|All Other Programs||78%|
|All Other Programs||77%|
The primary responsibility of the Market Oversight program is to foster markets that accurately reflect the forces of supply and demand for the underlying commodity and are free of disruptive activity. By detecting and protecting against price manipulation and abusive trading practices, this program assists the markets in performing the vital economic functions of price discovery and risk transfer (hedging). The Market Oversight program fulfills the Commission’s surveillance and oversight responsibilities for these markets. The program also will conduct trade practice surveillance and reviews of exchange rule amendments and submissions. In addition, the program will develop, implement, and interpret regulations that protect customers, prevent trading abuses, and ensure the integrity of the futures markets. Of increasing importance is Market Oversight’s effort to enhance market transparency by publication of a number of more meaningful market reports providing information on the types of trading and trading activity in the marketplace.
In FY 2011, the Market Oversight program requests 168 FTEs, an increase of 29 FTE over the FY 2010 level. The four major subprograms—Market Surveillance, Market and Product Review, Market Compliance and Office of Data Management —are requesting 59 FTEs, 29 FTEs, 50 FTEs and 30 FTEs, respectively.
Chief Counsel’s Office. The Chief Counsel is responsible for the issuance of rules and regulations related to oversight of regulated futures markets; the issuance of interpretations, policy statements, and no-action letters in connection with issues related to markets; the review of division matters generally to ensure their consistency with the CEA and the Commission’s regulations; and the review of matters originated by other divisions of the Commission to determine whether they implicate the division’s interests in any manner. A key duty of Chief Counsel’s Office is the design and implementation of a program to address the operations of foreign boards of trade (FBOTs) that permit their members or participants in the United States to directly access their electronic trading systems. The Chief Counsel’s Office designs and implements procedures regarding the handling of initial and subsequent FBOT requests to permit direct access from the United States, including the form and extensive content of those requests sufficient to undertake a meaningful evaluation of the operations of the FBOT and its regulator. This area of responsibility requires the Chief Counsel to: 1) maintain a comprehensive knowledge of, and sensitivity to, the Commission's regulatory approach, policies, and current agenda regarding foreign regulatory authorities and foreign exchanges; 2) coordinate with other divisions and offices of the Commission in a comprehensive knowledge of the laws, regulations, and policies applicable to FBOTs; and 3) negotiate with FBOTs and foreign regulators, market authorities, and experts in the derivatives industry and academia.
Market Surveillance. Futures prices are generally quoted and disseminated throughout the U.S. and abroad. Business, agricultural, and financial enterprises use the futures markets for pricing information and for hedging against price risk. The participants in commercial transactions rely extensively on prices established by the futures markets, which affect trillions of dollars in commercial activity. Moreover, the prices established by the futures markets directly or indirectly affect all Americans. They affect what Americans pay for food, clothing, and shelter, what we pay to heat our homes and fuel our cars, as well as other necessities. Because futures and option prices are susceptible to manipulation and excessive volatility, and producers and users of the underlying commodities can be harmed by manipulated prices, preventive measures are necessary to ensure that market prices accurately reflect supply and demand conditions.
The detection and prevention of price manipulation are the responsibility of economists who monitor all active futures and option contracts for potential problems. The staff requested for the Market Oversight program will work to detect and prevent threats of price manipulation and other market disruptions caused by abusive trading practices in listed futures and option contracts. They will investigate instances of possible manipulation, and analyze routine reports of large-trader activity. To maintain an effective Market Surveillance program, the Commission must expand its commitment to information technology resources. The innovation in and diversity of contracts listed for trading as well as the volume of contracts traded on a daily basis has increased enormously in recent years. Price linkages between contracts traded, in different venues, has increased the complexity of the surveillance mission to understand manipulative strategies that may occur across markets.
