SPEAKERS CONTENTS INSERTS
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59–525 CC
1999
1999
REVIEW THE COMMODITY FUTURES TRADING COMMISSIONS' AUTHORITY TO PROVIDE U.S. FUTURES EXCHANGES WITH REGULATORY RELIEF
HEARING
BEFORE THE
SUBCOMMITTEE ON RISK MANAGEMENT,
RESEARCH, AND SPECIALTY CROPS
OF THE
COMMITTEE ON AGRICULTURE
HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTH CONGRESS
FIRST SESSION
AUGUST 5, 1999
Serial No. 106–32
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Printed for the use of the Committee on Agriculture
COMMITTEE ON AGRICULTURE
LARRY COMBEST, Texas, Chairman
BILL BARRETT, Nebraska,
Vice Chairman
JOHN A. BOEHNER, Ohio
THOMAS W. EWING, Illinois
BOB GOODLATTE, Virginia
RICHARD W. POMBO, California
CHARLES T. CANADY, Florida
NICK SMITH, Michigan
TERRY EVERETT, Alabama
FRANK D. LUCAS, Oklahoma
HELEN CHENOWETH, Idaho
JOHN N. HOSTETTLER, Indiana
SAXBY CHAMBLISS, Georgia
RAY LaHOOD, Illinois
JERRY MORAN, Kansas
BOB SCHAFFER, Colorado
JOHN R. THUNE, South Dakota
WILLIAM L. JENKINS, Tennessee
JOHN COOKSEY, Louisiana
KEN CALVERT, California
GIL GUTKNECHT, Minnesota
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BOB RILEY, Alabama
GREG WALDEN, Oregon
MICHAEL K. SIMPSON, Idaho
DOUG OSE, California
ROBIN HAYES, North Carolina
ERNIE FLETCHER, Kentucky
CHARLES W. STENHOLM, Texas,
Ranking Minority Member
GARY A. CONDIT, California
COLLIN C. PETERSON, Minnesota
CALVIN M. DOOLEY, California
EVA M. CLAYTON, North Carolina
DAVID MINGE, Minnesota
EARL F. HILLIARD, Alabama
EARL POMEROY, North Dakota
TIM HOLDEN, Pennsylvania
SANFORD D. BISHOP, Jr., Georgia
BENNIE G. THOMPSON, Mississippi
JOHN ELIAS BALDACCI, Maine
MARION BERRY, Arkansas
VIRGIL H. GOODE, Jr., Virginia
MIKE McINTYRE, North Carolina
DEBBIE STABENOW, Michigan
BOB ETHERIDGE, North Carolina
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CHRISTOPHER JOHN, Louisiana
LEONARD L. BOSWELL, Iowa
DAVID D. PHELPS, Illinois
KEN LUCAS, Kentucky
MIKE THOMPSON, California
BARON P. HILL, Indiana
——— ———
Professional Staff
WILLIAM E. O'CONNER, JR., Staff Director
LANCE KOTSCHWAR, Chief Counsel
STEPHEN HATERIUS, Minority Staff Director
KEITH WILLIAMS, Communications Director
Subcommittee on Risk Management, Research, and Specialty Crops
THOMAS W. EWING, Illinois, Chairman
BILL BARRETT, Nebraska,
Vice Chairman
NICK SMITH, Michigan
TERRY EVERETT, Alabama
FRANK D. LUCAS, Oklahoma
SAXBY CHAMBLISS, Georgia
RAY LaHOOD, Illinois
JERRY MORAN, Kansas
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JOHN R. THUNE, South Dakota
WILLIAM L. JENKINS, Tennessee
GIL GUTKNECHT, Minnesota
BOB RILEY, Alabama
GREG WALDEN, Oregon
MICHAEL K. SIMPSON, Idaho
DOUG OSE, California
ROBIN HAYES, North Carolina
ERNIE FLETCHER, Kentucky
GARY A. CONDIT, California,
Ranking Minority Member
CALVIN M. DOOLEY, California
EARL F. HILLIARD, Alabama
EARL POMEROY, North Dakota
SANFORD D. BISHOP, Jr., Georgia
JOHN ELIAS BALDACCI, Maine
VIRGIL H. GOODE, Jr., Virginia
MIKE McINTYRE, North Carolina
DEBBIE STABENOW, Michigan
BOB ETHERIDGE, North Carolina
CHRISTOPHER JOHN, Louisiana
LEONARD L. BOSWELL, Iowa
KEN LUCAS, Kentucky
MIKE THOMPSON, California
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——— ———
(ii)
C O N T E N T S
Ewing, Hon. Thomas W., a Representative in Congress from the State of Illinois, opening statement
Smith, Hon. Nick, a Representative in Congress from the State of Michigan, opening statement
Stabenow, Hon. Debbie, a Representative in Congress from the State of Michigan, prepared statement
Witnesses
Bowen, Christopher, senior vice-president, general counsel, New York Mercantile Exchange
Prepared statement
Erickson, Thomas J., Commissioner, Commodity Futures Trading Commission
Prepared statement
Holum, Barbara, Commissioner, Commodity Futures Trading Commission
Prepared statement
Newsome, James E., Commissioner, Commodity Futures Trading Commission
Prepared statement
Salzman, Jerrold, counsel, Chicago Mercantile Exchange
Prepared statement
Spears, David D., Acting Chairman, Commodity Futures Trading Commission
Prepared statement
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Young, Mark D., partner, Kirkland & Ellis, on behalf of the Chicago Board of Trade
Prepared statement
Answers to submitted questions
Submitted Material
Bowe, James J., president and chief executive officer, New York Board of Trade, letter of August 12, 1999
Royal, Carl A., senior vice-president and special counsel, Chicago Mercantile Exchange, letter of June 25, 1999 to Jean A. Webb, Commodity Futures Trading Commission
REVIEW THE COMMODITY FUTURES TRADING COMMISSIONS' AUTHORITY TO PROVIDE U.S. FUTURES EXCHANGES WITH REGULATORY RELIEF
THURSDAY, AUGUST 5, 1999
House of Representatives,
Subcommittee on Risk Management,
Research and Specialty Crops,
Committee on Agriculture,
Washington, DC.
The subcommittee met, pursuant to call, at 2:03 p.m., in room 1302, Longworth House Office Building, Hon. Thomas W. Ewing (chairman of the subcommittee) presiding.
Members present: Representatives Smith, Moran, Jenkins, Gutknecht, Ose, Hayes, Fletcher, Dooley, Pomeroy, Baldacci, Goode, Stabenow, Etheridge, John, Boswell, and Lucas of Kentucky.
Staff present: David Ebersole, senior professional staff; Stacy Carey, subcommittee staff director; Ryan Weston, professional staff, Callista Bisek, assistant clerk; Hunter Moorhead, legislative assistant; and John Riley, minority consultant.
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OPENING STATEMENT OF HON. THOMAS W. EWING, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF ILLINOIS
Mr. EWING. The meeting of the Subcommittee on Risk Management, Research, and Specialty Crops, to review the Commodity Futures Trading Commission's authority to provide U.S. futures exchanges with regulatory relief, will come to order.
I want to welcome all of the witnesses here today as the subcommittee reviews the regulatory exemptive authority the Commodity Futures Trading Commission is afforded under the Commodity Exchange Act.
It is important to note that the subcommittee focus today is not about foreign exchange terminal access to the United States. I believe foreign terminals should have access and fair access.
Today's focus has more to do with an ongoing struggle for the Commission to provide workable, non-symbolic regulatory relief to the U.S. futures exchanges. The subcommittee wants the Commission to act with due diligence to ensure that domestic U.S. futures exchanges are being given equitable time and effort on their deregulatory petition.
We are living in a time of tremendous technological change and fierce business competition. This should be considered a good problem because it is the result of a strong, innovative, and growing economy, except for many in the agricultural sector.
It is not the intent of this subcommittee that Government regulation should empower one business structure or entity to flourish or struggle at the expense of another. It is our job to ensure that fair and equitable laws are passed and proper and thorough regulations are implemented to carry out these laws.
The Commission staff recently released a statement detailing its intention to review the application of foreign exchanges for placement of screen-based terminals in the United States. In that statement, the Commission staff will work to review and make decisions on these applications within 21 days.
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Three U.S. futures exchanges recently submitted a petition to the Commission requesting regulatory relief under section 4(c) of the Commodity Exchange Act.
The basis of this section of the act is to allow regulatory relief in order to promote responsible economic or financial innovation and fair competition. Any exemption granted must, of course, continue to be consistent with the public interest.
The Commission has recently published two proposed rules. One creates a pilot program that would allow the exchanges to list new contracts without Commission approval.
The other would streamline procedures for reviewing exchange rules and allow future exchanges to change some rules and make some rules amendments automatically, as long as they met certain requirements.
While these proposed rules may address some of the concerns in the exchanges' 4(c) petition, the subcommittee is concerned about whether there has been adequate input from the affected parties to make these proposed rules effective and far-reaching enough, if adopted.
We hope that by receiving input from the commissioners reviewing the petition and by receiving input from the exchanges that filed the regulatory relief petition, the subcommittee will be able to determine how this process has proceeded thus far and what additional actions the Commission will need to take to ensure proper and adequate regulatory relief.
We are not here today to discuss what has been done or what can be done. We are here to discuss what will be done and when it will be done.
Does anyone else wish to give an opening statement?
Mr. Smith.
OPENING STATEMENT OF HON. NICK SMITH, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF MICHIGAN
Mr. SMITH. My concern, Mr. Chairman, is that the profitability of some of the exchanges sometimes doesn't give the due regard to production agriculture that I would like to see.
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As we look at the justification for the reason we started these future markets was we find that that was specifically for farmers, for production agriculture. Now, as we see less flexibility in the size of the contracts, we see greater difficulty on the part of individual farmers, especially small farmers, delivering and taking delivery on these contracts, it makes it more difficult for many small farmers throughout the Midwest, at least throughout my area of Michigan, to utilize these contracts as much as they should.
So as we look at the possibility of fewer and less regulations, I want to try to help assure that the protection for farmers is still there and that these future contracts, as they pertain to agricultural products, have a direct relation to the real market price.
Thank you, Mr. Chairman.
Mr. EWING. Thank you, Mr. Smith.
Any other opening statements may be submitted for the record at this time.
[The prepared statement of Ms. Stabenow follows:]
PREPARED STATEMENT OF HON. DEBBIE STABENOW, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF MICHIGAN
Mr Chairman, thank you for bringing the subcommittee together today to consider the important issue of regulatory relief for U.S. futures exchanges. This year, the subcommittee has focused its attention on the reauthorization of the Commodity Exchange Act. The issue of foreign terminals and their regulation has been raised during our consideration of the CEA. The recent Commodity Future Trade Commission announcement regarding its intent to act on the ''no action'' requests from foreign boards of trade to open additional terminals, has set the course for a closer examination of CFTC regulatory practices.
