[Senate Hearing 106-922]
[From the U.S. Government Publishing Office]
S. Hrg. 106-922
S. 2697--THE COMMODITY FUTURES MODERNIZATION ACT OF 2000
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JOINT HEARING
before the
COMMITTEE ON AGRICULTURE,
NUTRITION, AND FORESTRY
UNITED STATES SENATE
and the
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
ONE HUNDRED SIXTH CONGRESS
SECOND SESSION
ON
S. 2697--THE COMMODITY FUTURES MODERNIZATION ACT OF 2000
__________
JUNE 21, 2000
__________
Printed for the use of the
Committee on Agriculture, Nutrition, and Forestry
U.S. GOVERNMENT PRINTING OFFICE
69-533 WASHINGTON : 2001
_______________________________________________________________________
For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC
20402
COMMITTEE ON AGRICULTURE, NUTRITION, AND FORESTRY
RICHARD G. LUGAR, Indiana, Chairman
JESSE HELMS, North Carolina TOM HARKIN, Iowa
THAD COCHRAN, Mississippi PATRICK J. LEAHY, Vermont
MITCH McCONNELL, Kentucky KENT CONRAD, North Dakota
PAUL COVERDELL, Georgia THOMAS A. DASCHLE, South Dakota
PAT ROBERTS, Kansas MAX BAUCUS, Montana
PETER G. FITZGERALD, Illinois J. ROBERT KERREY, Nebraska
CHARLES E. GRASSLEY, Iowa TIM JOHNSON, South Dakota
LARRY E. CRAIG, Idaho BLANCHE L. LINCOLN, Arkansas
RICK SANTORUM, Pennsylvania
Keith Luse, Staff Director
David L. Johnson, Chief Counsel
Robert E. Sturm, Chief Clerk
Mark Halverson, Staff Director for the Minority
__________
?
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
PHIL GRAMM, Texas, Chairman
RICHARD C. SHELBY, Alabama PAUL S. SARBANES, Maryland
CONNIE MACK, Florida CHRISTOPHER J. DODD, Connecticut
ROBERT F. BENNETT, Utah JOHN F. KERRY, Massachusetts
ROD GRAMS, Minnesota RICHARD H. BRYAN, Nevada
WAYNE ALLARD, Colorado TIM JOHNSON, South Dakota
MICHAEL B. ENZI, Wyoming JACK REED, Rhode Island
CHUCK HAGEL, Nebraska CHARLES E. SCHUMER, New York
RICK SANTORUM, Pennsylvania EVAN BAYH, Indiana
JIM BUNNING, Kentucky JOHN EDWARDS, North Carolina
MIKE CRAPO, Idaho
Wayne A. Abernathy, Staff Director
Steven B. Harris, Democratic Staff Director and Chief Counsel
(ii)
C O N T E N T S
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Page
Hearing:
Wednesday, June 21, 2000, S. 2697--The Commodity Futures
Modernization Act of 2000...................................... 1
Appendix:
Wednesday, June 21, 2000......................................... 47
Document(s) submitted for the record:
Wednesday, June 21, 2000......................................... 93
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Wednesday, June 21, 2000
STATEMENTS PRESENTED BY SENATORS
Lugar, Hon. Richard G., a U.S. Senator from Indiana, Chairman,
Committee on Agriculture, Nutrition, and Forestry.............. 1
Gramm, Hon. Phil, a U.S. Senator from Texas, Chairman, Committee
on Banking, Housing, and Urban Affairs......................... 3
Bennett, Hon. Robert F., a U.S. Senator from Utah................ 25
Fitzgerald, Hon. Peter G., a U.S. Senator from Illinois.......... 21
Grams, Hon. Rod, a U.S. Senator from Minnesota................... 30
Harkin, Hon. Tom, a U.S. Senator from Iowa, Ranking Member,
Committee on Agriculture, Nutrition, and Forestry.............. 5
Sarbanes, Hon. Paul S., a U.S. Senator from Maryland, Ranking
Member, Committee on Banking, Housing, and Urban Affairs....... 11
Kerrey, Hon. J. Robert, a U.S. Senator from Nebraska............. 23
Schumer, Hon. Charles E., a U.S. Senator from New York........... 27
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WITNESSES
PANEL I
Greenspan, Hon. Alan, Chairman of the Board of Governors of the
Federal Reserve System, Washington, DC......................... 9
Summers, Hon. Lawrence, Secretary of the U.S. Department of the
Treasury, Washington, DC....................................... 6
PANEL II
Levitt, Hon. Arthur, Chairman of the Securities and Exchange
Commission, Washington, DC..................................... 32
Rainer, Hon. William, Chairman of the Commodity Futures Trading
Commission, Washington, DC..................................... 34
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APPENDIX
Prepared Statements:
Lugar, Hon. Richard G........................................ 48
Fitzgerald, Hon. Peter G..................................... 50
Santorum, Hon. Rick.......................................... 56
Edwards, Hon. John........................................... 57
Craig, Hon. Larry E.......................................... 59
Greenspan, Alan.............................................. 66
Levitt, Arthur............................................... 73
Rainer, William.............................................. 85
Summers, Lawrence............................................ 60
Document(s) submitted for the record:
Position statement of the Bond Market Association, submitted
by Frank R. Hampton, Vice President Legislative Affairs.... 94
HEARING ON S. 2697--THE COMMODITY FUTURES MODERNIZATION ACT OF 2000
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WEDNESDAY, JUNE 21, 2000
U.S. Senate,
Committee on Agriculture, Nutrition, and Forestry, and the
Committee on Banking, Housing and Urban Affairs,
Washington, DC.
