BROOKSLEY BORN, CHAIRPERSON
COMMODITY FUTURES TRADING COMMISSION
CONCERNING THE OVER-THE-COUNTER DERIVATIVES MARKET
BEFORE THE U.S. SENATE
COMMITTEE ON AGRICULTURE, NUTRITION AND FORESTRY
JULY 30, 1998
Mr. Chairman and Members of the Committee:
I. Introduction
I am pleased to represent the Commodity Futures Trading Commission ("CFTC"
or "Commission")
here today to testify about oversight of the over-the-counter ("OTC")
derivatives market and about
the draft legislation recently offered by the Department of the Treasury
("Treasury proposal")
regarding OTC derivatives.
The Commission has significant concerns about the Treasury proposal
and urges this Committee to
consider it very carefully. The Treasury proposal would prevent the
Commission from taking action
in market or other emergencies arising in that portion of the OTC derivatives
market within its
statutory authority, would forbid the Commission from enforcing its
existing laws and regulations
relating to certain transactions in that market, and would bar the
Commission from addressing new
developments in that market. It would also impair the Commission's
exercise of its statutory duties
by assigning to the President's Working Group on Financial Markets
("President's Working Group")
-- an ad hoc coordinating body with no budget, no staff and little
expertise in derivatives market
regulation -- the task of evaluating and recommending changes to the
Commission's policies on OTC
derivatives. It would also retroactively legalize certain OTC futures
contracts that have been
forbidden by law since 1982. These profound changes in the law, having
significant impact on
long-standing regulation of the OTC derivatives market, should be thoroughly
examined. Important
public interests would be harmed by their adoption.
This legislative initiative was triggered by the Commission's decision
to evaluate the continuing
appropriateness of its own regulations regarding OTC derivatives in
light of changes in the OTC
derivatives market over the past five years. That decision was part
of an ongoing Commission effort
to review its regulations to determine whether they should be streamlined,
modernized or revised to
reduce unnecessary regulatory burdens. No emergency has been created
by the Commission's
review which would justify the profound legal changes that would result
from the Treasury proposal.
II. The OTC Derivatives Market
Derivative instruments are contracts whose value depends upon (or derives
from) the value of one
or more underlying reference rates, indexes or assets. The classes
of underlying assets from which
a derivative instrument may derive its value include physical commodities
(e.g., agricultural products,
metals, or petroleum), financial instruments (e.g., debt and interest
rate instruments or equity
securities), indexes (e.g., based on interest rates or securities prices),
foreign currencies, or spreads
between the value of such assets. Derivative contracts may be listed
and traded on organized
exchanges or privately negotiated between the parties. Derivatives
executed off of an exchange or
board of trade are referred to as over-the-counter ("OTC") derivatives.
OTC derivatives are similar in structure and purpose to exchange-traded
futures and options. Like
exchange-traded derivatives, OTC derivatives are used for risk shifting
and speculation. End-users
employ OTC derivatives to hedge risks from volatility in interest rates,
foreign exchange rates,
commodity prices, and equity prices, among other things. These instruments
also are used to assume
price risk in order to speculate on price changes. Participants in
the OTC derivatives market include
commercial corporations, insurance companies, mutual funds, pension
funds, colleges and
universities, governmental bodies, banks, other financial service providers,
and individuals with
significant assets.
A simple example will illustrate how exchange-traded and OTC derivatives
operate in a similar
fashion in order to achieve the same purpose. Consider a business that
has issued a note with a
variable rate of interest payable semiannually over a fixed time period.
If the firm becomes
concerned that interest rates might rise over the remaining life of
the note and that it might therefore
be paying higher rates, the firm may wish to consider ways in which
it can transform its variable
rate liability into a fixed rate liability.
One way of doing this would be for the firm to sell a series of exchange-traded
Eurodollar futures
contracts, each of which matured on or about one of the note's interest
payment dates. Because the
cost of a Eurodollar futures contract falls as interest rates rise,
profits from the futures position could
be used to cover the difference between market rates payable on the
note and the fixed rate
established by the firm's transaction on the futures exchange. Alternatively,
the firm could enter into
a swap agreement in the OTC derivatives market in which it paid a fixed
interest rate and received
a variable interest rate based on the market rate with payment dates
corresponding to the interest
payment dates of the note.
Either method would allow the firm to convert its variable rate exposure
to a fixed rate that would
not fluctuate with changes in the interest rate market. The firm might
choose exchange-traded
futures for reasons of liquidity and transparency. In addition, if
the firm chose exchange-traded
futures, the risk of counterparty default would be assumed by the exchange's
clearinghouse, which
serves as the counterparty to both buyer and seller in every exchange
transaction. If the firm chose
to enter a contract on the OTC market, it would have to bear that risk
of counterparty default itself.
On the other hand, the OTC market permits parties to negotiate greater
customization of terms,
which may be a significant consideration if the size of the firm's
exposure, or the dates on which its
payments become due, do not correspond to the standardized terms of
exchange-traded contracts.
Use of OTC derivatives has grown at a rapid rate over the past few years.
According to the most
recent market survey by the International Swaps and Derivatives Association
("ISDA"), the notional
value of new transactions reported by ISDA members in interest rate
swaps, currency swaps, and
interest rate options during the first half of 1997 increased 46% over
the previous six-month
period.(1) The notional value of outstanding contracts in these instruments
was reportedly $28.733
trillion worldwide, up 12.9% from year-end 1996, 62.2% from year-end
1995, and 154.2% from
year-end 1994.(2)
ISDA's 1996 market survey noted that there were 633,316 outstanding
contracts in these
instruments as of year-end 1996, an increase of 47% from year-end 1995,
which in turn represented
a 40.7% increase over year-end 1994.(3)
An October 1997 report by the General Accounting Office ("1997 GAO Report")
suggests that the
market value of OTC derivatives represents about 3 percent of the notional
amount.(4) Applying the
3 percent figure to the most recent ISDA notional value for contracts
outstanding as of June 30,
1997, indicates that the worldwide market value of these OTC derivatives
transactions is over $860
billion.
The OTC derivatives market is substantially larger than the ISDA survey
data indicate since the
data are limited to transactions involving ISDA members only and to
transactions in only three kinds
of instruments among the many instruments being traded. With a growing
market have come
growing profits for OTC derivatives dealers. According to an industry
publication, OTC derivatives
trading revenues reached a record $2.35 billion during the first quarter
of 1998, exceeding the
previous record by $100 million.(5)
III. Commission Regulation of OTC Derivatives
The CFTC or its predecessor agency, the Commodity Exchange Authority,
has regulated derivative
instruments for almost three-quarters of a century. Its authority is
contained in the Commodity
Exchange Act ("CEA" or "Act"), which is the principal federal law governing
regulation of
derivative transactions and derivative markets. The CEA vests the CFTC
with exclusive jurisdiction
over futures and commodity option transactions whether they occur on
an exchange or over the
counter. The Act generally contemplates that, unless exempted, futures
and commodity options are
to be sold through Commission-regulated exchanges which provide the
safeguards of open and
competitive trading, price discovery and dissemination, and protection
against counterparty risk.
