Crafting Regulatory Policy to Meet Today’s Challenge

Address by Chairman Reuben Jeffery III
U.S. Commodity Futures Trading Commission

Futures Industry Association
32nd Annual International Futures Industry Conference
Boca Raton, Florida

March 15, 2007

Thank you for that kind introduction. I appreciate the opportunity to appear here again in Boca Raton for the 2007 FIA conference. Thank you, Richard and John, for inviting me and allowing me the opportunity to share a few thoughts with you.

A Look Back: Overcoming Past Challenges

All of you here at this conference have every reason to feel very good about the success of your industry. Record increases in trading volume, an explosion of innovative new product offerings, successful cross-border exchange linkages, and expansion into markets around the world all speak to the vitality of the U.S. futures industry and the opportunities that lie ahead.

It is hard to remember that this robust track record and promising future belies an earlier developmental period during which success was by no means assured. Take, for example, the collection of speeches and articles found on the website of the Chairman Emeritus of the Chicago Mercantile Exchange, Leo Melamed. There you will find an amazing collection of Leo’s work that traces the evolution of futures from agricultural, pit-traded instruments to the electronically-traded, predominantly financial-based, risk-management instruments of today.

While futures are now recognized as an essential mechanism for sophisticated risk management and price discovery that has benefited the global economy, speech titles such as “Sleazy Speculator” (1974), “Futures, the Coveted Scapegoat” (1985), “In Defense of Derivatives” (1994), and “Derivatives: Not a Four Letter Word” (1995) are stark reminders that this has not always been the case. Futures trading has indeed been a convenient scapegoat over the years, whether for allegedly contributing to high food and energy prices, causing low agricultural prices, or exacerbating the stock market break of 1987, to name a few.

Even the introduction of financial futures – characterized by Nobel Laureate Merton Miller as “the most significant financial innovation of the last twenty years” – was derided in 1972 by a New York banker who, according to the Wall Street Journal, declared that “it was ludicrous to think that foreign exchange could be entrusted to a bunch of pork belly crapshooters.” In short: the history contained in Leo’s works teaches that success was never preordained.

The Challenge of Today

Today, the challenge we face as industry participants and regulators is one of sustaining this successful record of growth and innovation within the context of an ever-evolving global financial marketplace, and under the bright glare of constant media and public scrutiny.

The main drivers of this growth and innovation – technology, globalization and competition – will undoubtedly continue as major forces for change in the futures industry. The breathtaking pace and breadth of that change is fundamentally altering the industry itself, as traditional lines demarcating asset classes, financial intermediaries, and national borders are becoming increasingly blurred.

Ultimately, this challenge will call upon regulators and industry participants alike to demonstrate the wisdom – and the will – to deal creatively with emerging issues in a way that best fulfills the promise of dynamic financial markets while, at the same time, safeguarding the market integrity and customer protections without which no marketplace can succeed.

There are two key themes of the CFTC’s regulatory policy that I would like to highlight this morning. These have served us well in the past, and should leave us well-positioned to meet today’s challenge: i) first, a principles-based regulatory approach providing flexibility that promotes competitiveness; and ii) second, cooperation among domestic and international authorities to address shared regulatory concerns.

A Principles-Based Regulatory Approach:

Flexibility that Promotes Competitiveness

The challenge of sustaining the growth and fostering the competitiveness of our markets in a global economy is not unique to the futures industry. As a result, our efforts to meet that challenge are playing out amidst a similar debate within the U.S. financial services community as a whole. Last year, initiatives were launched by United States Treasury Secretary Paulson, and separately by Senator Schumer and Mayor Bloomberg, which highlighted a concern that the United States may be losing its preeminence in capital formation and called for a reexamination of the U.S. financial services regulatory approach in order to strengthen the global competitiveness of the U.S. capital markets.

Earlier this week, Secretary Paulson hosted a conference in Washington, D.C., to discuss how the United States can ensure its competitiveness in a rapidly changing global economy. Participants at this forum discussed the impact that corporate governance, the regulatory structure of the U.S. financial industry, and the American accounting system have on our capital markets.

The calls for regulatory reform considered by these initiatives reflect a concern that the existing regulatory structure, which has evolved from its Depression-era foundation of barriers between financial sectors and reliance on prescriptive rules, is ill-suited to meet the challenge of a dynamic, global market for financial services.

Notably, the CFTC has been a leader among financial regulators in implementing, pursuant to the Commodity Exchange Act (CEA), a principles-based approach to market oversight. A rigid prescriptive regime is simply incompatible with the flexibility and adaptability needed in a globally competitive environment. Instead, a principles-based approach establishes “high level” objectives and provides guidance on how regulated entities can achieve those objectives. What matters in a principles-based approach is not a focus on means, but rather effectiveness in achieving the desired policy outcomes.