The Committees met jointly, pursuant to notice, at 10:07
a.m., in room 106, Dirksen Senate Office Building, Hon. Richard
G. Lugar, (Chairman of the Committee on Agriculture, Nutrition
and Forestry,) presiding.
Present or submitting a statement: Senators Lugar, Gramm,
Bennett, Fitzgerald, Santorum, Grams, Harkin, Sarbanes, Dodd,
Kerrey, Conrad, Johnson, and Schumer.
OPENING STATEMENT OF HON. RICHARD G. LUGAR, A U.S. SENATOR FROM
INDIANA, CHAIRMAN, COMMITTEE ON AGRICULTURE, NUTRITION, AND
FORESTRY
The Chairman. This hearing of the Senate Agriculture
Committee and the Senate Banking Committee, held jointly, is
open for business. Today I would simply point out the
Agriculture Committee and the Banking Committees will hear
testimony from members of the President's Working Group in
regard to Senate Bill 2697, legislation to provide legal
certainty to the over-the-counter derivatives market and to
reauthorize and to reform the Commodity Exchange Act. The
Commodity Exchange Act expires on September 30 of this year and
the Senate Agriculture Committee is charged with reauthorizing
this statute.
However, we cannot accomplish this endeavor without the
strong assistance and cooperation of members of the Senate
Banking Committee. I am very pleased to have the distinguished
Chairman of the Senate Banking Committee, Senator Phil Gramm of
Texas, joining me as a cosponsor of this important legislation.
We look forward to working with the Banking Committee as the
legislation proceeds.
Our legislation has been several years in the making. The
Senate Agriculture Committee held a two-day roundtable of 19
industry experts in February 1999 to discuss the policies
surrounding CFTC reauthorization. Asked to prioritize the
issues of importance, most panelists thought legal certainty to
be the most pressing issue. Others suggested repeal of the
Shad-Johnson Accord and that testimony included Phil Johnson,
former CFTC chairman and one-half of the accord's namesake, and
several mentioned regulatory relief for the futures exchanges
as an important priority.
Today's hearing representing our committee's fifth public
forum on CFTC reauthorization in the last 18-months will hear
testimony regarding how all of these issues are addressed in
our legislation.
Signed into law in 1974, the modern Commodity Exchange Act
requires that futures contracts be traded on a regulated
exchange. As a result, a futures contract that is traded off an
exchange is illegal and unenforceable in a court of law. When
Congress enacted this act, the meaning of the terms ``future''
and ``exchange'' were relatively apparent and the over-the-
counter derivatives business was in its in infancy.
In the 26-years since the statute's creation, however, the
definitions of a swap and a future began to blur. In 1998 the
CFTC released its concept release on over-the-counter
derivatives, which was perceived by many as a precursor to
regulating those instruments as futures. Just the possibility
of reaching this conclusion threatened to move significant
portions of the business overseas. This led the Treasury
Department, the Federal Reserve and the SEC to ask Congress to
enact a moratorium on the CFTC's ability to regulate these
instruments until after the President's Working Group could
complete a study of the issue.
As a result, Congress passed a 6-month moratorium and in
November 1999 the President's Working Group completed its
unanimous recommendations on derivatives and presented Congress
with those findings. This legislation adopts many of the
unanimous recommendations of the Working Group's report,
including an exclusion for over-the-counter derivatives
transacted on an electronic exchange and a clarification of the
so-called Treasury Amendment.
Another important recommendation of the Working Group was
to authorize futures clearing facilities to clear over-the-
counter derivatives in an effort to lessen systemic risk. This
bill incorporates that finding.
