Market Oversight
Table Of Contents
| Budget | FTEs | |
|---|---|---|
| Total Budget | $33,831,000 | 133 |
| Total Change | $3,038,000 | 8 |
| Program Activity | Percentage |
|---|---|
| Market Oversight | 21% |
| All Other Programs | 79% |
| Program Activity | Percentage |
|---|---|
| Market Oversight | 22% |
| All Other Programs | 78% |
Justification of the FY 2010 President’s Budget & Performance Plan
The primary responsibility of the Market Oversight program is to foster markets that accurately reflect the forces of supply and demand for the underlying commodity and are free of disruptive activity. By detecting and protecting against price manipulation and abusive trading practices, this program assists the markets in performing the vital economic functions of price discovery and risk transfer (hedging). The Market Oversight program fulfills the Commission’s surveillance and oversight responsibilities for these markets. The program also will conduct trade practice surveillance and reviews of exchange rule amendments and submissions. In addition, the program will develop, implement, and interpret regulations that protect customers, prevent trading abuses, and assure the integrity of the futures markets.
In FY 2010, the Market Oversight program requests 133 FTEs, an increase of 8 FTE over the FY 2009 level. The three major subprograms—Market Surveillance, Market and Product Review, and Market Compliance—are requesting 70 FTEs, 26 FTEs, and 37 FTEs, respectively.
Chief Counsel’s Office. The Chief Counsel is responsible for the issuance of rules and regulations related to oversight of regulated futures markets; the issuance of interpretations, policy statements, and no-action letters in connection with issues related to markets; the review of division matters generally to ensure their consistency with the CEA and the Commission’s regulations; and the review of matters originated by other divisions of the Commission to determine whether they implicate the division’s interests in any manner. A key duty of Chief Counsel’s Office is the design and implementation of a program to address the operations of foreign boards of trade (FBOTs) that permit their members or participants in the United States to directly access their electronic trading systems. The Chief Counsel’s Office designs and implements procedures regarding the handling of initial and subsequent FBOT requests to permit direct access from the United States, including the form and extensive content of those requests sufficient to undertake a meaningful evaluation of the operations of the FBOT and its regulator. This area of responsibility requires the Chief Counsel to: 1) maintain a comprehensive knowledge of, and sensitivity to, the Commission's regulatory approach, policies, and current agenda regarding foreign regulatory authorities and foreign exchanges; 2) coordinate with other divisions and offices of the Commission in a comprehensive knowledge of the laws, regulations, and policies applicable to FBOTs; and 3) negotiate with FBOTs and foreign regulators, market authorities, and experts in the derivatives industry and academia.
Market Surveillance. Futures prices are generally quoted and disseminated throughout the U.S. and abroad. Business, agricultural, and financial enterprises use the futures markets for pricing information and for hedging against price risk. The participants in commercial transactions rely extensively on prices established by the futures markets, which affect trillions of dollars in commercial activity. Moreover, the prices established by the futures markets directly or indirectly affect all Americans. They affect what Americans pay for food, clothing, and shelter, what we pay to heat our homes and fuel our cars, as well as other necessities. Because futures and option prices are susceptible to manipulation and excessive volatility, and producers and users of the underlying commodities can be harmed by manipulated prices, preventive measures are necessary to ensure that market prices accurately reflect supply and demand conditions.
Actions to detect and prevent price manipulation are taken by economists who monitor all active futures and option contracts for potential problems. The FTEs requested for the Market Oversight program will work on detecting and preventing threats of price manipulation and other market disruptions caused by abusive trading practices, investigating instances of possible manipulation, analyzing routine reports of large trader activity, and implementing the ECM significant price discovery contract (SPDC) provisions of the CRA.
Price manipulation prevention activities of Market Surveillance economists are enhanced by support personnel, such as futures trading specialists, futures trading assistants, and statisticians. Their activities include operating an extensive daily data-gathering and verification system and collecting reports from exchanges, futures industry firms, and traders. The reports provide current market information on the size of futures and option positions held by large traders as well as other background information that is necessary to monitor the markets and to enforce Commission and exchange speculative limits.