Thus, the Act and CFTC regulations establish a regulatory framework
for exchange-trading of
futures and options and provide for Commission oversight of intermediaries
engaging in such
transactions on behalf of customers.
Through its regulation of derivative instruments, the CFTC attempts
to assure that: (i) prices are
established in an open, competitive and transparent manner free from
price manipulation; (ii) the
financial integrity of the markets is maintained; and (iii) customers
are protected from fraud and
other abusive practices. The Commission accomplishes these goals through
its surveillance of the
markets; its establishment of regulations governing, among other things,
minimum capital
requirements for market intermediaries, segregation of customer funds,
risk disclosure for
customers, and recordkeeping and reporting by commodity professionals;
its oversight of
self-regulatory organizations; and when necessary, its emergency intervention
or enforcement
action.
Transactions in OTC futures and options are generally prohibited under
the Act unless explicitly
excluded or exempted from the exchange-trading requirement of the CEA.
The Commission's
enforcement docket has historically included numerous proceedings against
persons trading in OTC
derivatives outside the scope of any exemption or exclusion.(6)
For example, the Commission currently has four pending actions involving
hedge-to-arrive contracts
charging that the transactions constituted illegal OTC futures or option
contracts. Similarly, its many
cases against bucket shops are based on the fact that such operations
sell derivatives off a regulated
exchange and are also specifically prohibited by Section 4b of the
Act.
The CEA specifically excludes certain types of OTC derivatives from
the requirements of the Act.
The so-called Treasury Amendment to the CEA provides that the CEA does
not apply to OTC
transactions in foreign currencies, government securities and certain
other financial instruments.(7)
Options on securities and options on securities indexes also are excluded
from the Act and are
subject to the jurisdiction of the Securities and Exchange Commission
("SEC").(8)
In addition, pursuant to its statutory authority, the Commission has
exempted certain types of OTC
derivative transactions from specified provisions of the CEA. For example,
under Section 4c of the
Act, the Commission has the authority to allow options to be traded
over the counter under such
terms and conditions as the Commission may prescribe. Pursuant to this
authority, the Commission
has by regulation exempted certain OTC options from most provisions
of the Act pursuant to
specified terms and conditions.(9)
The Futures Trading Practices Act of 1992 gave the Commission additional
authority to exempt
transactions from certain provisions of the Act, including the requirement
in Section 4(a) of the Act
that futures must be traded on exchanges. Section 4(c)(2) of the Act
provides that the Commission
may grant such an exemption if the Commission determines that (i) the
transaction would be entered
into solely between defined "appropriate persons"; (ii) the transaction
would not have a material
adverse effect on the ability of the Commission or any regulated exchange
to discharge its
regulatory or self-regulatory duties under the Act; and (iii) the exemption
would be consistent with
the public interest and the purposes of the Act. Section 4(c)(5) explicitly
authorizes the Commission
to grant exemptions for swap agreements and hybrid instruments. The
Commission may grant such
exemptions "either unconditionally or on stated terms or conditions."(10)
Thus, the Commission has been given the flexibility and authority to
tailor its regulatory program to
fit the changing realities of the marketplace and the changing needs
of market participants.
Pursuant to Section 4(c), the Commission adopted regulations in 1993
exempting certain swap
agreements and hybrid instruments from some -- but not all -- provisions
of the Act, subject to
specified terms and conditions. Part 35 of the Commission's Regulations
exempts certain swaps
from provisions of the Act other than the antifraud provisions, the
anti-manipulation provisions, and
Section 2 (a)(1)(B).(11) thus, swaps exempted under Part 35 may be
traded over the counter without
violation of the CEA. To be eligible for exemptive treatment under
Part 35, an agreement: (1) must
be a swap agreement as defined in Rule 35.1(b)(1); (2) must be entered
into solely between
specified eligible swap participants; (3) must not be a part of a fungible
class of agreements that are
standardized as to their material economic terms; (4) must include
as a material consideration in
entering into the agreement the creditworthiness of any party with
an obligation under the
agreement; and (5) must not be entered into and traded on or through
a multilateral transaction
execution facility.
The criteria contained in the swaps exemption were designed to assure
that exempted swap
agreements meet the requirements set forth by Congress in Section 4(c)
of the CEA and to
"promote domestic and international market stability, reduce market
and liquidity risks in financial
markets, including those markets (such as futures exchanges) linked
to the swap market and
eliminate a potential source of systemic risk."(12)
The criteria restrict OTC swap transactions to bilateral, customized
transactions between financially
sophisticated persons or institutions. The Part 35 exemption does not
extend to transactions that are
subject to a clearing system where the credit risk of individual counterparties
to each other is
effectively eliminated, nor does it extend to transactions executed
on exchanges.
Part 34 of the Commission's Regulations exempts certain hybrid instruments
from most provisions of
the Act, including the exchange-trading requirement.(13)
Under the rules, a hybrid instrument is defined as a financial instrument
that combines elements of
an equity, debt or depository instrument with elements of a futures
or option contract. Part 34
exempts hybrid instruments that are predominantly securities or depository
instruments and are
regulated as such.(14)
As part of the 1992 legislation, Congress also directed the CFTC to
conduct a study of OTC
derivatives to determine the need, if any, for additional regulation.(15)
In requesting the study, Congress recognized that the Commission, based
on its expertise in
derivatives markets, was the appropriate body to study the issue. The
Commission carried out its
Congressional mandate to study the OTC derivatives market in 1993 and
concluded that no
fundamental changes in the regulatory structure for OTC derivatives
were necessary at that
time.(16)
IV. Regulatory Issues Posed by the Evolving OTC Derivatives Market
Five years have passed since the Commission adopted its Part 34 and
Part 35 regulations and last
studied the OTC derivatives market. Since that time, the OTC derivatives
market has changed
significantly. When Congress gave the Commission its Section 4(c) exemptive
authority in 1992, the
Conference Committee expressly stated that the provision would permit
the Commission to review
its exemptions to "respond to future developments."(17)
The CFTC strongly believes that, in order to carry out its statutory
mandate responsibly, it must keep
its regulatory system in tune with changes in the market it oversees.
Failure to keep pace with the
changing market would stifle the capacity of U.S. firms to meet global
competitive challenges, would
create a cloud of legal uncertainty over the applicability of outdated
rules to new products and
innovative transactions, and would erode the regulatory system's ability
to protect customers and to
preserve the financial integrity of that market.