Without additional resources, new surveillance burdens will need to be allocated among existing staff, reducing the effectiveness and timeliness of their analyses and constraining the ability of staff to react to new potential sources of manipulation or disruptive behavior. Computerized trading has transformed futures trading from a floor-based marketplace into an electronic one; a trading environment with potentially greater price impacts and market developments that can only be analyzed with the aid of new technology resources. For example, the special call survey of swaps dealers and index traders required a significant commitment of staff resources. Routine surveillance of markets had to be temporarily reallocated to other staff in the surveillance program, reducing the amount of time focused on each surveilled market. Technology must be engaged to continue to fully process and analyze special call data to complement its surveillance mission.
Market and Product Review. The Market and Product Review subprogram oversees the regulatory and oversight activities of all DCMs to ensure customer protection and market integrity. In order to serve the vital price-discovery and hedging functions of futures and option markets, exchanges must provide consumers with safe marketplaces that have appropriate protections in place and provisions for ensuring the fairness of the market and the integrity of their contracts. To accomplish this, the subprogram evaluates all exchange applications for approval as a contract market or as a Derivatives Transaction Execution Facility (DTEF) to ensure that the exchange is in compliance with Designation Criteria and Core Principles and Commission regulations, and that the public is appropriately protected. The reviews, which are required by the CEA, ensure that exchanges provide for fair, equitable and secure markets and that have appropriate self regulatory programs in place to police their markets.
The foundation of the Market and Product Review program are the reviews carried out prior to, or shortly after, implementation of new rules, programs and products. The regulated exchanges file with the Commission a very large number of new contracts and rule amendments. Unfortunately, reviews of exchange rule and product submissions are taking longer to complete, and regularly new rules and rule changes are implemented and new products trade for some time before the staff is able to review and address any concerns that may exist. This increases the risk that problematic new product terms and conditions, inappropriate new incentive or market maker programs, new market trading methods, changes to disciplinary rules or governance, and other troublesome changes to contract terms may go undetected posing a risk to the general public resulting in possible undermining the price discovery process for industry participants.
The staff reviews new exchange rules and rule amendments for consistency with Core Principles and regulatory standards, thus maintaining fairness and integrity, protecting customers, and accommodating and fostering innovation and efficiency in self-regulation. The reviews consider complex new trading procedures and market structures that present novel issues and, in some cases, require amendments or interpretations by the Commission to facilitate implementation of the SRO’s rule changes. Deficiencies in the new programs or changes to existing programs increase the likelihood of trading abuses, inconsistent market oversight, or implementation of market or governance changes that create conflicts of interest or raise other regulatory concerns. With additional resources, the subprogram would be able to provide more guidance to the exchanges, thus increasing the likelihood that when exchanges adopt new trading programs, incentive plans, governance models, etc., that such changes will be better designed to address and prevent regulatory concerns, thus enhancing the markets’ integrity, fairness and security.
The Market and Product Review staff also review exempt commercial market and exempt board of trade filings to ensure compliance with the Act and the significant price discovery provisions adopted by the Farm Bill in 2008. The subprogram oversees an annual requirement to file a notice with the Commission regarding the markets’ operating status under the exemption and whether any of the contracts listed on these markets serve a significant price discovery function. ECMs list a very large number of contracts in the energy area, many of which require extensive analysis by staff to ascertain whether they meet the requirements for SPDCs. Initially, there are as many as 50 contracts that potentially meet the SPDC criteria and ECMs continue to develop new products. Staff must evaluate all potential SPDCs to ascertain whether they meet the SPDC criteria; for those that do, staff must conduct surveillance of activity on those markets to protect the public interest, as directed by Congress in the Farm Bill, more staff are needed to implement the new provisions regarding ECMs that trade SPDCs, including ongoing reviews of the new market rules or amendments and annual evaluations to determine whether any of the markets serve a significant price discovery function. Any and all SPDCs must be subjected to an oversight regime comparable to that for designated contract market contracts.