The second major section of this legislation addresses
regulatory relief for the futures market. In February, the
CFTC, under the leadership of Chairman Bill Rainer, issued a
thoughtful proposal that would provide relief to futures
exchanges and their customers. Instead of listing specific
requirements for complying with the act, the proposal would
require exchanges to meet internationally agreed upon core
principles. The CFTC proposal tailors regulation for exchanges
based on whether the underlying commodity can be manipulated or
whether the users of the exchange are institutional. Our
legislation incorporates this framework.
The bill's last major section addresses the Shad-Johnson
Jurisdictional Accord, which banned single-stock futures in
1982. The Working Group unanimously agreed that the accord can
be repealed if regulatory disparities are resolved between
futures and securities. In December Senator Gramm and I sent a
letter requesting that the CFTC and the SEC make
recommendations on reforming the Shad-Johnson Accord. The SEC
and the CFTC responded that although progress had been made,
the agencies could not resolve these issues before October of
this year.
Disappointment with this answer led Senator Gramm and me to
once again ask the agencies to attempt to resolve the problems
surrounding lifting the ban. Unfortunately, an agreement within
our legislative timeframe was not reached and we have decided
to move forward with our legislation.
This legislation would repeal the prohibition on single-
stock users and allow these products to trade on either a CFTC-
regulated futures exchange or an SEC-regulated securities
exchange. Our bill also would provide for joint jurisdiction
with each agency maintaining its core authorities over the
trading of single-stock users. The legislation would further
require that margin levels on these products be harmonized with
the options market.
The goal of the legislation is to ensure that the United
States remains a global leader in the derivatives marketplace.
Already the United States has lost much of its leadership role
in the exchange-traded futures markets in Europe and the over-
the-counter market may not be far behind. Congress has a good
opportunity at this point to reverse this tide by enacting
sound legislation this year.
For my own part, I am hopeful that the Agriculture
Committee can mark up this legislation prior to the July 4
recess, namely, next week.
The importance of this legislation is reflected by the
witnesses assembled before us today and we are grateful for
each one of them. Our first panel consists of the head of to
President's Working Group, the Honorable Lawrence Summers,
Secretary of the United States Department of the Treasury, and
the Honorable Alan Greenspan, Chairman of the Federal Reserve
System. Our second panel will consist of the Honorable Arthur
Levitt, Chairman of the SEC, and the Honorable Bill Rainer,
Chairman of the CFTC. We look forward to their insights
regarding their agencies' discussions on the Shad-Johnson
accord, as well as on all of the other issues.
[The prepared statement of Senator Lugar can be found in
the appendix on page 48.]
It is now a privilege to turn to my distinguished
colleague, Senator Gramm, for his opening remarks.
OPENING STATEMENT OF HON. PHIL GRAMM, A U.S. SENATOR FROM
TEXAS, CHAIRMAN, COMMITTEE ON BANKING, HOUSING, AND URBAN
AFFAIRS
Senator Gramm. Mr. Chairman, let me first thank you for
your leadership on this issue. Let me say for the record that
it has been a great privilege to work with you and the
excellent staff of the Agriculturee on this bill.
This is an effort that has been undertaken by the
Agriculture and Bamking Commmittees to do something that is
both important and, obviously, very difficult.
Whenever we work in areas that are cross-jurisdictional in
Congress, those differences sometimes become barriers to
legislative action, and I want to congratulate you for your
leadership in seeing that, that has not happened in this
important area.
As I see this bill, we are trying to do three simple things
that may not create great excitement among American consumers,
but they are very important and affect the well-being,
prosperity and financial security of everybody who works,
saves, invests and benefits from living and working in the
greatest economy in the history of the world.
We want legal certainty for swaps. Most people do not know
what swaps are. I am almost incapable of fathoming the volume
of swaps in dollar value. When I heard the number as we first
started discussing this issue, I was convinced that an error
had been made and that someone had mistakenly said trillions
instead of billions; I was wrong. This is a huge, critically
important markets, and we cannot allow uncertainty about the
enforceability of these contracts to stand.
We are all aware that uncertainty occurs because of the
off-exchange trading prohibition in the Commodities Exchange
Act. If the Commodities Futures Trading Commission deemed these
swaps to be futures, that would create this legal uncertainty.
I believe that a similar uncertainty could be created if
the SEC deemed them securities and then argued that they were
being traded without fulfilling the reporting requirements of
the Securities and Exchang4e Commission statute.
Also, it is important for us to note that while two of the
most enlightened people who have ever served now head the CFTC
and SEC, we have no guarantee that, that leadership is going to
remain in the future and regulation doth abhor a vacuum. So, I
think it is very important that we have legal certainty as it
relates to both CFTC and the SEC
Let me also say that we had hoped, Mr. Chairman, and I know
you had hoped, that we could get the CFTC and the SEC to work
out an agreement as to how they were going to regulate the new
instruments that would be created futures on individual stocks.
