GLOBAL DERIVATES MARKETS:
CHALLENGES FOR REGULATORS AND EXCHANGES
Address by Chairman Reuben Jeffery, III
U.S. Commodity Futures Trading Commission
Futures Industry Association, Japan Chapter
January 17, 2006
Tokyo, Japan
Introduction
It is a great pleasure to be here. I especially want to thank the Japanese regulatory authorities and futures exchanges for their hospitality during my visit. I also want to thank the Futures Industry Association – Japan Chapter for inviting me to speak before this distinguished audience.
We meet at a very compelling time for Japan. The Japanese economy is at its strongest in many years and continues to expand at a steady pace. Demand for Japanese goods is trending upward, driven by rising income and foreign demand. Japanese stock prices, buoyed by strong corporate profits, are at five-year highs. In short, there is optimism -- Japan is on its way to a strong economic recovery -- a testament to the resiliency and dynamism of its economy.
It is also an exciting time for the Japanese futures industry. Sweeping legal reform promises to enhance the growth and long-term competitiveness of Japan’s futures markets. And Japan’s futures exchanges are increasingly seeking opportunities abroad.
Let me now turn to today’s principle topic -- globalization. Globalization is a growing reality in the futures industry. Where once there were a handful of derivatives exchanges outside the United States, today there are more than 48. U.S. exchanges have set up communications hubs covering nearly every continent and U.S. firms are increasingly seeking trading strategies that are global in nature. Many foreign markets are opening for the first time to U.S. firms, notably in Japan, the Tokyo Commodity Exchange.
Today I will share with you the CFTC’s perspectives on expansion of global markets and some of the Agency’s thinking behind its policies towards cross-border initiatives. First, I will discuss the role of global competition in facilitating the growth of futures markets. Then, I will discuss what we view as the key building blocks for global expansion in today’s rapidly changing marketplace -- regulatory structures promoting free and open markets, recognition of comparable foreign supervisory systems, and continuing support for international cooperation and coordination.
Global Competition Benefits and Complements the U.S. Futures Market
Advances in technology are presenting greater opportunities for cross-border activities. The possibilities are stunning and affect almost every aspect of the futures industry. From electronic facilities linking traders to markets across continents, to development of sophisticated risk management tools, to operational innovation in clearing and settlement, technology is the catalyst for the global expansion we are seeing today.
From its earliest years, the CFTC has advocated a measured and innovative approach to cross-border initiatives. This forward-leaning policy is based on the notion that globalization is inevitable and has great potential to enhance market depth and competition. Competition, in turn, promotes innovation in products and services. Ultimately, the public benefits from lower transactional costs, broadened product diversification, and market liquidity. At the most basic level, of course, global competition also enables U.S. market participants to trade in markets and products otherwise inaccessible.
By all measures, our experience confirms this judgment. The U.S. futures markets continue to prosper, driven in part by global competition. Global futures volume has increased six fold during the last five years with the U.S. experiencing corresponding dramatic gains in volume. Last year, the U.S. futures markets traded in excess of two billion contracts, representing an increase in volume of 25% over the preceding year.
The U.S. growth has a significant international component: 30% of large traders on U.S. markets are located outside the United States, and almost 30% of U.S.-based accounts reflect margins deposited to support positions in foreign products.
It is clear that globalization, far from being a zero-sum game, expands the playing field and growth opportunities for all markets -- and to the benefit of market participants and the general public.
CFTC’s Flexible, Principle-Based Market Regulation
Now I would like to outline the three key elements that shape our policies with respect to cross-border initiatives. The first is our governing statute – the Commodity Exchange Act (CEA) – which provides for a flexible and calibrated approach to market regulation.
The CEA, as most recently amended, embodies the basic notion that industry itself is best positioned to make decisions affecting the business of futures trading. The landmark legislation, the Commodity Futures Modernization Act (CFMA), enacted in 2000, laid the foundation for a system of sensible regulation that would adapt to this market-oriented philosophy - and with appropriate safeguards - accommodate a rapidly changing and increasingly diverse marketplace.
The CFMA rejected a one-size-fits-all approach and established a flexible, principles-based regulatory model. Instead of prescriptive rules, CFMA established broad regulatory guidelines and objectives that permit variation in how particular markets conform to regulatory requirements, within specified parameters.
By doing so, it allows the industry and regulators to keep pace with the rapid-changing needs and demands of the marketplace, without being constrained by overly specific, outdated regulations -- and without the loss of industry accountability. This in turn, it was envisioned, should result in a heightened level of market innovation and competition and lower regulatory costs for new market entrants.