Market Compliance. The Market Compliance subprogram oversees the regulatory and oversight activities of all designated contract markets to ensure customer protection and market integrity. The cornerstone of the Market Compliance program is the Rule Enforcement Review (RER) program that consists of examinations of DCM self-regulatory programs on an ongoing routine basis to assess their compliance with applicable core principles under the Act and Commission regulations. Different aspects of DCMs’ compliance and surveillance programs are reviewed: audit trails, trade practice surveillance, disciplinary, and dispute resolution programs. Results are documented in comprehensive reports and if issues are identified, specific recommendations for improvement are made. Unfortunately, due to limited resources, RERs of a given exchange are periodic in nature rather than annual evaluations, which is necessary to ensure comprehensive oversight. As a result, the subprogram is planning to establish a program for annual review of exchange programs. The less frequent timing of these reviews dilutes their ability to promote and enhance effective self-regulation and ensure that exchanges rigorously enforce compliance with their rules. There is a risk that an ineffective DCM self-regulatory program may go undetected or a systemic risk may not be identified posing a risk to the general public. The SEC maintains an “inspection” program similar to the Commission’s RER program. Under this program, the SEC reviews its major exchanges annually and its smaller exchanges very two to three years for compliance with various securities laws and regulations.
Limited resources have severely impacted Market Compliance’s ability to conduct “horizontal RERs” across exchanges. The last horizontal RER completed by Market Compliance was in 1997. These reviews assess how several DCMs address a particular issue and allow staff to recommend “best practices” and make recommendations for all exchanges. The 1997 RER assessed broker association programs in place at numerous exchanges and made six recommendations applicable to all of the exchanges reviewed. Many significant changes in the futures industry over the past 10 years are well-suited to examination in the form of a horizontal RER yet they remained unexamined. Some that merit in-depth review across DCMs include how changing business structures have impacted self-regulation, comparison of compliance staff size for DCMs with similar trading volume, electronic trading audit trail reviews, and size and type of disciplinary sanctions across all DCMs for violations of a similar type.
Current Commission oversight of U.S. futures markets does not include an established program for conducting regular reviews of the automated systems and business continuity and disaster recovery (BC-DR) plans required by exchanges to maintain appropriate plans, oversight, and testing to ensure that their automated systems and related operations are secure and resilient, and have adequate functionality and capacity. In today’s world, where electronic trading predominates, automated trading systems play a critical role in the financial markets. Sophisticated computer systems are also crucial to a DCM’s ability to maintain a comprehensive audit trail, publish timely market data, conduct adequate market and trade practice surveillance, provide large trader reporting, and monitor and enforce compliance with exchange rules and Commission regulations.
The importance of regular Commission review of automated system resilience and BC-DR capability of DCMs was heightened significantly in the wake the September 11, 2001 terrorist attacks, the 2003 Northeast power blackout, and the cyber attacks on NYMEX from 2005-2007. The resilience of DCM’s automated systems is vital to the continued operation of the U.S. financial sector in the event of a severe pandemic. Recent market events have only emphasized the interconnectedness of economies, markets, and market participants, and the serious economic consequences that can flow from the unavailability of organizations that play key roles in the financial system. Effective Commission oversight of DCM BC-DR programs and automated systems is thus essential to mitigation of systemic risk in the financial sector.
To enable the Commission to conduct regular reviews of the automated systems and BC-DR programs of major DCMs on an annual basis, and to conduct similar reviews of smaller DCMs on at least a triennial basis, the Commission must establish a dedicated Market Continuity Unit similar to the SEC’s program. This unit, which would reside within Market Compliance, would require at least five to seven technical staff with certification and/or degrees in information technology and cyber security. One person with such technical qualifications has already been hired.
Other U.S. financial regulators, including the SEC and the Federal Reserve, maintain comprehensive programs for regular review of the automated systems and the BC-DR plans and resources of the exchanges that fall within their purview. For example, the SEC has a dedicated program with a technical staff of 15. SEC’s staff receives training and software from the National Security Agency and has its own computer systems and network separate from the main SEC network. The SEC conducts annual reviews of the automated systems and BC-DR programs of its major (13) exchanges and clearing houses and conducts such reviews at smaller exchanges at least triennially.