The SEC and CFTC made a legitimate effort, but they were unable
to reach a conclusion as to how to share this regulatory
authority.
Ultimately, I have not given up hope that this can be
worked out. It is important that it be worked out so that these
two important regulatory entities can do what they do best. We
need the SEC in all areas to exercise its authority on anti-
fraud and insider trading. We need the CFTC doing the things it
can do. I think an agreement as to how they can share
regulatory responsibility on individual futures could also
affect areas where there are still legitimate regulatory
concerns concerning swaps.
Second, this bill does provide a new financial instrument
that in my opinion is long overdue. There are problems in
providing it in that we have to harmonize margins, we have tax
differences between options and futures, but none of these
problems is insurmountable. We try to deal with them in this
bill, and I am sure we will refine the bill as we go along.
And finally, this bill does begin regulatory relief. I am
hopeful that by the end of the bill, we can go further. I do
not believe that we have done what we should do in providing
regulatory relief. The world is very different today than it
was in 1934, when we were willing to trade tremendous
regulatory burden for transparency. It was the right decision
to make at the time, but with modern technology, with the
evolution of markets, we have transparency at levels that never
existed before.
We have competition from all over the world that would very
much like to see this goose that lays the golden egg, these
financial markets, roosting in their coop. They are trying to
do things to attract it. They are unifying markets. They are
reducing regulatory burden. I believe that we need to do it. No
one can convince me that the regulations necessary to protect
my parents are the same regulations that are necessary to
protect my children in today's financial markets.
We would do well, Mr. Chairman, to remember the Lincoln's
adage that to ask a society to live under old and out-moded
laws, and I think you could say the same about regulation, is
like asking a man to wear the same clothes he wore when he was
a boy.
We need a comprehensive review of the regulatory burden in
financial markets. We need to challenge every regulation and
every law as to benefits versus costs, and when the costs
exceed the benefits, we either need to change, overturn or
repeal that regulation as law.
Mr. Chairman, you have made an important start here. I want
to congratulate you for it. We face a difficult challenge in an
election year and the waning days of this Congress, but this is
an important issue and, Mr. Chairman, I want to commit to you
that I intend to work hard to try to help you be successful.
The Chairman. Well, thank you very much, Chairman Gramm. I
appreciate those comments and your testimony.
Let me try to lay out a format that I hope will be
agreeable. I am going to call now upon the distinguished
Ranking Member of the Agriculture Committee for an opening
statement and upon his appearance, Senator Sarbanes as the
Ranking Democratic member on the Banking Committee.
I will ask other members, if I may, to forego opening
statements so that we may hear the witnesses. We will have a
round of questioning with no more than 5-minutes per Senator
because we do have two distinguished panels and we have two
committees.
So unless there are strong objections to that format, we
will try to proceed on that basis and I will call now upon
Senator Harkin for his testimony, his opening statement.
STATEMENT OF THE HON. TOM HARKIN, A U.S. SENATOR FROM IOWA,
RANKING MEMBER, COMMITTEE ON AGRICULTURE, NUTRITION, AND
FORESTRY
Senator Harkin. Thank you very much, Chairman Lugar and
Chairman Gramm. And we welcome Senator Sarbanes and other
members of the Committee on Banking, Housing and Urban Affairs.
I appreciate this opportunity to hear the views of the
Members of the President's Working Group on Financial Markets
concerning the legislation introduced by Senators Lugar, Gramm
and Fitzgerald. I especially want to commend you and thank you,
Chairman Lugar, for your conscientious work in crafting this
important legislation.
I have said before that when it comes to derivatives and
everything else that we are dealing with here in terms of
complexity, the subject matter of this legislation surely
rivals anything that ever comes before our committee, with the
possible exception of dairy policy. That may be more
convoluted.
The issues are indeed complicated. Their resolution has
tremendous ramifications in the markets. The bill that has been
introduced clearly reflects the hard work that Chairman Lugar
and his staff has put into it. And, for the most part, it
carefully follows the recommendations of the President's
Working Group, provides legal certainty for over-the-counter
derivatives, ensures regulatory relief for futures exchanges
and brings clarity to the Treasury Amendment, finally, in the
treatment of certain hybrid instruments, generally modernizes
the Commodity Exchange Act to take into account the rapid pace
of change in the financial markets and in technology. It seeks
to maintain and strengthen the protection of investors in the
public interest.
To be sure, there are a number of issues that require
further attention. I look forward to working with the Chairman,
the Regulatory agencies and other parties to resolve the
remaining issues.