As we all know, the Chicago Board of Trade, Chicago Mercantile Exchange, and the New York Mercantile Exchange filed a joint petition to the CFTC requesting regulatory relief under section 4(c) of the CEA. Section 4(c) authorizes the CFTC to exempt a designated contract market for any provision of the CEA, aside from Shad/Johnson and the exchange trading requirements, so long as the exemption is ''consistent with public interest.'' The petitioners are concerned that the new foreign terminals will operate at a regulatory advantage and that section 4(c) should be invoked to level the playing field.
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I am pleased to welcome the Commissioners of the CFTC as well as representatives from the Chicago Board, Chicago Mercantile Exchange, and the New York Mercantile exchange as witnesses at today's hearing. I am eager to hear testimony from today's panels. I am particularly interested in information from the petitioners regarding the impact of the new foreign terminals on their own commodity and futures exchanges. Furthermore, I have reviewed the letter sent to the subcommittee from the CFTC and would like more information about efforts to provide regulatory relief.
Mr. EWING. Due to time constraints, as always, we're asking all the witnesses to operate under the 5-minute rule, as well as all of the members of the committee in their questioning of the witnesses.
The Chair asks that witnesses help us meet our time constraints by summarizing their oral testimony as quickly as possible. Your entire written statement will be included in the hearing record.
The Chair would also ask witnesses to remain available throughout the hearing to comment on issues that may arise later in the proceedings. I'm very pleased to welcome all of the sitting members of the CFTC today and I think it would be appropriate to recognize that Thomas J. Erickson, Commissioner, has just taken his seat on the Commission. We welcome you.
You've moved up a whole row. You used to sit behind the chairman and we know that you come to this new position with a great deal of experience and knowledge and we welcome you.
I also want to welcome James E. Newsome, who is a relatively new Commissioner; Barbara Holum, who has been at the Commission for a while, has a great deal of knowledge; and David D. Spears, who is also Acting Chairman of the Commission at this time.
So I assume we will start with you, David.
STATEMENT OF DAVID D. SPEARS, ACTING CHAIRMAN, COMMODITY FUTURES TRADING COMMISSION
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Mr. SPEARS. Thank you, Mr. Chairman and members of the subcommittee. I am pleased to appear before you today to testify regarding the competitive concerns of the U.S. Futures Exchanges.
As you've already stated, Mr. Chairman, I would ask that the written testimony of the Commission, including attached survey of foreign regulatory systems, prepared by the Commission's Office of International Affairs, be entered into the hearing record.
Pursuant to your request, the other Commissioners and I will also present individual testimony. Mr. Chairman, exchange competitive concerns were expressed most recently in a June 25, 1999 joint petition by the Chicago Board of Trade, the Chicago Mercantile Exchange, and the New York Mercantile Exchange, requesting an exemption from certain statutory and regulatory requirements.
At the outset, let me assure you that the Commission is firmly committed to ensuring the global competitiveness of the U.S. futures industry in general and the U.S. futures exchanges in particular. That is a paramount concern of the Commission.
I have also attached, as appendix A to my individual testimony, a list of some 27 major regulatory reform measures taken by the Commission over the last several years.
With respect to the petition itself, the Commission staff intends to circulate, within a few days, a proposal to publish petition for comment in the Federal Register.
Even before the exchanges' petition was filed, the Commission began to address a central concern raised by the petition; i.e., the ability to list contracts for trading on a more expedited basis. On July 20, 1999, the Commission announced a 2-year pilot program to permit the immediate listing of new contracts for trading for a specified period of time prior to Commission approval.
Last week, the exchanges issued a joint statement commending the Commission for this initial action.
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Besides responding to the contract approval issue, Commission staff believes a substantial portion of additional kinds of relief requested by the exchanges in their petitions already provided for by the Commodity Exchange Act and existing regulatory scheme.
I've also attached, as appendix B to my individual testimony, a document prepared by the Commission's Trading and Markets Division staff, addressing actions by the Commission under its existing authority, that are responsive to many of the regulatory parity concerns raised in the petition.
In addition to regulatory issues raised by the exchanges' petition, I also believe it is important to address some of the assumptions underlying the request.
First, the petition assumes that foreign exchanges will be permitted unlimited access to the United States by having to be designated as a contract market under the act. In fact, the no action relief presumes that the foreign exchanges are seeking only limited access to the U.S. market and includes volume reporting requirements and other conditions.
To the extent that any foreign exchange substantially changes the nature of its contacts with the United States, the Commission could reexamine the relief granted and even require it become designated as a U.S. contract market.
Second, a careful analysis of the major foreign regulatory regimes suggest that the international playing field may not be as uneven as sometimes thought. Third, the Commission is required by statute to recognize the general public interest in futures markets, as well as the needs of market users, including futures Commission merchants, other Commission registrants, and customers, ranging from pension funds to small country grain elevators and individual investors.
Some have expressed a key desire to have free and open U.S. customer access to foreign boards of trade. Consistent with this trend toward globalization, U.S. futures exchanges currently have over 125 trading terminals operating in seven foreign jurisdictions.
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Finally, the Commission recognizes the role of Congress in regulatory relief issues. Some of the exchanges' suggestions for regulatory change may well relate to fundamental customer protection and market integrity measures that have formed the cornerstone of the U.S. futures regulation for decades. Those protections should not be weakened or withdrawn absent a determination by Congress to change the Commission's statutory mandate.
Another very significant issue raised by the petition is a proposal that would reduce U.S. regulatory protection to the lowest level of regulation offered by any jurisdiction gaining access to U.S. markets in trading contracts that clone domestically-traded products.
In effect, a U.S. contract market could select the least restrictive elements from various regulatory systems around the world and create a regulatory patchwork that would embody the least restrictive regulatory standards of all of the major foreign financial regulators.
The Commission looks forward to receiving comment on these and all other issues raised in the exchanges' petition and believes that it is important to reserve judgment on these issues until it has heard from the entire regulatory community through the public comment process.
In closing, I want to stress that the Commission stands ready to cooperate with Congress throughout the reauthorization process and to work closely with industry to resolve this and all issues that may arise during that process.
On a personal note, Mr. Chairman, as I enter my third month as Acting Chairman of the Commission, I'd like to take this opportunity to publicly acknowledge the cooperation of my fellow Commissioners and the hard work and dedication of the Commission's professional staff.
Thank you. I'd be happy to answer any questions at the appropriate time.
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[The prepared statement of Mr. Spears appears at the conclusion of the hearing.]
Mr. EWING. Thank you, Mr. Spears. Ms. Holum.
STATEMENT OF BARBARA HOLUM, COMMISSIONER, COMMODITY FUTURES TRADING COMMISSION
Ms. HOLUM. Thank you, Mr. Chairman and members of the subcommittee. I do thank you for the opportunity to testify concerning the joint petition of the Chicago Board of Trade, the Chicago Mercantile Exchange, and the New York Mercantile Exchange.
The views I am expressing are my own.
In 1992, Congress, in its wisdom, granted the Commission authority under section 4(c) of the Commodity Exchange Act to exempt certain markets and products from the requirements of the act. This provided the Commission the necessary flexibility to encourage and allow market innovation and development.
However, a conference report cautioned against using the newly adopted provisions to promote wide-scale deregulation of the markets. As I have stated publicly, I remain committed to the principles of market integrity and customer protection and to preventing systemic risks so that our markets remain safe, sound, and competitive in the evolving global marketplace.
There has been a dramatic change in the futures trading landscape which can be attributed primarily to the proliferation of electric cross-border trading vehicles. The Commission has played an active role in the continuing efforts of the International Organization of Securities Commissions to promote international regulatory harmony and to prevent protectionist policies.
In 1990, the Commission chaired a committee which wrote the original 10 principles for the oversight of screen-based trading systems. In fact, the Commission, for years, has played a key role in efforts to develop international benchmarks for oversight of the global markets and to increase the coordination and cooperation among the various international regulatory bodies.
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On June 25, 1999, three U.S. exchanges submitted a petition under section 4(c) of the act in response to the Commission's order of June 2, lifting the moratorium on placement of foreign terminals in the United States.
The exchanges seek authority to, one, list new contracts without approval and, two, adopt new rules 10 days after submission to the Commission without approval, and, three, to adopt trading rules comparable to competing foreign exchanges rules immediately upon notice to the Commission without approval.
Perhaps a chronology of events leading up to this point may be useful. In 1989, a U.S. exchange received recognition in the United Kingdom as an overseas investment exchange, which permitted that exchange to offer its products through electronic terminals located in the United Kingdom. In May 1990, another U.S. exchange was permitted to place electronic trading terminals in France. In 1999, the Japanese authorities permitted a U.S. exchange to place terminals in Japan.
Today, U.S. exchanges have over 125 trading terminals in seven foreign jurisdictions. By comparison, not until February 1996 was the first foreign country, Germany, permitted to place electronic trading terminals in the United States.
In 1997, a moratorium was imposed on reviewing other applications for placement of foreign terminals in the United States.
On June 2, the Commission lifted the moratorium, and on June 23, 1999, a U.K. futures exchange was permitted to place terminals in the United States.
Simultaneously, with the lifting of the moratorium, the Commission determined to address the regulatory parity issues facing our U.S. exchanges. To that end, the Commission's Global Market Advisory Committee, which I chair, appointed an ad hoc committee on regulatory parity to form specific recommendations.
The ad hoc committee adopted three resolutions to address regulatory parity and presented a report to the full GMAC in July 1999. It is significant to note that the Global Markets Advisory Committee is comprised of 30 members representing U.S. exchanges, financial intermediaries, market-makers, the National Futures Association, and the Futures Industry Association, the Managed Funds Association, and attorneys representing foreign and domestic market users, among others.
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The primary mission of this committee is to obtain input on international market issues that affect the integrity and competitiveness of U.S. markets. The committee's report and resolutions, along with comments received at the full meeting, will be presented to the Commission for its consideration.
This series of events, roughly covering a 10-year period, now brings us to the exchanges' section 4(c) exemption petition, which is substantively similar, though not identical to the ad hoc committee resolutions.
The issues raised by the exchanges' petition present important and fundamental policy questions which we are considering carefully.
The United States boasts the safest and soundest futures markets in the world. I believe and many agree that this can be attributed to a regulatory regime that is grounded in the principles of market integrity, financial integrity and customer protection.
