Remarks of William J. Rainer, Chairman
United States Commodity Futures Trading Commission


Personalizing Regulation in
Depersonalized Markets


Before
The IOSCO Emerging Markets Committee
Panel Discussion on Internet-Related
Market Developments from a Regulatory Perspective
(Presented by Andrea M. Corcoran, Director
CFTC Office of International Affairs)


Amman, Jordan
19th November 2000

Personalizing Regulation in Depersonalized Markets 

    It is my pleasure to send my representative to Amman, Jordan (1) to participate in the Annual Meeting of the IOSCO Emerging Markets Committee organized under the gracious auspices of His Majesty King Abdullah II and the Jordan Securities Commission and (2) to deliver my remarks to this forum. The CFTC is always pleased to be an invited guest to the Emerging Markets Annual Meeting. This meeting marks the unique work of IOSCO to achieve sound, fair capital markets systems everywhere around the globe. Our participation acknowledges the strong role of exchange derivatives markets in many jurisdictions outside the IOSCO Technical Committee.

    Today, my topic is how technology is causing the global marketplace to become increasingly impersonal and what challenges that poses for regulators and investors.

  1. Growth of Electronic Trading.
  2.     We have heard again and again how technological advances transform our markets by making it possible for almost any type of right or interest to be traded in a cost-effective way electronically. In just the last two years, electronic trading has become the trading model of choice internationally with non-electronic exchanges moving rapidly to reform their structure. At the same time, the Internet has permitted retail customers to go directly to a market without proceeding through a broker with whom they have a relationship.

        Last March, the European Commission projected in its status report on the EU Financial Action Plan that on-line trading of securities in Europe will increase 10-fold in the next few years. Even in the United States, which remains the largest outpost of non-electronic markets, the Chicago Board of Trade currently posts daily trading statistics which show that 20% of Treasury trading, almost 116,000 contracts per day, is now electronic and that electronic activity continues to grow.

        According to the Fédération Internationale des Bourses de Valeurs, exchanges everywhere are actively seeking to enhance the potential of their electronic markets by undertaking ventures with commercial entities. The commercial entities are interested in using existing market structures as a means to achieve a more liquid and efficient pricing base for their products. The exchanges are interested in competing with new entrants offering electronic systems for trading financial products. Each of these electronic forums may seek to sell subscriptions or user arrangements directly to the investing public.

        Electronic technology also permits intermediaries to offer their clients "do it yourself" execution services through Internet-based order routing systems that provide "direct access" to trade matching systems. Although now in their infancy, mature Internet markets are not far off.

        As the result of these developments and others, investors today are inundated with multiple direct electronic trading opportunities from multiple points around the globe. Search commands using words like "futures" yield an unparalleled amount of raw information and lead to thousands of Internet sites advertising various types of advice or products. As you have heard today, in some emerging markets, large percentages of overall trading may be Internet-based.

  3. Depersonalization of the Marketplace.
  4.     When technology is harnessed to trading, clients reap benefits in the form of efficiency, lowered transaction costs, global choice and access to massive amounts of information. Yet, technology is not an unmixed blessing. I have mentioned the problem of information overload. However, I believe that a more significant effect of technology is its capacity to depersonalize trading. One can obtain financial management services and trading recommendations online, open an account with an intermediary, place orders on an electronic market (either directly or through a broker), receive confirmation statements and transfer funds, all without interacting with a single human being. Moreover, as the medium becomes more sophisticated and dynamic, an Internet site can target or tailor itself based on an investor’s registration of a profile or on the pattern of an investor’s visits to the site.

        While the human element does not disappear from electronic markets, it can become invisible to market participants. Without an identifiable broker to turn to, a screen-based trader may not know where to take a problem or dispute that arose in the course of trading. The investor may have no reliable way of verifying the identity or fitness of the professionals behind the screen, and no way to verify the accuracy or usefulness of the wealth of information instantaneously available over the Internet. If a customer decides to resort to a regulator, he or she may not know which one to call.

        In addition, electronic markets, clearing organizations, intermediaries, back office services and market users can be scattered across several different countries. A customer operating from the privacy of his or her wireless Internet access device can be located anywhere. The impersonality of trading is, therefore, magnified by the globalization of trading.

  5. The Regulatory Response.

    How, then, should regulators respond to an increasingly impersonal trading environment?

