The Regulatory Road Ahead
Nusbaum, David, Modern Trader
How fast the futures industry will grow and whether it will be lapped by competing OTC and international markets will largely be a factor of the rules of the road on the regulation superhighway.
Change is a constant in futures markets, but perhaps never as the industry seemed at a crossroads on so many defining issues.
Recent growth in over-the-counter and international futures markets stands in stark contrast to some alarming signs at U.S. exchanges, heightening sensitivity to the ways regulation shapes (and confines). The brief Mary Schapiro era at the Commodity Futures Trading Commission (CFTC) brought a new emphasis on enforcement and, some say, a willingness to stretch the agency's reach. The next CFTC head will face a host of issues with limited resources.
"If you had sufficient resources, you'd probably attack several things simultaneously," says Edmund Schroeder, partner at Cadwalader Wickersham & Taft in New York. Although the CFTC was one government agency whose funding wasn't in constant jeopardy last fall, it still must battle for appropriations. Given scarce resources, how should it set its agenda? What are the most important regulatory issues facing the global futures industry today?
Of course, issues are "important" for different reasons - they may affect industry members' profitability, radically reshape the business, engender systemic risk or affect customer protection. Prioritizing regulatory issues to tackle becomes an interesting question, says Celesta Jurkovich, the Chicago Board of Trade's (CBOT) senior vice president-government relations, "because there are some things that get you on a track. It may seem like a small issue on the surface, but it opens the door to get you to a better place down the road."
Level playing field
A regulatory level playing field for all U.S. markets is no small issue. It incorporates many separate issues like audit trails, applying cost-benefit analysis to regulation and OTC competition.
Philip McBride Johnson, partner at Skadden, Arps, Slate, Meagher & Flom in Washington, considers competition the watershed issue: What will happen to futures markets as a higher percentage of all derivatives transactions move off-exchange?
With the financial community's present ability to replicate futures with swaps and "the virtual lack of any kind of regulation in the swap area, you don't have to be a genius to figure out which technique you want to use," Johnson says. "I've been around the futures business since 1965, and nothing in my career begins to take on [like] significance."
The critical issue isn't regulating OTC - that's already been resolved in dealers' favor - but "how will the futures industry and its regulators cope with a large, aggressive, innovative competitor?" Johnson says a race to the bottom, i.e. less regulation, isn't good public policy, but he doesn't see anyone facing the issue.
Rightly so, says Stephen Selig, counsel at Baer Marks & Upham in New York. He calls exchanges' level playing field concerns a non-issue.
"The bottom line is that OTC products generate exchange business," Selig says. Swaps dealers lay off trades on the futures market the same way grain elevators or precious metals dealers do.
But Johnson isn't so sure of swaps' complementarity anymore: "There are a lot of people doing back-to-back swaps as hedges in lieu of going into futures markets, so there's a good possibility we'll see utilization of futures decline."
In terms of fending off global competition, Jerrold Salzman, partner at Freeman, Freeman & Salzman in Chicago, says minor changes in the Commodity Exchange Act (CEA) could go a long way. At present, enacting significant new rules at U.S. exchanges requires CFTC preapproval, "which winds up, especially if it's something novel or might give us a competitive advantage [like large-order execution rules or settlement in non-U. …