In the course of discussion at the various committee meetings, brokers, traders and end users alike have indicated that they would oppose radical deregulation of the exchange-based markets. At the same time, our markets have evolved and, in fact, may not need many of the regulatory safeguards designed for a different market, serving a different customer base.
As a commissioner and as chairman of the Global Markets Advisory Committee, I am committed to do whatever is required to ensure that our exchanges remain competitive. Our exchanges have been and should remain at the forefront of this industry. We cannot stop the technological advances that are rapidly redefining the way the industry does business.
As we enter the next millennium, we must not attempt to micro-manage our markets. Such an approach could stifle innovation, impede productivity, create regulatory gridlock and harm U.S. competitiveness.
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With reauthorization of the Commodity Exchange Act now underway, it is an optimal time for all of us to consider whether broad revision of regulatory mandates would constitute an appropriate response to the changing competitive landscape of the global marketplace.
I thank you, and would be pleased to answer any questions which you might have.
[The prepared statement of Ms. Holum appears at the conclusion of the hearing.]
Mr. EWING. Thank you. Mr. Newsome.
STATEMENT OF JAMES E. NEWSOME, COMMISSIONER, COMMODITY FUTURES TRADING COMMISSION
Mr. NEWSOME. Thank you, Mr. Chairman and members of the subcommittee. I'm pleased to testify before you today and I thank you for the opportunity to discuss important issues related to regulatory relief of the U.S. futures exchanges.
As I stated in testimony before your subcommittee in May, this continues to be an area of major significance and concern to me. As I have stated repeatedly as I came to the Commission a year ago, I come from a business background and believe strongly in fair competition.
These are the foundations which form the bases of my decisions as a regulator. Accordingly, in looking back over speeches and testimony I have delivered in the past year, I find consistent reiteration of my beliefs that our exchanges need significant regulatory relief.
Well before any discussions of foreign exchanges and no action requests, I was making rounds to agricultural groups, to industry participants, and to our domestic exchanges, listening to their concerns and finding out what areas of regulatory relief could be addressed immediately and then what areas the Commission needed guidance from our oversight committees.
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In my testimony in May, I stated that I had convened a meeting of representatives from the three largest domestic exchanges to discuss the issue of regulatory relief. They provided to me a list of items to address some of their concerns and I have shared that list with this committee.
In the intervening months, I have made consistent strong efforts to try and get certain items on that list accomplished; specifically, relief from pre-approval of contract market designation rules, a payment order flow advisory, a market-maker program advisory, and a final resolution on dual trading orders.
I chose those items from the exchanges' list as ones that could and should be addressed immediately, without changes in existing authority and without further direction from Congress. However, as you know, regulatory relief issues have become enmeshed in matters relating to no action relief for foreign exchanges.
During the past months, I have consistently stressed my belief that the Commission should address the domestic exchanges' concerns regarding these four issues prior to acting on foreign exchanges' requests; not for any protectionist reasons, but simply for the reason that we have the authority, ability and information necessary to act promptly and accordingly should do so.
I welcome the opportunity we now have to address the joint 4(c) exemption petition from the three largest domestic exchanges. I believe this should be a matter for comment on the public record, which, combined with responsive comments to the Commission's recent release on proposed designation pre-approval procedures, will greatly enhance our ability to make correct determinations regarding appropriate regulatory costs and benefits in this and other areas.
As to other items on the exchanges' list, for example, large trader reporting, price reporting, account identification and segregation of customer funds, it was my determination that these issues address core provisions of the Commodity Exchange Act and that input from many sectors, and especially from our oversight committees, is not only appropriate, but necessary, prior to Commission action.
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I continue to believe this is the correct approach given the fundamental nature of these issues and their relationship to customer protection and fraud and manipulation functions of the Commission.
I look forward to receiving input on these matters.
Our domestic exchanges deserve the benefit of true competition and a level playing field, as do the industry participants who use these markets. While this does not mean I believe in protectionism, it does mean that I wholeheartedly support efforts to revamp the act and our regulation to give the Commission, as an oversight agency, the flexibility to allow for development or improvement of technological advancements and to enable domestic exchanges to compete without unnecessary hindrances, as regulation under which they operate should have clear benefits which outweigh the cost of that regulation.
If I may, let me reiterate a final point I have made repeatedly in the past year. If the cost of doing business is too high, businesses will go where costs are lower; outside of the sphere of the United States policymaking authority.
We cannot afford to lose the exchanges. We cannot afford to lose other industry participants and we cannot afford to lose the ability to make policy determinations that affect the global economy due to being overly regulatory.
With that in mind, I commend your efforts, Mr. Chairman, to bring more rationality to the regulatory structure affecting domestic exchanges, and I will continue to work with you, with industry, and with other regulators to achieve that goal.
Thank you.
[The prepared statement of Mr. Newsome appears at the conclusion of the hearing.]
Mr. EWING. Thank you, Mr. Newsome. Mr. Erickson.
STATEMENT OF THOMAS J. ERICKSON, COMMISSIONER, COMMODITY FUTURES TRADING COMMISSION
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Mr. ERICKSON. Thank you, Mr. Chairman and thank you for the warm welcome to the committee. I appreciate being here today.
In case anyone is wondering, the chairs are not more comfortable in this row as opposed to the row directly behind me.
Mr. Ewing, Mr. Condit and members of the subcommittee, I am pleased to appear before you to discuss the Commodity Futures Trading Commission's ability to address competitive concerns of the domestic futures exchanges.
My remarks this afternoon amplify a few of the points in the Commission's testimony summarized by Acting Chairman Spears. Before doing so, however, I would first like to spend just a few moments discussing the legal requirements of the Commodity Exchange Act.
The Futures Trading Practices Act of 1992 authorizes the Commission to exempt any agreement, contract or transaction, or class thereof from the exchange trading requirement of section 4(a) or any other requirements of the Commodity Exchange Act, except section 2(a)(1)(b).
The Commission may exercise this broad exemptive authority by rule of regulation or order. In enacting section 4(c), Congress directed the Commission to make certain determinations in granting exemptions. For example, the act requires that an exemption be consistent with the public interest, which the conference report deems to include the prevention of fraud, the preservation of the financial integrity of markets, as well as the promotion of responsible economic or financial innovation and fair competition.
Moreover, the Commission must determine that any exemption will not have a material adverse effect on the ability of the Commission or any contract market to discharge its regulatory or self-regulatory duties under the act.
Again, according to the conference report, Congress intended that the Commission look at the potential impact of the new product on such regulatory concerns as market surveillance, financial integrity of participants, protection of customers, and trade practice enforcement.
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Congress directed the Commission to use this authority sparingly and stated it did not intend to prompt a wide-scale deregulation of markets falling within the ambit of the act.
The fact that the Commission must make these determinations is not an impediment to the Commission's ability to consider petitions for exemption. The act is enormously flexible. In fact, I'm certain there are aspects of the Commission's existing regulatory framework which, after careful analysis and consideration of changes in the market, may prove to be unnecessary.
In order to conduct such a review, I believe the Commission must have the benefit of public comment on any petition received under section 4(c).
This process is essential for the Commission to make the determinations necessary to exempt markets or transactions from provisions of the act. As discussed more fully in the Commission's statement, the Chicago Board of Trade, the Chicago Mercantile Exchange, and the New York Mercantile Exchange, submitted to the Commission a petition requesting broad relief from Commission regulation.
Parenthetically, I might note that I received the petition having had only 4 days to warm my chair at the Commission, but as a result, most of the decisions with respect to foreign terminals and the regulatory relief were already in place.
I was pleased, however, that I arrived in time to participate in the Commission's action to propose a 2-year pilot program allowing pre-designation of new contracts. Just last week, I met with Exchange officials in Chicago. My message was to them then and is today that there must be a direct dialog between exchanges and the Commission on issues facing exchange markets.
Absent that dialog, I fear the Commission could end up doing its level best in addressing yesterday's problems. It's not much help to an industry that it continues to innovate.
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In my view, there is no question that the Commission can and should consider the issues presented in the exchanges' petition. To do so thoroughly, I believe the Commission must have the benefit of public comment and must encourage continued dialog.
Therefore, I fully support publication of specific and general requests included in the petition submitted by the exchanges.
The subcommittee has also asked for comment on the introduction of foreign terminals into the United States. As I told members of the Senate Agriculture Committee at my nomination hearing on May 5, the Commission, the regulated industry and the public interests are better served, I think, by rules that are clear and not unnecessarily burdensome and apply equally to all petitioners and that provide legal certainty to transactions.
The more we use the no action process to resolve questions concerning new trading systems and instruments, the more we contribute to legal uncertainty. The no action process has its place, but in significant areas, such as foreign terminals, reasonable workable rules would prove to be a far better, long-term solution.
I am hopeful that the no action process will be an interim step to providing the legal certainty through the Commission's promulgation of rules.
I thank you for the opportunity to testify today on this very important issue, and I look forward to responding to your questions.
[The prepared statement of Mr. Erickson appears at the conclusion of the hearing.]
Mr. EWING. Thank you very much.
Ms. Holum, you said in your testimony, I missed exactly who you were referring to when you said opposed deregulation of the exchanges.
Ms. HOLUM. There are many participants in the market who appreciate the customer protection provisions of the act and I don't think anyone is interested in totally deregulating these markets, because in many instances, I think that's why these markets have been so successful.
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That's not to say that I am opposed to taking a very close look at the regulations and making drastic changes.
Mr. EWING. So you didn't name a group. You just said there are those.
Ms. HOLUM. No, I didn't. There are those.
Mr. EWING. I missed that, and that's what I was trying to get at.
Mr. Erickson, you indicate that you believe the current act is pretty flexible.
Mr. ERICKSON. Yes, sir.
Mr. EWING. Do you think it's been administered in a way that reflects that flexibility?
Mr. ERICKSON. Having not been at the Commission to participate in the previous deliberations, it wouldn't be fair for me to necessarily give a view on those actions.
But I do think, looking forward, as we address these issues, what's required is that we do need a direct dialog on issues. My concern is in this regard that we can end up doing our level best, as I said, to address problems that might have addressed problems 5 years that the markets had.
So looking forward, I think we do have the flexibility. I'm not sure that that's necessarily been the relationship in the past.
Mr. EWING. Well, I guess maybe the question would be fairer to you to say that charges have been made in the past of the inflexibility of the act and, in fact, I think many casual observers feel it is a very rigid, inflexible act. I think that has to do with the way it's been administered.
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Mr. ERICKSON. That may, in fact, be the case, because I do think that in 1992, Congress gave the Commission enormous flexibility to address issues that will be coming ahead. I think that the Commission has the ability to look at the market as a whole and make determinations about what the regulatory interest is.
