DECEMBER 16, 1998

Mr. Chairman and members of the Committee, I appreciate the opportunity to appear before you today as you seek information concerning the progress of the President’s Working Group on Financial Markets in its studies of over-the-counter (OTC) derivatives and the factors contributing to the collapse of the Long Term Capital Management (LTCM) hedge fund. Details concerning the Commission’s response to the collapse of LTCM and its cooperation with the Working Group are set out in the written statement of the Commission submitted by Chairperson Born. I would like to use my oral testimony to give the Committee my views on some of the broader concerns affecting global financial markets and the appropriate legislative and regulatory approaches to addressing those concerns.

I know this Committee is already well aware of the profound changes reshaping world financial markets. U.S. futures markets are growing and changing as exchanges explore electronic enhancements to trading systems, innovative products, and new cooperative arrangements with exchanges in other countries. OTC derivatives markets have grown at an even faster pace as new participants enter the market and financial engineers continue to create a bewildering array of new products – products that don’t always fit within a neat jurisdictional pigeonhole under our existing financial regulatory structure.

Developments in OTC derivatives markets can present tremendous opportunities for investment and risk management. However, they also can present risks to U.S. markets and our economy. It is the duty of financial regulators to keep abreast of such market developments and to assure that regulatory systems stay in sync with changing markets. Regulatory systems that fail to keep pace with evolving markets can stifle innovation, put U.S. business at a competitive disadvantage in the global marketplace, and open the door to abuse of customers or to systemic risks to the financial system as a whole. That is why I supported issuing the Commission’s Concept Release on OTC derivatives. I see the Concept Release as a questionnaire – a fact-finding exercise – undertaken with no preconceived ideas in order to gather information that will help the Commission assess the current realities of the marketplace and determine the appropriate Commission response, if any.

I also realize, however, that the CFTC is not acting in a vacuum. OTC derivatives issues demand a coordinated response, requiring cooperation among U.S. financial regulators as well as coordination with financial regulators in other countries to address cross-border concerns. Therefore, I strongly support the Commission’s cooperative efforts as a member of the President’s Working Group. By the same token, where the statutory boundaries that govern financial regulatory systems are not crystal clear – and I believe recent experience has shown that to be the case with OTC derivatives – Congress may need to step in and provide additional guidance.

Indeed, it was in order to assure that Congress would have an adequate opportunity to address jurisdictional issues relating to OTC derivatives that Commissioner Newsome and I wrote to you, Mr. Chairman, on September 11, 1998. In that letter we confirmed that we would not vote to propose or issue any new rules, regulations, interpretations, or policy statements to regulate swaps and hybrid instruments prior to September 30, 1999. Let me assure you, I continue to stand by that commitment. Our letter did include the caveat that, in the interim, the Commission should continue to be able to respond to market emergencies, grant petitions for exemptive relief, and address issues relating to agricultural trade options. Consistent with views you have expressed, Mr. Chairman, I would add to that list the ability to act in cooperation with the other members of the Working Group as a part of any coordinated interagency response growing out of the studies that are the subject of today’s hearing.

I am sure the testimony of those more directly involved in the two Working Group studies will illustrate that those studies involve extraordinarily complex issues and events. For the moment, there are a lot more questions than answers. It remains to be seen just what statutory and regulatory changes, if any, will be needed to address the issues identified in the studies. It also remains to be seen exactly how oversight responsibilities for enforcing any changes in regulatory policy should be apportioned among the various federal financial regulators. In addition, any such policy changes may also need to be coordinated with our regulatory counterparts in other countries.

If I may be permitted a small digression, I would also like to assure the Committee that the CFTC has not lost sight of the fact that innovation and evolution are not limited to financial markets alone. Agricultural markets, which are a matter of no small concern to this Committee, are also being buffeted by the winds of change. Farmers too need access to a wide variety of risk management tools if they are to compete effectively in today’s global agricultural marketplace. In that context, I would like the Committee to be aware that the Commissioners and CFTC staff have been reviewing industry reaction to the rules setting up the agricultural trade options pilot program, which became effective on June 15, 1998. It is my hope and intention that this reassessment process will lead to changes in the pilot program rules that will make agricultural trade options simpler and easier to use; and a more effective risk management tool for producers, processors, and merchandisers alike.

In closing, I would like to give the Committee my personal pledge to remain flexible and open-minded as we jointly seek answers to the many perplexing issues and questions regarding OTC derivatives and hedge funds. As the process of addressing these difficult issues goes forward, I pledge to keep an open mind and to support a spirit of cooperation by the CFTC with the Congress and with the other members of the President’s Working Group.

Thank you for the opportunity to appear before you today. I will be happy to answer any questions the Committee may have.