Remarks of Acting Chairman James E. Newsome
International Swaps and Derivatives Association's
Energy and Developing Products Conference
March 6, 2001
Thank you for inviting me here today and for allowing me the honor of addressing this distinguished group. I have had the opportunity to work with some of you during my tenure at the CFTC and look forward to continuing these productive relationships in the future.
I'd like to first quickly recap the phenomenal progress that has been made this winter, progress that demonstrates just how effectively good government can work when everyone cooperates. First, on December 13th, after receiving much constructive input from you and others in the marketplace, the Commission published rules to implement last year's regulatory reform proposal.
Then, just two days later, Congress passed the Commodity Futures Modernization Act of 2000 (or "CFMA") which was signed into law on December 21st. This landmark legislation codifies many of the initiatives reflected in our regulatory reform rules. It also provides legal certainty for over-the-counter derivative markets, deregulates the futures markets, and lifts the ban on single-stock futures. Accordingly, the Commission promptly withdrew its rules and immediately turned its attention to implementation of the CFMA.
That implementation effort is my highest priority. Prompt implementation of the CFMA will require the Commission and its staff, in addition to promulgating rules, to conduct various studies (both independently and in coordination with other members of the President's Working Group on Financial Markets) mandated by the Act and to work closely with the Fed and the SEC to open the markets to single-stock futures. The Act, appropriately in my view, establishes deadlines for the agencies to accomplish these important cooperative tasks and I am fully committed to meeting each of those deadlines. As for issuing rules to implement the CFMA, we are already well under way; in fact, just last Friday, the Commission approved proposed rules governing exempt markets, derivative transaction execution facilities, and designated contract markets.
These proposed rules are now on our website and should appear in the Federal Register in about a week for public comment. I expect our next two sets of proposed rules (those dealing with privacy issues and opting out of segregated funds requirements, respectively) to also be published for comment next week. As always, I look forward to receiving the valuable insights and suggestions of those in the marketplace.
Many of you are familiar with my views on the proper role of regulation. For those of you who may not be, it is worth emphasizing, first, that I believe strongly in, and in fact have taken an oath to fulfill, the responsibilities and mandates of the Commission to maintain market integrity and protect market participants against fraud and manipulation. However, I do not subscribe to the idea of regulation for regulation's sake alone. There are different ways for the Commission to fulfill its responsibilities and I believe that reducing unnecessary and burdensome rules in favor of best management practices that allow flexibility and promote innovation is the appropriate path to take.
While the regulator cannot anticipate the substance of market innovations, the regulator must anticipate that innovations will take place and must stand ready to respond appropriately to, rather than impede and delay, such progress. The temptation to resort to prescriptive regulations that take an inherently static view of markets and technology can be hard to resist for some in the regulatory community. I have and will continue, however, to take a hard-line against reverting to such restrictions on innovation and progress. The alternative to prescriptive regulations, of course, is a rational set of principles-based rules, such as that called for by the CFMA.
I believe the CFMA and the principles-based approach that it advocates could not have come at a better time. Advances in technology are facilitating greater innovation in the markets. New products and new ways to trade existing products are evolving at an increasing pace. These innovations promise to improve both the efficiency of markets and their effectiveness as means of discovering prices and managing risks.
But there is an unavoidable relationship between market regulation and market innovation. The nature of that relationship influences whether resources are invested in valuable new innovations or are consumed in costly adaptation. Too often, inflexible regulations that lack a rational economic basis have forced market participants to adapt in ways that avoid inefficiencies imposed by such regulations but otherwise add no new value to the marketplace. The market bears the cost of such adaptation and whatever public policy the regulator might have been attempting to pursue is quite often not achieved. Not frequently enough, on the other hand, are rules designed with sufficient flexibility to permit (even encourage) true innovation that is driven by the economics of the marketplace and improvements in technology. Flexible rules can be effective in achieving necessary public policy goals without imposing unnecessary inefficiency or triggering costly adaptation.
The new regulatory approach that the CFMA calls for empowers the Commission to do just that: accomplish important public policy goals without imposing unnecessary costs on market participants, without stifling innovation made possible by new technology, and without implementing inflexible regulations that quickly become obsolete or ineffective. We have seen a direct benefit to markets when we have, in the past, been able to rationalize rules. A perfect example is what has happened in your own markets since the April 1993 energy exemption. What I hope to do is to make such improvements the rule rather than the exception.