Market Surveillance staff also collects and integrates information on large positions held on exempt commercial markets and foreign boards of trade in contracts that are linked by cash-settlement to a contract traded at a designated contract market in order to better accomplish the Commission’s mission of detecting and preventing price manipulation in markets under its jurisdiction.
Market and Product Review. In order to serve the vital price-discovery and hedging functions of futures and option markets, exchanges must provide consumers with safe marketplaces that have appropriate protections in place and provisions for ensuring the fairness of the market and the integrity of their contracts. Exchanges must list products for trading that are not readily susceptible to manipulation and do not lead to price distortions or disruptions in the futures or option markets, or in the underlying cash markets. Furthermore, exchanges must provide for fair, equitable and secure markets. Adherence to the approval criteria, CFTC Core Principles, and appropriate contract design minimizes market disruptions and the susceptibility of contracts to manipulation or price distortion and promote customer protection and market integrity.
The Market and Product Review subprogram, in cooperation with other offices of the Commission, reviews exchanges’ applications for approval as a contract market or as a Derivatives Transaction Execution Facility (DTEF) to ensure that the exchange is in compliance with approval criteria and CFTC Core Principles and Commission regulations. The subprogram also reviews filings by exempt markets and, as required, analyzes these entities to ascertain whether they comply with statutory requirements.
The subprogram reviews requests from exchanges for approval of new contracts and rule amendments to existing contracts to ensure that contracts are in compliance with statutory and regulatory anti-manipulation requirements. It also conducts reviews of new products and rule changes of economic significance submitted under certification procedures to provide information about the markets and product design features; and to ensure that contracts and rules comply with statutory requirements as well as the Commission’s rules and policies. The reviews foster markets free of disruptions, or price manipulation, provide essential information to conduct effective market surveillance, and address regulatory and public interest issues. In this regard, deficiencies in the terms and conditions of futures and option contracts increase the likelihood of cash, futures, or option market disruptions and decrease the economic usefulness and efficiency of contracts.
The subprogram also reviews new exchange rules and rule amendments for consistency with CFTC Core Principles and various regulatory standards, thus maintaining fairness and integrity, protecting customers, and accommodating and fostering innovation and efficiency in self-regulation. The reviews consider complex new trading procedures and market structures that present novel issues and, in some cases, require amendments or interpretations by the Commission to facilitate implementation of the SRO’s rule changes. In this regard, deficiencies in the new programs or changes to existing programs increase the likelihood of trading abuses, inconsistent market oversight, or implementation of market or governance changes that create conflicts of interest or raise other regulatory concerns.
The subprogram reviews exempt commercial market and exempt board of trade filings to ensure compliance with the Act. The subprogram oversees an annual requirement to file a notice with the Commission regarding the market’s operating status under the exemption, as well as any information that should be updated, including information on whether the market performs a price-discovery function, whether trades are cleared, the exempt markets’ basis for believing participants are appropriate and whether complaints have been received. Furthermore, the subprogram reviews exempt commercial markets and exempt board of trade on an ongoing basis to ascertain whether the operator has an appropriate belief in the status of its traders, that complaints are being provided to the Commission, and that the market’s public representations do not imply that the market is regulated or overseen by the Commission. With additional staff, the subprogram will implement new provisions of the CRA regarding exempt commercial markets that trade significant price discovery contracts, including ongoing reviews of the new market rules or amendments as well as annual evaluations to determine whether any of the market’s serve a significant price discovery function and, to the extent that any contract does, subjecting that contract to an oversight regime comparable to that for designated contract market contracts.