As we continue to work on this legislation, we, in essence,
have a balancing act to perform. To be sure, there is a real
need for legal certainty, for modernizing and reforming
regulations. I just Chairman Gramm saying about the old
Jeffersonian quote about--in fact, it is engraved in the
Jefferson Monument down here, about expecting the adult to wear
the clothes of childhood would be the same as expecting the
Nation to live by the laws of its ancestors.
But, at the same time, we must ensure that investors are
protected and that we do not create disparities in regulation
and in competitive positions of the various types of financial
markets.
Without a doubt, we now have a truly global financial
market. The regulatory climate should not hinder; should
enhance the competitive position of U.S. markets and firms.
However, when it comes to international competitiveness, there
is also a tremendous value to the integrity, safety and
soundness of markets, an area where the U.S. has excelled. The
cost of transactions is important but over time, money will
flow to markets where integrity, safety and soundness are
adequately protected. To me, that is the bottom line. Thank you
very much, Mr. Chairman.
The Chairman. Well, thank you very much, Senator Harkin. I
commend you again for your thoughtfulness in working with us.
Members of the Democratic staff, in a bipartisan way, have been
working on this legislation and we appreciate that.
At this point it is my privilege to recognize in the order
that I have introduced the witnesses, the distinguished
Secretary of the Treasury. He has been a good friend of our
committee, coming before us not in each of these five
iterations of the CFTC but in many of them, and in his role
with the Working Group has already made a contribution, I
believe, to American financial security.
Secretary Summers.
Senator Dodd. Mr. Chairman, before you do that, I presume
that opening statements in which we lavish praise on you and
Senator Gramm are appropriate?
The Chairman. Oh, they would be welcome, published in full.
Thank you.
Mr. Summers.
STATEMENT OF THE HON. LAWRENCE SUMMERS, SECRETARY OF THE U.S.
DEPARTMENT OF THE TREASURY, WASHINGTON, DC.
Secretary Summers. Chairman Lugar, Chairman Gramm, Ranking
Members Harkin and Sarbanes, members of these Committees, thank
you for giving me the opportunity to testify before you once
again on the Commodities Futures Modernization Act.
This is, as your opening statements recognized, an issue
that the President's Working Group has grappled with for some
time and it is an issue that these committees have been
grappling with for some time.
I believe it is a matter of great importance to the future
of our financial system and to the future of our economy to
move ahead with legislation that provides legal certainty for
swaps and OTC derivatives transactions. And I believe that such
legislation is now within our grasp, with the unanimous
agreement of the President's Working Group and the very
substantial consensus that has formed in the central area of
legal certainty for OTC derivatives among members of these
committees, members of the House of Representatives and the
various constituencies.
I believe that if anything, the events of the last year, as
we have seen dramatic increases in competition in the financial
services area across countries, only go to emphasize the
importance of the United States moving to provide legal
certainty.
So it is our very great hope that it will be possible to
move this year on legislation that, in a suitable way, goes to
create legal certainty for OTC derivatives while, at the same
time, reducing systemic risk, protecting retail customers, and
maintaining U.S. competitiveness.
And it is our belief that the central provisions contained
in this bill with respect to OTC derivatives make great
progress in achieving these goals and are provisions that we
can support as they follow very largely the recommendations of
the President's Working Group.
I want to address, however, three remaining issues: the
securities question, certain technical questions with respect
to regulatory relief for futures exchanges, and Shad-Johnson.
With respect to securities, the bill provides a broad
exclusion from the securities laws for swaps, including in
particular, swaps based on securities. As a general matter, we
do not believe that swaps should be regulated as securities.
However, it is important to preserve prohibitions against
insider trading, fraud, manipulation, and also to preserve
other measures which are demonstrably necessary to protect
retail customers.
We are concerned that the provisions as currently drafted
could have the unintended consequence of interfering with these
vital protections that are now in place for the securities
markets. Because the provisions as currently drafted have the
potential to impact the underlying securities markets, we
believe that it is imperative that they be amended to address
these concerns with respect to insider trading, fraud,
manipulation, and retail consumer protection.
I would hasten to point out that this is very much
consistent with the valid objective of removing unnecessary
regulation. I think it is worth emphasizing, however, that
there is one important distinction between the securities laws
and the commodities laws in that the application of securities
laws does not in any context create the kind of legal certainty
issues that can arise under the CEA.
The second concern we have is with respect to the
regulatory relief section that permits exempt boards of trade.
Let me first say that we have looked very carefully at the
recommendations that the CFTC has made and while we will be
making a formal comment down the road, I can say that we are
very much supportive in general of the changes that Chairman
Rainer has recommended and believe that they represent a
landmark achievement.
