With regard to legal certainty for OTC transactions, NYMEX has consistently supported the CFTC's use of its exemptive authority to create Part 35, which generally exempts bilateral swap transactions between sophisticated counterparties from most provisions of the CEA. We further agree with the Working Group that OTC markets suffer from legal uncertainty that should be resolved by amending the CEA.

Again, however, we believe strongly that addressing this uncertainty is best undertaken in the context of a comprehensive reform of the CEA that is fair and even-handed both for OTC and exchange markets. The Working Group has justified its proposed exclusion by asserting that OTC financial derivatives executed between sophisticated counterparties are determined in a highly liquid market with a very large deliverable supply. The Working Group suggests that these products are not susceptible to manipulation, do not implicate concerns about customer abuses and therefore do not need to be regulated by the CFTC. These same characteristics also apply to a number of futures and option contracts now trading on futures exchanges regulated by the CFTC. Fundamental fairness and due process require that like economic products traded between the same types of counterparties receive comparable regulatory treatment. Thus, these futures and option contracts also should be should eligible for the same light-handed regulatory treatment.

In particular, certain tangible commodities are traded between sophisticated counterparties and involve a highly liquid market and very large deliverable supply. We believe that such commodities do not require the same level of regulation as less liquid contracts that have significant participation by retail customers.

It is probably appropriate to review each physical commodity on a case-by-case basis, and it may be further appropriate to review the characteristics of the markets on which such products are traded. Therefore, we are not opposed to a review process that makes such a determination. However, we believe that Congress should amend the CEA to provide clear guidance to the CFTC that certain contracts, including physical commodities that are traded between sophisticated counterparties and that involve a highly liquid market and very large deliverable supply, are deserving of sweeping changes in their regulatory burden.

Electronic Trading Systems

The CFTC's Part 35 provides an exemption from most CFTC regulatory requirements for swap agreements entered into between eligible swap participants provided that: (a) the swap agreement is not part of a fungible class of agreements that are standardized as to their material economic terms; (b) creditworthiness is a material consideration in entering into the swap agreement; and (c) the swap agreement is not traded on a "multilateral transaction execution facility."

The Working Group recommended that the CEA be amended to permit excluded swap transactions to be traded under certain conditions via electronic trading markets. Specifically, the Working Group recommended that Congress clarify that entering into or trading excluded swap agreements, i.e., transactions between eligible swap participants that do not involve non-financial commodities with finite supplies, through electronic trading systems would not create a basis for regulation by the CFTC, provided that the systems limit participation to sophisticated counterparties trading for their own accounts. The Working Group's recommendations to omit the restriction on fungible instruments from the terms of the proposed statutory exclusion and to permit swaps to be traded on electronic trading facilities would thus eliminate two of the key regulatory conditions that have been applicable to eligible swaps under Part 35.

Earlier in the Report, the Working Group noted that, because certain instruments serve risk-management needs of a large number of market participants, "the extent to which market participants engage in large numbers of transactions increases." Indeed, not only is it the case that most of the business engaged in by OTC market participants involves standardized product specifications, but these product specifications often are blatantly identical to the terms and conditions of parallel futures contracts traded on regulated futures exchanges. Swap agreements provide for an opportunity to negotiate the terms of the swap agreement, such as credit terms. However, as the Report also noted, "in practice this opportunity may not be used to a great extent . . . ." In other words, the line separating swap agreements from exchange-traded futures transactions is becoming less and less distinct each day. To that extent, this dividing line is now less a product of the characteristics of the instruments themselves and more a function of their regulatory treatment.

To allow swap transactions to be traded on a centralized electronic trading facility would largely obliterate this dividing line. It also would appear to create the same policy interests that have been thought to be applicable to regulated futures exchanges.

The Working Group, by suggesting that excluded swaps be permitted to be traded on electronic trading systems, is asking Congress to create explicit statutory preferential regulatory treatment for one type of financial instrument, swap agreements, over an equivalent financial instrument that is already trading on a regulated exchange.⁽⁶⁾ If Congress was to follow that advice, it would be setting itself up to decide which financial instruments should be allowed to thrive and which instruments should be curtailed.

Rather than having Congress dictate this result by its apportioning of regulatory burden, we suggest that the more appropriate role for Congress would be to ensure a level regulatory playing field for comparable products and let the market decide. Establishing public policy on a principled basis requires consistency in regulatory treatment for entities for which no real regulatory distinction can be drawn. Therefore, derivatives that are labeled as futures and are traded on centralized electronic trading systems should receive the same regulatory treatment as derivatives that are labeled as swaps and are also traded on centralized electronic trading systems.

Clearing Systems

The Report further recommends that swaps excluded from the CEA could be cleared and could be regulated by the CFTC, another federal regulator, or a foreign financial regulator that satisfies appropriate standards. The Report suggests that the applicable regulator should depend upon the type of other contracts cleared by the clearing entity. Thus, for example, clearing organizations that clear futures generally could clear OTC derivatives subject to the oversight of the CFTC, while securities clearing agencies could clear OTC derivatives with the exception of instruments involving non-financial commodities. As to such non-financial instruments, the Report recommends that the CFTC be authorized by Congress to develop rules establishing and regulating clearing systems for these types of OTC derivatives (to the extent that they are exempted by the CFTC in a manner that allows clearing).