I think that we can address and take up issues, for example, with respect to the new technology that we're seeing in markets and move to electronic trading.
Mr. EWING. Do you believe that under this act, we could move to a oversight responsibility as compared to pre-approval of everything the exchanges do?
Mr. ERICKSON. I think in some cases, I think the Commission's action with respect to pre-designation on contracts is an important step, because that will, in fact, give us the ability to have a 2-year pilot program, where we can actually see the utility of having that tool available for exchanges.
With respect to rules, I think I am interested very much in seeing the public comment. I do know that there is a multiplicity of economic interests in the markets and rule changes sometimes can have economic effects on the participants in the market.
So I would be interested in the public comment on that.
Mr. EWING. Did you say that you thought that we should have the pre-approval process for contracts, except in the case of pilot programs?
Mr. ERICKSON. No. Under the pilot program, the choice is the exchanges'. The exchanges can select either the pre-designation under the pilot program or one of the other two processes that are currently available under fast track or the normal procedure.
And I think that pre-designation is an important step and I hope that it will be used and I hope that it will help the Commission in making determinations on the question that you're raising today.
Mr. EWING. Would you explain what you mean by pre-designation?
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Mr. ERICKSON. That is shorthand for what the Commission's action was on July 21 or 20, I can't remember, allowing the exchanges to list contracts the day after they notify the Commission, which I think gives the exchanges some additional flexibility in being able to respond to competitive forces that they see.
Mr. EWING. Was that with a pilot program?
Mr. ERICKSON. It is. It's a proposal. It's out, I think, now for 30-day comment period and it would be a 2-year pilot program and I'm looking forward to the comments.
I appreciated very much the exchanges' initial welcoming of the pilot program and like I've said before, I think that we may not get everything right the first time, but hopefully we can continue to proceed.
Mr. EWING. I really don't want the audience to think I'm picking on the newest Commissioner.
Mr. ERICKSON. It's OK.
Mr. EWING. But another question that came up from your testimony. When you talk about dialog between the Commission, you, as Commissioners, and the exchanges, do you really think there has been that kind of meaningful, frank, useful dialog or do you think there could a better way to phrase that.
Can we improve on that dialog a great deal so that the exchanges have a better idea of where they stand with the Commission on issues that are important to them?
Mr. ERICKSON. I hope to be able to contribute to that. I think it's very important for me, as a commissioner, to have information that's contemporaneous with what the market is going through today.
And I can't speak for the previous conversations or the other conversations that commissioners have had with exchanges or other market participants, but that is, in fact, something I believe very strongly and hope that that, if it hasn't been the case, that it can be the case.
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Mr. EWING. Mr. Dooley.
Mr. DOOLEY. No questions.
Mr. EWING. Mr. Lucas.
Mr. LUCAS. No questions.
Mr. EWING. Mr. Fletcher.
Mr. FLETCHER. Thank you, Mr. Chairman.
Looking over this, and you're going to have to bear with me and the fact that much of this information is new, there's obviously three requests that have been made by the exchanges in their petition.
Really, just if you could make it very clear to me, and maybe, Mr. Spears, we'll start with you. Does the Commission feel that it has the authority to grant these petitions? If not, what do they need, and, if not, why aren't we moving on it?
Mr. SPEARS. I'll try to answer that with a little bit of background, as well. Yes, I would say we do have legal authority to act on the petition. In order to grant a 4(c) petition of this magnitude, we have to make certain determinations as to findings of the act. In order to make those determinations, we need to receive public comment.
It's our intention to publish the petition in the next few days in order to get that public record and comment.
As to the three basic requests that you identified, we at the Commission have made a sincere effort to address the first one, which was the contract approval, with our 2-year pilot program that Chairman Ewing discussed with Commissioner Erickson. As to the rule approval, rule changes, that's an issue that, as Commissioner Holum alluded to, there is considerable discussion within the industry regarding the impact on rule changes, because somewhat different than a contract approval; where in contract approval, you have a new contract, there is no open interest and outstanding interest in that contract.
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It's a brand new contract, starting up brand new. With a rule change on existing contract, you may have existing open interest, public interest concerns that would be raised about changing rules in the middle of a contract.
With regard to the third request, which is basically identified in my testimony, an issue where an exchange can—would like to have the ability to—if there is a direct competition on a foreign contract, would like to adopt that type of regulatory scheme for that particular contract.
One issue there would be if you carried that to its fullest extent, you would end up having a patchwork of various regulatory schemes for various contracts within a single exchange.
So we have to be very careful that we don't find ourselves going to the lowest denominator as to the lowest regulatory scheme, that has been a cornerstone to the customer protection and market integrity issues of the U.S. exchanges.
I hope I answered your question. It was kind of a long-winded answer, and I apologize for that.
Mr. FLETCHER. I think you did. I've still, obviously, got a lot to learn on this subject. But let me ask you. In the testimony, it was stated that in the U.K., and I assume that doesn't stand for University of Kentucky, it allows listing of contracts without prior approval. And if this works there, are there problems that you think that we have such a difference that it wouldn't work here?
Mr. SPEARS. The United Kingdom is somewhat different in that they do not have a formal contract approval. They have a very active informal process. It's my understanding that an exchange in the United Kingdom will not list a contract unless they have already seen informal approval from the regulator. It's a lot smaller. There are less exchanges in the United Kingdom. It's a lot more informal process.
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I believe it's correct that the foreign regulator meets with each of the exchanges at least monthly, an open dialog, have a discussion regarding what contracts they plan to list and there is informal approval given. And the U.K. regulators assured us that there would be no contract listed on an exchange in their country unless they approved it first, although it may be informal approval.
Mr. FLETCHER. Just in closing, I certainly believe that we ought to have the flexibility. The way markets are changing these days throughout the global economy, obviously, I think it's very important to have the rapidity and the flexibility to act and make sure that we do stay very competitive and that our exchanges still lead the world economy.
So, Mr. Chairman, I yield back the remainder of my time.
Mr. EWING. Thank you, Mr. Fletcher.
I want take a moment to tell all of you that, as you probably know, we are losing our staff director, Stacy Carey. And this will be her last hearing. So she is coming down easily by darting in and out of the room and letting Ryan take over.
But, Stacy, we want to thank you for all your good work.
[Applause.]
Mr. EWING. And maybe you'll do like Mr. Erickson and come back as a member.
Mr. SMITH. She's not going to work for CFTC, Mr. Chairman.
Mr. EWING. No, I don't think so. But they would have been smart to hire her.
Mr. SPEARS. She's very welcome.
Mr. EWING. She would do well wherever she goes. Mr. Smith.
Mr. SMITH. Of course, our familiarity is with agriculture. Your oversight is much greater. What is the percentage of agriculture versus non-agriculture, as far as your oversight of trade?
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Mr. SPEARS. Currently, the volume on the U.S. exchanges is roughly around 15 percent agriculture and 85 percent non-agriculture.
Mr. SMITH. Does the Blackbird system of trading meet the MTEF requirements, the multi-lateral transaction execution facility? Does it meet that and how and when do you decide whether it's appropriate to have oversight?
Maybe you should explain the Blackbird system of exchanges.
Mr. SPEARS. The Blackbird system is a system—you said MTEF, multiple transaction execution facility. Currently, let me tell you the action the Commission staff took recently.
Commission staff, just last week, made a comprehensive request for more information regarding the Blackbird system. At this point in time, we are awaiting receipt of that information from the people who do have a Blackbird system and we would then, at that point in time, make an appropriate determination if it is that type of multiple transaction facility, as you've alluded to.
Mr. SMITH. So when the Blackbird system lists new products, what do you do as a Commission? Right now, do you consider you have oversight? Does it depend on what the product is, the new product that they're listing?
Mr. SPEARS. It would depend, in part, on the product they're listing, but we have not yet made a determination as a Commission where we have oversight of the system. There are still too many questions to be answered. We're still seeking information regarding the system in order to make that determination.
Mr. SMITH. Has the Commission taken a stand or made recommendations in terms of the legislation that we're considering for making changes in the regulatory oversight of the Commission? Do we know where every member stands? I sort of got an inkling from your testimony, but has the Commission ever taken a position on the proposed legislation?
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Mr. SPEARS. Let me try to go back. Staff just informed me that, and I agree, that I may not have answered your question properly.
If it is an MTEF, then we do have actual jurisdiction over that Blackbird facility, but we're waiting to make a determination whether or not is an MTEF or not. So hopefully that answers more directly your question regarding Blackbird.
Mr. SMITH. Well, yes. If it is MTEF, you absolutely do. But if it isn't, you're sort of wavering, it seems like, a little bit.
Is that right? You make a decision based on what the product is?
Mr. SPEARS. Yes. What the product is and what the appropriate level of regulation would be based on that.
Mr. SMITH. Has the Commission taken a stand on the proposed legislation before us?
Mr. SPEARS. Which proposed legislation?
Mr. SMITH. Well, I was thinking of the proposed legislation that the chairman of this subcommittee has—has that been made public yet?
Mr. EWING. No.
Mr. SMITH. So you couldn't do that. I'll jump from the chairman's proposal to the exchanges' proposal.
Have you reviewed the exchanges' proposal and have you taken a position on the exchanges' proposal?
Mr. SPEARS. On the 4(c) petition, we've reviewed it, analyzed it, and, as I said, we'll be publishing for public comment, hopefully in the next few days, their petition, to get a full record of the public comment in order to make a determination as to how we act on that petition.
Mr. SMITH. And does the Commission, in analyzing where we should be going in this country, have you reviewed what your counterparts in other countries are doing in terms of regulatory oversight and how do you—can you give us a brief description of the comparison?
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My impression is they have somewhat less oversight, but on the other hand, they have copied a lot of the things that you have suggested in this country, they have emulated in their country.
Mr. SPEARS. My document may be very helpful to you. Attached as part of the Commission's written testimony was a survey completed by our Office of International Affairs of a number of foreign regulatory jurisdictions, and it goes through in detail and lists out a comparison of what they do on contract approval, pre-approval, rule approval and those kind of things, and there is an executive summary to that document, at the front of that extensive document.
To try and answer your question, there is a variety of different types of regulatory schemes across the world. As I mentioned before, in the answer to one question, the United Kingdom has a very informal process. Another example might be Eurex, the German regulatory authority. I believe it's correct that actually a regulatory official sits on the board of the Eurex exchange and is there in the day-to-day decisions of the Eurex exchange.
So there is a general theme of regulation across the world which is becoming, as you alluded to, they look to our country as a model for that. But it varies and differs greatly by country.