And I believe that we will be successful in this effort. One example, just a first step really, is a new provision of the Act that Ken referred to a few moments ago, Section 2(h). This important section provides legal certainty for transactions in exempt commodities, just as other sections provide legal certainty for transactions in derivative and swap transactions involving excluded commodities. Exempt commodities, as you know, are defined to include all commodities that are neither excluded commodities (such as interest and exchange rates, certain economic or financial indices, and occurrences beyond the control of the parties) nor agricultural commodities. A good example of an exempt commodity is an energy product with a deep, liquid market, such as crude oil.
Section 2(h)(3) may be of particular interest for some because it clears the way for principal-to-principal transactions among eligible commercial entities on an electronic trading facility, or, what can be called an "exempt commercial market." As you know, an eligible commercial entity is a type of eligible contract participant, which is a broader category than the former concept of an "eligible swap participant" and which includes, among other things, a company with total assets of $10MM or a net worth of $1MM that enters into the transaction to manage risks related to assets or liabilities which are carried as a normal part of conducting its business. An eligible commercial entity is such a company that also either (i) has the ability to make or take delivery of the underlying commodity, (ii) incurs some commodity risk beyond price risk, or (iii) is a dealer in the underlying commodity or derivatives transactions involving that underlying commodity. An electronic trading facility is, of course, a type of trading facility that both (a) "operates by means of an electronic or telecommunications network" and (b) "maintains an automated audit trail" of bids, offers, order matches, and executions.
Subject to the normal prohibitions against fraud and manipulation, innovative new exempt commercial markets that provide real value for participants are now free to develop as quickly as technology permits. And an important public policy goal will continue to be served because, if such a facility comes to serve a significant price discovery function in the marketplace, the CFTC's authority to ensure transparency for such a market is preserved.
While passage of the CFMA is a very positive first step, and its prompt implementation is my highest priority, I do have other priorities. I plan to move forward with reviewing the need for comprehensive relief for intermediaries. I also want to respond appropriately to developments in the business-to-business arena as new innovations there enable firms engaged in online procurement to manage price volatility, lock-in prices, and assure themselves of adequate supplies.
I look forward to working in partnership with the various market participants as other innovative products and trading arrangements evolve. You are the experts in your areas of business and your motives properly are profit-driven. We are regulators, not experts in running your business, and as such our role is to protect the public good and should be confined to what I like to call outcome-neutral regulatory action where competition among market participants, not governmental prescription, determines the results. Section 3 of the Act clearly defines those legitimate public interests which should be furthered by this Commission. It is the place of Congress, not this Commission, to create new public policy. In this regard, it is noteworthy that the Commission has been strongly encouraged by members of Congress to utilize its exemptive authority under Section 4(c) and I plan to do so whenever appropriate.
Obviously, the year 2000 was an extremely important year for the futures industry. However, when we look back ten years from now, I predict we will find that 2001 was a critical year because, today, our challenge is to implement the much-needed relief granted by the new legislation, to anticipate future needs, and to react quickly to market dynamics. Your challenge is to help us address these issues properly.
The key to success for a regulator facing such great potential change in the marketplace is to pursue the same innovativeness and creativity that successful market participants rely upon in conducting their business. Fortunately, the CFMA affords us the opportunity to do so. But if we, as regulators, fail to take hold of this opportunity, if we resist the clear need to 'think outside the box', then we risk jeopardizing the leading role of U.S. markets, we risk squandering the current U.S. advantage in B2B and other areas.
There is perhaps no better example of an area in which we must change our regulatory approach, in which we must 'think outside the box,' than with respect to the traditional approach of churning out prescriptive regulations. It's been wisely said that enough regulations will ensure that nothing ever goes wrong in the marketplace but at the same time nothing right will be permitted to take place, either. Principles-based rules that suit the nature of the participant and the nature of the product, that take into consideration the costs as well as the benefits of compliance, and that reflect a common sense approach are most often the rules that are best able to effectively achieve public policy goals. For us, that means preventing fraud and manipulation while promoting markets that are reliable mechanisms for price discovery and risk allocation.