Market Compliance. The Market Compliance subprogram oversees the regulatory and oversight activities of all designated contract markets in furtherance of the Commission’s primary goals of ensuring customer protection and market integrity. The oversight program consists of examinations of exchange self-regulatory programs on an ongoing, routine basis to assess their continuing compliance with applicable CFTC Core Principles under the Act and the Commission’s regulations. The examinations result in rule enforcement review reports that evaluate an exchange’s compliance and surveillance capabilities. The reports set forth recommendations for improvement, where appropriate, with respect to an exchange’s trade practice surveillance, market surveillance, disciplinary, audit trail, record-keeping, and dispute resolution programs. These periodic reviews promote and enhance continuing effective self-regulation and ensure that exchanges rigorously enforce compliance with their rules.
The Market Compliance subprogram also monitors trading activity on all exchanges in order to detect and prevent possible trading violations. This type of oversight is conducted through the use of automated surveillance and floor surveillance, and it fosters markets that are free of trading abuses. The identification of potential trading violations results in referrals to relevant exchanges and to the Commission’s Division of Enforcement. In addition, the Market Compliance subprogram reviews and analyzes proposed exchange trading platforms, rule enforcement programs, and disciplinary procedures in conjunction with new designated contract market applications. The subprogram also conducts special studies of exchange rules, procedures, and trading practices as issues arise affecting a particular exchange. This serves to promote orderly trading and facilitates open and competitive markets.
Electronic trading accounts for over 80 percent of total exchange volume. As part of the Commission’s overall mission to ensure market integrity and customer protection, it collects trade data from all U.S. futures exchanges and conducts investigations to detect possible trading abuses through the Exchange Database System (EDBS), which was developed in the mid-1980s. Presently, the Commission is developing a new trade surveillance system, TSS, to replace EDBS because it has not been upgraded since its inception. New technology will enhance staff’s ability to effectively detect and deter trade practice violations in a rapidly changing environment, especially with respect to electronic trading data, and will provide staff with greater efficiency and flexibility. Trade violation detection software will perform sophisticated pattern recognition and data mining to automate basic trade practice surveillance, and detect novel and complex abusive practices in today’s high-speed, high-volume global trading environment. TSS will be used to monitor inter-market trading, a blind spot in surveillance which only the Commission can address, and side-by-side trading, e.g., simultaneous trading of a contract on a DCM’s floor and the DCM’s electronic trading platform.
The Market Compliance subprogram also is directly involved with emergency planning for the markets and Commission and business continuity in the event of an emergency. In this capacity, a Market Compliance staff member represents the Commission as a President’s Working Group (PWG) Duty Officer, serving as one of the Commission’s point persons for information flow and coordination between the Treasury, Federal Reserve, SEC, and CFTC in the event of market moves or physical events (terrorism, hurricanes, etc.) that could disrupt the normal functioning of the financial sector. Market Compliance staff also represent the Commission on the Financial and Banking Information Infrastructure Committee (FBIIC), a standing committee of the PWG that is charged with enhancing financial sector resiliency and improving coordination and communication among financial regulators and between regulators and private sector financial institutions.
Consequence of Not Receiving Requested Level of Resources
The growth in the number and different types of facilities that trade a wide array of derivatives products, including single-stock futures, futures on over-the-counter (OTC) instruments, contracts based on events or occurrences, as well as novel approaches to derivatives trading, requires an increased and more sophisticated level of surveillance, data collection, analysis, reporting, and research to conduct effective oversight and develop the necessary expertise to monitor these developments. Surveillance and oversight of exchanges and product design involves monitoring an increasing number of innovative and often complex futures and option contracts to detect or prevent potential problems, price manipulation, and other major market disruptions caused by abusive trading practices or contract design flaws.
In FY 2010, the Market Oversight staff will be required to monitor a large and diverse array of markets and products to carry out the Commission’s oversight and surveillance program to deter and prevent price manipulation and investigate suspect activity. The Commission anticipates that a large number of new, novel contracts, including contracts based on complex financial derivatives, broad-based debt indexes and SFPs based on debt instruments, will be listed for trading on futures exchanges. The number and diversity of agricultural and energy futures contracts is also expected to continue to grow, as exchanges develop new types of contracts to meet commercial needs, such as new exchange-traded contracts that replicate OTC products.