Consistent with these responsibilities, the CFTC over the past 18 months
has been engaged in a
comprehensive regulatory reform effort designed to update, to modernize
and to streamline its
regulations and to eliminate undue regulatory burdens.(18)
The Commission's review of its regulatory system would be incomplete
in an important respect if it
did not address the Commission's rules regarding OTC derivatives.
As noted earlier, the five years since the adoption of the Part 34 and
Part 35 rules have been
characterized by dramatic growth in the volume and value of OTC derivative
transactions.
Furthermore, the structure of the OTC derivatives market has changed
significantly, creating a
potential divergence between the Commission's regulations and the realities
of the marketplace. For
example, since 1993 the proliferation of OTC instruments has resulted
in broader participation in the
swaps market, encompassing new end-users of varying degrees of sophistication.
This evolution in
the market requires the Commission to evaluate whether it should broaden
the definition of eligible
swaps participants contained in its current rule and whether recordkeeping,
sales practice, or other
protections may now be appropriate.
The swaps market also has experienced a proliferation of new products
and proposed new trading
systems. While the Part 35 exemption does not extend to swap agreements
that are part of a
fungible class of agreements, market information indicates that some
swap agreements have
become increasingly standardized, indicating a need to consider broadening
the exemption under
appropriate terms and conditions. Furthermore, the swaps exemption
does not permit clearing of
swaps or trading of them through multilateral transaction execution
facilities, but developments in the
marketplace have indicated a significant demand for both. For example,
the London Clearing House
recently filed a petition with the Commission for an exemption under
Section 4(c) of the CEA to
provide swap clearing services, and other organizations have indicated
that they are developing
similar facilities.(19)
Swaps clearing and execution facilities pose regulatory issues concerning
systemic risk and price
discovery that are not involved in privately negotiated, bilateral
off-exchange swaps transactions.
Any consideration of permitting clearing and execution facilities must
also take into account the need
to promote even-handed regulation and fair competition between any
such new facilities and existing
futures and option exchanges.
An additional concern is the legal uncertainty that may result from
trading in OTC derivative
instruments that do not comply with the terms and conditions of the
current swaps exemption. To
the extent that such instruments are futures or options and are not
subject to another exemption in
the Act, they violate the CEA. Moreover, Section 12(e)(2)(A) of the
Act was enacted in order to
"provide legal certainty under . . . state gaming and bucket shop laws
for transactions covered by
the terms of an exemption" by preempting the application of such state
laws.(20)
OTC derivative instruments that are outside the Commission's exemptions
are also outside the
protective umbrella of that preemption and may be deemed illegal under
state law.
Another factor suggesting a need to request information about the OTC
derivatives market arises
from the large, well-publicized financial losses in the OTC derivatives
market since the 1993
exemptions were adopted. While OTC derivatives serve important economic
functions, these
products, like all complex financial instruments, can present significant
risks if misused or
misunderstood. The 1997 GAO Report, entitled OTC Derivatives: Additional
Oversight Could
Reduce Costly Sales Practice Disputes, chronicles 360 end-user losses,
of which 58% reportedly
involved sales practice concerns.(21)
Major OTC derivatives losses relating to the recent instability in Asian
financial markets are
currently being reported, and more may be anticipated. According to
a recent press report, J.P.
Morgan "last year declared it had $659 million in nonperforming assets,
90% of which were defaults
from Asian derivative counterparties."(22)
The same article states that Chase Manhattan "saw its 'nonperforming'
assets in Asia triple in the
first three months of 1998, to $243 million, due in part to derivatives."(23)
Concerns have also been raised regarding the potential effect of derivatives
losses on the investing
public(24)
and on the financial system as a whole. As Alan Greenspan, the Chairman
of the Board of
Governors of the Federal Reserve System, stated on May 7, 1998:
the major expansion of the over-the-counter derivatives market has occurred
in [a] period of
unparalleled prosperity. . . [in] which losses generally, in the financial
system, have been remarkably
small . . . And as a consequence of that, I don't think that one will
fully understand or know how
vulnerable that whole structure is until we have it really tested.
And eventually that's going to
happen.(25)
Chairman Greenspan testified just last week before the U.S. House of
Representatives Committee
on Banking and Financial Services, "I have no doubt derivatives losses
will mushroom at the next
significant [economic] downturn as will losses on holdings of other
risk assets, both on and off
exchange."(26)
Allegations of serious sales practice abuses by OTC derivatives dealers
have been made in recent
years in cases involving major losses by derivatives end-users. For
example, an affiliate of Bankers
Trust was charged with fraud in the sale of OTC derivatives in some
well publicized cases involving
Proctor and Gamble, Gibson Greeting Cards, and other large entities.(27)
Likewise, Merrill Lynch recently agreed to pay $400 million to Orange
County, California to settle
claims involving sales of derivatives that caused Orange County's bankruptcy
and is reportedly in
settlement negotiations with the Government of Belgium relating to
its loss of $1.2 billion in
derivatives trading. Furthermore, the 1997 GAO Report recommended that
the SEC and the CFTC
examine the experience of the members of the Derivatives Policy Group,
an organization of five
large OTC derivatives dealers, with respect to the voluntary sales
practice standards they have
adopted and also recommended a comprehensive review of sales practices
and counterparty
relationships in the OTC derivatives market.(28)
Losses resulting from misuse of OTC derivatives instruments or from
sales practice abuses in the
OTC derivatives market can affect many Americans and their savings
-- many of us have interests
in the corporations, mutual funds, pension funds, insurance companies,
municipalities and other
entities trading in these instruments. Obviously, regulation cannot
and should not seek to eliminate
market losses, but under the circumstances it is appropriate to request
information regarding industry
practices to assess whether they merit a regulatory response.
In light of these sales practice issues and the rapid development and
evolution of the market, federal
financial agencies are reviewing and revising their regulatory requirements
regarding OTC
derivatives. For example, on April 23, 1998, the Office of Thrift Supervision
of the Department of
the Treasury proposed what it termed "a comprehensive revision" of
its "outmoded regulations" in
response to "the development of new financial derivative instruments."(29)
In addition, the SEC proposed rules in December 1997 that would create
for the first time a
comprehensive SEC regulatory regime for certain very large OTC derivatives
dealers.(30)
Not surprisingly, the CFTC as the expert federal agency in derivatives
transactions and derivatives
markets also is reviewing its existing regulations relating to OTC
derivatives, as discussed below.
