Questioning the effectiveness of the regulatory structure in the United States is nothing new, particularly in the equity options industry, which faces a much more burdensome structure. So on March 25, the International Securities Exchange (ISE) called for the creation of a new financial markets commission to oversee all U.S. financial markets and trading platforms. The current functions of the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) would all fall into the three sub-groups: one regulator focused on systemic risk, another focused on disclosure issues and a third focused on market industry operations. There would no longer be a separate SEC and CFTC.
Through the new regulator “the regulatory gaps and some of the jurisdictional stalemates (like what happened with the gold ETF) would be eliminated,” says Gary Katz, president and CEO of ISE. When the options industry wanted to trade options on the gold ETF, “the SEC and the CFTC were frozen because they weren’t sure whose jurisdiction the product fell under. It added risk to the system because the two regulators aren’t positioned in a way that allows them to simply regulate by function,” Katz says.
“It’s not surprising that ISE is out there saying ‘please rationalize this mess,’” says Gary DeWaal, general counsel of Newedge.
Katz says another example of the regulatory framework failing is the credit default swaps (CDS) market. “Here’s an OTC market that grew to be so large that it created a systemic risk to the marketplace,” he says. Katz is not suggesting all OTC products need to trade on an exchange, but adds, “The regulatory framework today failed to address the systemic risk created by a market that was both large and opaque.”
DeWaal agrees that the current regulatory structure has held up CDS regulation. “We haven’t been able to get this done for years because the CFTC and SEC can’t get their act together on anything that’s in the hybrid futures-securities world. The two agencies haven’t agreed on what happens when futures are in the equity bucket or when equities and equity options are in the futures bucket. ISE is very badly impacted by that. They’re losing an opportunity because of this jurisdictional nonsense,” he says.
While Katz and DeWaal believe in the need for an overarching regulator to keep an eye on regulatory gaps, former CFTC Chairman Philip McBride Johnson points out the relative success and failure of the two agencies in recent years.
“[It’s] hard to argue that gaps don’t exist but not in the way that ISE means. There is a $1 trillion gap between the failures in the banking and securities sectors vs. the [success] for regulated derivatives as measured by TARP and related bailouts,” Johnson says.
Katz says that reaction to the proposal from the options community has been very positive. ISE has shared its proposal with members of Congress, but there is no timeline for when it will move forward. “The people involved in these decisions want to improve the process, and that’s a good sign,” Katz says.
Peter Bottini, executive vice president of trading at optionsXpress, says ISE’s proposal is very similar to the Treasury Blueprint released in March 2008 that called for an SEC-CFTC merger. “The options exchanges would all prefer a regulator similar to the CFTC, with a more principles-based approach. There is a large degree of frustration with the SEC approach and inefficiencies. Getting rules passed as an exchange is much too slow,” he says.