Testimony of Patrick M. Parkinson
Associate Director, Division of Research and Statistics
H.R. 4541, the Commodity Futures Modernization Act of 2000
Before the Committee on Banking and Financial Services, U.S. House of Representatives
July 19, 2000
I am pleased to be here to present the Federal Reserve Board's views on the Commodity Futures Modernization Act of 2000 (H.R. 4541). Much of my testimony today will repeat testimony that Chairman Greenspan and I have presented during the last few weeks to other committees in the Senate and the House.
The Board continues to believe that such legislation modernizing the Commodity Exchange Act (CEA) is essential. To be sure, the Commodity Futures Trading Commission (CFTC) has recently proposed issuing regulatory exemptions that would reduce legal uncertainty about the enforceability of over-the-counter (OTC) derivatives transactions and would conform the regulation of futures exchanges to the realities of today's marketplace. These administrative actions by no means obviate the need for legislation, however. The greatest legal uncertainty affecting OTC derivatives is in the area of securities-based transactions, to which the CFTC's exemptive authority does not extend. Furthermore, as events during the past few years have clearly demonstrated, regulatory exemptions carry the risk of amendment by future commissions. If our derivatives markets are to remain innovative and competitive internationally, they need the legal and regulatory certainty that only legislation can provide.
In my remarks today, I shall focus primarily on three of the areas that the legislation covers: (1) OTC derivatives, (2) regulatory relief for U.S. futures exchanges, and (3) repeal of the Shad-Johnson prohibition of single-stock futures. Before concluding, I shall also discuss the importance of legislation clarifying the treatment of derivatives and other financial contracts in bankruptcy.
The provisions of H.R. 4541 that address OTC derivatives are generally consistent with the PWG's conclusions. Therefore, the Federal Reserve Board believes it would be appropriate to enact these provisions. In addition, the Board recommends incorporating into the legislation provisions that would enhance the Federal Reserve's enforcement authority with respect to derivatives clearing organizations that seek to organize as uninsured state member banks. Provisions should also be added that would clarify how clearing organizations organized as uninsured state member banks or Edge Act corporations would be resolved in the event of their bankruptcy.
Regulatory Relief for U.S. Futures Exchanges
Using the same approach as the PWG, the CFTC has evaluated the regulation of futures exchanges in light of the public policy objectives of deterring market manipulation and protecting investors. When contracts are not readily susceptible to manipulation and access to the exchange is limited to sophisticated counterparties, the CFTC has proposed alternative regulatory structures that would eliminate unnecessary regulatory burden and allow domestic exchanges to compete more effectively with exchanges abroad and with the OTC markets. More generally, the CFTC proposes to transform itself from a frontline regulator, promulgating relatively rigid rules for exchanges, to an oversight agency, assessing exchanges' compliance with more flexible core principles of regulation.
The Federal Reserve Board supports the general approach to regulation that was outlined in the CFTC's proposals. For some time, the Board has been arguing that the regulatory framework for futures trading, which was designed for the trading of grain futures by the general public, is not appropriate for the trading of financial futures by large institutions. The CFTC's proposals recognize that the current "one-size-fits-all" approach to regulation of futures exchanges is inappropriate, and they generally incorporate sound judgments regarding the degree of regulation needed to achieve the CEA's purposes.
Similarly, the Federal Reserve Board generally supports the regulatory relief provisions of H.R. 4541. However, the CFTC has expressed concerns that the bill unduly restricts its authority to correct violations of the core principles of regulation. To facilitate expeditious passage of legislation, it thus may be prudent to address the CFTC's concerns about its enforcement authority.
If it would facilitate repeal of the prohibition, the Federal Reserve Board is willing to accept regulatory authority over levels of margin on single-stock futures, as provided in H.R. 4541, so long as the Board can delegate that authority to the CFTC, the SEC, or an Intermarket Margin Board consisting of representatives of the three agencies. The Board understands that the purpose of such authority would be to preserve the financial integrity of the contract market and thereby prevent systemic risk and to ensure that levels of margins on single-stock futures and options are consistent. The Board would note that, for purposes of preserving financial integrity and preventing systemic risk, margin levels on futures and options should be considered consistent, even if they are not identical, if they provide similar levels of protection against defaults by counterparties, taking into account any differences in (1) the price volatility of the contracts, (2) the frequency with which margin calls are made, or (3) the period of time within which margin calls must be met.
Financial Netting Legislation
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