The Market Compliance program also is directly involved with emergency planning for the markets and Commission and business continuity in the event of an emergency. In this capacity, a Market Compliance staff member represents the Commission as a President’s Working Group (PWG) Duty Officer, serving as one of the Commission’s point persons for information flow and coordination between the Treasury, Federal Reserve, SEC, and CFTC in the event of market moves or physical events (terrorism, hurricanes, etc.) that could disrupt the normal functioning of the financial sector. This same individual also represents the Commission on the Financial and Banking Information Infrastructure Committee (FBIIC), a standing committee of the PWG that is charged with enhancing financial sector resiliency and improving coordination and communication among financial regulators and between regulators and private sector financial institutions.
The Market Compliance subprogram monitors trading activity on all DCMs in order to detect and prevent possible trading violations. This type of oversight is conducted through the use of automated surveillance and floor surveillance, to foster markets that are free of trading abuses. The identification of potential trading violations results in referrals to relevant DCMs and to the Commission’s Division of Enforcement. In addition, the Market Compliance subprogram reviews and analyzes trading platforms, rule enforcement programs, and disciplinary procedures in connection with new DCM applications.
A key and under resourced function in Market Compliance is the conduct of investigations to detect possible trading abuses. This work protects market users and the integrity of the marketplace, but increasingly cannot be performed without a concerted focus on an investment in technology. Two years ago, staff began shifting resources away from the legacy system, EDBS, which relied heavily on manual analysis, to the development of an automated trade practice alert system, known as the Trade Surveillance System (TSS). TSS, when fully developed and implemented, will provide staff with automated alerts on possible trade practice abuses, exponentially improving their detection capabilities in the electronic trading environment. Trade violation detection software performs sophisticated pattern recognition and data mining to automate basic trade practice surveillance, and detect novel and complex abusive practices in today’s high-speed, high-volume global trading environment. TSS will be used to monitor inter-market trading, a blind spot in surveillance which only the Commission can address, and side-by-side trading, e.g., simultaneous trading of a contract on a DCM’s floor and the DCM’s electronic trading platform.
Office of Data Management. Detecting and preventing price manipulation in the markets under its jurisdiction rests on the ability to efficiently and effectively capture data and ensure its quality, accessibility, and storage management. The staff currently processes data records from between 250-270 firms daily and collects approximately 110 million records every year through a business process that is not fully automated. The application of technology and business process reengineering are essential to ensuring the integrity of the data and its timely accessibility.
The data is used in reports that provide current market information on the size of futures and option positions held by large traders as well as other background information that is necessary to monitor the markets and to enforce Commission and exchange speculative limits. These data are also used to publish reports that improve market transparency. Several transparency initiatives, begun in FY 2009, need additional resources in order to improve upon the timeliness and frequency of the reports, as well as the efficiency of the data collection. Separately, staff has issued “special calls” to about 40 trading entities, including swap dealers, to supplement what we already know about their on-exchange trading and, more importantly, to obtain critical information about their OTC trading and their clients.
The effectiveness gained through automation will allow Commission staff to periodically conduct audits of the firms to assure that information is being properly and accurately submitted. Limited funding severely curtailed the number of audits conducted, potentially affecting the accuracy of data collected and the ability of surveillance analysts to properly oversee activity in the market. For example, if accounts are not aggregated properly, it is impossible to track speculative limit violations, which can be a risk to the market.
The Commission anticipates that a large number of new, novel contracts, including contracts based on complex financial derivatives, broad-based debt indexes and SFPs based on debt instruments, will be listed for trading on futures exchanges. The number and diversity of agricultural and energy futures contracts is also expected to continue to grow, as exchanges develop new types of contracts to meet commercial needs, such as new exchange-traded contracts that replicate OTC products.
The current marketplace demands a sophisticated level of surveillance to adequately protect the public. The growth in the number and different types of facilities that trade a wide array of derivatives products, including futures on OTC instruments, contracts based on events or occurrences, and nontraditional contracts listed by ECMs, as well as, novel approaches to derivatives trading that must be overseen by experienced staff to monitor these products and examine the benefits and risks to the public arising from these developments. To adequately protect the public, effective surveillance and oversight of exchanges and product design requires adequate staff to monitor the increasing number of innovative and often complex futures and option contracts to detect or prevent potential problems, price manipulation, and other major market disruptions caused by abusive trading practices or contract design flaws and to deter and prevent price manipulation and investigate suspect activity.