V. The Commission's Concept Release on OTC Derivatives
In order to examine whether its regulatory framework relating to OTC
derivatives remains
appropriate in light of market developments since that framework was
first adopted, the Commission
issued a Concept Release on OTC Derivatives on May 7, 1998.(31) (See
Attachment 1.) The
Concept Release seeks public comment on whether the Commission's current
exemptions for swaps
and hybrid instruments remain appropriate as to, among other things,
the definitions of eligible
transactions and eligible participants and the prohibitions against
fungible swaps, swaps clearing and
multilateral swaps transaction execution facilities. It asks whether
the current prohibitions on fraud
and manipulation are sufficient to protect the public or whether the
Commission should consider
additional terms and conditions relating to registration, capital,
internal controls, sales practices,
recordkeeping or reporting. The Concept Release also asks whether,
if additional oversight of those
markets were required, such oversight would best be administered by
the Commission itself or
through self-regulatory organizations.
The Concept Release does not propose any modification of the Commission's
regulations, nor does it
presuppose that any modification is needed. It merely asks for information
about current realities in
the marketplace and views as to the appropriate Commission response,
if any. The Commission
wishes to draw on the knowledge and expertise of a broad spectrum of
interested parties, including
OTC derivatives dealers, end-users of derivatives, futures and option
exchanges, other regulatory
authorities, and academicians. The Commission would also welcome the
comments of the members
of this Committee and their constituents.
In issuing the Concept Release, the Commission has no preconceived result
in mind. The
Commission is open to evidence in support of broadening its exemptions,
evidence indicating a need
for additional safeguards and evidence for maintaining the status quo.
Serious consideration will be
given to the views of all interested persons as well as the Commission's
own research and analysis.
In the event that the Commission believes that proposed regulatory
changes might enhance the
competitiveness of the OTC derivatives market or provide necessary
regulatory safeguards, such
proposed changes would first be published for additional public comment
before any final rules
would be considered for adoption. Moreover, changes which impose new
regulatory obligations or
restrictions, if any, would be applied prospectively only.
The Concept Release explicitly states that it does not in any way alter
the current status of any
instrument or transaction under the CEA. All currently applicable exemptions,
interpretations, and
policy statements issued by the Commission regarding OTC derivatives
products remain in effect
and may be relied upon by market participants.
Concerns have been expressed about the Concept Release. Many of the
concerns reflect a lack of
understanding as to the nature and purpose of the Concept Release or
a desire to avoid government
oversight. Indeed, arguments have been made that OTC derivatives do
not need government
regulation or oversight of any kind. These arguments ignore that the
OTC derivatives market is
already subject to regulation by the Commission through the CEA's prohibition
of OTC futures and
options that are not exempted from the exchange-trading requirement,
through the terms and
conditions of the Commission's exemptions and through the Commission's
preservation of the CEA's
fraud and manipulation prohibitions as to exempted swaps transactions.
The Commission agrees that
unduly burdensome or duplicative regulation of the OTC derivatives
market would not be in the
public interest. However, it is the Commission's statutory mandate
to oversee and safeguard the
derivatives market, where billions of dollars of Americans are at risk.
In testimony last week before the House Committee on Banking and Financial
Services, Federal
Reserve Chairman Alan Greenspan went so far as to argue that, whether
traded on an exchange or
over the counter, there is little or no need to apply the CEA to derivative
contracts on financial
instruments, because the CEA "was designed in the 1920s and 1930s for
the trading of grain
futures" and is intended to prevent price manipulation in agricultural
commodities.(32) Chairman
Greenspan's view of the CEA and its purposes is incorrect and overly
narrow and ignores that the
Act and the regulations issued thereunder have been repeatedly amended
over the years to address
the regulatory issues raised by the tremendous growth in financial
derivatives, which now account
for almost 75 % of exchange-traded futures and option contracts. As
to exchange-traded derivative
contracts based on both agricultural and financial commodities, the
CEA is intended to do far more
than prohibit price manipulation. Its provisions and regulations adopted
thereunder are designed to
control systemic risk and to ensure the financial integrity of futures
market intermediaries,
exchanges and clearinghouses, to foster price discovery and transparency,
to protect market
participants from fraud and other abuses, to assure fair access to
the markets and to impose fitness
standards on intermediaries. These provisions serve to protect market
participants regardless of the
nature of the underlying commodity from which a given contract is derived.
As the Commission recognized in 1993 when it adopted Part 35, a lesser
degree of regulation may
be appropriate for truly customized, bilateral OTC swap agreements
between sophisticated,
well-capitalized entities, and the Commission's exemptive power under
the CEA allows it to tailor
regulation to the particular market and the public policy issues raised
by the market. However, to the
extent such instruments become more standardized, are centrally traded
or cleared or are sold to a
broader segment of the public, the concerns that are addressed by the
CEA -- financial integrity and
control of systemic risk, price discovery and transparency, fitness
of intermediaries and fair
treatment of market participants -- become more critical. As the federal
agency with expertise and
statutory authority over the derivatives markets, the Commission must
study the evolution of the
OTC marketplace to determine whether its existing rules remain appropriate.
There have been unsupported claims that the Concept Release has created
concerns about legal
certainty that have disrupted the OTC derivatives market and driven
business offshore. As the
Commission was careful to point out in the Concept Release, the Concept
Release does not in any
way alter the current legal status of any instrument. The Commission
has yet to be provided with
any empirical evidence that the Concept Release has caused disruption
in the market. Commission
staff have been monitoring the market and have seen no adverse effects
from the issuance of the
Concept Release. Likewise, as recently as last week, in their testimony
regarding OTC derivatives
before the House Committee on Banking and Financial Services, officials
from the Treasury
Department, the SEC and the Federal Reserve System's Board of Governors
were unable to cite
any evidence of disruption in the OTC derivatives market related to
the Concept Release. The
Commission does not believe that this robust, multi-trillion dollar
market is so fragile that mere
governmental examination of it will cause dislocation. Rather, in the
Commission's view, the market
will benefit from assuring that government regulations do not ignore
developments and innovations in
the marketplace.
Some argue that, having adopted exemptions for certain OTC derivatives
transactions in 1993, the
Commission cannot now update those exemptions to reflect the changes
in the marketplace. This
argument is flatly inconsistent with the intent of Congress in passing
the Futures Trading Practices
Act of 1992. The House and Senate Conference Committee stated:
[T]he Conferees intend for the general exemptive authority. . . to allow
the [CFTC] to respond to
future developments in the marketplace to avoid disruption and promote
responsible economic and
financial innovation, with due regard for the continued viability of
the marketplace and considerations
related to systemic risk in financial markets.(33)
As the President's Working Group -- consisting of the Secretary of the
Treasury, the Chairman of
the Board of Governors of the Federal Reserve System, the Chairman
of the SEC and the
Chairperson of the CFTC -- wrote to Congress in 1994 concerning the
CFTC's regulation of the
OTC derivatives market:
[I]n order to fall within the safe harbor created by the Commodity Futures
Trading Commission's
(CFTC's) exemptions from the Commodity Exchange Act for swaps and other
types of OTC
derivatives transactions, all market participants must comply with
the access and design restrictions
contained in those exemptions. The CFTC's authority to reevaluate and
impose conditions on
exemptions for OTC derivative transactions can always be drawn upon
if additional constraints on
these instruments were determined to be warranted.(34)
Another claim is that the Commission lacks jurisdiction with respect
to OTC derivative instruments.