And we recognize the importance of competitive parity
between the exchange and off-exchange markets, particularly as
the status of off-exchange markets is clarified.
Our concern is with certain provisions that, as drafted,
could have the perverse consequence of creating a situation
where protections that are present with respect to off-exchange
trades could actually not be present with respect to
transactions that took place on an exchange. These matters are
particularly important with respect to the integrity of the
Government securities market, as any reduction in the integrity
of the Government securities market could lead to higher
financing costs for the Treasury and an increased burden on
American taxpayers.
Let me turn finally to the question of the Shad-Johnson
Accord. We believe that as the Working Group report states, the
current prohibition on single-stock futures can and should be
repealed if issues about the integrity of the underlying
securities market and regulatory arbitrage are resolved. There
are a number of concerns, however, that the regulatory agencies
consider important that have not been resolved in the
legislation. While we have no objection to the introduction of
single-stock futures, it is vitally important that the
integrity of the underlying markets be preserved and that these
instruments not be used as a means to avoid the regulation of
the cash market.
But let me be very clear on one point. We believe that this
issue should not be allowed to be an impediment to clarifying
legal certainty with respect to OTC derivatives. It is our very
great hope that it can be resolved in a mutually satisfactory
way but we do not believe that it should be allowed to defer
OTC derivatives legal certainty, given the overwhelming
importance of that issue.
Let me just take this opportunity to comment on an issue
that is not part of the bill before you today, and that is the
question of the treatment of OTC derivatives in instances of
bankruptcy and insolvency.
I would like to take the opportunity to strongly urge the
Congress to adopt the President's Working Group's
recommendations regarding the treatment of certain financial
contracts, including OTC derivatives, in cases of bankruptcy or
insolvency. This is a step that could have a meaningful impact
on the mitigation of systemic risk.
Mr. Chairman, let me conclude where I began. The
achievement of legal certainty and a modern legal and
regulatory framework for OTC derivatives is an issue of great
importance to our financial system, the competitiveness of our
markets and businesses and our economy. With this legislation,
it appears that, that goal is within our grasp. I urge this
committee to rapidly address the remaining concerns so that we
can move forward on much-needed legal certainty in the OTC
derivatives market. Thank you.
[The prepared statement of Secretary Summers can be found
in the appendix on page 60.]
The Chairman. Well, thank you very much, Secretary Summers,
for your comments and for your endorsement with the caveats
that you have given and we will take those seriously.
When I visited with you and with Chairman Greenspan
earlier, the Chairman noted a very, very large audience here
today for something that is very difficult to understand. I
would say the audience is a tribute to the two of you. You are
persons that are listened to. You make a difference in our
thoughtfulness and I call now upon Chairman Greenspan for his
testimony.
STATEMENT OF THE HON. ALAN GREENSPAN, CHAIRMAN OF THE BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM, WASHINGTON, DC.
Mr. Greenspan. Thank you very much, Mr. Chairman. I should
say chairmen and Ranking Members. This, incidentally, is the
first time in all of my years testifying before the Senate that
I recall, appearing before a joint committee of this nature,
and I must say that considering the nature and presumed
complexity and obscurity of this type of legislation, it is a
clear testament of how important this issue is to the financial
system of the United States, its integrity, and essentially the
underlying prosperity which it has been so important in
contributing to.
I am especially pleased to be here to present the Federal
Reserve Board's views on the Commodity Futures Modernization
Act of the Year 2000. My testimony today will be largely
identical to the testimony of my colleague Patrick Parkinson
delivered on behalf of the Federal Reserve Board last week to
the House Subcommittee on Risk Management, Research, and
Specialty Crops.
Let me say first that I wish to associate myself with all
of the remarks of Secretary Summers and will endeavor not to
repeat and go over similar grounds.
The Federal Reserve Board continues to believe that the
Commodity Futures Modernization Act of 2000, modernizing the
Commodity Exchange Act, is essential. To be sure, the CFTC has
recently proposed issuing regulatory exemptions that would
reduce legal uncertainty about the enforceability of OTC
derivatives transactions and would conform the regulation of
futures exchanges to the realities of today's marketplace.
These administrative actions by no means obviate the need for
legislation, however.
In my remarks today I shall focus on three of the areas
that the legislation covers: first, legal certainty for OTC
derivatives; second, regulatory relief for U.S. futures
exchanges; and third, of course, repeal of Shad-Johnson
restrictions on the trading of single-stock futures.
In its November 1999 report, the President's Working Group
concluded that OTC derivatives transactions should be subject
to the CEA only if necessary to achieve the public policy
objectives of the act, deterring market manipulation and
protecting investors against fraud and other unfair practices.
