Remarks of Acting Chairman James E. Newsome
to the Silver Users Association
May 23, 2001
Thank you, for that kind introduction and for inviting me here today. It is both an honor and a pleasure to address this distinguished group. This is obviously an exciting time for your industry and others that utilize the futures and options markets.
I believe that Congress exhibited great vision in passing the Commodity Futures Modernization Act, a truly landmark piece of legislation that clears the path for revolutionary changes in the marketplace. Passage of the Act was an important first step and I commend Congress for taking it. Now, we at the CFTC must continue the momentum as we implement the Act's provisions. And prompt implementation of the new Act is my highest priority.
Overview of the CFMA
The Act has three primary goals. The first is to provide regulatory relief to futures and options exchanges. The second is to provide legal certainty for over-the-counter derivatives. And, finally, the Act lifts the ban on single-stock and narrow-based stock index futures. I would imagine that the provisions seeking to further the first goal may be of greatest interest to many of you, as users of our domestic futures and options exchanges. And I believe that, as those exchanges become even more competitive as trading platforms, as they improve both their efficiency and their effectiveness, you and other users will be the ultimate beneficiaries.
Implementation efforts at the CFTC are already well under way. The Commission has adopted final rules that protect customer privacy and that allow certain participants on designated transaction execution facilities to opt out of segregated funds treatment. Proposed rules to implement new regulatory frameworks for both exchanges and clearinghouses have been published for public comment. And we've got a lot more work ahead of us. All together, the Act directs the CFTC to accomplish almost two dozen separate tasks, including several joint rulemakings and studies with the SEC, and we are making substantial progress, both on individual projects and in productive cooperation with the SEC.
I am firmly committed to having in place by August 21st all the rules necessary for eligible contract participants to trade security futures products should they so choose and, by December 21st, all the rules necessary for retail participation. As always, I look forward to receiving the valuable insights and suggestions of all interested market participants as proposed rules are published for comment. Lots of these proposals are coming at you now and will continue to come over the next several months so I want to thank you in advance for your responsiveness and continued interest.
Review of Philosophy
Some of you are familiar with my views on the proper role of regulation in the economy. For those who may not be, I should emphasize, first, that I believe strongly in, and in fact have taken a[n] [solemn] oath to fulfill, the responsibilities and mandates of the Commission to maintain market integrity, to prevent manipulation of prices, and to protect market participants against fraudulent practices. I'm confident that the events of 1980 are as fresh in our minds at the CFTC as they are in yours. The CFTC will continue to vigorously prosecute those who attempt to manipulate markets or to defraud market participants.
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 implementing best management practices that allow flexibility and promote innovation is the appropriate path to take. The temptation to resort to prescriptive regulations that take an inherently static view of markets and technology has traditionally been hard to resist for some in the regulatory community. However, I have and will continue to take a hard-line against reverting to such restrictions on innovation and progress.
You and other market participants are the experts in running your respective businesses. We, as regulators, are not. Our role is to protect the public good and should be confined to what I like to call outcome-neutral regulatory actions where competition among market participants, not governmental prescription, determines the results. It is the place of Congress, not this agency, to create new public policy.
How the CFMA Helps
Principles versus Prescription: The alternative to prescriptive regulations, of course, is a rational set of principles-based rules and I believe, therefore, that the Commodity Futures Modernization Act and the principles-based approach it takes could not have come at a better time. Advances in technology are facilitating great innovation in the marketplace. New competitors and industry veterans alike are developing new products and new ways to trade existing products. In my view, these innovations promise to improve both the efficiency of markets and their effectiveness as a means of discovering prices and managing risks. For you, the ultimate user of the commodity, improved efficiency and effectiveness should translate directly into more reliable supplies and more reasonable prices.
Adaptation versus Innovation: There is an unavoidable relationship between overly burdensome market regulation and market innovation. The nature of the regulatory approach influences whether resources are invested in valuable new innovations (if the regulatory approach is flexible and economically sound) or are consumed in costly adaptation efforts (if regulations are overly burdensome and inflexible). Too often, an inflexible and prescriptive regulatory approach that lacks a rational economic basis has forced market participants to adapt to regulations in ways that avoid the inefficiencies imposed by such regulations but otherwise add no new value to the marketplace. Someone in the market ... often the commodity user ... must bear the added cost of such avoidance efforts. And whatever public policy the regulator might have been attempting to pursue is quite often not achieved anyway.
Not frequently enough, on the other hand, are rules designed with sufficient flexibility to permit (and even encourage) true market innovation, innovation that is driven by the economics of the marketplace and by improvements in technology. This is where flexible rules can be most effective: in achieving necessary public policy goals without imposing unnecessary inefficiency or triggering costly avoidance behaviors.
The CFMA's New Approach: The new regulatory approach that is called for by the CFMA empowers the Commission to do just that: accomplish important public policy goals without imposing unnecessary costs on market participants, without stifling innovation driven by new technologies and the evolving needs of the customers, and without implementing inflexible regulations that quickly become obsolete or ineffective. Congress has provided the opportunity for market innovations that provide real value to develop as quickly as technology permits and customer demand requires.
For example, one provision of the Act clears the way for principal-to-principal transactions among eligible commercial entities on an electronic trading facility, what will be called an “exempt commercial market.” An eligible commercial entity is just one type of eligible contract participant. This category is much broader than the former concept of an “eligible swap participant.” It 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 that are carried as a normal part of conducting its business. An eligible commercial entity is 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 a 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.
This provision means that 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.
The key to success for a financial 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 businesses. Fortunately, the CFMA affords us the opportunity to do so.
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, that allow business people to conduct business without unnecessary restrictions, and that reflect a common sense approach to regulation through a genuine partnership with market participants, are most often the rules that are best able to achieve public policy goals.
And, when combined with a continued focus on vigorously prosecuting those who attempt to manipulate markets or to defraud market participants, this regulatory innovativeness can help guarantee that our markets will not only be the safest, but also as efficient and effective as possible.
These are my ideas about where we go from here and what the core mission of our agency should be. I look forward to working with you as we move forward.