Address by Chairman James E. Newsome of the
U.S. Commodity Futures Trading Commission before the
International Swaps and Derivatives Organization at the
Energy and Developing Products Conference
March 26, 2003
Thank you, Bob, for that kind introduction. It is an honor to address this distinguished group. Today, I would like to mention some of the most recent things we’ve done in the way of modernizing our rules and our oversight approach, efforts that bring us even closer to my goal of fully implementing the Commodity Futures Modernization Act. I’d also like to talk a bit about our ongoing enforcement efforts, including the actions announced yesterday in Washington. Finally, I want to share with you several of my own thoughts on where we go from here.
Very quickly following passage of the CFMA, the Commission implemented a variety of rule modernizations that affected exchanges and other trading platforms. We were also able, with a bit more effort and through joint efforts with the SEC, to put in place last year the rules necessary to allow trading to begin in single stock futures, at least for those listed domestically. Congress also directed us to review rules affecting futures market intermediaries, from futures commission merchants to pool operators and trading advisors. After soliciting input from market participants through hearings and roundtables, we recently published a number of modernization proposals for public comment. Some of these initiatives address issues that have challenged us for years and they will involve rule changes that affect not only our registrants but also mutual funds, insurance companies, and banks.
Some of these rule changes will provide much-needed clarity, certainty, and operational flexibility for market intermediaries, such as FCMs. Some directly reflect my belief that firms should not be unnecessarily impeded in their pursuit of overseas customers who want to trade on U.S. markets. I have spoken before of my commitment to lowering unnecessary barriers to cross-border transactions and I intend to continue with that effort.
Pool operators and trading advisors also found rule proposals in the Federal Register that will provide them greater operational flexibility. The Commission has proposed an exemption from registration requirements for entities that restrict participation to highly sophisticated persons or that limit trading activity to a de minimus level. We also proposed to lift restrictions on the ability of otherwise-regulated institutions - such as banks, mutual funds, and insurance companies - to make greater use of the risk management tools provided by our markets.
More Effective Oversight
In addition to modernizing rules, we are also looking at how we approach our oversight responsibilities with an eye toward increasing our effectiveness and making best use of taxpayer resources. For example, we announced last month that we have authorized the National Futures Association to perform additional front-line review functions because we have been very pleased with the success of past delegations to NFA. Another big change in our oversight holds particular promise, and that is risk-based auditing, which has been very successful for banking regulators and is now well accepted by the financial institutions themselves. In a risk-based audit of an FCM, for example, CFTC staff will focus their resources on areas that could pose the greatest danger to the safety of customer funds or the financial integrity of a the registered firm. This change is expected to better focus the resources of both the CFTC and the self-regulatory organizations for maximum effectiveness. The first major risk-based audit got underway just yesterday in Chicago, in fact, and I will monitor its progress with interest.
There is a major aspect of our oversight that will not be changing, however, and that is our firm commitment to bring our investigative and enforcement capabilities fully to bear on anyone who attempts to compromise the integrity, efficiency, or reliability of these critically important markets. Derivatives -- both on-exchange transactions and over-the-counter contracts -- now serve the risk management needs of businesses, investors, and financial institutions in virtually every sector of the economy. As Chairman Greenspan and others have observed, the increased use of derivatives can quite reasonably be said to have made the financial system more flexible, resilient, and efficient, which in turn has benefited the economy as a whole. The Commission’s recognition of just how important these risk management markets really are only strengthens our determination to protect them from attempts at fraud, abuse, and manipulation.