    I submit that the impersonal nature of electronic trading, especially cross-border trading, demands an increasingly "personal" response from financial regulators. This response should make use of new technology to help foster appropriate levels of customer and market protection without impeding the efficiency that technology brings to trading. Importantly, in an environment of inevitable and rapid change, it should avoid prescriptive rules that could inappropriately thwart new ventures.

    The types of "personal" responses that I contemplate regulators exploring fall into four categories:

  1. Enhanced Regulatory Coordination and Cooperation.
  2.     In a global trading environment, no one regulator or market authority will have all of the information that is necessary to address customer and market protection concerns. This observation is not new to IOSCO members, who have developed very extensive networks of bilateral information sharing arrangements. We have also noted today practical multilateral arrangements, such as FESCOPOL.¹

4.1.    Enhanced Information Sharing.

    However effective these arrangements may have been, I believe that the Internet age requires regulators to enhance them further and to practice using their personal relationships to move quickly and cooperatively in addressing multi-jurisdictional problems. Let me stress the word "quickly." We regulators must become as efficient as the technology that is used by our markets and investors.

    For example, false information can now be disseminated globally on the Internet and affected markets virtually instantaneously. When false claims can be made on the Internet that involve markets located in numerous jurisdictions, one regulator may need to seek advice from another to confirm the validity of such claims. The exchange of this information will be expedited if agencies identify in advance the offices and individuals responsible to answer such inquiries. The response to the inquiry will be speedier if one knows the person on the other end of the telephone or the e-mail.

    The CFTC has seen an increase in such cases and in the last seven months, it has taken 17 actions to shut down firms that were fraudulently promoting commodity trading methods over the Internet. We should explore developing a mechanism to post warning notices of such actions electronically so that regulators in other countries can readily access information about the companies and the individuals involved.

¹ FESCOPOL is a multi-lateral information sharing arrangement among the 20 European Economic Area members of the Forum of European Securities Commissions (FESCO).  Many regulators also have entered into other multi-lateral information sharing arrangements, such as the "Boca Declaration," that was developed following the collapse of Barings, Plc, now with 28 signatories.

4.2.    Regulatory Alliances.

    Just as our markets are forming joint ventures and alliances to be more competitive in a global marketplace, so too must regulators form alliances to address resulting regulatory issues. The CFTC early on adopted a policy of provisionally allocating regulatory responsibilities in cross-border situations, as reflected in our approach to the Globex Alliance and to the mutual offset clearing arrangements between the Singapore Exchange and the Chicago Mercantile Exchange. These types of practical relationships concede no jurisdiction, but acknowledge the practical impossibility of having multiple international regulators apply all of their requirements to every aspect of a single cross-border system. Alliances can make regulators more effective by combining their powers and information while avoiding unnecessary regulatory duplication. Borderless systems, such as the Internet, will increasingly require regulators to rely on each other and to coordinate their requirements and regulatory efforts.

4.3.    Creative Solutions.

    Regulators also may make use of their personal cross-border connections with other regulators to devise creative solutions to the problem of transnational fraud. Increasingly, fraud may originate in one jurisdiction and cause injury in another. In one such case, the CFTC introduced the competent regulatory authorities in Taiwan to a firm established in France, with branches passported into the UK, overseen by US compliance personnel, doing business around the globe. This firm’s name was being misused by a fraudster located in Macao, selling financial products to customers in Taipei. The Taiwan regulator (the SFC), its futures trade association (TFA), and the firm agreed to hold a joint press conference and to otherwise act together to warn potential targets of the fraud -- an unconventional, but effective course of action.

4.4.    Coordinated Action.
  1.     Cooperation can also take the form of coordinated action. The IOSCO-sponsored International Surf Day that took place on March 28, 2000, in which many IOSCO members participated, visited approximately 10,000 Internet websites from the US and 27 other countries and identified approximately 1000 sites for further review, including 250 sites that involved cross-border activity. More recently, the CFTC joined with US and foreign regulators and other civil and criminal authorities to conduct the so-called Top Ten Dot Con² Sweep, a joint law enforcement project sponsored by the US Federal Trade Commission that focused on Internet-related fraud.

  2. Enhanced Transparency.
  3.     Let me turn now to transparency. A regulator cannot promise more than it can reasonably deliver to its domestic customers that are trading on non-domestic markets. While we can foster a generally high level of regulatory protection through the adoption of internationally accepted core principles of regulation and, as noted previously, by coordinated cyber-surveillance activities, we cannot do it all. Nor should we attempt to do so, lest we impede the very flexibility and efficiency that technology offers.