Mr. SMITH. Would any of the other Commissioners have any comment either on the Blackbird or the comparison of our system versus other countries or otherwise?
I have no further questions, Mr. Chairman.
Mr. EWING. Mr. Gutknecht. I'm going to come back to you, Mr. Baldacci. I thought I had hit everybody on this side. Mr. Gutknecht has to go, and with your permission, we'll skip to him and then come right back.
Mr. GUTKNECHT. Thank you, Mr. Chairman. I will be brief. First of all, I want to say a big thank you to Mr. Doug Leslie and Fred Lindsey of your staff who helped do a little research for me about what's happening with the basis.
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There has been a tremendous variance, at least in the upper Midwest, between the cash price quoted in Chicago and what actually is happening at the local elevators. I'm not completely satisfied, but I think they did a very professional job in getting me some good information about that.
Second, I want to say that you have a very difficult job and now the more we learn about that, trying to balance all the needs of the various people who use the exchanges and the companies who are involved, as well as the needs of agriculture, when you put that all together in a business that's changing at the speed of light and things that happen on other parts of the planet, and trying to regulate all that and make sense of it, it is a very difficult job.
But I want to come back to something that Mr. Smith talked about in his brief opening statement. That is, originally, the whole purpose here was to serve the farmer in agriculture. Do you have any marketing research in terms of the percentage of the transactions? How many of them actually involve real farmers who grow this stuff?
Mr. SPEARS. I don't know of any numbers that come to my head directly. Let me ask our staff if they have any feel for numbers.
Mr. GUTKNECHT. Well, I guess more of a comment than a question. I think it is important that we become as friendly as possible. One of the purposes, I think, of this subcommittee is trying to figure out how we can get our farmers, our producers to better utilize futures markets, to take some of those big bumps out of the road.
That is at least what I think part of our charge is. I think we should work together with you to make the various commodity exchanges more user-friendly. For example, now, this is a dumb question, but for example, if I were a pork producer in southeastern Minnesota and I took out a contract to sell hogs for January delivery, where would I deliver them?
Mr. SPEARS. There are specified delivery points on the contract, and I don't know specifically, off the top of my head, what those delivery points are for the hog contract.
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Mr. GUTKNECHT. We and you and the exchanges need to work with the folks out in production agriculture to make it easier for them to use it. I think that there is a—anytime people don't understand something completely, there is a sense of mistrust, and I think we have to work together. Really, it's more of a comment than a question, but I want to work with you and hopefully you'll work with us so we do a better job explaining to our producers how they can use futures.
I was one who really pushed the whole idea of a dairy options pilot program.
Mr. SMITH. If the gentleman would yield.
Mr. GUTKNECHT. Yes.
Mr. SMITH. Does the gentleman consider ADM a producer?
Mr. GUTKNECHT. Well, in some respects, I guess they are. But the only point I wanted to make is I think you're doing a great job. It's a tough job. But I hope you never forget, at the end of the day, the reason you're here and, in some respects, the reason these exchanges were started was to make it easier for farmers to use them. In some respects, I think we fall short of that.
So thank you very much, Mr. Chairman.
Mr. EWING. Mr. Gutknecht, my staff tells me there is a dairies option program.
Mr. GUTKNECHT. There is, I know, but it's very difficult to get our dairy producers to use them.
Mr. EWING. I see.
Mr. GUTKNECHT. It's like pulling teeth to get them to, because it's just complicated enough that they're afraid of it.
Mr. EWING. Mr. Pomeroy. I'm sorry. I went through all the Members here and you had stepped out. So we're glad to have you.
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Mr. POMEROY. I figured it was choice by merit and you were getting to me in due time.
I used to run an agency that was charged with regulating a financial services component and I know that it's easier to watch and second-guess than it actually is to do the financial regulating. So I say that as an outset. What you do is hard, even harder to explain it.
Part of our oversight role is the classic Monday morning quarterbacking and we get to do it for a living. We can be absolutely unabashed about it. The could have, should have, would have business, that's our stock in trade.
So with that as a predicate, let me just observe that in light of the fact that U.S. exchanges have had foreign electronic desks or presence for about 10 years, is that correct?
Mr. SPEARS. Right.
Mr. POMEROY. And that Eurex, the German exchange, had an electronic presence on our shores for about 3 years, is that correct?
Mr. SPEARS. Correct.
Mr. POMEROY. It would seem to me that the Commission might have engaged in this kind of inventory for the following purposes, and I do think this is an excellent inventory.
Even in conjunction with looking at foreign exchanges, also done an introspective analysis of your requirements and identified, of all the things required, what is the heart of it, what really is essential, what's not essential.
And in comparison with the major requirements of other countries, harmonized, taken parts of ours that were not deemed to be essential and provided regulatory relief in those areas. On the other hand, prepared for the review of the application of foreign domiciliaries by whether or not they had the requisites that we still maintain here.
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I have not said that artfully, so I'll try to say it again. You identified, both for us and for other countries, what you think are the most important parts, the essential parts. You discard the non-essential parts and then you evaluate the application of a foreign exchange by whether or not its regulatory entity has its essential parts, just as we require the essential parts.
It seems like we're playing catch-up. We're further along on the approval of foreign exchanges than we are this analysis at harmonization and discarding the non-essential parts of our code, and that raises the specter that we're going to have domestic exchanges more rigorously regulated than foreign exchanges doing business on our shores and in non-essential areas.
So I'm glad about the review underway, but I think it's belated. And if we're trying at this date to restructure things in kind of a rational framework in terms of how this ought to unfold, I very much agree with Mr. Newsome that we ought to, first of all, tidy up what we do and keep which we need to keep and discard the rest and then evaluate foreign exchanges by whether or not it's compatible with our scheme.
I'd like, across the panel, you to react to that, starting with Mr. Spears.
Mr. SPEARS. I would agree, as well.
Mr. POMEROY. What kind of timeframe can this happen?
Mr. SPEARS. Hopefully, we can, as we publish public record over the course of the next 30 to 60 days, with the publishing of the petition, we can start to get that kind of input to make those kind of determinations. But there are things already currently within the 4(c) petition to answer Mr. Ewing's question directly, that as I laid out in my testimony, that our staff feels that the exchanges currently can do now and that would be such things as payment order flow, delay pricing, block trading, expedited audit identifiers.
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Mr. POMEROY. But you don't even need new regulations to do that. You think that's implicitly allowed.
Mr. SPEARS. That's something the exchanges could give us as far as rules now.
Mr. POMEROY. Publication and publicizing a clarification letter or something would take care of it.
Mr. SPEARS. Yes, sir.
Mr. POMEROY. Excellent. Ms. Holum.
Ms. HOLUM. Thank you, Mr. Pomeroy. I would agree with Chairman Spears that we have started the process. I would agree with you that we are late and technology is changing the way all of us do business so rapidly and I think the Commission is just coming out of the period of feeling that we had to have a rule and a regulation to cover every possibility in the marketplace.
It seems to me that we can't do that. We'll get into regulatory gridlock, and we need to be flexible enough to provide necessary oversight to follow the changes in the marketplace and encourage innovation.
I think that's where this Commission is heading for now.
Mr. POMEROY. I strongly agree with you. Regulation is reactionary and it's appropriately so. It can't be anticipatory. Nobody is smart enough to regulate by figuring everything out and dealing with it in advance. You've got to see what happens and then respond quickly.
So that, I think, is an appropriate way to proceed. Mr. Newsome.
Mr. NEWSOME. As I addressed this in my testimony, I won't go back into that. I guess just another comment to add to it. I think as we look at the scheme and those individuals and systems in the marketplace, we just need to make sure that the market determines those that succeed and fail instead of undue regulatory burdens from the Commission.
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Mr. POMEROY. When I regulated insurance companies, it was very difficult, but if they were in solvency trouble, they were mine. If they were simply being poorly managed, but weren't in solvency trouble, they weren't mine.
No one elected me to be the manager of the insurance industry. I was the regulator of the insurance industry, and so it is with those contract approvals.
Mr. Erickson.
Mr. ERICKSON. Thank you. I would ally myself with the comments of my colleagues here. I would also just like to add a couple of points.
One is, as we're reviewing the foreign terminals under the no action process, one of the points that we're looking at is to see if those electronic trading systems meet the standards of the IOSCO principles on screen-based trading, which are internationally subscribed to basics for electronics systems.
Those, I think, would generally apply for our own domestic markets, as well. I think we have a ways to go in providing the necessary relief for these new technologies with our own domestic markets. There is a little bit of a difference as far as many of our domestic markets continue to be open outcry, not the electronics systems that we're seeing come in under the no action process for foreign terminals right now.
So there is a little difference in the market structure, I think, but otherwise, we do need to continue to make progress in identifying those areas for electronics systems where we need to.
Mr. POMEROY. Just one follow-up question. I see my time has elapsed. Do you see it as a regulatory purpose to preserve open outcry or will the market ultimately determine that?
Mr. ERICKSON. I think the market will determine that, no matter what. I don't see my job as trying to pick winners or losers, and I think we need to make the accommodations necessary for the market to continue to innovate. That's why we need the information in order to make reasonable decisions.
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Mr. POMEROY. I agree with your point on non-action letters. I mean, I think we owe it to let people know what the ruling is and why rather than non-action. I thought your testimony made a good point in that regard.
I yield back, Mr. Chairman.
Mr. EWING. Mr. Baldacci.
Mr. BALDACCI. Mr. Chairman, thank you for holding these hearings and also for the panel for being here.
I guess just to continue to make the point about the questions that have been raised about the unfairness of placing these terminals, foreign trading establishments here and not with the same requirements that we are requiring of our exchanges and creating a competitive disadvantage.
I appreciate your testimony in terms of that maybe there are more similarities between the regulatory processes that you put the exchanges through and what foreign countries do with their trading establishments. But I was not convinced by the example cited in the testimony in Germany and in England that were presented.
I think that, frankly, the old axiom of whatever is being done to us overseas, we should be doing to those that want to be able to practice on our shores. It would be something that could be adhered to.
And I appreciate the chairperson's attention to trying to bring things more into the 21st century and not trying to micro-manage each individual economic situation into a rule, but I just have to say I am to a point of maybe that we're getting to a place where the exchanges ought to be empowered more and the CFTC should be more of an oversight as to how the exchanges are operating and to allow the flow to be able to be better developed in the safety procedures based on the safety and public protection, based on more of an oversight role rather than micro managing role.
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I just feel, in the few years that I've been here in Congress, that this issue has not gotten any clearer and, frankly, as I've been talking with my colleagues, I'm actually beginning to understand some of this stuff, which is always a little bit dangerous when you're in this field.
