From the October 01, 2009 issue of Futures Magazine • Subscribe!

Regulators hold hands

To prevent what one exchange leader said was change that could do “more harm than good,” industry leaders testified before commissioners of the Commodity Futures Trading Commission (CFTC) and Securities and Exchange Commission (SEC) their views on how the financial regulatory landscape should be altered. By Sept. 30, the agencies must complete a blueprint for “harmonization.” If this doesn’t happen, the Financial Services Oversight Commission will take over. Industry leaders, trying to prevent a draconian regulatory overhaul, were vigorous in what should and should not be done.

In his testimony, CME Group CEO Craig Donohue warned that “merger of the existing regulatory structures into a single set of one-size-fits-all rules administered by separate agencies will do substantially more harm than good.”

Exchange heads called for a focus towards the CFTC’s principles-based approach vs. the SEC’s rules-based approach to regulation. “We believe that the harmonization discussion must take account of the basic fact that these markets are highly dissimilar in many critical aspects and that the regulatory framework, by necessity, should be different,” Donohue said, adding that “harmonization may be interpreted to mean abandoning the principles-based regulation of the Commodity Futures Modernization Act.” He also reiterated the point that inappropriate levels of regulation could push derivative market participants overseas.

Chicago Board Options Exchange Chairman and CEO Bill Brodsky in his testimony said “we support the Administration’s proposal that the SEC give serious consideration to shifting closer to a principles-based approach for exchanges and clearing organizations under its jurisdiction.” He mentioned that inconsistencies in regulation “have led to conflicts between the agencies over new products, clearing and portfolio margining.” Options Clearing Corporation Chairman Wayne Luthringshausen called for “combining the functions of the SEC and CFTC under a new principles-based statute to ensure holistic oversight of all derivatives products.”

Several panelists cited past regulatory stalemates that resulted in delays for the introduction of new products such as credit default options and options on gold and silver ETFs.

“A more flexible principles-based approach will allow innovation in new products. The delays associated with the lengthy review process inherent in a rules-based approach inhibit innovation,” says Andy Nybo, head of derivatives at Tabb Group.

Paul Zubulake, senior analyst at Aite Group, says futures exchanges will retain principles-based regulation. “The SEC doesn’t want to be in a situation where they’re jumping in and making the new regulatory world look more in their favor,” he says, adding that the agencies need to sort out the uncertainties that still exist in over the counter (OTC) market regulation. “They’re headed in the right direction but the OTC market situation is still up in the air,” he says, noting that the agencies will add efficiencies in the product approval process.

Nybo says that the biggest obstacles to the harmonization process are political. “Melding the two organizations and creating an efficient management structure are one challenge but the bigger challenge is sorting out the various committee oversight issues that will certainly become part of the debate over harmonization.” He notes that regulatory change will force firms to remain vigilant with respect to how they can operate in a new environment, and legal and compliance expenses will expand as firms adapt to the evolving regulatory environment.

Listening to the two heads of the prospective regulators and those pushing a merger of the agencies, you might think that the agencies have very similar missions, but others would point out serious differences.

“The securities and futures markets provide radically different services and that fact must never be forgotten,” says former CFTC Chairman Philip McBride Johnson, adding that understanding how different the two agencies’ missions are will be the biggest challenge in the harmonization process. “They should remain separate, pursuing their own statutory missions. The SEC must give everyone comparable information to maintain a level investment field, while the CFTC must not prevent people from hedging,” he says.

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