Speeches and Testimonies

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March 20, 2000



Senator Fitzgerald, I certainly appreciate the opportunity to present the views of the National Futures Association on the CFTC's proposed New Regulatory Framework, which I consider to be one of the most important regulatory developments in the futures industry since the Commission itself was created. Like many other industry leaders I have testified many times before this Committee in the last few years and each time my message was the same.

The futures industry is facing greater competition than ever before, both from off shore markets and OTC markets, and the regulation of the industry needs to be overhauled and streamlined if regulated markets are to remain competitively attractive. In short, my message over and over was that Congress and the Commission had to find ways to reduce regulatory burdens without reducing regulatory protections. I also said that the way to achieve that goal was to maximize the use of self-regulation while returning the Commission to its intended role as an overseer of the self-regulatory process rather than a micro-manager of that process. It is truly a pleasure to testify before you today and to state that the Commission's proposed framework is a dramatic and bold step in the right direction.

The focus on core principles for both exchanges and intermediaries is exactly the right approach. The Commission should tell those that it regulates what they have to do, not how they have to do it. The old approach of having detailed regulation specifying exactly how firms should cross their t's and dot their i's was never well grounded, but it is particularly inappropriate today. The answer to the "how" question changes with every new development in technology. That's why the role of self-regulation will be even greater in the markets of tomorrow than it has been in the past.

Technology is tearing down barriers to entry faster than any government policy ever could. The simple fact is that it is easier to create a central market place for buyers and sellers in cyberspace than it is in Chicago or New York. In the 22 years from 1977 to 1999 there were a grand total of zero new futures exchanges. In the last six months at least six different enterprises have stated their interest in creating new electronic futures exchanges. All of them are dedicated to using effective self-regulation to ensure the integrity of their markets and the public's confidence in those markets. But these new exchanges are not shackled by the past. They are looking for more efficient ways to perform their self-regulatory functions and each has contacted NFA about outsourcing that function to us. We certainly look forward to working with each of them.

My point is not simply that NFA will play an even greater role in the years ahead than we have already, although I would be happy to discuss that for an hour or two if you have the time. My real point is that the burgeoning number of exchanges and the corresponding changes to the entire industry, including its self-regulatory structure, point out the need for action now. As never before, time is of the essence. I applaud the Commission on its efforts to date but would urge both the Commission and Congress to move ahead as aggressively as possible. We simply do not have time to delay.

I certainly recognize that difficult work lies ahead. The proposed framework is just that, a framework. The proposal does not address some of the details which will have to be resolved to move the proposal from paper to the real world. Some of these details should be readily soluble. As I mentioned earlier, the Commission's reliance on core principles, rather than detailed, one size fits all regulations is exactly the right approach. But those core principles need to be supplemented with interpretive guidance which the industry can rely on. The Commission's proposal recognizes this point but does not discuss how that guidance would be provided.

Let me tell you how that guidance should not be provided. If we revert to having regulators in Washington dictating to the industry how the core principles have to be followed, we will end up right back where we are, a result which no one wants. NFA is currently involved with the Futures Industry Institute on a Best Practices study on order transmission and entry, a study which was ordered by the Commission and funded from a portion of a fine imposed in a CFTC enforcement action. I am convinced that a Best Practices approach is the best way to supplement the CFTC's proposed core principles and to provide guidance to the industry.

I should explain two basic points, however. Whenever we talk about "best practices," we have to consider the basic question of "best practices from whose perspective." To be effective, best practices have to be considered from the perspective of the customer. We have spent a good deal of time in our current study talking to end users and customers, and what they want from best practices is clear. They want procedures that ensure that they will be treated fairly and procedures that will ensure that their orders are executed as quickly as possible. If customer protection rules prevent the customer from getting the quickest fill at the best price at the lowest cost, then we haven't done the customers any favors at all.

The second point is that, by definition, best practices have to be developed through direct and active involvement of the industry itself. The best way to ensure that involvement is through the self-regulatory process. The Commission should specify that the core principles will be supplemented with best practices guidance developed through the industry's self-regulatory process.

Another detail which can be resolved quickly involves the registration process. The Commission's proposal states that the registration process should be streamlined but doesn't really address how in any detail. Over the past several years NFA has made a number of proposals to simplify the registration process, and we have recently updated those suggestions and submitted them to the Commission staff. If a firm or individual has gone through a screening process in the securities industry, conducting another background check for registration in the futures industry is clearly wasted effort, and we agree with the Commission's proposal to, in effect, "passport" those firms and individuals into registration.

These passported firms, though, would still be registered and still be subject to the same core principles as other firms, and there needs to be some mechanism to monitor their compliance with those principles, even if those firms are dealing with institutional customers. The answer, again, is self-regulation subject to Commission oversight. The Commission's proposal, though, would not require these passported firms to be members of a futures industry SRO. We believe that this is an oversight which needs to be corrected.

One of the major questions unanswered in the current proposal is exactly what the Commission means by the term "institutional customer." There are at least six different definitions of sophisticated customers in the Commission's rules, which is about five more than we need. We should not be adding a seventh. NFA proposed a uniform definition of sophisticated customer several years ago that was modeled very closely on the Commission's definition of eligible swaps participant. The eligible swaps definition has served well for the last seven years and should be the basis for the definition of institutional customer in this context. We would recommend that the threshold tests for that term should be no higher than those currently in place for eligible swaps participants.

Another key under the proposal will be the types of commodities which are not readily susceptible to manipulation, and which should therefore be subject to less regulation. Any issue which involves both lawyers and economists is likely to get complicated real quick. My only recommendation on this question is that the answer has to be a practical one, one which is dictated by the realities of the market place rather than theories of the classroom. The end users of the markets for petroleum products, for example, may well have the best perspective on this issue and their views should be accorded great weight by the Commission as it goes forward.

Finally, Senator, let me reiterate my enthusiastic support for the Commission's overall approach, but let me also remind you that this exercise of the Commission's exemptive authority does not obviate the need for legislative action. The basic regulatory structure for the industry should not hinge on the exercise of exemptive authority. What this Chairman of the CFTC has embraced the next Chairman might reject. Without legislative confirmation of this approach, we will have injected an entirely new dimension into the discussion of legal uncertainty. I urge the Commission to move as quickly as possible to resolve the remaining issues and to enact its proposal, and I urge Congress to support that effort and adopt legislation to codify the Commission's approach.

I again thank you for the opportunity to present my views and look forward to any questions you may have.

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