The 24th International SFOA Bürgenstock Conference
The International Forum for Derivative Markets
Address by Chairman James E. Newsome
of the U.S. Commodity Futures Trading Commission
Before the Regulators Meeting
September 4, 2003
KEEPING PACE WITH CHANGE – THE NEW FRAMEWORK FOR FUTURES
REGULATION AND GLOBAL DEVELOPMENTS
It is an honor and a pleasure to address this group of distinguished derivatives regulators on the occasion of the 24th Annual Meeting and International Forum for Derivative Markets in Bürgenstock.
This conference is coming at a time when the use of markets for risk management has dramatically increased. In 2001, total world-wide contract volume in futures and options increased by 47 percent, and in 2002, by 37 percent. More than one billion futures contracts traded for the first time in history last year. Statistics based on the most recent survey by the Bank for International Settlements cited 140 trillion in notional value for derivatives. This growth reflects various trends:
One core reason for growth may be an increased appreciation of the special cost efficiencies and credit enhancement typical of exchange markets. As risk management decisions move from the trading desk to the boardroom, and as risk management methodologies are better understood, one can expect their use to expand, especially in times of price volatility, and that is exactly what is happening. It is very appropriate that much of the main meeting focuses on what risk management is, and how risk officers can make risk transfer work to reduce volatility and risk for their companies.
I believe that some of the changes in the U.S. market have occurred because Congress and the CFTC moved from a regulatory model that relied on the regulator’s judgment about products, to a flexible, principles-based model that uses the judgment of the marketplace. I similarly believe that competition occurring in U.S. markets is resulting in new entrants, new products, and new ways to assure that the objectives of a fair and efficient marketplace are met. It is my goal to ensure a level regulatory playing field so that all participants, new and existing alike, have the opportunity to compete. The market process must and will sort out the winners and losers. In the end, I am confident that it will be the end users, the futures customers, who will benefit the most from this process, as it is being driven by strong competitive forces that reflect the demands and the needs of market users.
The new regulatory framework in the U.S. is one that squarely places with the market itself the obligation for assuring, in the first instance, that exchange products are economically useful and not readily susceptible to manipulation. At the same time, the law makes the markets accountable by providing the Commission with the regulatory and enforcement clout to oversee whether products meet relevant legal requirements.
For those who, through legitimate business practices, innovation, and vigorous competition, bring to the marketplace greater liquidity, more useful risk management tools, and more efficient pricing, I believe in providing the most flexible and responsive oversight structure possible. Such flexibility must be accompanied, however, by firm enforcement of the rules. Over the past year, we have brought and settled five cases in the energy area, assessing $68 million in penalties for false reporting of prices, among other things, and we are actively pursuing other investigations. Another example of how we have vigorously used our authority to go after illegal, off-exchange and fraudulent activity is in the foreign currency area, where, over the last 32 months we have brought 41 cases, involving over 3,400 customers. The amount of fines, restitution and disgorgement assessed thus far has totaled more than $167 million. These cases have also spawned criminal actions, which have resulted in fourteen indictments.
Today, I would like to share with you some of the issues that are arising as a result of the growth in the marketplace, the new types of products that are emerging, the increased interest in clearing, and how these issues are affecting how we conduct our business as an oversight authority.
Increasing Need for Cooperation
For many years we have talked about the world becoming a global financial market. Although derivatives markets have always had some level of international participation, today we are facing new practical questions flowing from the competition for global business and the fact that technology makes it easy to reach out from anywhere to anywhere to expand a market base. Consider the following:
Without even addressing how best to allocate regulatory responsibilities among the various regulatory, supervisory, and oversight authorities involved, these developments clearly put a premium on effective cooperation and coordination among regulators, and among regulators and markets. The CFTC actively supports cooperation, but we realize that allocation of regulatory oversight arrangements can be challenging. That is why we place considerable importance on the relationships that we develop with our international counterparts through participation in forums such as this one.
Recognizing that cooperation should begin at home, the CFTC actively supports the applications of U.S. regulated entities to operate in other jurisdictions in an effort to reduce the potential for duplicative requirements. In just the last few months, we have worked with regulatory authorities in Switzerland, Australia, Portugal, and France, on how to address their interests so that they can rely on our home market supervision.
Also, over the past year, we have been intensively negotiating with the U.S. SEC on how best to organize our joint supervision of security futures products, and have developed a draft agreement for coordination of such oversight. And, because access works in two directions, I am hopeful that these discussions will yield some progress on the treatment of foreign equity futures. In that regard, Commissioner Walt Lukken is taking a lead role in working with SEC Commissioner Paul Atkins to discuss what arrangements may bear fruit to permit U.S. access to a full range of global risk management products.
