"A CFTC Perspective on Operations and Technology"

Joseph B. Dial, Commissioner

Commodity Futures Trading Commission

Futures Industry Association

New York Operations Division

OpTech Conference


Marriott Financial Center

New York, New York

April 10, 1996

I appreciate this opportunity to address the members of FIA's New York Operations Division. As technology transforms futures markets -- just like it is transforming nearly every other aspect of society -- operations and information management professionals like yourselves must deal with some of the most difficult and complex issues facing the futures industry. Just trying to keep up with the latest hardware and software innovations is a major challenge -- especially if you don't have any school age children at home to explain them to you. Like the industry it regulates, the CFTC is also working hard to keep pace with a rapidly changing environment.

This afternoon, I would like to give you a quick look at the Commission's efforts in the two areas that form the principal focus of this conference. First, I will review some recent changes in CFTC operations, especially as they affect areas of particular interest to industry operations people. I will follow up with a quick look at some of the Commission's recent and planned technology initiatives.

One recent innovation in the Commission's operations, instituted by former Chairman Mary Schapiro, is the idea of holding periodic, public roundtable discussions targeting specific areas of concern. These roundtables bring together a wide range of experts, from both inside and outside the futures industry, to help us develop creative approaches to some of the more difficult problems facing the Commission and the industry.

Of particular interest to this group, on September 18, 1995, the CFTC hosted a roundtable discussion on net capital rules. The big issue on the agenda was the possibility of moving toward a risk-based capital rule. For now, the Commission is awaiting the results of an industry study of the potential impact of such a rule. The broad cross-section of clearing FCMs participating in this test are running numbers, with live data, on a month-end basis over time, to determine the impact a risk-based system would have on their net capital status.

In the meantime, the Commission is acting on some of the less cosmic issues discussed at the roundtable. For example, in two weeks the Commission will vote on final rules increasing the CFTC's minimum financial requirements for FCMs and IBs to keep our rules consistent with changes to NFA's net capital rules. The same rulemaking package will also include revised rules regarding prepayment of subordinated debt and gross collection of exchange- set margins for omnibus accounts.

At that April 25 meeting, the Commission also hopes to take up amendments originally proposed in December 1994 to conform our early warning rules more closely to those of the SEC. Greater harmonization between CFTC and SEC rules was another issue raised at the capital rules roundtable. Again, the CFTC followed up by publishing, on February 26, 1996, proposed changes to conform our financial rules, related reporting requirements, and the debt- equity ratio requirement more closely to those of the SEC.

The net capital roundtable was actually the second in the series. An April 1995 disclosure roundtable led to rules completely revamping the managed funds disclosure framework by eliminating unneeded boilerplate and reorganizing important information into a shorter, clearer presentation. The third roundtable, held last December, dealt with agricultural trade options. The staff is currently working on a "white paper" that will lay out a possible course of action in this difficult area. What issue will the Commission tackle next? According to Acting Chairman Tull's recent appropriations testimony, "a roundtable on internal controls is planned for the near future."

Another CFTC operations innovation involves the Commission's ongoing oversight of exchange and NFA rule enforcement programs through what we call rule enforcement reviews. Traditionally, these have been "vertical" reviews covering a variety of programs at a single exchange. Recently, however, we have added "horizontal" reviews to the mix. A horizontal review looks at a single area or program across all the exchanges. In essence, it seeks to identify the exchanges with the "best practices" in a given area and then to encourage the rest of the industry to meet that standard.

Horizontal reviews provide a more efficient use of CFTC resources. They allow us to target specific problem areas, identify proven, industry-derived approaches, and transmit recommendations based on those approaches to all affected parties at the same time. Thus, enhancements can be implemented quickly, and on an industry-wide basis.

The first horizontal rule enforcement review, involving "Outtrade, Unmatched Trade and Error Rules," was brought before the Commission in September 1995. We saw the next one, covering "Exchange Programs for Enforcing Corrections to Time and Sales Records," in March of this year. The Commission has been very pleased with the results of this program and additional horizontal reviews will follow in the future.

Coordination with other regulators and with self-regulatory organizations is a long-standing tradition, not a new operation, for the CFTC. Nevertheless, I would like to note in passing one recent example of particular interest to this group. Last October, the CFTC and the SEC cooperated with the Intermarket Financial Surveillance Group to forge an agreement providing for coordination between securities and futures SROs in audit and examination activities. SRO auditors may now rely upon one another's work. Such mutual reliance will encourage all SROs to coordinate scope- setting, scheduling and sharing of findings, with the result that dually registered firms will be freed from much of the burden of duplicative audits.

