Remarks of Acting Chairman James E. Newsome before the European Financial Markets Convention, Panel Discussion on Transatlantic Relations, (Presented by Marcia Blase, Counsel to the Acting Chairman)
June 15, 2001
It is my pleasure to be in Paris to present the remarks of Acting Chairman Jim Newsome to this European Financial Markets Convention. As transnational business becomes increasingly important, discussions such as this one, to explore the evolving role of regulatory authorities, are vital.
This Conference is particularly timely. The announcement on June 6 of the creation of a committee of financial regulatory authorities drawn from the members of FESCO and of a securities advisory committee (the ESC) to assist the European Commission in implementing your framework directives, mark a significant milestone in Europe’s movement toward a common financial market.
The CFTC applauds the tremendous accomplishments of the EU in harmonizing national laws and in developing an analytical framework for making its planned European market a reality. Your actions are one model for other regulatory authorities to consult when considering cross-border issues.
Which brings me to the subject of today’s remarks: the evolution of the CFTC’s regulatory response to the increase in cross-border business.
World markets are not new to us. The history of the US futures markets demonstrates that commodity transactions are not confined within a single jurisdiction. Users often are located outside the jurisdiction of the market; derivatives designers can choose reference prices from anywhere in the world; and risk managers and hedgers will seek whatever means are available to reduce geographic risk.
Congress established the CFTC in 1974 as an independent regulator for futures markets and related intermediaries, at least partly in response to perceived global developments in the grain futures and gold options markets and to the emergence of futures markets in world commodities, such as cocoa, coffee, and foreign currency. From the outset, therefore, the CFTC’s powers reflected that futures trading was a global business.
However, there were not many futures markets outside the US in 1974. But, this quickly changed. Beginning in the 1980s, many jurisdictions developed futures markets, some of which entered into linked trading and/or clearing with CFTC-regulated markets. In 1982, Congress recognized the growing participation by US residents in foreign markets and the increased participation in US markets by residents of other countries. In response, it expanded the CFTC’s authority over the offer and sale of foreign futures in the US and made it easier for the CFTC to cooperate with foreign futures authorities.
In granting the CFTC broad authority to protect US customers trading on non-US markets, Congress made clear that it did not intend for this authority to be used to impose our own design on those markets. Congress cautioned the CFTC to exercise its authority by “tak[ing] into account the customs and practices of foreign boards of trade or markets and [by] recogniz[ing] that differences may exist between the practices of foreign boards of trade and their US counterparts.”
Congress also made clear that it did not intend for the CFTC to use its authority to approve the contracts or rules of a foreign board of trade, or to approve rules that would place the solicitation or acceptance of orders in the US for bona fide foreign futures contracts at a comparative disadvantage with similar solicitation and acceptance of orders for domestic futures contracts.
Today, forty-five markets outside the US report their futures trading volume to the Futures Industry Association. During the last year, Europe accounted for more than forty-five per cent of that volume overall. As trading between US and non-US markets in derivatives products increasingly moves in both directions, the day-to-day operations of staff increasingly involve communications with their foreign counterparts.
For example in March of this year, of the large traders required to file reports with the CFTC, forty-two per cent of those trading in agricultural products, and thirty-eight per cent of those trading in financial instruments, were foreign based. To get an idea of size, during three selected weeks in March, almost 1,000 of these reporting traders, approximately forty per cent of which reported in financial instruments, were foreign-based.
During the first quarter of 2001, based on reports filed by nearly 200 of the largest brokers, US FCMs reported secured amounts held with respect to foreign trades in the aggregate amount of approximately 7.4 billion dollars, or about twelve per cent of the total amount segregated.
The CFTC also has permitted numerous foreign stock indexes to be offered to US customers and we continue to receive new proposals for alliances between markets in different jurisdictions.
We expect these trends to continue. Indeed, as collective investments, such as pension funds are permitted to invest in a broad range of asset classes, fund managers increasingly may need to hedge their global, as well as their domestic risks in available markets. Because of their low transaction costs and short settlement periods, futures products are particularly suited for this purpose.