But I just think that when you get to a point of shoring up the exchanges and modernizing the exchanges and being able to allow those exchanges to be able to do business worldwide and to being in more of an oversight role would be the kind of a role that I guess I would like to see the Commission, the CFTC play.
I guess then it would be up to our committee to work on developing that model as we get ready. But I don't have any particular questions. I appreciate your responses and your presentations and testimony, and thank the chairman, and yield back the balance of my time.
Mr. EWING. Thank you very much. Mr. Jenkins.
Mr. JENKINS. Thank you, Mr. Chairman. I'm sorry that I missed the testimony of these witnesses and I haven't reached the level of understanding that Mr. Baldacci has yet, so I don't have any questions at this time. Thank you.
Mr. EWING. A question for any of you on the panel. Do you believe agriculture and non-agriculture contracts require different levels of regulation? Start with you, Mr. Spears.
Mr. SPEARS. I guess I personally believe they require similar regulation. I think that you have to look at the individual market itself and there may be certain components that could have some variances. But I think the overall scheme of regulation should be the same both for agriculture as well as other products.
Mr. EWING. Ms. Holum.
Ms. HOLUM. I would certainly agree with that. However, there are I wouldn't say less or more regulation, but there are different regulatory schemes that apply to each individual contract that seem to be working very well, whether they're agriculture or non-agriculture.
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Mr. EWING. Mr. Newsome.
Mr. NEWSOME. I guess I would tend, Mr. Chairman, instead of saying ag versus non-ag, to look at those that are physically delivered versus those that are not, and that, I think, draws part of that same ag/non-ag line that you're talking about.
I think currently we adequately address the majority of the problems. I certainly think that as we go down the road, that that's an area that we need to continue to look at as we split more into what I would call retail markets versus more sophisticated markets.
So definitely I think that's something we need to keep an eye on.
Mr. EWING. Mr. Erickson.
Mr. ERICKSON. I would concur with the comments of the other Commissioners. I do think that there are some natural divisions along the lines of physical and non-physical delivery markets.
I do also tend to think that the markets all serve similar economic function and they are financial instruments. So I think that part of it is the physical/non-physical. It's also the sophistication of participants. It may be even trading systems, as far as what the level of regulatory interest might be in those instances.
Mr. EWING. Thank you. Are there other members that have additional questions?
Mr. POMEROY. Mr. Chairman.
Mr. EWING. Mr. Pomeroy.
Mr. POMEROY. The exchanges will be testifying on the next panel. Just for our background, when might their application or their petition, when will that be ruled on? How quickly could that be turned around?
Mr. SPEARS. It's my intent to have that petition circulate within the next few days for sign-off by the Commission and then there will be a comment period, probably 60 days, where the public can build a record and the Commission could have a record of public comments to make a decision as to the comments.
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As to how fast we would act on it once we have the comments and determine on the comments we get how the public perceives the petition and what various sectors of the public say.
Mr. POMEROY. Is there a moratorium presently in effect on the approval of foreign exchanges?
Mr. SPEARS. No, sir.
Mr. POMEROY. Will there be other foreign exchanges approved during the pendency of this petition?
Mr. SPEARS. That would be something that—those no action letters are issued by trading and market staff and I fully expect a continuation of additional no action letters to be issued during that time period.
Mr. POMEROY. And the effect of a no action letter is what?
Mr. SPEARS. The no action letters would be where other foreign exchanges would be allowed to list those contracts in the United States.
Mr. POMEROY. As I mentioned in my prior remarks, that is a little backward. It's 180 degrees backwards. So I hope that you can quickly make that right. I hope that petition gets action as quick as possible.
Mr. SPEARS. Understood.
Mr. POMEROY. Thanks, Mr. Chairman.
Mr. EWING. Just a couple more questions to be sure we have covered everything.
Does the Commission believe that it has ample legal authority to approve each of the three areas of relief requested by the exchanges in their petition, Mr. Spears?
Mr. SPEARS. As I said, we have ample legal authority on the petition. In order to do that, we have to build a public record and get public comments in order to make the appropriate determinations that need to be made per the act.
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Mr. EWING. You have the authority.
Mr. SPEARS. Yes, sir.
Mr. EWING. Anyone else want to differ with that?
Ms. HOLUM. No.
Mr. EWING. The Commission's written testimony stated that it is the Commission's intent to publish the exchange petition soon. When do you expect that to be published and how long will it take you to act on it?
Mr. SPEARS. As I said, we would expect the petition to be published in the next few days and then I would expect the petition to have a 60-day comment period to receive the appropriate comments to build a public record and make a determination, and then our action would be based on the comments that we received.
Mr. EWING. So you really don't have a timetable after the 60 days. Do you know what the normal period of time is?
Mr. SPEARS. I don't know what the normal period of time would be, but it would be my intention, as the acting chairman, to make sure that action would be as quick as possible.
Mr. EWING. The Commission has put forth two new proposed rules that may partially address exchange requests to have pre-approval of new contracts and to give the exchange the ability to expeditiously adopt new rules or rule changes.
Have you consulted with the exchanges in regard to those proposed pilot programs?
Mr. SPEARS. Yes.
Mr. NEWSOME. When you get to be acting chairman, that's where——
Mr. SPEARS. I don't want to hog everybody's time here. We have had ongoing dialog with the exchanges and we'll continue to have that dialog. As you know, they participate in our various advisory committees that we have, the advisory committee that Chairman Holum chairs as far as GMAC. I chair the agriculture advisory committee.
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We meet with the exchanges regularly. As I said, it was a sincere effort to address their concern and if there are initial issues or concerns regarding that proposed pilot program, we'll be happy to try and address them as we receive the comments and take action accordingly.
Mr. EWING. Does anyone else want to add to that?
[No response.]
Mr. EWING. I think we all realize that there is a great deal of the financial markets out there that are not regulated, not regulated by CFTC or maybe partially regulated under some agency, but not directly regulated like the CFTC regulates the futures exchanges.
Do you believe that the U.S. exchanges should be permitted to establish subsidiary operations that are unregulated to better compete with the over-the-counter industry? Mr. Newsome.
Mr. NEWSOME. Mr. Chairman, that is something that I know I haven't spent a lot of time thinking about and I don't know if our fellow Commissioners have. My initial opinion would be, as private sector businesses, that they ought to have the authority to set up subsidiaries to compete on level playing fields with anyone within the business.
Mr. EWING. Anyone else? Tom?
Mr. ERICKSON. I think it is an excellent question. It's something that we as regulators will be wrestling with. I'm sure that other regulators will be dealing with similar issues. I think we may have a few cases of first impression coming our way as exchange alliances continue and plans such as what you're suggesting come to fruition.
I think we'll need the benefit of public comment and also some fair consideration within the Commission and the regulatory community and Congress.
Ms. HOLUM. Also, I think if the Commission moves toward a more oversight function rather than a micro-managing function, that the exchanges will find the regulatory relief that they need to make them more competitive with the over-the-counter markets.
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Mr. SPEARS. I would just add that I'd also look forward to discussing that issue with you at the reauthorization process and looking forward to the Congressional input on that issue, as well as the public and Commission input.
Mr. EWING. You don't think the law, though, prohibits that at this time, or do you have a comment?
Mr. ERICKSON. I don't think, upon first blush anyway, that there would be any preclusion from other kinds of arrangements. It's an issue that we'll be wrestling with in a lot of contexts, such as demutualization of the exchanges themselves; how do we, as a regulator, respond to those changes, and I think we can.
Mr. EWING. Anybody else?
[No response.]
Mr. EWING. I appreciate your comments and I know those aren't easy questions to answer, but I would say to you that as we move through the process of reauthorization for your agency, I think that is really the crux of what we have to decide and what the Congress will have to decide.
These exchanges know their function in the area that they have functioned, but they see enormous amounts of the market being handled differently; not totally differently, but differently and outside of the same system they're involved in.
To be competitive, I think they feel there has to be a level playing field and that's, I think, the responsibility of the Congress working with the Commission.
Thank you all very much for coming.
Mr. SPEARS. Thank you, Mr. Chairman.
Mr. EWING. I want to welcome the second panel. Mr. Mark D. Young, partner, Kirkland & Ellis, on behalf of the Chicago Board of Trade; Mr. Jerrold Salzman, counsel, Chicago Mercantile Exchange; and, Mr. Christopher Bowen, senior vice-president and general counsel, New York Mercantile Exchange.
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Welcome, all of you. We'll start with you, Mr. Young.
STATEMENT OF MARK D. YOUNG, PARTNER, KIRKLAND & ELLIS, ON BEHALF OF THE CHICAGO BOARD OF TRADE
Mr. YOUNG. Thank you, Mr. Chairman. Good afternoon, Mr. Chairman and members of the subcommittee. I am Mark Young, a partner in the law firm of Kirkland & Ellis, appearing on behalf of the Chicago Board of Trade.
The Board of Trade's chairman, David Brennan, and CEO and president, Tom Donovan, regret that they were able to attend in person today, but wanted you to know how much they appreciate your commitment to the ongoing efforts to modernize regulation of the U.S. futures exchanges.
The subject of today's hearing, the exchanges' June 25 petition, is one important part of our regulatory relief effort, and I understand that a copy has already been included in the record of that hearing; if not, I'd just like to tender a copy for that purpose.
Before I go on to talk about anything else relating to that petition, we've heard a lot in prior hearings and today about the concept of fairness, and that concept comes into very high relief today when we hear the CFTC describe how they're going to treat the exchanges' petition.
The petition was filed 40 days ago today. It has not yet been prepared for a Federal Register notice, but we understand that that's going to happen soon. When it does go to the Federal Register, it will go for a 60-day public comment period. In contrast, when the Commission proposed what it called breathtaking reforms in both the rule approval and contract market designation area, the Commission put those proposals out, including their pilot program, for 30 days of comment.
I think that 30 days should set the standard for the Commission's consideration of the exchanges' petition, as well, and I would hope that the Commission would reconsider and put our petition out for 30 days of comment, since the issues largely overlap, as I'm going to discuss today.
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Now that I've talked about an area in which we disagree with——
Mr. EWING. Mr. Young, which petition went for 30 days?
Mr. YOUNG. The Commission put out two proposals, one in the rule approval area and one in the contract market designation area, what Commissioner Erickson called pre-designation. Those both went out for 30-day public comment.
Acting Chairman Spears said today that the thinking at the Commission now is to put the petition out for 60 days of public comment. We think 30 is better than 60 and consistent with the comments of members of the subcommittee. I would hope that the Commission would reconsider and put the petition out for 30 days of public comment.