This position is incorrect, as the President's Working Group so clearly
stated in 1994. As discussed
above, the CFTC has always had jurisdiction over futures and options,
whether traded on an
exchange or over the counter. It is the nature of the instruments,
and not where they are traded, that
determines jurisdiction under the CEA. (35)
The Commission is cognizant of the fact that other federal regulatory
authorities have responsibility
for certain aspects of the OTC derivatives market. Some OTC derivative
instruments are excluded
from the CEA by the Treasury Amendment and the Shad-Johnson Accord
and are the regulatory
responsibility of the SEC, the banking regulators, or the Department
of the Treasury. Moreover, the
SEC and the banking regulators oversee some of the institutions participating
in this market and
impose prudential requirements on them, including capital requirements
and internal control
requirements. Other OTC derivative instruments and other market participants
are within the
CFTC's exclusive authority. Thus, coordination and cooperation among
the CFTC and these
agencies are very important to avoid duplication and inconsistent regulation.
In its Concept Release,
the Commission stated that it "anticipates that, where other regulators
have adequate programs or
standards in place to address particular areas, the Commission would
defer to those regulators in
those areas."(36)
However, each federal financial regulator must act within its own statutory
authority and comply
with its own statutory mandate. On March 11, 1998, Secretary of the
Treasury Robert Rubin, on
behalf of the President's Working Group, wrote to the Senate Committee
on Government Affairs
that the President's Working Group would not conduct a study of sales
practices and counterparty
relationships in the OTC derivatives market, as the 1997 GAO Report
had recommended. In
explaining that refusal, he stated,
The Working Group is designed as a mechanism to exchange information
about financial market
issues that cross traditional jurisdictional lines. It works through
its constituent agencies with no
independent budget. The authority of the Federal Government to collect
sales practice information
from federally regulated entities rests with the appropriate federal
regulators.
In recent years, the federal financial regulators that are members of
the Working Group have taken
a number of measures to improve dealers' sales practices for OTC derivatives
. . . . Because the
issue of the relationship of parties involves differing product classes,
regulatory structures, and
customer profiles, we believe there may not be a "one size fits all"
solution. Therefore, we believe
these processes should be allowed to evolve and that, at this time,
there is no need for the Working
Group as a whole to take additional measures. Each financial regulatory
agency will continue to
decide its appropriate role.(37)
The Commission believes that that position was correct in March 1998
and continues to be correct
today, four months later. In issuing its Concept Release, the Commission
has appropriately decided
to address OTC derivative issues within its statutory authority and
in conformity with its statutory
mandate.
VI. The Commission's Concerns Regarding the Treasury Proposal
The legislative proposal offered by the Treasury Department raises serious
concerns. The Treasury
proposal would severely limit the CFTC's ability to fulfill its oversight
responsibilities with regard to
OTC derivatives transactions within its statutory authority, would
result in a substantial change in the
CEA, and would potentially leave the American public without federal
protection in the event of an
emergency in the OTC derivatives market.(38) No justification has been
offered for these sweeping
changes in OTC derivatives regulation. Indeed, the Treasury proposal
does not appear to be based
on any principled concern about the need for a coordinated approach
to the OTC derivatives market,
since it aims to restrict only the activities of the CFTC.
Section 3(1) of the Treasury proposal would effectively prohibit the
CFTC from proposing or taking
regulatory or enforcement actions relating to swaps and hybrid instruments.
It would forbid the
CFTC to "propose or promulgate any rule, regulation or order, or issue
any interpretative or policy
statement, that restricts or regulates activity in any hybrid instrument
or swap agreement that is
eligible for exemption under Part 34 or Part 35 of Title 17, Code of
Federal Regulations (as in effect
on January 1, 1998)." This prohibition of CFTC action would continue
for an extended, indefinite
period of time until the enactment of legislation authorizing
CFTC appropriations for any fiscal year
after fiscal year 2000.
Section 3(1) could prevent the CFTC from adopting new regulations or
policies to address a market
crisis or financial emergency in the OTC derivatives market. We have
entered a period of
substantial volatility in the world financial markets with recent enormous
losses in derivatives
reported in connection with Asian financial instability. If a crisis
were to occur in the OTC
derivatives market after enactment of the proposed legislation, the
Commission would be unable to
respond with any meaningful action: the Commission's hands would be
tied. Since aspects of the
OTC derivatives market are within the CFTC's exclusive jurisdiction,
no other federal regulator
would be able to react with emergency action in such spheres, creating
a dangerous gap in
regulation.
Section 3(1) could also prevent the Commission from enforcing its current
fraud and manipulation
prohibitions applicable to certain OTC swap transactions. Under this
provision, the CFTC would
apparently be prohibited from conducting an enforcement investigation
or issuing a cease-and-desist
order in an enforcement case involving fraud or manipulation in swaps
transactions eligible for
exemption. Thus, for example, the Commission would not have been able
to issue its
cease-and-desist order to an affiliate of Bankers Trust in a case involving
fraud in the sale of swaps.
In the Matter of BT Securities Corp., CFTC Docket No. 95-3, 1994 WL
711224 (December 22,
1994). Similarly, the Commission recently issued an order finding that
Sumitomo Corporation
engaged in manipulation of the U.S. copper markets in violation of
the CEA. The Commission
imposed a cease-and-desist order and $150 million in civil penalties
and restitution related to
manipulative activity involving OTC derivatives transactions as well
as transactions on the London
Metal Exchange. That investigation is currently continuing with respect
to other individuals and
institutions, but could not consider the use of swaps if the proposed
legislation were passed.
In addition, the scope of Section 3(1) is ambiguous and likely would
create significant legal
uncertainty as to the Commission's legal authority. For example, the
meaning of the term "eligible for
exemption under Part 34 or Part 35" in Section 3(1) is unclear, especially
in contrast with the phrase
"satisfies the definitions and conditions for exemption under Part
34 or Part 35" used in Section 3(2).
Section 3(1) might be construed to prohibit CFTC action with regard
to swaps or hybrid instruments
as long as the instruments were theoretically eligible for the Part
34 or Part 35 exemption even
though the instruments did not in fact comply with the terms and conditions
set forth in those
exemptions. If it were so construed, the Commission would no longer
be able to enforce the terms
and conditions of its current regulatory exemptions for swaps and hybrid
instruments or to
investigate possible violations of those terms and conditions. Thus,
as a result of the proposed
legislation, the Commission might be required to abandon ongoing investigations
and inquiries.
