Any U.S.-based investor who has placed trades on overseas exchanges was able to do so because the Commodity Futures Trading Commission (CFTC) had issued a so-called “no action” letter recognizing the regulatory regime in which that exchange operated as well as the exchange itself and certain contracts. It has been the CFTC’s modus operandi on dealing with foreign exchanges for decades — especially with financial contracts that also fall under the jurisdiction of the Securities and Exchange Commission (SEC).
But is the system up to the challenge of a world where most trades occur in cyber space as opposed to a trading floor and there is more direct competition for contracts?
More intriguingly, should a foreign exchange be considered American for regulatory purposes if the majority of its customers are in the United States?
The CFTC floated these questions at a public hearing on June 27, attended by a dozen regulators and industry participants from Europe and the United States and a consensus seemed to form around the status quo, but the issue has hardly been laid to rest.
CFTC Commissioner Mike Dunn opened with a broadside on the current system. “The types of major policy decisions involved in granting access to U.S. markets by foreign boards of trade should be made by the Commission through an open and transparent public process, not ad-hoc staff letters,” he said. “No action relief should be reserved for emergency or extraordinary circumstances.”
Not surprisingly, U.S. exchanges leaned towards either more regulation on their foreign competitors or less on domestic ones. Kathleen Cronin, general counsel at the Chicago Mercantile Exchange (CME), came out in favor of a special category of registration for foreign exchanges, or at least a codification of the “no action” process, arguing the current system essentially gives non-U.S. exchanges a regulatory break.
New York Mercantile Exchange (Nymex) boss and former CFTC chairman James Newsome agreed and directed the focus onto the specific turf war between Nymex and ICE Futures, which is regulated by the U.K. Financial Services Authority. ICE launched a competing West Texas Intermediate (WTI) crude oil futures contract in February that is cash settled and based on the Nymex price; it has managed to capture 30% of WTI market share.
Newsome blamed the CFTC’s tighter reporting requirements and position limits for the loss of market share to ICE, claiming that larger players were drawn to the anonymity of the procedure in London. ICE chairman Robert Reid said the laws are very similar and suggested Nymex’s loss of market share was due to it being tardy on electronic trading. He also suggested that claims of regulatory arbitrage have been exaggerated. “The original ‘no action’ letter [to the International Petroleum Exchange, today’s ICE Futures] contains lots of details on what the exchange is obligated to do. It is a very comprehensive list — and it is the basis of our cooperation with the United States.”
However in the past the “no action” process was a means to ensure proper oversight and didn’t have to deal with competing contracts having different standards to choose from. The fact that ICE has launched an exact copycat of the Nymex contract under a different regulatory environment has changed the game.
By Steve Zwick