Mr. EWING. Thank you for the clarification.
Mr. YOUNG. Now that I've talked about areas where we disagree, at least on procedure, I want to focus, because I think it's important to do so, on an area where we agree with the Commission, and there are a number of them.
First, U.S. futures exchanges today face more competition than ever before. Technology, innovation and globalization all contribute to those significant competitive forces and new competitors are emerging at an incredible rate.
Second, one factor in this new competition is cost. How much does it cost to run a marketplace? How much does it cost to do a trade? Those questions are critical today.
Regulation imposes costs. Some of those costs stem from exchange self-regulation; what a market knows it must do to provide a fair marketplace with integrity and financial security.
Some of those costs stem from government regulation and mandates.
Fourth, U.S. exchanges have more government regulatory costs by a fairly substantial margin than their existing and emerging competitors. That imposes a heavy competitive handicap on U.S. exchanges.
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Fifth, U.S. exchanges provide benefits of centralized and transparent price discovery in a fair, open and safe environment. They should be allowed to meet their new competition on a level playing field.
Sixth and finally, as a result, U.S. exchanges need regulatory relief. None of the commissioners I heard testify today disagree with that conclusion.
Having agreed on the goal, the problem is to define what relief is needed. The exchange petition is a first step to answering that question. We say that exchanges should be able to list new products and adopt new rules without waiting for the Commission's approval. Other countries give their exchanges that latitude. We want the same treatment.
Even the Commission, through its inaction to date on the Blackbird swaps trading system, which I've described in my written testimony, in effect, allows new markets to list any new product without prior or subsequent review, and I would add, parenthetically, that we understand that the Blackbird system has begun trading and did visit the Commission before they started to trade.
So all our petition asks for is the same treatment the Commission and other regulators afford our competitors.
Now, in the past months, the Commission's response to our petition has been to issue its own proposals. Both are well intentioned and well short of the mark. Both continue to hold on to the idea that the Commission ultimately must approve new contracts and new rules.
Why? The Commission never really says, other than to assert that its review provides unidentified benefits. What are those benefits and if they exist, are they worth the cost both in terms of government resources and competitive harm? The Commission provides no answer to those questions, nor could it.
Developing sound products that provide useful risk management tools is the business of the exchanges, not the Commission. If the exchanges do not do a good job, the new products will fail in the marketplace, which we know provides the ultimate verdict for any new product.
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Implementing fair trading rules and procedures so that market participants have confidence in a market is the business of the exchanges, not the Commission. If the exchanges do not do a good job, market participants will go elsewhere to trade.
The Commission has observed that in other countries, foreign exchanges often discuss new contracts or rules with their regulator before implementing them. That same practice could occur here under the exchanges' petition. If an exchange believed that consultation with the Commission would lead to better products or results, it would be foolish not to do so.
But in foreign countries, the decision whether to consult is made by the exchanges and only the exchanges. U.S. exchanges should be able to make the same decision and they would under our petition.
Mr. Chairman, as I explained in my written testimony, the relief sought in the petition is but one phase of our overall effort to transform and modernize the regulation of exchanges. We know that you and Senator Lugar have embraced the idea of making the CFTC an oversight agency, not an exchange manager. We strongly support that objective.
The trick, of course, is defining what is oversight. To the exchanges, CFTC approval of our products and new rules is not oversight. It is akin to having the CFTC empanelled as a super-exchange board of directors and affords the Commission the opportunity to second-guess business judgments the exchanges have already made. That is not oversight, Mr. Chairman, that is overkill. We cannot afford that kind of excessive government involvement in the fast-moving global competitive environment we face.
We urge the Commission to take action to approve our petition immediately. We thank you for your continued leadership in an effort to achieve true regulatory reform under the Commodity Exchange Act.
[The prepared statement of Mr. Young appears at the conclusion of the hearing.]
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Mr. EWING. Thank you, Mr. Young. Mr. Salzman.
STATEMENT OF JERROLD SALZMAN, COUNSEL, CHICAGO MERCANTILE EXCHANGE
Mr. SALZMAN. Mr. Chairman, members of the committee, I'm Jerrold Salzman. I represent the Chicago Mercantile Exchange, and I have since 1967. I've participated in it on behalf of all the legislative debates that have wound up shaping the Commodity Exchange Act, and I think I can fairly say that I've never heard five Commissioners come in here and testify before a committee so positively in favor of what the exchanges needed and wanted, nor have I ever heard a committee so in tune with what's necessary to let the exchanges prosper into the future.
We can only hope that all of this gets carried through into reality and that the actions of the Commission actually match its words.
As Mark has told you during his testimony, the actual numbers that we see when we look at the facts don't always match the words. We did file our petition 40 days ago. Rather than simply publishing it and getting on with the question of whether or not it's going to be approved, it's, in our opinion, been languishing, and when it does get published, we're very concerned that we're going to get the same treatment we got with our last petition, which is instead of a simple publication of the petition, asking for public comment, we got, what was it, Mark, 124 or 146?
Mr. YOUNG. I think only 106.
Mr. SALZMAN. One-hundred five questions clearly prejudicing how that petition is going to be treated, while, at the same time, the Commission, with no question, no public comment, essentially exempted the entire over-the-counter market and a number of other transactions.
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So that's what we've been faced with in the past. We hope that these expressions we heard at the table today mean we're not going to be faced with the similar sort of treatment into the future.
I'm going to actually not yield back all of my time, but give away most of my testimony, because Mark covered it very clearly, most of the things I was going to say.
I do, however, want to comment generally that we are going to have a real problem in the future if the Commission doesn't follow through on its testimony here today. In the past, the Commission generally has had a pension to exempt everyone from its regulatory grasp other than the exchanges that have been historically—have had the historical misfortune to have been, quote, designated contract markets.
In addition to the OTC market, which I discussed, and foreign exchanges, a number of electronic derivative exchanges are now operating or about to be operating in the United States without registration or exemption.
It's very difficult for me to imagine how there isn't enough information to decide whether Blackbird is or isn't an MTEF, at least on the documents it's published. It does have a web site and, of course, you do have to have a password to get in to tell what it's doing, but from all the reports I've had, it's operating a multi-lateral transaction execution facility and derivative contracts, including FRAs, a contract that we, after 367 days of waiting, have finally received approval to trade.
Of course, after waiting 367 days to trade a new contract, the fact of the matter is it's not clear that the market that we thought was there is still there or that our competitive opportunity hasn't evaporated.
So just to give you a little history of what we're facing from the Commission up until two weeks ago, in any event, we certainly have been put upon.
Now, I am a little concerned that the Commission is being taken advantage of by some of these new exchanges. As you know, the Commission got itself in some significant controversy with its actions with regard to the OTC concept release, but also came under incredible pressure with regard to its release in connection with foreign terminals. Therefore, we think some of these exchanges think they can sort of bluff the Commission into not taking action against them, without getting an adverse reaction.
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The exchanges have come running to Congress saying, ''Oh, look, the Commission is trying to extend its jurisdiction again.'' But I don't think that is the case here. What we have is an act that's relatively clear in terms of at least exchanges dealing in derivative products.
The Commission has an obligation to give them an exemption under the act, under 4(c), or to make sure that they are properly designated as are the exchanges before you today. It's not a discretionary duty.
So I don't think the Commission should be gun-shy. I think it has to investigate quickly and move forward with those exchanges.
I see my red light is on. So I will simply thank the Commission on behalf of my chairman, Scott Gordon, who was unable to be here today because of certain announcements he was making in Chicago today. We very much appreciate where this committee is going and the intelligence of its questions.
Thank you very much.
[The prepared statement of Mr. Salzman appears at the conclusion of the hearing.]
Mr. EWING. Thank you, Mr. Salzman. Mr. Bowen, I want you to understand up front that there was no prejudice in going to the two Illinois exchanges first, from this member from Illinois.
Mr. BOWEN. From all the agriculture questions, I think that might be appropriate.
Mr. EWING. All right. We're ready to hear from you.
STATEMENT OF CHRISTOPHER BOWEN, SENIOR VICE-PRESIDENT AND GENERAL COUNSEL, NEW YORK MERCANTILE EXCHANGE
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Mr. BOWEN. Thank you, Mr. Chairman. Mr. Chairman, members of the committee, my name is Christopher Bowen. I'm senior vice-president and general counsel of the New York Mercantile Exchange. NYMEX chairman Dan Rappaport has asked me to express his regret that he is unable to attend today's hearing due to prior commitments.
I also wish to thank you at the outset for the opportunity to participate in today's hearing regarding the 4(c) petition filed jointly by NYMEX with the Chicago Board of Trade and the Chicago Mercantile Exchange.
The regulatory relief sought in the 4(c) petition is urgently needed in order for the U.S. exchanges to function effectively in a competitive environment and to respond quickly to changing market demands. While the derivative products offered by OTC markets, foreign exchanges and domestic exchanges are often very similar, the current level of regulation imposed on these three markets varies dramatically. With respect to swaps, in 1993, the CFTC promptly exercised its new exemptive authority, exempted eligible swap transactions from virtually all requirements of the Commodity Exchange Act, except for fraud and manipulation prohibitions. Since then, the swaps markets have thrived.
With respect to foreign exchanges, CFTC staff has recently issued a no action letter that permits one foreign exchange to place computer terminals for its electronic trading system in the United States, followed by a promise that three more foreign exchanges will receive no action letters within 21 days.
As a matter of public policy and given the importance of the issues involved, we believe that the CFTC should issue consistent standards through rulemaking and disagree with the use of the staff's no action process.
It should also be clearly noted that underlying the no action approval is the recognition by the Commission that foreign exchange products can be offered to U.S. customers and be considered, quote-unquote, safe, without the full panoply of regulatory requirements currently imposed on domestic exchanges.
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United States exchanges thus face the daunting challenge of competing with OTC markets and with foreign exchanges, while strapped with the heavy burden of regulation under regulatory regime not imposed on those other derivative providers.
The weight of this regulation on U.S. exchanges imposes major costs and limits our ability to respond quickly to competition through innovative products and practices.
Turning to the petition, the exchanges seek regulatory relief in three areas. First, we seek the elimination of prior CFTC review of contract terms, because we believe strongly that each exchange's reputational risk is a major driving force that ensures that its own processes will be detailed and thorough.
In addition, through its clearing function, an exchange puts its own and its members capital at risk. In our experience, detailed CFTC review and approval of contract terms and conditions provides marginal, if any value, and that's costs, uncertainty and delay to the rollout of new contracts.