The increasing inter-relationship among exchange-traded contracts, OTC products, and cash markets, involving many commodity areas, increases the complexity of conducting surveillance to detect manipulative strategies and to understand the factors causing price movements. Exchanges have indicated an interest in listing a large number of contracts, including new kinds of contracts, based on events that raise core issues regarding the extent of the Commission’s jurisdiction. Furthermore, the Commission anticipates that new technology and a number of new market plans and new trade execution methods will be adopted by exchanges. In addition, the development of new technology, side-by-side trading, and directly competitive markets creates the potential for new types of abuses across markets as well as abuses that utilize these newly available capabilities.
Additional staff are critical to enable the Market Oversight program to focus on the complex issues and changing practices in the derivatives markets, especially in the energy and agricultural sectors. Without adequate staff and technology resources, the Market Oversight program cannot keep up with the growth in new types of exchanges, new trading execution methods in futures markets, and the initiation of trading in new, innovative complex products that require detailed analysis and raise substantive legal and policy questions. In addition resources are required to conduct necessary reviews to ensure that exchanges adequately address potential conflicts of interest between their self-regulatory functions and responsibilities and their commercial interests. Furthermore, changes to the CEA now require reviews of ECMs that list for trading any contracts which have been determined to perform a significant price discovery function. This requires extensive additional staff hours focused on markets previously only lightly reviewed. Without adequate resources, staff will not be able to complete reviews in a timely manner, allowing traders to continue to use these markets to carry out manipulations or abusive trading strategies in that regulatory oversight.
Surveillance staff will be stretched to a level that puts at significant risk the Commission’s strategic goal to detect and deter price manipulation without new expert staff. Proper surveillance coverage of markets requires highly specialized and comprehensive knowledge of assigned markets. Surveillance economists currently are required to cover many markets, limiting the amount of expertise and attention that can be devoted to each market. It is likely that this situation will only deteriorate. Thus, some price manipulations and abusive trading practices will go undetected or will be detected too late to permit amelioration or intervention. Also, staff will not be able to assess trader participation in the markets to evaluate the extent of speculative and commercial activity. In particular, there is a substantial risk that abusive trading in agricultural and energy futures markets will go undetected, potentially costing American consumers hundreds of millions of dollars. This is of critical importance during recent periods of unprecedented prices and volatility in many commodity markets.
The efficacy of exchange self-regulatory programs is not being evaluated on a timely basis. The length of the time between reviews significantly grew over past several years. Staff must be able to ensure on an annual basis that exchanges are effectively fulfilling their self-regulatory responsibilities with respect to customer protection and market integrity and, if not, traders, affected industries and the general public may suffer direct economic harm from an increase in illegal trading activity. In addition, without sufficient resources to sufficiently advance the development of the TSS system staff will be constrained in its ability to conduct surveillance across multiple markets and exchanges to detect trading violations and potentially volatile activity. TSS also will provide staff with the necessary tools to recognize and monitor today’s often-novel and complex trading practices and strategies. TSS development and implementation is expected to be an ongoing process and is part-and-parcel of the Commission’s innovation to keep pace with rapid developments in today’s high-volume global electronic trading environment.
Staff will not be able to review all new contracts, new rules and rule change submissions for approval within statutory time frames, and will not be able to appropriately review all new contract, new rule and rule change certifications in a timely manner. In the absence of a timely new contract reviews, it is possible that a contract market might inadvertently list for trading a flawed contract that does not meet statutory or regulatory requirements. In the absence of a timely new rule or rule amendment review, a contract market might lead to a violation of the CEA or the Commission’s regulations. This could result in direct economic harm to producers, consumers, and other users of the underlying commodities and indirect harm to the economy as a whole because market prices may not accurately reflect supply and demand conditions or because the contract may not be a useful risk management tool.
