Address by Chairman James E. Newsome of the
U.S. Commodity Futures Trading Commission at the
28th Annual International Futures Industry Conference
Boca Raton, Florida
March 13, 2003
Thank you for that kind introduction. It is an honor to again address this distinguished group. Quite a bit has happened in the industry since I spoke here last year and there have been significant changes within the Commission as well. Commissioner Tom Erickson took the reins at the new Washington office of an important agricultural market participant and we welcomed two new Commissioners, Walt Lukken and Sharon Brown Hruska, who bring impressive skills and abilities. In fact, I am excited about the expanded roles that I have asked my fellow Commissioners to undertake as we move forward, in addition to their traditional roles.
Commissioner Barbara Holum chairs our Global Markets Advisory Committee and will soon be holding a Committee meeting to continue discussions on various issues, including the Commission’s policy on foreign exchanges doing business in the U.S. Commissioner Sharon Brown-Hruska will be lending much-needed assistance in monitoring and evaluating legislative proposals and issues that relate to the energy markets. Commissioner Walt Lukken has agreed to take a lead role in working with the Securities and Exchange Commission to complete our full implementation of the Commodity Futures Modernization Act. The insights that Walt gained through his involvement in that landmark legislation while he was on the Hill will be invaluable to this important effort.
Today, I would like to mention some of the most recent things we’ve done in the area of rule modernization, particularly some changes that will affect intermediaries. Additionally, I’d like to talk a bit about security futures, our ongoing enforcement efforts, particularly in the energy sector, and mention one or two other issues that may be of interest.
Rule Modernization for Intermediaries
Let me begin by expressing how pleased I am to be able to announce that a number of key rule modernization proposals have been approved by the Commission for publication in the Federal Register. Some of these initiatives represent solutions to challenging issues that have been outstanding for years. They involve changes to CFTC rules affecting not only FCMs, commodity pool operators, and commodity trading advisors, but also mutual funds, insurance companies, and banks.
Last year, the Commission held a very productive roundtable discussion with market participants to discuss rule modernization for intermediaries. We now have a variety of proposals that I believe are responsive to concerns expressed at the roundtable. For example, we have proposed substantial changes to our rules on bunched orders. These changes will simplify the process, increase its availability, and clarify the respective responsibilities of FCMs and account managers. All customers and a greater number of account managers would be eligible, potentially confusing and overly burdensome certification requirements would be removed, and the revised recordkeeping requirements would make clear that the account managers will be held responsible for the fairness of allocations.
Another area in which CFTC requirements have long needed modernization was the restriction on an FCM’s ability to hold customer funds in offshore locations or in foreign currencies. This unnecessarily impeded firms in their pursuit of overseas customers who want to trade on U.S. markets. Staff worked very hard to come up with a solution, one that I was pleased to see adopted recently by the Commission as a final rule. I have long been an advocate of lowering unnecessary barriers to cross-border transactions and I believe this new rule does just that while continuing to ensure the protection of customer funds in the event of an insolvency.
Registered commodity pool operators will also find relevant rule modernizations in the Federal Register, such as our proposals to reduce duplicative disclosure and financial reporting requirements among master/feeder funds and to permit electronic distribution of account statements. For registered commodity trading advisors, we are proposing to modernize the rules governing the disclosure of past performance data. In fact, we have also requested comment on whether a regulatory core principle may be appropriate in lieu of specific rules. As some of you know, this subject is one with which the Commission struggled for many years and I am grateful both to our staff who have worked so hard on this proposal and to the market participants who have been generous with their insights and patience.
The CFTC has for some time provided a more flexible set of requirements for operators and advisors of pools that limit participation to sophisticated persons. We are now proposing to provide a new exemption for operators and advisors of pools that limit participation to highly sophisticated persons. And we are proposing that the operator or advisor of a pool that permits participation by persons who may not meet quite as high a standard of sophistication, but that limits its futures activity to a de minimus level, should also be eligible for an exemption. We are seeking comment on the appropriate level of investor sophistication and de minimus activity. Such exemptions may encourage greater use of futures by entities that have been reluctant to do so under rules where registration requirements could be triggered by a single futures contract.
Finally, we are proposing to lift the restrictions on the ability of otherwise-regulated institutions - such as banks, mutual funds, and insurance companies - to make greater use of futures. These institutions may have substantial risk management needs. The futures markets, now more than ever, offer tools to meet those needs. Because such entities are regulated by other authorities, they may not need to be constrained in their use of those risk management tools or to be required to subject themselves to additional regulation in order to do so.
More Effective Oversight
Rule modernization is not the only change on the horizon. We are also looking at how we approach our oversight responsibilities with an eye toward making improvements wherever they promise increased effectiveness and better use of taxpayer resources. We announced last month that we have authorized the National Futures Association to review annual financial reports filed by CPOs. We have been pleased with successful delegations to NFA of other functions. The latest will not only improves efficiency but also provide our staff with prompt electronic access to information that can puts them into an even better position to effectively oversee compliance.
Another change in our approach to oversight holds particular promise in my view. Risk-based auditing has been very successful for banking regulators and is now well accepted by the financial institutions themselves. Under a fully-implemented risk-based auditing approach, Commission staff will focus their resources on those areas that can pose the greatest risks to the safety of customer funds or the financial integrity of the FCMs. This move from a strictly compliance-based audit approach to a risk-based approach can better focus the resources of both the Commission and the self-regulatory organizations for maximum effectiveness. We recently initiated the first such examinations and the process appears to be working very smoothly so far.