The increasing inter-relationship among exchange-traded contracts, OTC products, and cash markets, involving many commodity areas, increases the complexity of conducting surveillance to detect manipulative strategies and to understand the factors causing price movements. Also, exchanges have indicated an interest in listing a large number of contracts, including new kinds of contracts, based on events that raise core issues regarding the extent of the Commission’s jurisdiction. Furthermore, the Commission anticipates that new technology and a number of new market plans and new trade execution methods will be adopted by exchanges. In addition, the development of new technology, side-by-side trading, and directly competitive markets creates the potential for new types of abuses across markets as well as abuses that utilize these newly available capabilities.
Additional staffers are critical to enable the Market Oversight program to meet its regulatory and oversight responsibilities. These additional staff persons are needed for staff to focus on the complex issues and changing practices in the derivatives markets, especially in the energy and agricultural sectors. Without adequate resources, the Market Oversight program of surveillance, exchange oversight, new exchange reviews, and studies to enhance understanding of the markets and new technology cannot keep up with the growth in new types of exchanges, new trading execution methods in futures markets, and the initiation of trading in new, innovative complex products that require detailed analysis and raise substantive legal and policy questions. In addition, the Commission proposed acceptable practices for CFTC Core Principle 15 relating to exchange governance and conflicts of interest. Without adequate resources, staff will not be able to conduct necessary reviews to ensure that exchanges adequately address potential conflicts of interest between their self-regulatory functions and responsibilities and their commercial interests.
Without these additional resources, surveillance staff will be stretched to a level that puts at significant risk the Commission’s strategic goal to detect and deter price manipulation. Proper surveillance coverage of markets requires highly specialized and comprehensive knowledge of assigned markets. Without adequate staffing to cover each commodity area, the surveillance economists will be required to cover many markets, and the amount of expertise and attention that can be devoted to each market will suffer dramatically. Thus, some price manipulations and abusive trading practices will go undetected or will be detected too late to permit amelioration or intervention. Also, staff will not be able to assess trader participation in the markets to evaluate the extent of speculative and commercial activity. In particular, there is a substantial risk that abusive trading in agricultural and energy futures markets will go undetected, potentially costing American consumers hundreds of millions of dollars. This is of critical importance during recent periods of unprecedented prices and volatility in many commodity markets.
Further, in the absence of sufficient resources, the efficacy of exchange self-regulatory programs will not be evaluated as effectively or on a timely basis. By materially lengthening the time between reviews, staff will not be able to ensure that exchanges are effectively fulfilling their self-regulatory responsibilities with respect to customer protection and market integrity and, as a result, traders, affected industries and the general public will suffer direct economic harm from an increase in illegal trading activity. In addition, without sufficient human resources to further develop the Commission’s new Trade Surveillance System the system may not be developed to its full capabilities or could quickly become obsolete. TSS, which is in the early stages of development, will enhance the Commission’s trade practice surveillance program and allow staff to conduct surveillance across multiple markets and exchanges to detect trading violations and potentially violative activity. TSS also will provide staff with the necessary tools to recognize and monitor today’s often-novel and complex trading practices and strategies. TSS development and implementation is expected to be an ongoing process and is part-and-parcel of the Commission’s innovation to keep pace with rapid developments in today’s high-volume global electronic trading environment.
In addition, staff would not be able to review all new contracts, new rules and rule change submissions for approval within statutory time frames, and will not be able to appropriately review all new contract, new rule and rule change certifications in a timely manner. In the absence of a timely new contract reviews, it is possible that a contract market might inadvertently list for trading a flawed contract that does not meet statutory or regulatory requirements. In the absence of a timely new rule or rule amendment review, a contract market might lead to a violation of the CEA or the Commission’s regulations. This could result in direct economic harm to producers, consumers, and other users of the underlying commodities and indirect harm to the economy as a whole because market prices may not accurately reflect supply and demand conditions or because the contract may not be a useful risk management tool.