In the case of financial derivatives transactions involving
professional counterparties, the Working Group concluded that
regulation was unnecessary for these purposes because financial
derivatives generally are not readily susceptible to
manipulation and because professional counterparties can
protect themselves against fraud and unfair practices.
Consequently, the Working Group recommended that financial OTC
derivatives transactions between professional counterparties be
excluded from coverage of the CEA.
The Federal Reserve Board continues to support the Working
Group's conclusions and recommendations. Thus, it supports the
exclusions of OTC derivatives from CEA that are included in S.
2697 because with a few exceptions that appear readily
resolvable, they are consistent with the Working Group's
report.
The Working Group did not make specific recommendations
about the regulation of traditional exchange-traded futures
markets that use open outcry trading or that allow trading by
retail investors. Nevertheless, it called for the CFTC to
review the existing regulatory structures, particularly those
applicable to financial futures, to ensure that they remain
appropriate in light of the objectives of the CEA.
The Federal Reserve Board supports the general approach to
regulation that was outlined in the CFTC's recent proposals.
For some time the Board has been arguing that the regulatory
framework for futures trading, which was designed for the
trading of grain futures by the general public, is not
appropriate for the trading of financial futures by large
institutions. The CFTC's proposals recognize that the current
''one-size-fits-all'' approach to regulation of futures
exchanges is inappropriate, and they generally incorporate
sound judgments regarding the degree of regulation needed to
achieve the CEA's purposes.
Furthermore, the Board generally supports codification of
the CFTC's proposal so as to provide the exchanges with greater
certainty regarding future regulation. However, the Treasury
Department is concerned that the exempt board of trade
provisions might have unintended consequences that could reduce
the effectiveness of the existing regulatory framework for the
trading of government securities. To facilitate expeditious
passage of legislation, it thus may be prudent to limit the
codification of the exempt board of trade provisions, at least
so that markets currently regulated under the Government
Securities Act of 1986 are not affected. In such a scenario,
the CFTC could address any unintended consequences for the
regulation of government securities by changing the terms of
its exemptions.
The Working Group concluded that the current prohibition on
single-stock futures, part of the Shad-Johnson Accord, can be
repealed if issues about the integrity of the underlyng
securities markets and regulatory arbitrage are resolved. The
Board believes that S. 2697 provides an appropriate framework
for resolving these issues. Such instruments should be allowed
to trade on futures exchanges or on securities exchanges with
primary regulatory authority assigned to the CFTC or the SEC,
respectively. However, the bill recognizes that the SEC should
have authority over some aspects of trading of these products
on futures exchanges. The scope of the SEC's authority can and
should be resolved in negotiations between the CFTC and the
SEC. The Congress should continue to urge the two agencies to
settle their remaining differences so that investors have the
opportunity to trade single-stock futures.
If it would facilitate repeal of the prohibition, the
Federal Reserve Board is willing to accept regulatory authority
over levels of margins on single-stock futures, as provided in
the bill, so long as the Board can delegate that authority to
the CFTC, the SEC, or an Intermarket Margin Board consisting of
representatives of the three agencies.
The Federal Reserve Board understands that the purpose of
such authority would be to preserve the financial integrity of
the contract market and thereby prevent systemic risk and to
ensure that levels of margins on single-stock futures and
options are consistent. The Board would note that for purposes
of preserving financial integrity and preventing systemic risk,
margin levels on futures and options should be considered
consistent, even if they are not identical, if they provide
similar levels of protection against defaults by
counterparties.
This bill reflects a remarkable consensus on the need for
legal certainty for OTC derivatives and regulatory relief for
U.S. futures exchanges, issues that have long eluded
resolution. These provisions are vitally important to the
soundness and competitiveness of our derivatives markets in
what is an increasingly integrated and intensely competitive
global economy. The Federal Reserve Board trusts that remaining
differences regarding single-stock futures and the potential
application of the securities laws to OTC derivatives can be
resolved quickly and this important piece of legislation can be
expedited through this Congress.
Thank you very much, Mr. Chairman.
[The prepared statement of Mr. Greenspan can be found in
the appendix on page 66.]
The Chairman. Thank you very much, Chairman Greenspan.
We have been joined by Senator Sarbanes, the Ranking Member
of the Banking Committee. As the Chair announced earlier, the
Ranking Member will be recognized for an opening statement and
then we will proceed with a round of questions for the
witnesses.
Senator Sarbanes.
STATEMENT OF HON. PAUL S. SARBANES, A U.S. SENATOR FROM
MARYLAND, RANKING MEMBER, COMMITTEE ON BANKING, HOUSING, AND
URBAN AFFAIRS
Senator Sarbanes. Mr. Chairman, thank you very much.
