Editor’s note: Philip McBride Johnson is a former chairman of the Commodity Futures Trading Commission (1981-1983) whose name is part of the 1981 Shad-Johnson Accord, which was an agreement between Johnson and then SEC Chairman John Shad over jurisdiction on stock index products. After serving in government, Johnson practiced law with Skadden-Arps, retiring in 2010. Now he spends the day enjoying the warmth of Florida and writing commentary for industry sites, including Futuresmag.com. We asked him for a perspective on changing regulation over the past 40 years.
Has it been 40 years? Had I spent it wisely, I would know. "Those were the best of times; those were the worst of times." And I enjoyed every minute.
Once upon a time, the Commodity Futures Trading Commission (CFTC) was the new kid on the Federal block. Courts routinely misnamed it in their judicial opinions. After all, if you weren't in the grain business, who cared? Even if you were CFTC chairman (raking in $49,500 a year), the visits to the White House were few and a bit awkward. But the ambiguity of the futures markets was a positive force, with the listener lost by the second sentence. It was like explaining astrophysics to a grade school class (or Congress).
A strange gaggle of men (women would join later) left home each day, collected their trading jackets from the exchange cloak room, and behaved like children-in-tantrum from the opening bell until the close. They were "making markets" without fully realizing it. Being perched on the trading pit's top step was like Olympic gold.
The markets changed, of course (don't we all?). The transition from farm products to financial instruments fed the dominant evolution for a decade or so, followed by the replacement of trading floors with electronic matching systems. The markets also embraced other industries like metals and energy.
Then came the first serious off-exchange instruments with the humble name of "swaps" that the CFTC tolerated (within limits) for more than a decade. When it decided to reconsider this largesse in the 1990s, Congress directed the CFTC to, well, butt out. The Dodd-Frank Act following the 2008 financial meltdown tried to re-introduce the CFTC into this field but assumed (wrongly, in my view) that swaps are "different" from futures contracts and commodity options already within the CFTC's remit and established a new, complex and wildly costly regime for swaps that should keep the agency (and clever industry lawyers looking for loopholes) busy for a generation. After all, creating jobs is the mantra of both major political parties these days.
And then there was the gender gap. As counsel to the Chicago Board of Trade for nearly a generation, I found myself frequently at the Union League Club just down the street for meetings or social affairs. It was male-only and there was a separate "women's entrance" (regardless of pedigree or position) that seemed quaint to me. I threatened to quit the Club and eventually did. That policy has also changed. And the CBOT admitted its first female member during that period, ending the "bathroom argument" (i.e., nothing personal, madam, but we don't have ladies' rooms on the trading floor).
Electronic markets have proven to be a mixed blessing. High-frequency trading with algorithms has created the occasional chaos, not to mention a chasm between the computerized culture and the average hedger or speculator. Facebook indiscretions pale by comparison.
And the adage "no good deed goes unpunished" thrives in the markets. For generations, customer funds were deemed to be safe in the hands of futures brokers but two recent (and rare) corruptions of that system have caused pundits to question the integrity of the mechanism as a whole. I favor putting customer funds with a regulated third-party custodian to eliminate the risk but, so far, the industry has pushed back. With the alternative of private swaps, at least for commercial hedgers, this is a risky strategy.
Over the past 40 years, the futures industry has grown and shrunk simultaneously. Contract volumes have soared while industry professionals have fallen in number. Where there were once hundreds of futures commission merchants, at least two-thirds have disappeared (most quietly, and a few spectacularly). Whereas the typical nonmember per-contract commission rate in the 1970s was around $85, today the rate often is quoted in pennies.
Speaking of nonmember commission rates, the exchanges used to set them and God help the member who tried to undercut them. Not surprisingly, the rates for outsiders were some multiple of what members paid for the same service. The official justification was that raising transaction costs for nonmembers would induce them to join the exchanges, subjecting them to the markets' self-regulatory standards and discipline. The Justice Department was not buying any of it and the practice ended quietly.
But not until after the CBOT hired a national consulting firm, then known as the Stanford Research Institute, to make an independent assessment of the minimum-commission-rate policy. Its staff met with me many times, hoping I would point them in the direction of the "right" (i.e., desired) outcome. I did not, but it taught me volumes about the consulting business.
One change that is worrisome involves the breadth of what constitutes "hedging," a form of market use that carries many privileges like no (or higher) position limits, lower margin requirements, etc. For decades, a hedge was a market transaction that generated profit from the same event that would cause losses in the trader's own commercial operations, and usually in roughly the same amount if fully hedged. Today, something called "macro hedging" occurs in which a variety of activities are bundled together and market positions are taken to address the "net" risk across all lines of exposure. One prominent enterprise just lost $5 billion or more using what I presume was this strategy. This is not supposed to happen.
Meanwhile, the CFTC has gone from sole and exclusive futures regulator to sharing jurisdiction with other agencies. In 1974, much blood, sweat and tears went into the "exclusive jurisdiction" goal for this new entity, out of genuine fear that any other structure could bring forth dozens of other regulatory wannabes claiming some sort of interest in the process. Despite failed legislative attempts to undo that structure, the CFTC retained its exclusivity until the year 2000 when the Securities and Exchange Commission (SEC), with futures industry backing, was awarded co-regulator status over single-stock and narrow stock-index futures. This has emboldened other authorities, notably the Federal Energy Regulatory Commission, to venture into view as well. While there appears — ironically — to be little interest in the products where the CFTC and SEC share jurisdiction, the energy sector is prominent among futures users. Can other claimants be far behind?
Finally, despite the passage of four decades, the futures community has never hired the wordsmiths needed to overcome its "grain gambler" image. The term "speculator" has not achieved public acceptance in the way that "investor" has. Even though both commit funds voluntarily to a venture over which they have no effective control in search of profits. And both serve valuable societal purposes, one to underwrite the legitimate needs of commercial hedgers and the other to provide working capital to business enterprises.
Forty years ago I was a fit 34 year old who felt blessed to be part of an exciting futures world in transition from soybeans to serving dozens of industries at home and abroad. It has been a good ride, alternatively fun and frustrating. Throughout, the futures community has bloomed. I can't wait to share my thought (sic) when Futures Magazine completes its next 40 years in print.
Philip McBride Johnson profile from 2007 "Agents of Change," issue