Without adequate resources, staff may not be able to maintain its ability to process requests from foreign boards of trade to permit direct trading access to U.S. market users and ensure that the public is adequately protected. Delays would have a detrimental impact on the ability of U.S. market users to avail themselves of foreign liquidity pools and would generally impede the accelerating rate of globalization in the futures industry. Also, without adequate staff, the Market oversight Program cannot monitor activity on the foreign boards of trade granted direct access privileges to ensure that the conditions imposed by staff are met and that trading on these markets do not adversely affect trading on markets in the United States.
Without adequate resources, the Market Oversight program cannot monitor exempt markets and carry out the requirements of recently enacted legislation related to SPDCs on exempt markets. A shortfall of resources could significantly affect the public interest by undermining the intent of Congress to bring SPDCs under Commission oversight permitting such contracts to trade without effective surveillance and exchange oversight, thereby creating the potential for undetected market abuses and manipulation.
In addition, without adequate resources, staff cannot implement the various initiatives adopted by the Commission to improve transparency in the futures markets, especially the energy and agriculture markets. These initiatives focus on providing critical market information to traders and the public to address concerns about volatility and high prices. At very critical junctures of the streams of data processing, development, and maintenance of these current systems the staff has literally a person or two, who if unavailable for any reason, would delay those efforts. Additional hires are essential to remedy this situation.
Some of the transparency initiatives were the result of the staff’s special call to swap dealers. Much of the data collected from that endeavor, however, is currently not processed for lack of resources. As a result, the Commission and the public do not benefit from what is otherwise the only resource for further insight into Dodd-Frank Act markets. Without additional resources, the number of trading entities subject to the call is severely constrained. The call currently focuses on entities with “index investment” activity. Ideally, we need to expand the call to additional, major swap dealers who are not necessarily involved in index investment. In order to expand the list of recipients, we need additional resources to develop a list of targeted entities, prepare and issue the additional call letters, deal with follow-up discussion with the recipients to ensure proper interpretation and consistent results, process the incoming information, and then incorporate the new information into appropriate reports—for both internal use and potentially for public dissemination in aggregate form.
It is anticipated that some time in 2009, legislation will be adopted that will make fundamental changes to U.S. financial regulatory system, including new obligations with respect to the oversight of Dodd-Frank Act markets. While the precise allocation of those new regulatory responsibilities is unclear, there is a very high probability that the CFTC will have some increased market monitoring responsibilities over markets that have heretofore never been subject to regulation. Without additional resources, CFTC staff may not be adequate to effectively carry out the duties that would likely be attendant to those new responsibilities, including regulation drafting, market surveillance, and evaluations of exchange compliance with regulatory requirements.
|Subprogram||FY 2010||FY 2011||Change|
|Market & Product Review||6,618||26.00||8,261||29.00||1,643||3.00|
|Market & Product Review||17%|
|Outcomes||FY 2010||FY 2011||Change|
|GOAL ONE: Protect the economic functions of the commodity futures and option markets.|
|1.1 Futures and option markets that accurately reflect the forces of supply and demand for the underlying commodity and are free of disruptive activity.||$22,481||90.00||$30,479||109.00||$7,998||19.00|
|1.2 Markets that can be monitored to ensure early warning of potential problems or issues that could adversely affect their economic vitality.||1,865||7.00||3,212||11.00||1,347||4.00|
|Subtotal Goal One||$24,346||97.00||$33,691||120.00||$9,345||23.00|
|GOAL TWO: Protect market users and the public.|
|GOAL THREE: Foster open, competitive, and financially sound markets.|
|3.2 Commodity futures and option markets are effectively self-regulated.||$7,681||30.00||$10,230||35.00||$2,549||5.00|
|3.3 Markets are free of trade practice abuses.||2,529||10.00||3,190||11.00||661||1.00|
|3.4 Regulatory environment responsive to evolving market conditions.||565||2.00||625||2.00||60||0.00|
|Subtotal Goal Three||$10,775||42.00||$14,045||48.00||$3,270||6.00|