From the February 01, 2008 issue of Futures Magazine • Subscribe!

Rube Goldberg’s regulatory legacy

Back when the American regulatory apparatus was being pieced together, securities transactions weren’t considered cleared until a runner physically delivered the stock certificate to its new owner. The New York Stock Exchange routinely shut down one day a week to catch up on all the paperwork it was generating, and no one worried that business would migrate to London or Frankfurt on that day off – because ye Olde World was still dusting off the debris of World War II.

But times changed. Germany’s industrial ‘Economic Miracle’ gave way to its glistening ‘Finanzplatz Deutschland,’ and the doors to London’s clubby trading rooms were blown open by the City’s ‘Big Bang’ of 1986.

Markets went global, and asset classes blended. Single stock futures, e-minis, and exchange traded funds (ETFs) emerged, and it became difficult to tell where futures ended and securities began.

Governments around the world responded with multi-asset-class regulatory agencies – most famously the United Kingdom a decade ago, which began the long and tedious process of combining its nine different financial regulatory agencies (including self-regulatory organizations) into the Financial Services Authority (FSA). Japan began following suit in 1998, but left the job incomplete.

The Germans, who previously had left securities regulation to state authorities (which often left all matters to local fraud bureaus), came up with BaFin, the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht), but it is the FSA that has become the template for modern, multi-asset class regulation.

The United States, meanwhile, maintained its same old regulatory structure, with the Securities and Exchange Commission (SEC) keeping dominion over securities at the federal level, the Commodity Futures Trading Commission (CFTC) holding sway over futures, and more than 100 state securities and insurance regulators holding onto some degree of control over securities and insurance business on their turf.

They’re still holding on, creating a situation that Options Clearing Corporation CEO Wayne Luthringshausen says not only drives up the cost of regulation, but prevents U.S. exchanges from effectively competing with their overseas counterparts. In a letter posted on the Federal eRulemaking Portal,, he cited the example of options on ETFs that invest in gold, which some exchanges have been trying to launch for years.

“To this day, the SEC and the CFTC have not reached agreement on who has jurisdiction to regulate the product,” he wrote. “Meanwhile, our foreign competitors can introduce similar products on an expedited basis.”


Until last June, the debate over U.S. regulatory reform seemed about as relevant to reality as pondering life in a world where man had gills and breathed water: fun to think about in an abstract way, but impossible to actually contemplate.

With U.S. securities exchanges bleeding IPOs to Europe in 2005 and 2006 and more recently to emerging markets (see “Making the U.S. Capital Markets More Competitive,” Futures, August 2007), however, U.S. Treasury Secretary Henry Paulson has fostered bona fide, serious debate on the issue and promises to unveil detailed proposals for a new financial services regulatory paradigm by springtime.

After airing his concerns in June, he put out a formal request for comments on Oct. 11, asking the financial services industry whether the United States should keep its separate regulators for securities and futures on the federal level, as well as whether regional regulators should remain for insurance and securities. The questions he posed were focused both narrowly and broadly (see: “Paulson’s petition”), and garnered hundreds of responses (among them Luthringshausen’s) by the time the deadline for submissions passed in late November. All comments can be viewed at the Web portal cited above – where you’ll find the late great cartoonist Rube Goldberg’s name invoked quite liberally. Now the industry is awaiting the release of what Paulson is calling a “blueprint” for improving financial services regulation, with the actual structure to be hammered out in the ensuing months.


If the responses are any indication of what the actual structure will look like, we can expect increased coordination among the various regulatory agencies, but no FSA-style merger in the near term. That’s not because everyone wants to see the SEC and CFTC remain separate entities, although a number of respondents do. Rather, it’s because many who do advocate a merger in principle feel it’s simply not doable in practice.

Several respondents said the President’s Working Group on Financial Markets (PWG) could act as a conduit between the two agencies, either informally or in a more statutory role. The PWG is comprised of Federal Reserve Chairman Ben Bernanke, CFTC Chairman Walt Lukken, SEC Chairman Chris Cox, and Paulson, who chairs it.