While we recognize that providing clearing facilities for OTC derivatives can serve a valuable function in reducing systemic risk, we agree with the Working Group that clearing systems, which involve the centralization to some extent of financial risk, should be subject to appropriate federal regulation. In general, we believe that clearing organizations that presently clear futures and options on futures also should be permitted to clear OTC derivatives. In particular, we agree with the Working Group that it is appropriate for Congress to authorize the CFTC to regulate clearing systems for OTC derivatives for non-financial commodities. In addition, though, we would argue that the rules promulgated by the CFTC for the clearing of OTC derivatives should provide regulatory parity on clearing rules as between futures contracts and OTC products.

As to financial commodities, we believe that the division of jurisdiction among federal regulators deserves further study to clarify potential differences in regulatory treatment of comparable products. We believe that Congress should review carefully whether this proposed division of jurisdiction might give rise to disparities in regulatory treatment between classes of similar financial instruments and thus could generate competitive concerns based upon such regulatory disparity.

Regulatory Relief for Exchange-Traded Derivatives

The appropriate level of regulatory burden for exchange-traded derivatives is not directly addressed in the Report. However, buried in the Report is what may be characterized as a general principle for determining this regulatory level. The Report stated that "[e]xchange trading should not be subject to regulations that do not have a public policy justification." We strongly agree with this organizing principle.

The Report recommends that Congress give the CFTC explicit statutory authority to provide appropriate regulatory relief for exchange-traded futures if deemed by the CFTC to be consistent with the public interest. We believe that such statutory authority would be useful to the extent that it clarifies that the CFTC has been given exemptive authority by Congress that is even more sweeping in scope than that contained in Section 4(c) of the CEA.

By comparison, the Report states that continuing regulation of trading activity for particular exchange-traded futures contracts is warranted depending upon the degree of: 1) accessibility to these markets by retail customers; 2) price discovery occurring in such markets; and 3) the susceptibility of such markets to market manipulation. The Report indicates that, to the extent that these factors are less relevant, "regulatory adjustments" may be necessary.

We generally agree that the extent of retail participation in a contract and its susceptibility to manipulation are relevant factors in determining the appropriate level of regulation. On the other hand, we note that, with the continuing proliferation of electronic billboards and quote dissemination systems for OTC products, OTC markets are now also providing a price discovery function for certain products, albeit a function that is different in certain respects from the function provided by regulated futures exchanges. Therefore, we question the appropriateness of this factor as a standard for determining the appropriate level of regulation for exchange-traded derivatives.

Exclusive Jurisdiction

The Report discussed eliminating the CFTC's exclusive jurisdiction of futures contracts. The Report did not make a formal recommendation in this area, and noted that the CFTC is still reviewing the consequences of this change. We believe that it is appropriate for the CFTC to weigh all of the ramifications of making such a change. However, we would suggest that consistency in regulatory treatment is advanced if one regulator is charged with sole jurisdiction for futures contracts; the CFTC has served in that role for a sufficient period as to develop real expertise with regard to such products. Therefore, we believe that the CFTC is well-positioned to offer consistency in regulatory treatment and could thus diminish the likelihood of creating further regulatory disparities and the competitive disadvantages resulting from such disparities.

Single Stock Futures

The Working Group members, while not making a formal recommendation, agreed that the current prohibitions on single stock futures can be repealed if issues about the integrity of the underlying securities market and regulatory arbitrage are resolved. We believe that these issues are resolvable, and we support such a repeal.

Summary

As a basic principle of public policy, attempts at serious and comprehensive regulatory reform should be fair and even-handed both for OTC and exchange markets. The Report, taken as the basis for a legislative reform program, falls short of meeting that standard. The Report recognizes the regulatory disparities and blurred product distinctions that unduly restrict U.S. exchanges in today's competitive global market, but does almost nothing to address those issues.

As a regulated, public futures market, we have serious concerns regarding our future ability to serve effectively and efficiently a demanding marketplace under the present regulatory regime. We urge this Committee and the Congress to provide urgently needed flexibility to exchanges to develop and provide innovative risk management products and trading methods, and to support harmonization of the regulatory structure over foreign boards of trade offering instruments with pricing impact in United States commerce. We credit this Committee and the current Chairman and commissioners at the CFTC for their willingness to wrestle with long-standing regulatory disparities, and we hope to work with the CFTC, President's Working Group and Congress to achieve comprehensive reform of the risk management markets.

Mr. Chairman and Members of the Committee, NYMEX thanks you for your consideration and pledges its full support to work with you and your staff to address these issues and any others that may be of concern to you. Thank you very much.

1. H.R. Rep. No. 825, 105th Cong., 2d Sess. 991-92 (1998).

2. Letter from the Honorable Richard G. Lugar, Chairman, Senate Committee on Agriculture, Nutrition and Forestry, and the Honorable Robert Smith, Chairman , House Committee on Agriculture, to the Honorable Robert Rubin, Secretary of the Treasury (Sept. 30, 1998).

3. Although the CFTC staff report is not yet public, it is our understanding that the staff is conducting an intensive review of current CFTC regulations with a view to making recommendations, consistent with the regulatory objectives of the CEA, that could eliminate unnecessary regulations for certain exchange-traded products and markets.

4. The Report does not specify what the Working Group meant by the term "finite supplies."