Second, our petition would allow exchanges to adopt new rules 10 days after submitting them to the Commission. The CFTC would still have the authority to stay or to delay rules if a finding was made that the rule would be subject to fraud, would make trading readily susceptible to manipulation, or would threaten the market's financial integrity.
Third, our petition would allow U.S. exchanges to implement trading rules and procedures comparable to those of a foreign exchange, upon certification to the CFTC that the rule was being used in a contract which directly competes with the U.S. contract.
This would ensure regulatory parity and would preclude a situation where a foreign exchange, with a much more flexible regulatory environment, could exploit that advantage by implementing innovative trading practices designed to catch U.S. business or by launching a contract which directly competes with that of the U.S. exchange.
While the CFTC has taken two steps to address the regulatory parity issue, these efforts have not been sufficient and make no guarantee of speedy relief to the exchanges. First, the CFTC recently proposed a new rule to establish the 2-year pilot program, which they have been speaking about, where exchanges could launch a new contract 1 day after providing notice to the CFTC.
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This proposal, however, contains a number of limitations such as continuing to require the contracts receive CFTC approval would create uncertainty and would affect the viability of a new contract.
Second, a recommendation regarding relief to the domestic exchanges has been presented to the CFTC's Global Markets Advisory Committee by a subcommittee of that group. To date, the CFTC has taken no action and it's unclear how and when the CFTC will address these recommendations.
In conclusion, NYMEX urges this committee, the Commission and Congress to provide urgently needed flexibility to exchanges. We also urge the CFTC to act quickly and favorably on our petition, with the same expeditiousness now shown in the review of a no action request by foreign exchanges.
Mr. Chairman and members of the committee, NYMEX thanks you for your consideration and we pledge our full support to work with you and your staff to address these issues.
[The prepared statement of Mr. Bowen appears at the conclusion of the hearing.]
Mr. EWING. Thank you, Mr. Bowen.
I think you have all addressed the issue of the timing, the comment period, the swiftness with which the CFTC acts on some business and delay that appears to be in your situation.
Do you find that is something that is prevalent whenever the exchanges go there? Does it always seem to take more time when the futures exchanges have something pending?
Mr. YOUNG. I don't know that I'd say always, but I'd say there is a pattern and it's a pattern that's gone on for almost a decade.
Mr. SALZMAN. I think we have to give the Commission credit for loosening up on routine matters. They have made a concerted effort, where something is a copy of something they've done before, not to take the full time period. But every time we come up with something truly innovative, we're in for the long haul because everybody has to try and understand what it is, what it's going to do.
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Eventually it gets approved without any change, but the second we make it public, it's open to all of our competitors and even under the Commission's new rules, after we spend a year working on it with them, many of our competitors can do it in 10 days.
So I would say yes, it's fine, until you do something innovative, and then it's not fine.
Mr. BOWEN. I absolutely have to agree with Jerry. I think they've made a concerted effort to make routine matters better. But in terms of any sort of significant action, particularly in trade practice areas, it's taken sometimes a matter of years to get things through the Commission.
Mr. EWING. So besides the time and cost, and time is cost to your exchanges, waiting for that approval, is the loss of competitive advantage, is that a major issue?
Mr. SALZMAN. We truly believe it is. We believe that we spend months thinking up clever new kinds of contracts. The cleverer it is, the longer it takes to get approved. Nonetheless, it has to be immediately published and then it's available to anybody else.
The fact is, as you said, time is money and we once took a look at how much we've lost by reason of the delay between the time we filed the contract and the time it was approved, just figuring out what the average trading volume was during the first 8 months after it was approved, and it turns out to be a very significant amount of money.
Mr. YOUNG. Mr. Chairman, in many cases, the timing is very critical and it has been in past years. But to me, that's really not as germane as how it's going to be in the future. In the future, in a more global, more technologically efficient marketplace, those time considerations are going to be absolutely essential. To be held up for a year waiting for a contract approval is simply not in keeping with a modern marketplace.
Mr. EWING. That's a very good point. Is there a reason that the comment period for what the CFTC has put out for publication and what you have petitioned for, the suggested 60 days, can you give me a reason why one should be 30 days and one would be 60? I know I'm asking the fox to talk about the chicken house, but realistically, for us here on this side of the table, is there a reason that you can think of?
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Mr. YOUNG. No, I can't, Mr. Chairman. I could say the following to you. They could have published the petition after they received it and if they had, they would be in a position today, after 30 days of public comment, to approve the petition. That's No. 1.
Number two, they could have included the petition verbatim with either the rulemaking proposal that they adopted or the contract market designation proposal that they put out for public comment.
So either of those they could have attached our petition to and there would have been—we would have been within the 30-day public comment period that would be ongoing.
I cannot think of a reason why they could not do this in a 30-day public comment period. I know that they have looked at many reforms within 30 days and I know that, as their testimony indicates, indicated to you today, these are issues that we have been talking about and kicking around for many, many years.
Mr. EWING. Anyone else?
Mr. SALZMAN. Well, we usually apply three initials to that process, which is NIH, it's not invented here. That is, that which they invent is easy for them to put out for publication. That which comes from an outside source has to be contemplated for a long time before it's put out for outside publication.
But the reason you're putting it out for outside publication is to get public comments. So why would you hold something up or why would you hold it for a long time?
The public has been debating the elements of our petition for four months. Everybody knows what's in our petition. They're ready to comment. Let's get it out there.
Mr. EWING. Mr. Fletcher.
Mr. FLETCHER. Thank you, Mr. Chairman. I appreciate the testimony from both panels and certainly it's been very informative to me. We shortly have to vote. Let me ask you if I could just—Mr. Chairman, maybe there's four or five questions we have here from the committee, if we could give those to you and have you all answer those in writing, first of all, in light of time.
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Second, just for my information, if you could take a real simple down-to-earth example of a contract that you might have that you would want to get approved and how what we currently have in place would impede you from really acting on that contract versus maybe something in England or Germany.
Mr. SALZMAN. Well, I tried to give the example of an FRA contract. This is a little—in fact, it's quite complicated. I'll give the Commission that. The FRA contract is a different kind of way of trading our Eurodollar contract. It's essentially the same thing, but there's different convexity because of the pay-out. So just take that as a given.
I don't know what it means, but that's what they say to me every time. So that's where we are. But it's essentially the same thing.
It is a contract that's traded in the cash market. It's a contract that's traded in the derivative market. But because of the way the payment flows are organized in this new contract, it's quite different than anything ever done on an organized exchange before.
As I said, it took 357 days to approve that contract. In the meantime, we had an organization called EBS, which operates an electronic trading system in Europe, which has not yet come into the United States, which trades this thing in the thousands every day, and we have certain exchanges or what I consider to be exchanges that are supposedly operating in the U.S. trading it right now.
So the problem is because we're an organized exchange, because we've been designated in the past, because there is focus on our actions, we have to follow this process and explain to everybody at the Commission a new concept, so they're comfortable, but nobody else does.
Mr. FLETCHER. Thank you very much, Mr. Chairman. I yield back the time. I do submit these five questions, if you could answer those for us, it would be appreciated. Thank you very much.
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Mr. EWING. Thank you, Mr. Fletcher, for submitting those questions. A couple more questions.
Do you believe that the current act authorizes the Commission to give you the regulatory relief that you need?
Mr. YOUNG. Yes, there is no question about that.
Mr. SALZMAN. The answer is yes, but I am going to say, as I think I've said before in some of your roundtables, that there are a lot of things in the act that the Commission can turn and look at and there are some things in the legislative history that the Commission can turn and look at and say we must be really cautious before we give 4(c) relief to designated contract markets, but we can give it to everybody else easily.
So as long as those things are in the act, if the Commission is reluctant to act, and I heard today they weren't, but if they were, they have an excuse for not acting, which always makes us nervous.
Mr. YOUNG. Mr. Chairman, it's not often that I disagree with Mr. Salzman. This disagreement is of a very subtle nature, but I think that some of the statements that he was referring to appear in the legislative history of the 1992 statute, and those statements are coupled with other statements that say to the Commission to apply its exemptive authority to exchange markets and over-the-counter markets in a fair and evenhanded manner.
And if certain statements in that legislative history are going to rise to the level of statutory provision and law, then I think all statements in that legislative history should rise to the level of statutory provision and law.
I would, therefore, stand by my answer that there is no legal reason for the Commission not to be in a position to approve our petition as we've written it.
Mr. BOWEN. I don't mean to sound like a tie-breaker, but I actually agree with Mr. Young on this point. I see no reason why they shouldn't have the authority to do this.
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Mr. SALZMAN. Well, I actually agreed with that, too. I was just saying I don't even want them to have an excuse in the statute for not doing it.
Mr. EWING. I would have been very disappointed if the three lawyers had all agreed. Some argue that the use of exemptions under section 4(c) should be limited because of report language in the 1992 Futures Trading Practice Act that states the use of this authority should not lead to wide-scale market deregulation.
Are these provisions in the exchange 4(c) petition, would you think they should would lead to wide-scale deregulation and do you think that may counter the answer that we just had to the question that the act gives the authority to really change the way they operate?
Mr. YOUNG. No, Mr. Chairman. The conference report language is very important, but it's not statutory language and that does not appear in the statute.
Second, I don't consider this to be wide-scale deregulation, especially in light of what that language actually says, which is wide-scale deregulation of markets within the ambit of the act. It talks about markets within the ambit of the act, not exchanges.
The Commodity Exchange Act can apply to markets beyond exchanges, beyond formally organized exchanges, and the Commission has already exempted, in a very broad manner, many of those markets. We don't have any problem with that. We're simply asking for fair and evenhanded treatment.
Mr. SALZMAN. This is not disagreement with Mark, but what I would say is that the relief we seek in the petition is not deregulation of the exchanges. The fact that we don't have to do things in advance and the fact that we don't have to get approval in advance doesn't mean we're deregulated. We're still absolutely bound by the provisions in the act and to the extent that the act requires us to take steps that prevent manipulation, that still binds us.
To the extent that we have to protect our customers, that still binds us. We are not deregulated. We are simply taken out of the stream of having to wait 357 days to get something done.
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Mr. BOWEN. Right. I think that deregulation basically implies that there is sort of no basis to regulate someone, where I think the language that we contemplate here is just sort of getting rid of a lot of the regulations that we're subject to. And being subject to the core principles of the act, that's what we want, that's what we think the CEA is intended to do, anti-fraud, anti-manipulation.
We intend to do nothing with those. We always want to be subject to those. So I think deregulation is really a misnomer in that instance.
Mr. EWING. Gentlemen, as you know, there is a vote and I will bring this hearing to a close, so that you won't be waiting.
I would make a couple of observations. I notice that the commissioners have,