It is important to understand that a principles-based approach does not mean the elimination of all prescriptive rules. Relying solely on fixed rules may be appropriate in situations where, for example, the risks can be identified with a degree of confidence and uniform treatment is critical. Customer funds protection rules generally fall within this realm.

Nor does a principles-based approach signal an absence of regulatory interest. Markets function best when they are, and are perceived to be, fair and free from abuse. The CFTC’s principles-based approach, therefore, is accompanied by a vigorous enforcement program based on a zero-tolerance policy for those who seek to game the system through acts of fraud or manipulation.

The question, then, really is how best to achieve the correct balance between rules and principles. In such a rapidly evolving industry, having the option to rely upon a flexible, principles approach provides a useful tool in carrying out our mandate under the CEA to promote responsible innovation and fair competition. The virtues of a principles-based approach are illustrated well by the following three examples:

Foreign Boards of Trade

First, last year there were calls for the CFTC to develop a rule that would establish a fixed threshold test to determine when a foreign board of trade was no longer located outside the United States, and thus required to be designated as a U.S. contract market. Concerns were expressed that failure to do so would harm the competitive status of U.S. futures exchanges.

The CFTC rejected the traditional option of drawing bright lines through rulemaking. Instead, our Statement of Policy reaffirmed, with some important enhancements, the CFTC’s flexible “no-action” approach to permitting direct electronic access to foreign boards of trade.

Our main concern, and one that was voiced in many of the comments we received, was that a fixed test of “location,” if adopted by other countries as well, could inadvertently inhibit the ability of U.S. futures exchanges to innovate and compete globally. Equally important was the recognition that many of our counterparts around the world have developed their own regulatory and enforcement programs that achieve the same regulatory objectives, albeit in different ways.

In the end, the CFTC chose flexibility over rigidity. The Statement of Policy adopted an approach that is tailored to the risks, and that stays out of the way of legitimate global competition without sacrificing our unwavering commitment to U.S. customer and market protections.

SRO Governance

Second, the CFTC’s adoption of new governance standards for exchanges last month illustrates the flexibility that a principles-based approach gives us to craft regulatory solutions, particularly in areas of potentially competing policy considerations such as minimizing conflicts of interest in a self-regulatory environment. The CFTC’s new Acceptable Practices under Core Principle 15 of the CEA set standards for exchanges to demonstrate that they have effectively insulated their self-regulatory functions, personnel, and decisions from improper influence and commercial considerations.

The CFTC reconciled the need to achieve that Core Principle’s critical policy objective, which is so vital to maintaining public confidence in our markets, with the policy of self-regulation by issuing a “safe harbor.” Under this approach, exchanges can adhere to the safe harbor criteria to ensure compliance, or develop their own plan, which would be evaluated by the CFTC to ensure that such alternative plan meets the policy goal. The adoption of safe harbor criteria, in lieu of prescriptive rules, also affords exchanges the flexibility to adapt their governance structure – and exceed the safe harbor criteria if they deem appropriate – to fit their business.

President’s Working Group Principles for

Private Pools of Capital

Third, the President’s Working Group on Financial Markets (PWG), which is chaired by Treasury Secretary Paulson and composed of the chairmen of the Federal Reserve Board, Securities and Exchange Commission, and the CFTC, recently endorsed a principles-based approach in the context of private pools of capital. The PWG’s principles are intended to guide market participants, as well as U.S. financial regulators, as they address investor protection and systemic risk issues associated with the rapid growth of these pools of capital, including hedge funds.[1]

Unquestionably, the activities of private pools of capital raise legitimate policy issues. The concern that financial failures can have broader spill-over effects has always been a priority for all U.S. financial regulators.

The issue, then, is not whether these activities should be subject to regulatory supervision, but what is the most effective mechanism of supervision. The PWG recommended a principles-based approach instead of prescriptive rules because it concluded that a flexible approach, combining market discipline and supervisory oversight, is the most appropriate way to address systemic risk and investor protection concerns without inadvertently stifling private capital’s positive benefits to our economy.

The PWG believes that a self-interested and sophisticated, informed industry has its own powerful incentives to guard against systemic risk and to protect investors. But reliance on market discipline does not mean wholesale acceptance of the status quo. On the contrary, the PWG also believes that regulators have an important role to play in addressing these issues. The guidelines therefore contemplate a proactive, dynamic approach by market participants in coordination with government regulators.[2]

Although the PWG principles specifically target private pools of capital, they contain valuable advice for every financial services provider. These principles are compelling at a time when the globalization of markets and innovation in financial products has created a much more complex financial environment.

Cooperation among Domestic and International

Authorities to Address Shared Regulatory Concerns

The PWG developed a collaborative approach to private pools of capital in order to achieve a consistent and coordinated policy among U.S. regulators in an area that raises shared regulatory concerns, but in which no one agency has complete supervisory jurisdiction. In addition to its principles-based approach, another primary theme of CFTC regulatory policy has been its historically proactive interaction with other regulators, both here in the United States and abroad. We have done so in recognition that in this interconnected marketplace, no one regulator can responsibly carry out its mandate without working closely with other regulators that share common interests and concerns.

