Commodity Futures Trading Commission
Office of External Affairs
Three Lafayette Centre
1155 21st Street, NW
Washington, DC 20581
The 17th Session of the U.S.-China Joint
Economic Committee (JEC)
October 16/17, 2005
Grand Epoch City, Hebei Province (October 16)
Diaoyutai State Guest House, Beijing, China (October 17)
Remarks of CFTC Chairman Reuben Jeffery
JEC Plenary Session
October 16, 2005
It is an honor and a privilege to have the opportunity to address you during this important time in the development of your capital markets and the evolution of a corresponding regulatory structure. We applaud your interest in enhancing the efficiency of the markets, as well as the rigor of the judicial system and laws that support their operation. In particular, I am pleased to describe the experience of the United States in developing its futures markets, because there appear to be remarkable similarities in our respective markets and the needs of their commercial users.
The CFTC and the Structure of U.S. Markets
Let me begin with a few words about the U.S. oversight of futures and options. In 1974 the U.S. Congress established the CFTC as in independent agency in response to domestic and international market developments. The objective of the CFTC is to protect against manipulation, abusive trade practices and fraud. In doing so, the regulatory framework takes into account the user base, in particular the fact that the principal participants in the organized futures markets are professional traders, sophisticated individuals, and commercial interests.
Futures are big business. 1.3 billion contracts traded in 2004, a 27% increase over the previous year; and more than a billion dollars in cash and many trillions in risk pass through the U.S. system daily. While the historical roots of the U.S. futures markets are agricultural, today, more than 80 percent of all contracts are interest rate, equity and currency products.
The Parallels between China and the United States
China, of course, must deal with its own local realities. Nonetheless, the experience of the United States may be relevant to China, as the creation of the CFTC was driven in part by the rapid growth and diversification of financial markets.
With respect to foreign currency futures in particular, there are similarities between the situation of China today and that of the United States in the early 1970s when the Bretton Woods agreement that fixed the dollar exchange rate collapsed. At the time, Nobel Prize winning economist Milton Friedman predicted that the end of the Bretton Woods system for fixed rate global currencies would necessitate the creation of a derivatives market in foreign currencies. Friedman wrote:
“Under a system of rigidly-fixed rates that do not change . . . there is only limited room or need for a broad, resilient public futures market in currencies... [But] the demand that will rise for forward cover under [a flexible currency regime], and the greater opportunities for speculation, mean that the present futures markets are bound to expand – soon and rapidly.”
Friedman believed that this development would be in the national interest because it would encourage growth in the financial services sector, improve the functioning of foreign trade and enhance the central bank’s ability to manage monetary policy. He also noted the importance of speculators as an essential source of liquidity and stability.
Friedman’s views became the theoretical underpinnings for the opening of foreign currency futures trading on the Chicago Mercantile Exchange. Today, the CME conducts markets for 15 national currencies and the Euro, and also offers a dollar index based on a basket of seven currencies.
As China opens its markets, it also may have an interest in developing its derivatives markets as a mechanism to assist in managing price volatility and facilitating price discovery within the parameters that China deems appropriate. Like our futures markets in the early 1970s, the Chinese futures market today consists primarily of agricultural and physical commodity products. But the growth and sophistication of China’s financial markets is creating demand for financial derivatives. In the area of foreign currency, demand by foreign investors, domestic commercial interests, and speculators, for foreign currency futures that permit risk shifting and price discovery may be expected to grow substantially.
China has taken certain responsive steps already. As an example, the largest U.S. futures exchange, the Chicago Mercantile Exchange, has agreed with the China Foreign Exchange Trading System to provide a continuous flow of information, counsel, and expertise on the development of foreign exchange derivatives. Earlier this year, CFETS launched an independent foreign exchange trading system that provides quotations of foreign currency pairs for bank members. In addition, several Chinese government- sponsored enterprises also participate in foreign derivatives markets.
Currently, we understand that the Chinese authorities, particularly the banking and the securities regulatory commissions, are introducing new laws that will facilitate the trading of derivatives products on organized exchanges and take account of international standards in this area.
Role of the Regulator
Government can play a role in the success or failure of any futures market. In structuring a regulatory system, it is important to keep in mind the three component parts of any futures market. The first component is a contract based on a reference price (usually from a cash market). The second component is a trading venue, which, whether floor-based or electronic, operates according to rules and usually uses an auction-type pricing model. The third component is a credit enhancement mechanism, such as a clearinghouse, which assures settlement.
These three components can be assembled within a single institution, or they can be segmented and provided by different parties. However implemented, the basic objective of the regulatory system is achieving functional reliability and financial integrity without unnecessarily restricting the creativity of the marketplace in the design and trading of various product types. Success also depends upon a two-way demand for the type of risk management offered in the market—that is, there must be interest in both transferring and assuming the risk that is to be traded.
There is no one right or wrong way to approach these objectives. It is important to focus less on the specific types of regulatory structures that are put in place, and more on seeking to ensure compliance with applicable international standards, including the promotion of fair, efficient and transparent markets, appropriate customer protection, and the avoidance of systemic risk.
Regulatory Cooperation and Information Sharing
Importantly, regulators must also be able to cooperate to combat fraud and market abuse. I am happy to say that in 2002, the Commodity Futures Trading Commission and the China Securities Regulatory Commission entered into a Memorandum of Understanding to establish a mutually acceptable basis for cooperation, consultation and the provision of technical assistance.
We are hopeful that in this visit to China, we can lay the groundwork for a more comprehensive MOU to facilitate investigatory assistance and effective enforcement. Further, we would like to clarify the legal authority of the Chinese Securities Regulatory Commission and the Chinese Banking Regulatory Commission to compel the production of critical records, including bank and trading records.
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I am excited by my visit to China, and thank you for the opportunity to be here today. The vision and desire for business growth expressed by officials in both the public and private sectors is truly impressive. We hope that as China moves forward, we can share more specific experience and expertise as you further develop your futures and derivatives markets. I want particularly to personally extend an offer of our agency’s assistance as you and your colleagues refine the regulatory framework for futures and related products.