This regulatory framework has an important implication for cross-border initiatives. The regulatory principle that allows variation in how a domestic market may meet regulatory requirements applies equally to a foreign entity seeking entry into the U.S. market. This, in turn, lowers the cost of access for non-U.S. markets.
To be sure, cross-border activities add complexity, due to the practical fact that effective supervisory oversight requires vigilance beyond national borders. A level-playing field is also important as competition must be open, fair and equitable across international markets in order to sustain a healthy and growing global market. In this regard, close cooperation and coordination among different countries is absolutely key to assuring the ability to effectively supervise an ever-increasing cross-border business.
To date, since the CFMA was enacted, at least 5 non-U.S. trading platforms are operating in the United States and at least one non-U.S. clearing organization has satisfied the new requirements to become a U.S. designated clearing organization.
The CFTC has also approved a number of innovative cross-border trading and clearing arrangements, including CME-Simex, CBT-Liffe, CME-Meff, and most recently NYMEX Europe-NYMEX. Generally speaking, these arrangements facilitate greater participation by U.S. investors and traders in foreign markets by making operational adaptations to cross-border business possible.
These arrangements were varied in structure and operational complexity -- and as such, entailed different types and levels of risks. And appropriately, in accordance with our flexible, principle-based approach, each was structured to suit the business needs of the exchanges, clearinghouses, and market participants involved and the markets in which they would operate and the related regulatory framework.. We expect that sort of healthy customization to continue as other cross-border arrangements are proposed.
Recognition of Comparable Foreign Regulation
Globalization demands that international regulators take a cooperative and creative approach to achieving market integrity and customer protection. Cross-border competition and innovation are unnecessarily stifled and the global market cannot grow if jurisdictions impose redundant or inconsistent regulatory burdens. A sensible approach to global expansion calls for the recognition of comparable foreign regulatory frameworks. In this, the CFTC is one of the pioneers.
A good example of our approach is our administration of Part 30 Rules, which permit non-U.S. intermediaries to deal directly with U.S. persons on the basis of compliance with their home jurisdictions’ licensing schemes for intermediaries, subject to certain conditions, including, importantly, effective information-sharing arrangements.
In a similar vein, CFTC permits direct screen access from the United States to bona fide foreign markets, in reliance on the foreign market’s home regulatory regime. Today, 16 markets from 10 non-U.S. jurisdictions have received such permission, subject to access to books and records, submission to U.S. jurisdiction, and effective information sharing and cooperative surveillance arrangements.
Our overall approach towards globalization allows U.S. businesses and investors safely to access derivatives markets. In fact, foreign brokers have served US customers in a growing number of jurisdictions, without incident, for more than fifteen years. In each case, our confidence in foreign supervision has been based upon careful inquiries into its foundations and negotiation of necessary cooperative arrangements.
Just as non-U.S. institutions seek entry in the U.S. markets, so too are U.S. institutions trying to access and compete in foreign markets. Accordingly, the CFTC actively supports the applications of U.S. regulated entities to compete for business in other jurisdictions. Toward that end, we work with other regulatory authorities on how to address their interests so that they can permit such competition, while appropriately relying on our home market supervision.
International Cooperation and Coordination
As futures trading becomes more global, cooperation among regulators is an imperative. In that respect, one of the priorities at the CFTC is working with other regulators to assure that cross-border arrangements can be adequately monitored and overseen and that regulators on each side of any link or cross-border relationship have the tools and the powers necessary to assure that they can properly protect their markets.
Accordingly, the CFTC has been active in setting up relationships with other countries to establish information sharing, technical assistance, and enforcement agreements. Just yesterday, the CFTC, the U.S. Securities and Exchange Commission, and the Financial Services Authority of Japan, executed a Statement of Intent to enhance and streamline information sharing with respect to financial derivatives contracts. This arrangement reflects a long and on-going effort by the Japanese authorities to work with the CFTC to improve our cooperative arrangements.
Our cooperative efforts occur not only bilaterally but also multilaterally in forums such as the International Organization of Securities Commissions (IOSCO), with whom we entered into a multilateral memorandum of understanding (MOU) with two dozen other nations. This MOU will enable regulators to exchange essential information to investigate cross-border securities and derivative violations. In addition, CFTC has been an active participant in IOSCO and its related regional committees, working to develop regulatory “best practices” and “benchmarks” that are intended to help foster higher international regulatory standards.
Conclusion
Futures markets have become increasingly global as technology and market demand promote greater opportunities for the linking of markets across the world. To ensure that these opportunities serve as a catalyst for market growth and prosperity, it is vitally important for us – regulators and industry participants – to work together to allow our markets to innovate and compete, while preserving the safeguards necessary to protect the public and market integrity.
I look forward to hearing from the distinguished guests and members of the audience.
Last Updated: March 29, 2007