Domestically, the need for inter-agency regulatory cooperation is often the result of product innovation. The creativity of the U.S. futures industry in this regard is second to none. However, this creativity can sometimes lead to a degree of “product convergence” that may potentially implicate the supervisory interests of other U.S. regulators.

Just last month, the CFTC approved the Chicago Mercantile Exchange’s new credit event derivatives, which were designed to provide a more transparent, liquid and easy means of acquiring protection against the risk of bankruptcy. During the consideration of this product, the CFTC and SEC staffs met to address various issues, and we will continue to do so as innovative new products inch ever closer to existing jurisdictional boundaries. A primary goal of our discussions will be to ensure that, while there are no gaps in regulatory coverage, products are able to come to market in a prompt manner, unimpeded by legal uncertainty or burdensome regulatory overlap.

Just as we must collaborate with our domestic regulatory colleagues here at home, so, too, with our regulatory counterparts abroad. The CFTC recognized very early in its history the value of international cooperation with foreign authorities. Indeed, as one foreign participant noted during a hearing last year on the CFTC’s foreign board of trade policy, “the CFTC is a thought leader in this area.”[3]

The CFTC has been active for many years in the International Organization of Securities Commissions (IOSCO), where it participates in the ongoing development of common regulatory principles that help establish effective securities and derivatives regulation worldwide. Participation in IOSCO and other international organizations also assists the CFTC in maintaining strong international partnerships.

For example, last year, when questions were raised regarding the possible impact on U.S. markets of new contracts that traded on London-based ICE Futures but that settled off NYMEX prices, the CFTC and the UK’s Financial Services Authority (FSA) agreed to share information needed to detect potential abusive or manipulative trading practices in these related contracts. In addition to sharing surveillance data, FSA and CFTC staffs have initiated an ongoing monthly dialogue to exchange views on market events.

Such arrangements are critical in a global marketplace where no one regulator has all the information needed to supervise its markets. And they came about in this instance in no small measure because of the long-standing partnership that exists between our two agencies.

These partnerships benefit not only the CFTC, but also the U.S. futures industry, by ensuring that concerns can be discussed, information shared and problems resolved. There is no better evidence of the close relationship among international regulators than the presence today of so many of our international regulator friends and colleagues attending this conference.


In concluding, the challenge confronting us today – maintaining the competitiveness of the U.S. futures industry in a rapidly evolving global environment – is a vital one. The CFTC is responding to this challenge with, first, a flexible, principles-based regulatory regime; and second, coordination and cooperation with our domestic and foreign regulatory colleagues.

Such an approach can only succeed, though, in a deeply-rooted culture of ethics, professionalism, and compliance. This is where you, the industry, must concentrate your efforts. An unyielding commitment to the highest standards of integrity and professionalism, as well as a robust dedication to risk management, controls and compliance, will guarantee the public trust and confidence that is essential for our futures markets to flourish, and to compete on a global stage.

As I noted at the outset, because of the hard work of industry and the CFTC, the days of futures being a four-letter word are long since past. Yet more work lies ahead.

For your part, industry must not take for granted the progressive regulatory environment in which it has thrived. As you savor your success to date and contemplate the year ahead, never lose sight of our shared responsibility to the markets, the broader financial community and, most importantly, the public at large, to behave responsibly within the context of a dynamic principles-based regulatory framework.

The CFTC, in turn, stands committed to promoting innovation and competitiveness in the U.S. futures industry. We will of course remain vigilant in sanctioning abusive or manipulative conduct that can undermine market integrity. And we will continue to hew to our twin themes of principles-based regulation and regulatory cooperation to proactively take down unnecessary barriers and avoid artificial constraints to trading in our markets.

Thank you for your attention. I would be happy to take your questions.

[1] “Agreement Among PWG and U.S. Agency Principals on Principles and Guidelines Regarding Private Pools of Capital” (February 27, 2007). http://www.treasury.gov/resource-center/fin-mkts/Documents/hp272_principles.pdf

[2] As recently noted by Treasury’s Undersecretary for Domestic Finance, Robert K. Steel, the PWG guidelines should not be taken as “a green light to go forward with business as usual. A market as dynamic as this one requires concerted updating and review of procedures and processes.” See Remarks of Under Secretary for Domestic Finance Robert K. Steel, “On Private Pools of Capital.” (February 27, 2007). http://www.treasury.gov/press-center/press-releases/Pages/hp280.aspx

[3] Anthony Belchambers, Chief Executive, Futures and Options Association. Transcript: Hearing on What Constitutes a Board of Trade Located Outside the United States (July 27, 2006), p. 103. Available at: http://www.cftc.gov/foia/comment06/foi06--002_1.htm

Last Updated: December 22, 2010