    ² "Con" is a confidence Scheme or fraud.

        How, then, can we help investors who operate in an unbundled trading environment understand the over-all structure and risks within which their trading takes place?

5.1.    Transparency of Market Rules.

    First, I believe that we need to take a fresh look at the transparency needs of investors who operate in the global electronic market place to assure that investors will have sufficient information to make informed choices. In order to evaluate a market, it is important to be able to understand the operating rules and conditions of trade execution, clearing and settlement, associated costs, and protections in case of default, and to know the identities of market operators and government regulators who can help address any problems. Regulators should encourage markets, intermediaries and clearing organizations to use technology to provide more information to investors and to do so in clear, "user-friendly" formats; that is, in languages that can be readily understood by the expected customer.

5.2.    Fitness Information.

    Second, in order to assist investors in evaluating the bona fides of intermediaries who may offer their services over the Internet, regulators need to make available to the public the full scope of whatever public authorization and other "fitness" information can be released in their jurisdiction. In keeping with the principle that the regulator should be as efficient as the trading environment, regulators should make this information available on the Internet. For example, in the United States, the National Futures Association, operating under delegated authority from the CFTC, makes this information available to the public on its BASIC Internet website. After its homepage, BASIC is NFA’s most visited website, receiving almost 30,000 visits per month. The non-US jurisdictions that are most actively using BASIC to verify the fitness of futures professionals are the United Kingdom, Japan, Hong Kong, France, Canada, Germany, Australia, the Netherlands, Singapore, Belgium, New Zealand, Malaysia and Taiwan.

5.3.    Linked Information Systems.
  1.     Regulators also may want to consider the development of a linked or dedicated information sharing system or database for the immediate exchange of actions that affect the registration status of firms and markets in their jurisdiction, subject to applicable confidentiality constraints. This will help reduce the possibility that fraudulent Internet schemes that are shut down in one jurisdiction will simply migrate or redirect their communications into another.

  2. Investor Education.
  3.     However, transparency should be coupled with education tailored to the type of investors using the markets. Investor education, previously a minor aspect of regulatory concern, should play an increasing role in enhancing the ability of investors to make informed choices. In the future, an informed investor may be the best, front-line protection against fraud. Investor education was an area particularly identified in the IOSCO Objectives and Principles of Securities Regulation. Markets, intermediaries, and self-regulatory organizations may be best placed to offer such educational materials and should be encouraged to do so. Nonetheless, regulators also should examine their programs to identify areas for appropriate investor education actions. The CFTC has issued customer advisories concerning: "Foreign Currency Trading Fraud," "Sales Pitches Based on Seasonal Demand and Other Public Information," and "Promises of Easy Profits for Buying Precious Metals and Other Commodities." These advisories are among the most frequently viewed parts of our website.

  4. Competition.
  5.     In addressing the issues raised by an impersonal trading environment, we should keep in mind that competition can be the regulator’s ally. Competition provides a strong incentive for market participants to perform at the lowest cost and the highest degree of integrity by giving market users the ability to choose the markets, products and providers that best serve their individual needs. By encouraging competition, we foster a market discipline that may lessen the need for direct regulation. Regulators can encourage competition by embracing policies of national treatment and recognition and by exploring areas of harmonization critical to permitting markets and offers qualified in one jurisdiction to be passported into another. By permitting open access to qualifying markets (that is, as a general proposition, markets that meet international standards), regulators provide a competitive environment that can motivate domestic entities to perform at the highest levels of safety and efficiency.

  6. IOSCO and the EMC.

    Finally, I would like to mention the very important role that meetings such as this play in enhancing our cross-border effectiveness. IOSCO singled out the Internet, by creating an Internet Task Force, as an important area where emerging and mature markets needed to work together to find the correct solutions. The personal relationships that we forge during this work and through face-to-face meetings of international regulators establish a network of trust and confidence that can be drawn upon in times of regulatory need. Each of us can, and do, sign cooperative arrangements and seek to adopt high regulatory standards -- but, at the end of the day, the effective global implementation of these arrangements and standards depends upon trust.

    We are pleased to participate today in a conference that permits us to build on the personal relationships that we, as regulators, must have if we are to meet the challenges of an increasingly global environment.