Joint Statement of

Chicago Board Options Exchange
New York Stock Exchange
National Association of Securities Dealers
American Stock Exchange
Boston Stock Exchange
Chicago Stock Exchange
Cincinnati Stock Exchange
Pacific Stock Exchange
Philadelphia Stock Exchange
The Options Clearing Corporation

Before the Senate Committee on Agriculture, Nutrition and Forestry

February 13, 1997

Regarding S. 257 Commodity Exchange Act Amendments Act of 1997

Presented by Alger B. Chapman Chairman and CEO Chicago Board Options Exchange

STATEMENT OF ALGER B. CHAPMAN

Mr. Chairman and members of the Committee, I am Alger B. Chapman , the Chairman and Chief Executive Officer of the Chicago Board Options Exchange. The CBOE initiated trading in standardized securities options in 1973 and has remained the leading market for securities options ever since. I appear today on behalf of CBOE and nine other securities self-regulatory organizations: the American Stock Exchange, the Boston Stock Exchange, the Chicago Stock Exchange, the Cincinnati Stock Exchange, the National Association of Securities Dealers, the New York Stock Exchange, the Pacific Stock Exchange, the Philadelphia Stock Exchange and the Options Clearing Corporation.

I am appearing to express our concern over the proposed exemptions from the Shad-Johnson Accord that are contained in Section 5 of S. 257, and which the futures exchanges have proposed also be included in the professional markets provisions of Section 6. We take no position on any other provisions of the bill. If these exemptions were enacted, virtually all transactions in securities futures and securities hybrids between "appropriate persons" that are effected either over-the-counter or in a professional market would be statutorily exempt from regulation by the CFTC. In our view, the case for these exemptions from Shad-Johnson has not been made. If the Committee feels there is a need to re-examine the Accord, this should be done with the involvement of both the CFTC and SEC, in consultation with the other members of the Working Group on Financial Markets, all relevant congressional committees, relevant self-regulatory organizations and the members of the affected industries.

The Shad-Johnson Accord, which prescribes how options and futures on securities and securities indices are to be regulated, was enacted in 1982 based upon the joint agreement of the then Chairmen of the SEC and CFTC, and after thorough consideration by the four congressional committees having oversight over both agencies. The Accord established the conditions under which futures on broad-based securities indices could be traded, prohibited the trading of futures on any security (other than an exempted security), and, in effect, prohibited trading in futures on narrow-based securities indices. Shad-Johnson is an important law governing the regulation of securities transactions and, in our view, should not be tampered with.

Whether swaps and other hybrids should be exempted from Shad-Johnson was carefully considered by Congress when it enacted the Futures Trading Practices Act of 1992 (FTPA). At that time, Congress withheld the CFTC's authority to exempt transactions in these instruments from Shad-Johnson, thus preserving the jurisdictional balance provided for in Shad-Johnson. Nevertheless, transactions in equity swaps have continued as the Conference Committee considering the FTPA intended they would - so long as they do not violate Shad-Johnson.

The Conference Committee directed the CFTC, in conjunction with the SEC and the Federal Reserve Board, to study the markets for swaps and other derivatives and to report back to Congress. The CFTC's report, OTC Derivatives Markets and Their Regulation, issued in October 1993, concluded that no fundamental change in regulatory structure appears to be needed but that greater coordination among federal regulators would help assure that federal oversight remains adequate. Since then, the Working Group has continued to facilitate policy coordination of these derivative products to assure that they do not adversely affect the effective functioning of the United States securities and other financial markets.

Nothing has occurred since that report, and there has been no other report or study, to establish the need for a broad statutory exemption from Shad-Johnson for OTC or professional market transactions between appropriate persons in securities swaps and other securities hybrids. The Committee should not take action on the proposed deregulation of these products until it can conclude, based on the record before it, that this action would be safe and in the public interest, and that it will not have an adverse effect on the proper functioning of, and the competitive balance in, the securities markets.

Our own experiences in the development of standardized stock options trading has shown that problems arise that were not foreseen in advance. It took an SEC-imposed moratorium on expansion, a special study of the options markets, and numerous other rules changes before regulators and the general public have become comfortable with our product. The markets for swaps and other hybrid instruments are relatively new, and neither Congress nor the regulatory agencies yet know what could go wrong.

On Tuesday of this week, representatives of the futures exchanges presented to the Committee a proposal that would eliminate the application of Shad-Johnson to the professional markets created under Section 6 of the bill. If this were done, it would lead to futures and other derivatives based on a single equity security being traded on the commodities exchanges free from virtually all government regulation.

Why does the creation of a blanket exemption for these markets give us such concern? We do not know what particular problems might arise from totally unregulated derivatives markets in equity products. We do know that there is a strong relationship between trading in derivatives and related cash markets. We also know that there is, at best, incomplete information on the extent or nature of trading in these markets. We also know that a market in which regulators have no legal ability to require trading reports, to impose "circuit breakers," position limits, trading halts or margin requirements if they should prove necessary, to obtain the information required to monitor the markets, or to mandate fair competition among participants, is a market that could present great potential dangers for the nation's regulated securities markets. To preclude regulators from having the means to step in if necessary to address systemic risk is neither wise nor necessary in order to achieve the primary objectives of this bill.

The concerns we have identified could be resolved by a savings clauses in Sections 5 and 6 to make clear that the exemptions are not intended to affect Shad-Johnson. That approach is consistent with the Treasury Department's bill's approach to the Treasury Amendment and the approach that Congress took five years ago in enacting the FTPA.

Thank you for giving me this opportunity to express our concerns. I am, of course, happy to respond to any questions you may have. We look forward to working with the Committee as it progresses in its consideration of these difficult issues.