NYSE Euronext, in a letter attributed to the exchange itself and not to any single executive, listed a variety of ways the derivatives and securities worlds have converged – from e-minis bringing more retail participants into the futures world to ETFs extending futures-like functionality to the securities world. But then it goes on to say:

“Notwithstanding these points, we do not believe it is practical to attempt to combine or unify securities and futures regulation in the United States at this time. The very success of each of these industries under their different regulatory regimens means that the process of reconciling disparate regulations has become exponentially more difficult, suggesting that unification would be too complex and take too long. It is simply impractical to expect to be able to completely reorganize our existing regulatory system within an acceptable timeframe.”

Managed Futures Association (MFA) President John Gaine, himself a former CFTC general counsel, walked a fuzzy line in his submission, stating at one point that members would prefer one regulator, but also arguing that a rationale exists for separate regulators, and ultimately arguing against a merger. “While MFA members do not believe strong reasons exist to merge the CFTC into the SEC, or vice versa, MFA would support the creation of more areas of shared jurisdiction by the SEC and CFTC using the currency options template,” he wrote. “This template would allow an exchange to decide whether it wanted to list its products under the SEC’s jurisdiction or that of the CFTC.”

CME Group boss Craig Donohue was less circumspect, and seemed at times to be saying that keeping the two entities separate is more than just something we must grudgingly tolerate: it’s something we should embrace.

“Separate functional regulators should continue to regulate futures and securities markets given the very significant differences between these markets,” he wrote, going on to contrast the nature of participants in both markets, as well as the methods of execution and clearing.

“A merger of the CFTC and the SEC would stifle innovation and competition in the futures industry, and would not benefit either industry with respect to the goals articulated by the Treasury Department,” he noted. “Putting the regulators of these very different markets under one roof would only create a larger, more inefficient bureaucracy, and would not enhance global market competition.” He also, however, called for more coordination among existing regulatory agencies and cited the PWG as a potential conduit for cooperation.

At the other end of the debate, you have people like Marc Lackritz, president and CEO of the Securities Industry and Financial Markets Association (SIFMA). “The bifurcated jurisdiction has created needless legal uncertainty as to the status of new financial products,” he wrote. “The first step towards comprehensive structural reform is the consolidation of the SEC and CFTC, whereby the securities and futures industries would be regulated under a single regulatory scheme and by a

single agency.”

Professor Michael Mainelli, chairman of London think tank Z/Yen, says that, contrary to what we normally expect, a single regulator can promote competition in new markets such as carbon trading, gambling and hybrids between insurance and capital markets – in short, all areas where Europe is surging forward. “Innovators can go straight to a single source for a clean opinion on regulatory treatment,” he says, adding that, ironically, Britain’s Northern Rock debacle may be pointing Europeans the other way.

The mortgage provider, which had been responsible for 20% of the UK market, was unable to refinance and is now effectively underwritten by the government. “The FSA itself became a single point of failure,” he says. “This leaves it tarnished by any single failure, whereas the plethora of entangled U.S. institutions provides plenty of room for each to crow about its successes while sloughing off failures.”


Respondents also disagree on where regulation ends and law enforcement begins.

Jeffrey Neubert, CEO of the Clearing House Association, criticized the increasing reliance on enforcement actions, rather than a supervisory approach, arguing that such actions bring into the game federal, state and local law enforcement authorities

that simply don’t understand the issues they are dealing with.

“In some situations, enforcement actions have been taken against financial institutions for long-standing practices that have been well-known in the marketplace and have not previously drawn regulatory criticism,” he wrote.

His prescription: establish a ground rule that says regulators only enter the fray of regulated industries when industry regulators explicitly request their help. Other respondents, however, said that regulatory agencies are simply too small and too understaffed to police the entire field themselves. There is, however, one area where nearly all respondents agree: the SEC needs to abandon its tendency to prescribe detailed rules and embark upon the more principles-based path of the CFTC.

“The development of such an approach would benefit from an examination of the experience of the U.S. futures industry since the adoption of the Commodity Futures Modernization Act of 2000 (CFMA), a revolutionizing statute that replaced ‘one-size-fits-all’ regulation with flexible core principles,” wrote Donohue. “The futures industry has thrived under core principles regulation, while the SEC continues to apply prescriptive laws and regulations to the securities industry.” And that goes to the core issue. The need for the SEC to reform and adopt a principles-based approach. While no one likes to deal with dual regulation, for those who only have to deal with it on the periphery, like futures exchanges, it is preferable to a merger of regulators as long as there is a chance that they could fall under the current SEC structure.

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