In December, we ordered a $5 million civil monetary penalty against Dynegy and West Coast Power in connection with false reporting and attempted manipulation. On March 12th, we filed a three-count complaint against Enron in federal court here in Houston. Our complaint charges Enron with manipulating the price of Henry Hub natural gas, with operating an unregistered futures exchange, and with offering off-exchange agricultural futures. Yesterday, the Commission allowed El Paso Merchant Energy to enter into a consent order that penalizes it in the amount of $20 million for the reporting of false information to certain energy price reporting indices. I should note that the penalty imposed upon El Paso reflects, in part, the Commission’s recognition of El Paso’s cooperation during the CFTC investigation of this particular conduct and its agreement to continue cooperating in related matters. In addition to these three cases, our Enforcement Division is actively engaged in other investigations in the energy sector, which may result in further charges being filed. As I have said before, our efforts to modernize rules to allow greater flexibility and innovation in legitimate business endeavors will be accompanied by a determination to use strong enforcement actions to deter unethical and illegal activity.
During these investigations, we have cooperated with other regulators and enforcement authorities and will continue to do so. The cases are complex and require substantial time and resources to develop, but it is my 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 and the public. I know that many within the energy sector have been and are hard at work in this effort and should be commended for the things that have been implemented or proposed thus far, including various initiatives on best practices, standards of ethical conduct, and, where appropriate, greater transparency.
Let me also point out that investigations and enforcement cases are not the only ways in which we are cooperating with other agencies. 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. I greatly appreciate the participation of key market participants, some of whom are here today, in what turned out to be a very informative program. I was made even more keenly aware of the challenges facing those who very much need the risk management tools offered by OTC energy derivatives. As a follow-up to some of the things we heard at that conference, FERC Chairman Pat Wood and I wrote jointly to Congress to express our support for previously proposed amendments to certain portions of the bankruptcy code. The changes may help alleviate credit risk concerns in energy markets by ensuring the enforceability of acceleration and termination provisions, netting clauses, and other contractual safeguards in the event of counterparty’s insolvency. I know that this organization has also supported these legislative changes.
Certainty and Flexibility
A key reason that I have expressed my support for those particular amendments to the bankruptcy code -- most recently with Chairman Wood but also previously as a member of the President’s Working Group on Financial Markets -- is that they would provide market participants with greater certainty that key protections which they negotiate into their transactions and agreements will be honored and enforceable should a problem ever arise. I believe that the concept of legal certainty for counterparties is critically important to the smooth and efficient operation of markets. If laws, regulations, or policies are unclear, then market participants must factor that uncertainty into their decisions and this often results in missed opportunities, inefficient results, or misallocated resources.
Legal certainty is a concept that Congress directly addressed in the Commodity Futures Modernization Act. For example, a key provision of the CFMA assured market participants that their transactions cannot be voided or otherwise called into question, and that they themselves cannot be deemed to have violated the Commodity Exchange Act, solely because of a trading platform’s failures to comply with the Act or our regulations. In other words, market participants need not fear that transactions will be unwound just because we brought charges against EnronOnline. The fact that the CFMA provided this legal certainty while also bringing about much-needed regulatory flexibility was one of the main reasons that I have strongly commended Congress for its passage and have worked hard to fully implement it at the CFTC.
The approach to derivatives oversight adopted by the CFMA recognizes, for example, the different needs of retail and sophisticated market participants and the different levels of appropriate oversight for commercial and non-commercial markets. Notwithstanding the challenges that have arisen -- the type of challenges that might be expected as any industry undergoes major technological, competitive, and regulatory changes -- and which we are addressing head-on through our enforcement efforts, I continue to believe that one-size-fits-all regulations and prohibitions which ignore unique risk management needs are effective neither in maximizing the efficiency of our various markets nor in minimizing the risks to participants. Rather, I believe that a legal and regulatory environment in which oversight is focused on real risks and which permits valuable innovations in risk management while maintaining and enhancing workable safeguards is the best protection against systemic problems.
Let me conclude by assuring you that the Commission is attentive to all the various concerns that market participants and others have expressed about energy and energy derivatives markets. I have asked Commissioner Sharon Brown-Hruska -- who is here today and who brings the skills of a PhD economist to the Commission -- to take a leading role in working with me to evaluate legislative proposals and other issues that may arise with respect to the energy markets. I look forward to working actively with Commissioner Brown-Hruska as we continue to monitor these important markets closely.
Thank you for allowing me to update you on our efforts at the CFTC.