In fact, Section 3(1) is sufficiently ambiguous that it might also be
interpreted to prevent the
Commission from amending its exemptions to reflect new developments
in the marketplace. For
example, the Commission's exemption for swaps currently prohibits swaps
clearing and swaps
exchange trading. The draft legislation might prevent the Commission
from creating a regulatory
framework for clearing and exchange trading of swaps despite increasing
interest in establishing
such operations and might require the Commission to withhold action
on the pending London
Clearing House petition to clear swaps and on other similar requests.
Thus, either innovation in the
marketplace would be stifled, or swaps clearing and exchange trading
could develop in an
unregulated manner in violation of the Commission's regulations and
in direct competition with
existing futures and option exchanges.
The Treasury proposal would make other fundamental and unwarranted changes
in federal policy
regarding the derivatives markets. For example, it would amend the
Shad-Johnson Accord and
retroactively legalize certain OTC futures contracts. The Shad-Johnson
Accord clarified the
respective jurisdictions of the SEC and CFTC and was codified in the
CEA in 1982. Section 3(2) of
the Treasury proposal would amend the Shad-Johnson Accord by temporarily
eliminating the
prohibitions in Section 2(a)(1)(B)(v) of the CEA against OTC futures
contracts on nonexempt
securities and on securities indexes that do not reflect a substantial
segment of the market. Careful
consideration by Congress of the public policy reasons underlying the
long-standing statutory
prohibition of such instruments and its proposed elimination is needed
prior to acting on this
provision.
While permitting OTC transactions in these instruments, Section 3(2)
would continue the current
prohibition on exchange trading in them. If OTC transactions in these
instruments were to be
permitted, Congress should certainly consider whether such instruments
should also be permitted to
be traded on the safer, more regulated exchange markets, as they currently
are in a number of
foreign countries. The U.S. futures exchanges would have a valid competitive
interest in being able
to trade these instruments under such circumstances.
Section 2 of the Treasury proposal would authorize the President's Working
Group to conduct a
study of OTC derivatives, to develop recommendations for changes in
statutes, regulations and
policies for these products and to submit a report to Congress within
one year.(39)
To the extent that Section 2 is intended to give the President's Working
Group power to influence
the action of the Commission as a regulatory agency acting within its
own statutory authority, it
would clearly impair the independence of the Commission and its ability
to enforce its statutory
mandate.
The President's Working Group, which consists of the Secretary of the
Treasury, the Chairman of
the Board of Governors of the Federal Reserve System, the Chairman
of the SEC and the
Chairperson of the CFTC, has never discussed or approved the Treasury
proposal or the study
proposed in Section 2. As discussed above, on March 11, 1998, the President's
Working Group
wrote to Congress that it would not undertake a study on sales practices
and counterparty
relationships in the OTC derivatives market, as the General Accounting
Office (GAO) had
recommended. (See Attachment 3). At that time the President's Working
Group stated that it had no
budget and that it was lacking in statutory authority to obtain information
and otherwise to conduct
the study. It also advised that instead each of its individual members
should continue to regulate the
OTC derivatives market within its own statutory authority. The study
proposed in Section 2 of the
Treasury proposal is a much broader and more substantial undertaking
than the study that the GAO
recommended. Yet now three members of the President's Working Group
have proposed that the
President's Working Group undertake what the President's Working Group
stated that it would not
and could not do just four months ago.
At a June 10, 1998 hearing on the OTC derivatives market conducted by
the Committee on Risk
Management and Specialty Crops of the House Committee on Agriculture,
representatives of the
Treasury Department, the Federal Reserve Board and the SEC testified
that they have already
concluded that the CFTC should no longer retain its current statutory
authority with regard to the
OTC derivatives market and that the Commission's jurisdiction should
be transferred to and divided
among themselves. The Treasury proposal for a study appears to be merely
a vehicle for the other
members of the President's Working Group to implement this transfer
of the CFTC's statutory
authority to them.
The Treasury proposal would neither maintain the regulatory status quo
relating to the OTC
derivatives market nor facilitate regulatory coordination. While the
bill would bar the CFTC from
taking actions with regard to OTC derivative instruments within its
jurisdiction, other federal
regulators would remain free to go forward with their plans to issue
new regulations relating to the
OTC derivatives market. For example, the SEC would be free to finalize
its proposed new
regulatory scheme applicable to OTC derivatives dealers.(40)
Likewise, the Office of Thrift Supervision of the Department of the
Treasury would be free to adopt
its proposed comprehensive revision of regulations on derivatives.(41)
Such new regulatory action relating to the OTC derivatives market would
destroy the regulatory
status quo rather than preserve it. To impose a moratorium on CFTC
action while allowing the other
agencies to move forward would severely hinder -- not facilitate --
coordination and cooperation
among federal financial regulators with respect to the OTC derivatives
market.
Proponents of the Treasury proposal have argued that emergency legislation
is needed to maintain
the status quo in regulation of the OTC derivatives market and to resolve
legal uncertainty. The
ambiguities in the Treasury proposal would create legal uncertainty,
not reduce it. As discussed
above, there is no emergency: the Commission's Concept Release has
not disrupted the market or
altered the legal status of any OTC derivative instruments. In any
event, the Commission decided on
July 24, 1998, that it will not propose or issue new regulations to
regulate swaps and hybrid
instruments prior to Congress' reconvening in 1999, except as necessary
in an emergency.(42)
Finally, as demonstrated above, it is clear that the Treasury proposal
would profoundly alter the
regulatory status quo, not preserve it.
In sum, the Treasury proposal would eviscerate key provisions of the
CEA and facilitate transfer of
the statutory authority in the CEA to other federal financial regulators
whose expertise does not
include derivatives market regulation. It purports to enhance legal
certainty, but raises more legal
questions than it resolves. Most importantly, it would create significant
regulatory gaps by tieing the
Commission's hands in addressing emergencies and wrongdoing in the
market. If Congress wishes
to take such actions, it should do so only after careful consideration
of the dangers posed by this
proposal, not precipitously in response to cries of an emergency for
which no evidence has been
offered.
VII. Conclusion
Mr. Chairman, I would like to thank you for this opportunity to present
the views of the Commission,
and I would be happy to answer any questions that the members of the
Committee might have.
1. International Swaps and Derivatives Association, Summary of Recent
Market Survey Results,
ISDA Market Survey (1998), available at http://www.isda.org.
2. Id.
3. Id.
4. General Accounting Office, GAO/GGD-98-5, OTC Derivatives: Additional
Oversight Could
Reduce Costly Sales Practice Disputes 3, n.6 (1997) ("1997 GAO Report").
The notional amount
represents the amount upon which payments to the parties to a derivatives
transaction are based and
is the most commonly used measure of outstanding OTC derivatives transactions.