The ability of the Commission to work productively with, and confidently rely upon, this industry’s self-regulatory organizations has been integral to the success of these markets. And successful they certainly have been, as futures trading volumes once again shattered records last year, serving the needs of businesses and investors throughout the economy. I remain optimistic that, even as the structure of the industry changes with developments such as demutualization and increasing competition, the Commission will continue to be able to work with market participants to ensure that the principles of objectivity, confidentiality, and consistency prevail and that the self-regulatory system can be protected from misuse or neglect.
There is a major aspect of our regulatory approach that will not be changing. I remain firmly committed to bringing our investigative and enforcement capabilities fully to bear on those who would attempt to compromise the integrity, efficiency, or reliability of the futures markets. That determination, on the part of everyone at the CFTC, has only been strengthened by recent events.
In December, the Commission ordered a $5 million civil monetary penalty against Dynegy and West Coast Power in connection with false reporting and attempted manipulation. Our Division of Enforcement is actively engaged in other investigations in the energy sector and some will undoubtedly result in further charges, such as those announced yesterday against Enron. In the course of these investigations, we have cooperated with the Federal Energy Regulatory Commission, the SEC, and the Justice Department, and will continue to do so. The cases are complex and require substantial time and resources to develop, but it is my firm goal to identify the wrongdoers, and, just as importantly, to exonerate those not involved, as expeditiously as possible so that these markets can work toward restoring the confidence of market participants.
As I have stated before, our effort to modernize rules to allow greater flexibility and innovation in legitimate business endeavors goes hand-in-hand with our determination to use strong enforcement as a deterrent to unethical and illegal activities. My confidence in our ability to continue to effectively police against wrongdoing in our marketplaces -- even as those marketplaces evolve with new technologies, new products and players, and a new and less prescriptive regulatory framework -- is based on a successful track record. A good example is what we have accomplished recently with regard to illegal foreign currency operations. In less than two years, our enforcement team has initiated more than two dozen formal actions.
On a more positive note, I want to point out that investigations and enforcement cases are not the only ways in which we are cooperating with other federal regulators. A couple of weeks ago, we jointly hosted with the Federal Energy Regulatory Commission a conference to discuss possible solutions to credit risk problems in the energy sector. Because I am keenly aware of the challenges facing those who need the risk management tools offered by OTC energy derivatives, I was very interested in hearing what the panelists had to say. As a follow-up to some of the things we heard at that conference, Chairman Wood and I have written jointly to appropriate House and Senate committees to express our support for previously proposed amendments to certain portions of the bankruptcy code. These changes could alleviate credit risk concerns in energy markets by ensuring the enforceability of acceleration and netting clauses and other contractual safeguards in the event of counterparty’s insolvency.
Clearing and Market Structure
Let me take a moment to address a topic that is of great interest to many of you; that is, certain issues related to the traditional structure of the futures industry in terms of execution, settlement, and clearing functions. I recognize that some of the most well-respected people in this business hold very different views about the optimal industry structure. I also recognize that any decisions reached in this regard could have profound economic consequences within the industry. At this stage, I would continue to point out that the Congress, the President’s Working Group, market participants, and we at the Commission have worked hard to clarify the types of situations in which the CFTC should take a lead role or proactive stance, and those in which it should not. My own view remains that the issue of how best to structure institutions and relationships in the marketplace is fundamentally a business decision. Ideally, disagreements over such decisions should be resolved by those in the market because, I believe, that will result in far better outcomes than could be imposed by a regulator or a court. I am grateful for the cooperative spirit expressed by the market participants that have met several times thus far and am encouraged by those who have agreed to meet again to discuss technical issues surrounding this debate. The results of that discussion might help to inform the Commission should it decide to hold a hearing at some future date as we continue to define our role in the debate.
Let me finish my remarks today by noting that a great many people deserve praise for their tireless efforts to bring about the launch of trading in domestic security futures last year, including key CFTC staff and many of the market participants here today. But that achievement was by no means the end of our efforts. Chairman Donaldson and I enjoyed a very productive meeting last week and I look forward to working with him as our two agencies cooperate to resolve some issues that are still outstanding, such as how we handle foreign access. Last week, our staff exchanged comments on an inter-agency agreement to coordinate our respective oversight responsibilities in a manner consistent with Congress’ mandate under the CFMA that we avoid placing unnecessary and duplicative regulatory burdens on dual registrants.
I recently visited both OneChicago and NasdaqLiffe to view firsthand their operations and to discuss any areas of regulatory concern. Not surprisingly, I am sometimes asked for my views on the growth thus far in trading activity. Prior to last year’s launch, I refrained from making forecasts of how popular these products would be because I felt that it was my role as a regulator to make sure that success would not be decided by regulators but by market participants in a marketplace made as free as possible from unnecessary, duplicative, or unduly restrictive regulations. Having said that, I would point out that other products in our markets have faced some initial skepticism and yet turned out to be quite successful. While I recognize that it may not be exactly an apples-to-apples comparison, I would note, for example, that average monthly volumes in the each of security futures offered by OneChicago and NasdaqLiffe on Microsoft have, during the first four months, exceeded the volumes in the T-bond, Eurodollar, and crude oil contracts during corresponding periods when they were introduced. And the total volume of security futures trading at each exchange has been significantly greater than the volume of stock option trading during the corresponding launch months on the Chicago Board Options Exchange.
Thank you for allowing me to update you on our efforts at the CFTC .