Thus, long before the Internet challenged us to think about where markets are located, the commercial nature and the global scope of futures markets challenged us to think about how to regulate a market where certain features are located outside the US, or depend on the conditions in another market.
On a day-to-day basis then, we have no choice. We must cope with an international market from our perspective as a national regulator.
Consequently, CFTC policy makers have faced some of the same issues as the EU in developing its directives calculated to create an internal market for financial services within Europe. Although differing in content and in detail, our approaches share a common acknowledgment of the limits of our practical capacity to reach outside our national borders. The CFTC, while ceding no jurisdiction over cross-border transactions and arrangements, has concluded, therefore, that to be effective, oversight arrangements must be founded on cooperation with other regulatory authorities. Indeed, this observation began at home.
To promote thinking about this type of regulatory cooperation, the CFTC has actively supported efforts in IOSCO and in some cases, has led its own initiatives like the Boca Declaration with other interested regulators to clarify what types of practical arrangements between regulators are useful and appropriate in overseeing cross-border business. The CFTC also has worked on its own and with others to promote the movement toward common standards, both in IOSCO, with respect to screen based trading systems, and in the Windsor Declaration and the Tokyo Communique.
We have applied these practical techniques in our own program. For example, the CFTC has developed cooperative regulatory arrangements to support cross-border industry ventures, such as clearing through a mutual offset system and mutual access to linked markets; to permit reliance for some purposes on foreign regulators’ authorization processes to admit brokers selling offshore products to US customers and to permit foreign terminals to be accessed from the US; and to strengthen the capacity of regulators to oversee linked markets by specifying in advance information that would be immediately available under bilateral information sharing agreements for surveillance purposes, information that could be passed to markets for oversight of market integrity, and information that would support the more rigorous oversight of members operating in related markets located in different jurisdictions.
Illustrative examples of these arrangements include:
(1) Mutual Offset. As early as 1984, the CFTC approved a mutual offset system for clearing between the Singapore International Monetary Exchange and the Chicago Mercantile Exchange. Under the harmonized rules of the two markets, futures contracts could be put on in one jurisdiction and closed out in another. This arrangement made each local clearing organization a member of the other system and required working out common margining, emergency management, information sharing, and taxation issues. The CME/SIMEX linkage is still in place and, during the first quarter of this year, 892,000 trades were executed on the CME for inter-exchange transfer to SIMEX, and 4,361,000 trades were executed on SIMEX for inter-exchange transfer to the CME.
(2) Cross-Access Arrangements. Later, the CFTC approved an arrangement whereby the members of one exchange could access products on another. Several of these arrangements were tried over the years, the most recent in 1997. The very first was an arrangement between the then French MATIF and the CME, which used common trading rules for Globex-traded products. In permitting cross-access to each market, neither regulatory authority ceded any jurisdiction. The contracts that were permitted to trade between the markets were designed so as to contain no rules that were materially inconsistent with either regulatory regime, were supported by the availability of equivalent information to each regulator on the transactions occurring on the system, and assumed that each market in the first instance would discipline its own members when trading on either market.
(3) Comparability or Substituted Compliance. Also in the 1980s, the CFTC developed rules intended to permit brokers located outside the US to sell non-US futures products to US customers without being registered as futures commission merchants under our rules. In place of FCM registration, the CFTC accepted notification and substituted compliance with comparable rules of the foreign regulatory authority. This arrangement required the CFTC to depend on the other regulator to assure the fitness of the broker and assumed that the authorization requirements in place were sufficiently harmonized that, a US broker restricted from offering customer services here, could not end-run our system by registering offshore. The rules also relied primarily on the so-called “home regulator” for oversight of the prudential aspects of the broker’s business, but added some additional customer protections (such as segregation of customer funds and, in some cases, enhanced risk disclosures) to permit the tracing of customer money in the event of a loss and to eliminate any potential confusion in the expectations of US customers. This certification procedure also required foreign brokers granted relief to ensure access to books and records and to consent to US jurisdiction for their activities relating to US customers.