Notional amounts
generally overstate the amount at risk in such transactions.
5. First Quarter Trading Revenues Soar to Record Levels, Swaps Monitor, May 18, 1998, at 1.
6. See, e.g., In the Matter of MG Refining and Marketing, Inc., et al.,
CFTC Docket No. 95-14,
1995 WL 447455 (July 27, 1995); Commodity Futures Trading Commission
v. Noble Metals
Intern., Inc., 67 F.3d 766 (9th Cir. 1995), cert. denied sub nom. Schulze
v. Commodity Futures
Trading Commission, 117 S.Ct. 64 (1996); Commodity Futures Trading
Commission v.
American Metals Exchange Corp., 991 F.2d 71 (3d Cir. 1993); Commodity
Futures Trading
Commission v. Co Petro Marketing Group, Inc, 680 F.2d 573 (9th Cir.
1982).
7. The Treasury Amendment provides that nothing in the CEA shall be
applicable to "transactions in
foreign currency, security warrants, security rights, resales of installment
loan contracts, repurchase
options, government securities, or mortgages and mortgage purchase
commitments, unless such
transactions involve the sale thereof for future delivery conducted
on a board of trade." Section
2(a)(1)(A)(ii) of the Act, 7 U.S.C. § 2(ii).
8. Section 2(a)(1)(B)(i), 7 U.S.C. § 2a(i). The SEC also has jurisdiction
over foreign currency
options, but only when they are traded on a national securities exchange.
Section 4c(f) of the Act, 7
U.S.C. § 6c(f). The CFTC has jurisdiction over foreign currency
options when traded on a board of
trade. Sections 2(a)(1)(A)(ii) and 4c(b) of the Act, 7 U.S.C. §§
2(ii) and 6c(b).
9. The Commission has exempted trade options. Commission Rule 32.4(a),
adopted in 1976, permits
the sale of OTC commodity options in circumstances in which the offeror
"has a reasonable basis to
believe that the option is offered to a producer, processor or commercial
user of, or a merchant
handling, the commodity which is the subject of the commodity option
transaction" and that such
commercial party is offered or enters into the transaction "solely
for purposes related to its business
as such." 17 C.F.R. § 32.4.
This trade option exemption does not extend to the basic agricultural
commodities enumerated in the
CEA. Due to concerns over historical abuses relating to agricultural
options, they were subject to a
statutory ban until 1982, and the Commission imposed a regulatory prohibition
on OTC agricultural
options thereafter. Recently, however, major changes in U.S. farm policy
have created a growing
demand in the marketplace for innovative agricultural risk management
tools. Therefore, earlier this
year the Commission approved a pilot program to permit OTC agricultural
trade options subject to
regulatory safeguards. 63 Fed. Reg. 18821 (Apr. 16, 1998).
10. Section 4(c)(1) of the Act, 7 U.S.C. § 6(c)(1).
11. 17 C.F.R. Part 35.
12. 58 Fed. Reg. 5587, 5588 (Jan. 22, 1993).
13. 17 C.F.R. Part 34.
14. Part 34 exempts hybrid instruments, and those transacting in and/or
providing advice or other
services with respect to such hybrids, from all provisions of the CEA
except Section 2(a)(1)(B) and
thus permits OTC transactions in such hybrid instruments, subject to
the following requirements: (1)
a requirement that the issuer must receive full payment of the hybrid
instrument's purchase price;
(2) a prohibition on requiring additional out-of-pocket payments to
the issuer during the hybrid
instrument's life or at its maturity; (3) a prohibition on marketing
the hybrid instrument as a futures
contract or commodity option; (4) a prohibition on settlement by delivery
of an instrument specified
as a delivery instrument in the rules of a designated contract market;
(5) a requirement that the
hybrid instrument be initially sold or issued subject to federal or
state securities or banking laws to
persons permitted thereunder to purchase the instrument; and (6) a
requirement that the sum of the
values of the commodity-dependent components of a hybrid instrument
be less than the value of the
commodity-independent components.
15. See H.R. Conf. Rep. No. 102-978, 102d Cong., 2d Sess. 83 (1992)(Conference
Report to
accompany P.L. 102-546, the Futures Trading Act of 1992).
16. See CFTC, OTC Derivatives Markets and Their Regulation (1993).
17. See H.R. Conf. Rep. No. 102-978, 102d Cong., 2d Sess. 81 (1992).
18. See, e.g., Revised Procedures for Commission Review and Approval
of Applications for
Contract Market Designation and of Exchange Rules Relating to Contract
Terms and Conditions, 62
FR 10434 (Mar. 7, 1997); Final Rulemaking Concerning Contract Market
Rule Review Procedures,
62 FR 10427 (Mar. 7, 1997); Contract Market Rule Review Procedures,
62 FR 17700 (Apr. 11,
1997); Electronic Filing of Disclosure Documents With the Commission,
62 FR 18265 (Apr. 15,
1997); Recordkeeping; Reports by Futures Commission Merchants, Clearing
Members, Foreign
Brokers, and Large Traders, 62 FR 24026 (May 2, 1997); Bunched Orders
and Account
Identification, 62 FR 25470 (May 9, 1997); Alternative Methods of Compliance
With Requirements
for Delivery and Retention of Monthly, Confirmation and Purchase-and-Sale
Statements, 62 FR
31507 (June 10, 1997); Interpretation Regarding Use of Electronic Media
by Commodity Pool
Operators and Commodity Trading Advisors for Delivery of Disclosure
Documents and Other
Materials, 62 FR 39104 (July 22, 1997); Securities Representing Investment
of Customer Funds
Held in Segregated Accounts by Futures Commission Merchants, 62 FR
42398 (Aug. 7, 1997);
Concept Release on the Denomination of Customer Funds and the Location
of Depositories, 62 FR
67841 (Dec. 30, 1997); Account Identification for Eligible Bunched
Orders, 63 FR 695 (Jan. 7,
1998); Maintenance of Minimum Financial Requirements by Futures Commission
Merchants and
Introducing Brokers, 63 FR 2188 (Jan. 14, 1998); Requests for Exemptive,
No-Action and
Interpretative Letters, 63 FR 3285 (Jan. 22, 1998); Voting by Interested
Members of
Self-Regulatory Organization Governing Boards and Committees, 63 FR
3492 (Jan. 23, 1998);
Regulation of Noncompetitive Transactions Executed on or Subject to
the Rules of a Contract
Market, 63 FR 3708 (Jan. 26, 1998); Distribution of Risk Disclosure
Statements by Futures
Commission Merchants and Introducing Brokers, 63 FR 8566 (Feb. 20,
1998); Amendments to
Minimum Financial Requirements for Futures Commission Merchants, 63
FR 12713 (Mar. 16,
1998); Two-Part Documents for Commodity Pools, 63 FR 15112 (Mar. 30,
1998); Rules of
Practice; Proposed Amendments, 63 FR 16453 (Apr. 3, 1998); Trade Options
on the Enumerated
Agricultural Commodities, 63 FR 18821 (Apr. 16, 1998); Trading Hours,
63 FR 24142 (May 1,
1998); Recordkeeping, 63 FR 30668 (June 5, 1998); Elimination of Short
Option Value Charge, 63
FR 32725 (June 16, 1998); Futures-Style Margining of Commodity Options,
63 FR 32726 (June 16,
1998); Changes in Trading Hours, 63 FR 33848 (June 22, 1998); Revision
of Federal Speculative
Position Limits and Associated Rules, 63 FR 38525 (July 17, 1998);
Economic and Public Interest
Requirements for Contract Market Designation, 63 FR 38537 (July 17,
1998); Concept Release on
the Placement of a Foreign Board of Trade's Computer Terminals in the
United States, 63 FR 39779
(July 24, 1998).
