Regulatory Turf War

THE DAILY FED

Regulatory Turf War

A 10-year-old regulatory tug-of-war involving at least eight federal agencies has tied up congressional attempts to make the laws governing U.S. futures trading more efficient and effective, while many key government and industry officials say the best proposal may be no proposal at all.

After six months of hearings and steady staff work, Senate Agriculture Chairman Lugar and ranking member Patrick Leahy, D-Vt., have pushed back introduction of their bipartisan bill to reform the Commodity Exchange Act, and now plan to offer only a "discussion document" before Congress adjourns, aides said in recent interviews. At issue is a provision in the bill that attempts to clarify the so- called Treasury amendment to the CEA, which excluded certain foreign currency, government securities and a limited number of other transactions from the supervisory jurisdiction of the Commodity Futures Trading Commission.

By far the bulk of the multi-trillion-dollar-a-day exempted transactions are conducted by banks and overseen by bank regulators. But leaders of the seven U.S. futures exchanges have asked Congress to give their regulator, the CFTC, clear supervisory authority over retail transactions that fall into a regulatory gap where there is no clear enforcement authority to try to prevent a fraudulent or other criminal practice from taking place.

"Unregulated bucket shops, Internet dealers and even the retail trading desks of currency dealers are taking advantage of the public, evading the intense regulation mandated for futures trading and siphoning liquidity away from markets," explained Jack Sandner, chairman of the Chicago Mercantile Exchange, in recent testimony before the Senate panel. However, those opposed to the legislative fix contend retail transactions account for such a small amount of the market that the CFTC has issued enforcement actions against only a handful in the last decade.

"Before we bring federal intervention into a private market, we need to ask whether there is enough of a problem out there to warrant a whole new regulatory structure. It doesn't sound like there is a terribly big problem," commented an official at the Federal Reserve, one of the agencies in a presidential working group considering this issue. "Legislation may also severely limit a bank's ability to provide customer- tailored [products] to their customers."

In preparing their bill, Lugar and Leahy asked Treasury and CFTC officials to work out a solution to clarify federal law and jurisdiction in this area. They were unable to do so in the time specified, and Agriculture Committee staff are saying the senators may leave the Treasury amendment out of their bill for now. "We think there should be legislation to fill the gap, and we want to craft a solution carefully enough so that it does not push the market off-shore or adversely effect the markets or the banks. That's why it is taking so long," a Treasury official explained.

The negotiations on a solution now have been expanded, he said, to include the other members of the presidential working group, the SEC, the Fed, the Fed Bank of New York, the FDIC and the Office of the Comptroller of the Currency. Still, industry and government opponents say this is really a turf battle between regulators looking to expand their jurisdictions, in this case giving the CFTC a monopoly over exchanges on trades of less than $5 million. "The foreign currency and government-securities markets have functioned effectively without CFTC involvement for the past 100 years. Who is making an effective case for CFTC jurisdiction?" asked Mark Brickell, managing director at J.P. Morgan and a board member of the International Swaps and Derivatives Association.

A CFTC official said this over-the-counter market is "rife with fraud" by unregistered companies.

There is a case pending before the Supreme Court to address a part of this question, but Congress should not wait for the courts to decide, he said, adding, "The best thing would be for the CFTC and Treasury to decide."