Turning to technology issues, the Commission has been active in a variety of areas. One recent initiative involved technology briefings by representatives of four exchanges subject to enhanced audit trail requirements mandated by the Futures Trading Practices Act of 1992. The briefings, by NYMEX, CSCE, CME and CBOT, were very thorough, lasting anywhere from two to over three hours. They went beyond audit trail issues to cover exchange technological initiatives in areas such as: trade matching and clearing systems; order-routing and order-entry systems, including proprietary systems; trade tracking and trade practice surveillance systems; whether system improvements will improve financial integrity; how those improvements will

integrate with existing and planned automated systems; and how the Commission can facilitate implementation of these systems.

I view the process itself -- the fact that we invited the exchanges in for these comprehensive face-to-face meetings -- as a very good sign. It shows that we are interested not only in keeping track of what the exchanges are doing, but also in keeping the lines of communication open. As a result of such cooperative efforts, I believe the futures industry should be able to achieve a higher degree of efficiency and economy in developing and implementing new technology.

I must admit, I was impressed by some of the exchanges' plans for newfangled hardware and sophisticated systems. I think I saw a real commitment to try to keep pace with technological trends and adapt trading systems to the changes sweeping through world society. Nevertheless, the exchanges still have a long way to go in meeting the technological challenge.

Nothing illustrated this more clearly than our final technology briefing. It was presented by the FIA and entitled "The FCM Perspective on Automation in the Futures Industry." The briefing included a "report card" for the exchanges, with grades ranging from A- for "safety and soundness," to D for "standardization and efficiency." I don't really have time here to go into the details of the FIA presentation. In any case, I'm sure those same issues will be covered in the working sessions of this conference. Suffice it to say, your representatives did an excellent job. They gave the Commission and the exchanges a lot to think about -- and I'm hopeful the future will see some very positive, tangible benefits for the FCM community emerging from this exercise.

Another CFTC technological initiative involves plugging into the Worldwide Web. In October 1995, the Commission launched its Internet Home Page. The CFTC's website provides access to a variety of information, including:

News developments -- press releases, speeches, interp. letters, Commission opinions and orders, and so on;

Consumer information -- CFTC informational brochures, an explanation of the reparations program, and even a filing package for reparations complaints; and finally

Market data -- including the Commitments of Traders Report, T-Bond and T-Note deliveries, and selected FCM financial data.

The CFTC home page currently generates close to 6,000 hits per month, from the U.S. and as many as 40 foreign countries. We expect this to increase as we continue to add more information of interest to consumers, market users and commodity professionals.

The Commission is also exploring other regulatory implications of the Internet. Staff members in the Division of Trading and Markets are in the process of drafting proposed rules that would address several areas of concern, including:

Customer solicitation -- The Commission has taken the position that people who use the Internet to solicit customers are subject to the same CPO/CTA registration requirements and other rules as people who use telephones or printed matter. But how can the Commission and self-regulatory authorities most effectively monitor solicitation activity on the Internet, so as to enforce these rules?

Disclosure -- How can you use electronic media to provide required risk and performance disclosures in a manner that sufficiently mirrors current hard copy disclosure documents? How do you confirm electronically that the customer consents to electronic rather than paper disclosure? Once that hurdle is crossed, how do you confirm electronically that the prospect has received the disclosure materials?

Reporting -- Can electronic media be used effectively to provide transaction confirmations, quarterly statements, and so forth to customers?

Another possibility being studied is a pilot program for something along the lines of the SEC's EDGAR system -- a program that would allow futures industry professionals to file reports and other documents with the Commission electronically.

An additional regulatory initiative currently in the drafting process would provide for more effective oversight of exchange automated systems -- not just trading systems like GLOBEX or ACCESS, but electronic order routing systems, computerized trade practice compliance programs, and so on. The goal is not to impose specific technical standards, but rather to assure that automated systems operate in a manner consistent with the exchanges' obligations under the Commodity Exchange Act. Thus, the program would operate somewhat like the current rule enforcement review process. The primary regulatory obligation would require the exchanges to provide for "independent review" of their automated systems. This review could be done by an inside team or an outside consultant. The reviewers would look at issues such as:

Does the automated system include adequate procedures to prevent breakdowns or failures?

Does the exchange periodically test the system's capacity?

Are there adequate procedures in place to keep unauthorized persons from breaking into or tampering with the system?

Does the exchange have an adequate disaster recovery plan?

I should point out that the foregoing staff proposals are just that -- staff proposals. They have not been reviewed or approved by the Commission. Assuming they got past that hurdle, any such proposals would then be subject to the public comment process. Any final rules, if actually adopted, would undoubtedly include revisions -- perhaps quite substantial revisions -- as a result of these additional regulatory steps.

In closing, I would like to thank the FIA and its New York Operations Division for giving me the opportunity to share these thoughts with you today. The CFTC values its good working relationship with the Futures Industry Association. We certainly don't see eye to eye on every issue, but I am confident we can always count on each other for frank and open communications, a cooperative spirit, and a willingness to listen to the other side's point of view with an open mind.