19. The Commission has requested public comment on the London Clearing
House petition. 63 FR
36657 (July 7, 1998).
20. H.R. Conf. Rep. No. 102-978, 102 Cong., 2d Sess. 80 (1992).
21. 1997 GAO Report at 10. See also Jerry Markham, Commodities Regulation:
Fraud,
Manipulation & Other Claims, § 27.05, at 27-30 27-34
(Supp. 1997) (presenting an extensive array
of major OTC derivatives losses in 1994 alone).
22. Bernard Baumohl, The Banks' Nuclear Secrets, Time, May 25, 1998, at 50.
23. Id. at 46.
24. See, e.g., AARP/CFA/NASAA Background Report: The Five Biggest Problems
'Legitimate' Investing Poses for Older Investors (1995) (discussing
"hidden derivatives in
investment products touted as 'safe.")
25. Transcript for CNBC-TV "Power Lunch," May 7, 1998, provided by Video
Monitoring
Services of America, L.P.
26. Testimony of Alan Greenspan, Chairman, Board of Governors of the
Federal Reserve System,
before the Committee on Banking and Financial Services, U.S. House
of Representatives, at 5 (July
24, 1998).
27. See In the Matter of BT Securities Corp., CFTC Docket No. 95-3,
1994 WL 711224 (Dec. 22,
1994) (Gibson Greeting Cards); Procter and Gamble Co. v. Bankers Trust
Co., 925 F. Supp. 1270
(S.D. Ohio 1996).
28. 1997 GAO Report at 137-38.
29. Financial Management Policies: Financial Derivatives, 63 Fed. Reg.
20252 (Apr. 23, 1998). See
also Supervisory Policy Statement on Investment Securities and End-User
Derivatives Activities, 63
Fed. Reg. 20191 (Apr. 23, 1998).
30. OTC Derivatives Dealers, 62 Fed. Reg. 67940 (Dec. 30, 1997). The
SEC has jurisdiction over
OTC options on securities and OTC options on securities indexes under
the CEA. 7 U.S.C. § 2a(i).
The GAO has reported that the SEC's jurisdiction extends to about 1.4%
of the instruments in the
OTC derivatives market. 1997 GAO Report at 42. Nonetheless, the SEC
proposal purports to
regulate trading in all OTC derivative instruments by OTC derivatives
dealers operating under its
proposed rule, including, for example, commodity swaps and other instruments
which are clearly not
within the SEC's jurisdiction. The proposal also purports to permit
trading in certain OTC derivative
instruments which are not exempt under the CEA and the Commission's
regulations.
31. 63 Fed. Reg. 26114 (May 12, 1998).
32. See Testimony of Alan Greenspan, Chairman, Board of Governors of
the Federal Reserve
System before the Committee on Banking and Financial Services, U.S.
House of Representatives at
6-8 (July 24, 1998).
33. H.R. Conf. Rep. No. 102-978, 102d Cong., 2d Sess. 81 (1992).
34. Views of the Working Group on Financial Markets on the Recommendations
of the U.S.
General Accounting Office Concerning Financial Derivatives at 3, attached
to a letter dated July 18,
1994, from Lloyd Bentsen, Secretary of the Treasury, to John D. Dingell,
Chairman, House
Committee on Energy and Commerce, attached hereto as Attachment 2.
35. As the House Agriculture Committee stated in 1982 in approving the
amendments to the CEA
adopting the Shad-Johnson Accord on the respective jurisdictions of
the SEC and the CFTC:
The committee has long recognized and accepted the inherent differences
between the futures
industry and the securities industry and endorses the concept of separate
regulation. Basically, the
CFTC will retain its traditional role of regulating markets and instruments
that serve a hedging and
price discovery function while the SEC will regulate markets and instruments
with an underlying
investment purpose.
H.R. Rep. No. 97-565, Part 1, 97th Cong., 2d Sess. 40 (1982) (House
of Representatives
Committee on Agriculture, Report To Accompany H.R. 5447, the Futures
Trading Act of 1982).
36. 63 Fed. Reg. 26119-20 (May 12, 1998).
37. Letter dated March 11, 1998, from Robert Rubin, Secretary of the
Treasury, to Fred Thompson,
Chairman, Senate Committee on Government Affairs, attached hereto as
Attachment 3.
38. Section 1 of the Treasury proposal, the findings section, inaccurately
characterizes prior CFTC
actions related to swaps and hybrid instruments by stating that the
CFTC has acknowledged that
these instruments are not within the coverage of the CEA. The Commission
has never made such a
finding. Rather, when issuing the Statement of Policy and the Statutory
Interpretation referred to in
the draft legislation, the Commission indicated only that, with respect
to such instruments, it would
not impose the full regulatory regime of the CEA but instead would
place them in a safe harbor.
Such action was necessary because, when the CFTC issued the Policy
Statement and the Statutory
Interpretation, it did not yet have the power to exempt futures contracts
from the exchange trading
requirement of the CEA.
39. If this provision were adopted, Congress would be assigning statutory
responsibilities for the first
time to an ad hoc coordinating body with no statutory authority, no
budget and no staff. The Working
Group was created by Executive Order in 1988 by President Ronald Reagan
to study the 1987
market crash and completed its work pursuant to the Executive Order
that year. More recently, in
1994 its members were informally convened by then Secretary of the
Treasury Lloyd Bentsen in
order to discuss cross-jurisdictional issues. It has met occasionally
since then about five times in
the past 23 months.
40. See OTC Derivatives Dealers, 62 Fed. Reg. 67940 (Dec. 30, 1997).
41. See Financial Management Policies: Financial Derivatives, 63 Fed. Reg. 20252 (Apr. 23, 1998).
42. The Commission may, however, respond to petitions for exemptive
relief regarding OTC
derivatives, including the imposition of terms and conditions with
respect to such exemptive relief.