The CFTC also has been a strong proponent of reducing duplicative or redundant regulation by relying, when possible, on comparable regulatory regimes to permit access to our markets. Our experience with this program has been positive. Today, for example, twelve markets from eight non-U.S. jurisdictions have received CFTC no-action positions to permit direct screen access from the U.S. to their markets, in reliance on the foreign market’s home regulatory regime, subject to access to books and records, submission to U.S. jurisdiction, effective information sharing, and cooperative surveillance arrangements. Of these, as of August, nine were actually operating terminals in the U.S., and two have cooperative clearing arrangements with the Chicago Mercantile Exchange. Under the Commission’s Part 30 rules, 152 brokers from ten jurisdictions are currently permitted to deal directly with U.S. persons on the basis of compliance with their home jurisdictions’ licensing schemes for intermediaries. Additionally, 167 firms originating from fifteen jurisdictions operate in the U.S. under Part 30 exceptions for commodity pool operators, commodity trading advisors, and introducing brokers.
Regulated Clearing Facilities that are Independent of Markets
Other important issues currently confronting the CFTC flow from our new authority to regulate clearing organizations and, in particular, the provisions of the CFMA authorizing the decoupling of execution and clearing. This has occurred at the same time as other changes in market structure and governance have developed. I am certain you are not surprised to hear that there is a spectrum of views on what the appropriate role of the regulator is with respect to clearing oversight and clearing organization structures.
I see the Commission’s role in this restructuring process as identifying areas of regulatory concern – which we are doing through our recently initiated review of self-regulatory organizations, and our development of an oversight program specifically directed to clearing – and as encouraging and working with all sectors of the industry as they cooperate, ideally through business decisions made among business people, to work out mutually beneficial solutions to the challenges that lie ahead. I note that derivatives markets do not function properly if the trading system produces unfair prices or the credit model is deficient and believe, therefore, that the markets also should have the right incentives to design themselves in the public interest.
Updating and Enhancing the Business of Regulation
In addition to addressing the substance of regulation, we are also addressing the mechanics of how our oversight is delivered and how we communicate what we are doing to the general public. We are enhancing the technological tools at our disposal and expanding the range of financial market expertise of our staff.
For example, we are in the process of updating our mission statement and our means of demonstrating our regulatory performance with the use of a consultant who specializes in strategic planning. This process is causing us to think with new precision about just where we want to direct our emphasis in making needed changes to programs and to our infrastructure. In this regard, we will be updating our corporate documents and our recruitment packages, and will develop a video on the CFTC and how it works.
We have also become increasingly aggressive and timely about getting our message on how we enforce the law into the public domain. This includes:
As part of the tremendous effort we are making to modernize our oversight program, the CFTC is taking account of the work being done in various other jurisdictions to develop better means of prioritizing regulatory objectives and measuring regulatory performance. In this regard, we have sent high level participants to the U.K. to discuss regulatory planning, observed how the Committee of European Securities Regulators is conducting consultations as it develops means for implementing the European Directives, conferred with the Australians on how they track enforcement cases, and engaged in dialogue with international financial institutions, such as the World Bank and the Inter-American Development Bank on how development experts look at capital markets and risk management. We have welcomed a staff person from the U.K. FSA with experience in risk-based surveillance methodologies to give us training in the philosophy and specifics of applying those techniques, and have seconded a person to the European Central Bank to look at its analysis of clearing issues. Our staff are discussing examination procedures used by the federal banking authorities and we are talking to intermediaries about how they conduct their internal examinations. In addition, in preparation for fundamentally upgrading our in-house exchange database system for overseeing exchange trading activity, market oversight personnel are planning to consult with several non-U.S. regulators and markets to mine their experience in the electronic trading area. All of this practical research is being built into developing oversight that is more completely adapted to the substantial changes in the marketplace and the new flexibility our laws provide for markets to innovate.
This year, at our training seminar, in addition to a full week’s program of topical discussion, case studies, and practical instruction, we are planning one full day of break-out sessions for in depth dialogue on issues of interest to particular regulators. We also will issue an invitation to our in-house staff to take the occasion of the seminar to draw on the expert presenters from around the world for further discussion on issues of interest to us. It is very clear to us that the need for dialogue on how best to perform our responsibilities is a multi-lateral one.
The CFTC believes that one of its important missions is to engage directly with regulators around the world to improve how regulation is performed, to promote broader access to markets, and to reduce unnecessary redundancies and regulatory inconsistencies that can prove costly to market users and intermediaries engaged in international business. We are pleased that this effort, over time, has facilitated our ability to tailor our regulatory program, taking into account the programs of other markets and our favorable experience in cooperating with other authorities to address market abuses. In consequence, we have provided our highest level senior staff to support standard setting efforts at the international level.
I am pleased to be here today, and look forward to a productive meeting.