(4) Foreign Terminal Recognition-No Actions. The Commission, although clearly concerned with equivalent conditions of competition among US and non-US markets, also declined to regulate US access to foreign terminals as separate markets. Instead, the terminals received staff no-action relief from CFTC exchange designation requirements. The resulting de facto recognition of the related foreign market is based on compliance with the international standards for derivatives screen-based trading systems adopted by IOSCO and submission by the operators to jurisdiction in the US for enforcement purposes.
(5) Specific Cooperative Undertakings. The CFTC also has entered into a number of practical arrangements to provide to regulatory authorities outside the US, specified information on US-authorized firms—such as, information on certain large exposures of common members, information on fitness and propriety, and information on financial and operating capacity—in order to support access to those markets by our US-authorized firms.
Each of these solutions required us to seek practical partnerships with other regulators. In each of these cases, many of the matters evaluated by the EU, where certain types of inter-jurisdictional cooperation are mandated by treaty, were relevant to the CFTC’s consideration of appropriate arrangements. Among others, these included:
- the level of harmonization of the relevant law;
- the amenability of the activities within our jurisdiction to enforcement and dispute resolution;
- the accessibility of records; and
- appropriate levels of information sharing between regulators on the continuing fitness and authorization status of firms taking advantage of the arrangements.
Not surprisingly, these arrangements were concluded only after some difficult negotiations. Further, their success depends not only on the will of the affected regulators to cooperate with each other, but also on how well the cooperative arrangements work in practice. In any case, the bridges we built between markets and regulators have also been useful in addressing market problems that span jurisdictions, such as the collapse of Barings and the manipulation of Sumitomo, and in facilitating the process when we need to work jointly to investigate and sanction transnational misconduct.
The most recent legislative changes in the US have again recognized the importance of transnational business. Just enacted last December, the Commodity Futures Modernization Act of 2000 (CFMA) removed many prescriptive requirements that could render harmonization across borders difficult. It also directs the CFTC to take account of competition and of the differences between US and non-US markets. For example, the new Act directs that, in developing rules to permit the offer and sale of a security futures product traded on a foreign board of trade, the CFTC “shall take into account, as appropriate, the nature and size of the markets that the securities underlying the security futures product reflect.” In addition, the CFMA acknowledges that a US regulator can rely on certain parts of a foreign regulatory regime if it meets relevant standards.
In adopting the CFMA, Congress explicitly recognized the importance of global cooperation by adopting a sense of Congress provision that made clear that the CFTC was to continue its cooperative efforts with foreign authorities and its participation in international organizations to encourage, among other things, the facilitation of cross-border transactions through the removal or lessening of any unnecessary legal or practical obstacles, the development of internationally accepted standards of best practice, and the enhancement of international supervisory cooperation.
As you may know, there is an ongoing rulemaking related to implementing the CFMA and to the design of those portions of the regulatory regime for the offer and sale of security futures products within the US that are not explicitly set out in the legislation. As these rules will affect how offshore products may be sold in the US, you may wish to offer comments during the short public comment period afforded by the timeframes in the statute.
If you doubt whether cross-border cooperation can succeed, we have an example before us. Our host today, EURONEXT, is the product not only of a meeting of minds among business leaders, but also of a meeting of minds among three competent regulatory authorities. These regulators have concluded a practical memorandum of understanding pertaining to the oversight of EURONEXT’s rulebook, its common members and a tri-jurisdictional trading platform. I am told that at least one of the three of you called this MOU the second miracle of Amsterdam.
In conclusion, while the challenges of globalization—like the challenges of EU integration—are great, ultimately, increased harmonization and common approaches can facilitate both the seamless cross-border access that customers and market users demand and the high level of customer and market protection that they take for granted.