take a comprehensive look at the Act with an eye toward making amendments to accommodate these changes relating to electronic trading. I would submit, for example, that provisions relating to designation of a completely electronic exchange should be reviewed. Also, as the movement to electronic trading systems may have an effect on the design of exchange governance systems, let me say that the current law envisions designation of traditional membership exchanges, as opposed to proprietary exchanges, and I believe these issues also deserve Congressional attention.
Issues Relating to Legal Certainty
In May 1998, the Commission issued a concept release relating to over-the-counter derivatives. The issuance of that document created significant legal uncertainty in a dynamic and vital market. Ultimately, this resulted in Congressional action instituting a moratorium on Commission action until Congress has the opportunity to address the issue. That opportunity is now before you. I remain committed to the principles I have stated time and again during my tenure at the CFTC: market participants must have clear and unambiguous understanding of the nature of their regulatory responsibilities. I recognize that there are several different avenues that have been suggested to you in this area. For example, some exchanges have proposed making a distinction between privately- and publicly-negotiated instruments, and regulating accordingly. You have also heard of proposals relating to allowing market participants to choose their regulator. You have heard discussions of institutional, as opposed to functional regulation. Once again, let me say that I do not have answer for you as to how you should make your final judgments: the various sectors of the industry must make clear to you what their concerns and desires are in order for you to best make your determinations in this area. I look forward to continuing discussions with market participants and with other regulators to review the numerous aspects and ramifications of regulatory options on this topic, and I would offer that we should keep in mind during this debate the primary public policy aims I have mentioned.
Let me also mention that legal uncertainty has not been confined to the issue of OTC instruments. We have also heard many comments regarding this problem as it relates to other issues, for example, the definition of a forward contract. As I am made aware of these issues by market participants, I hope that they will also convey their concerns to you.
There has been discussion of specifically reducing the regulatory authority of the CFTC, and/or merging the CFTC and the SEC. I want to state that I believe the agricultural emphasis should be maintained in a clearly defined way, given the role commodity markets play as significant risk management and price-discovery tools for American agriculture. In whatever manner this issue is ultimately addressed, the CFTC should have the statutory flexibility to allow markets to grow and prosper, and to continue to be useful mechanisms for agribusiness concerns.
I believe that the Commodity Futures Trading Commission has an extremely talented and dedicated group of people, committed to public service, and I am proud to be associated with them. However, the fact of the matter is that times have changed, we must change with them, and I am confident that we have professional, responsible staff to carry out the mandates issued by this Congress. Let me reiterate my belief that providing legal certainty and decreasing overly burdensome regulation should be paramount concerns as you proceed in this task, and I am committed to working with you, your staffs, other regulators, and industry participants as we take advantage of this unique opportunity to modernize the Commodity Exchange Act. I recognize that this will not be an easy or quick undertaking, and that it will require compromise on the part of all interested parties to reach an appropriate consensus. However, as noted in the recent GAO report on the CFTC’s reauthorization, the cost of not reaching consensus in this area is high, and I encourage the industry to continue their efforts to make their viewpoints known to Congress and to regulators. Thank you, and I would be happy to answer any questions you may have.