Without adequate resources, staff may not be able to maintain its ability to promptly process requests from foreign boards of trade to permit direct trading access to U.S. market users. Any such delays would have a detrimental impact on the ability of U.S. market users to avail themselves of foreign liquidity pools and would generally impede the accelerating rate of globalization in the futures industry.
Without adequate resources, the Market Oversight program cannot monitor exempt markets and carry out the requirements of recently enacted legislation related to significant price discovery contracts on exempt markets. This could significantly affect the public interest by permitting such contracts to trade without effective surveillance and exchange oversight, thereby creating the potential for undetected market abuses and manipulation.
In addition, without adequate resources, staff cannot implement the various initiatives adopted by the Commission to improve transparency in the futures markets, especially the energy and agriculture markets. Many of these initiatives were adopted as a result of the staff’s special call to swap dealers. These initiatives focus on providing critical market information to traders and the public to address concerns about volatility and high prices.
It is anticipated that some time in 2009, legislation will be adopted that will work fundamental changes to U.S. financial regulatory system, including new obligations with respect to the oversight of Dodd-Frank Act markets. While the precise allocation of those new regulatory responsibilities is unclear, there is a very high probability that the CFTC will have some increased market monitoring responsibilities. Without additional resources, CFTC staff may not be adequate to effectively carry out the duties that would likely be attendant to those new responsibilities, including regulation drafting and market surveillance.
| Subprogram | FY 2009 | FY 2010 | Change | |||
|---|---|---|---|---|---|---|
| Budget Request |
FTE | Budget Request |
FTE | Budget Request |
FTE | |
| Market Compliance | $8,989 | 36.00 | $9,525 | 37.00 | $536 | 1.00 |
| Market & Product Review | 6,098 | 24.00 | 6,817 | 26.00 | 719 | 2.00 |
| Market Surveillance | 15,706 | 65.00 | 17,489 | 70.00 | 1,783 | 5.00 |
| Total | $30,793 | 125.00 | $33,831 | 133.00 | $3,038 | 8.00 |
| Subprogram | Percentage |
|---|---|
| Market Compliance | 28% |
| Market & Product Review | 20% |
| Market Surveillance | 52% |
| Outcomes | FY 2009 | FY 2010 | Change | |||
|---|---|---|---|---|---|---|
| Budget Request |
FTE | Budget Request |
FTE | Budget Request |
FTE | |
| GOAL ONE: Protect the economic functions of the commodity futures and option markets. | ||||||
| 1.1 Futures and option markets that accurately reflect the forces of supply and demand for the underlying commodity and are free of disruptive activity. | $19,292 | 79.00 | $21,185 | 84.00 | $1,893 | 5.00 |
| 1.2 Markets that can be monitored to ensure early warning of potential problems or issues that could adversely affect their economic vitality. | 2,003 | 8.00 | 2,330 | 9.00 | 327 | 1.00 |
| Subtotal Goal One | $21,295 | 87.00 | $23,515 | 93.00 | $2,220 | 6.00 |
| GOAL TWO: Protect market users and the public. | ||||||
| None | ||||||
| GOAL THREE: Foster open, competitive, and financially sound markets. | ||||||
| 3.2 Commodity futures and option markets are effectively self-regulated. | $6,493 | 26.00 | $7,217 | 28.00 | $724 | 2.00 |
| 3.3 Markets are free of trade practice abuses. | 2,497 | 10.00 | 2,575 | 10.00 | 78 | 0.00 |
| 3.4 Regulatory environment responsive to evolving market conditions. | 508 | 2.00 | 524 | 2.00 | 16 | 0.00 |
| Subtotal Goal Three | $9,498 | 38.00 | $10,316 | 40.00 | $818 | 2.00 |
| Total | $30,793 | 125.00 | $33,831 | 133.00 | $3,038 | 8.00 |
| Goal | Percentage |
|---|---|
| Goal One | 70% |
| Goal Two | 0% |
| Goal Three | 30% |