I will really forego an opening statement except simply to
observe that this is a very complex issue and I think we have
to proceed with considerable caution and when I have my
question period, I will have an opportunity, I think, to pose
some questions to the secretary and the Chairman in this
regard.
I think we have to work extra hard at trying to get the
regulators, who are, after all, the experts in this area upon
whom we rely, to see if they can reach a consensus on how they
would recommend proceeding with respect to these important
questions.
Thank you very much.
The Chairman. Thank you very much, Senator Sarbanes.
We will have questions now. I will ask that Senators stay
within a 5-minute limit. I will ask questions. I will then
defer to Chairman Gramm, then to the distinguished Ranking
Members--Mr. Harkin, Sarbanes--and then we will alternate back
and forth, republican and Democratic Senators as they have
appeared.
Secretary Summers and to some extent Chairman Greenspan has
reflected this, in a comment that you make on page 5 of your
statement you say, ``To be clear, there are provisions of the
bill as currently drafted which could have the perverse
consequences of creating the situation where protections that
are present with respect to off-exchange trades would not be
present with respect to transactions that took place on the
exchange. These matters have particular importance with respect
to the integrity of government securities markets.''
Could you amplify that somewhat more? That general point of
view of the Treasury, which has been fairly well known in the
securities markets for the past week or so, has brought
considerable consternation and I would like for you to explore
that more in your testimony.
Secretary Summers. Let me just say that I think this is an
important but somewhat limited issue in the following sense. We
are supportive of the broad program that Chairman Rainer has
laid out for deregulation. We are supportive of the pillar of
that broad program, which is the idea of exemption for boards
of trade.
Our difficulty comes from what is almost a drafting
question. In the way the legislation is drafted, it appears to
us to allow participants in the exempt boards of trade to avoid
the kinds of rules that we have had in place with respect to
the Government securities market.
You will recall that there was a major episode a decade ago
in which one major firm was involved with an excessive share of
a number of different Treasury auctions, subjecting the market
to possible manipulation. It is our intent and our desire only
that nothing in this legislation preclude the effective
enforcement of those provisions with respect to the Government
securities markets.
And my understanding is that there has been considerable
discussion among the affected parties and I think there is a
feeling that it is possible to find language that would address
our particular and quite narrowly focused concern, which does
not go to the desirability of regulatory relief for futures
trading, but only goes to the question of whether or not it
would be possible to avoid restrictions that are in place with
respect to cornering and the like in the Government securities
markets by trading on one of these exempt boards of trade.
The Chairman. I thank you for that response and I raise the
question knowing that there have been considerable efforts on
the department's behalf with exchanges with other parties to
try to clarify this language. I think Senator Gramm and I share
the thought that the greatest hope we have with this
legislation is that you and Chairman Greenspan and others are
still working with us. This is a work in process because these
clarifications are important.
This legislation might last for a long while and it would
be difficult to get everybody concentrated again, so we want to
do it right. But we appreciate the flexibility that you have
already demonstrated and I simply wanted to offer that thought.
Mr. Greenspan. Mr. Chairman, if I may, I think it is
important to emphasize, as the Secretary has just done, that
this is a very narrow technical amendment. It is not
questioning the usefulness, the potential usefulness of the new
board of trade vehicle. There are many different types of
usefulness of that vehicle and we certainly at the Federal
Reserve Board see advantages in it.
This is a very narrow issue which we fully subscribe to the
Treasury's position on and would like to see some amendment to
this particular provision to take care of the Treasury's
concerns.
The Chairman. Well, we look forward to working with you on
that language and your proposal would be welcome.
Let me just initiate a subject I suspect that Chairman
Gramm will get into further. With regard to legal certainty, we
have talked about legal certainty that arose from the so-called
Concept Paper on Swaps that the CFTC was responsible for, so we
have tried to settle that over there.
Now Chairman Gramm has raised the question, ``Well, what
about legal certainty with regard to the SEC in this sort of
situation?'' This seems to have kicked off tremors in various
directions.
Let me just say that what is sauce for the goose is sauce
for the gander. I share Chairman Gramm's thought that we need
to explore really where we are headed with regard to legal
certainty. It may have started in one agency but has picked up
other problems somewhere else.
Why has this become an element of such consternation?
Because obviously it is and your testimony, you mention this,
Secretary Summers, as a point of considerable concern.
Secretary Summers. Let me make three points, if I could. I
will preface them by saying that having spoken with Chairman
Gramm about this, my impression is that there are not
fundamental differences that cannot be bridged on this
question.
The Chairman. Well, that is reassuring.
Secretary Summers. Having said that, let me make three
points.
First, there is, I think, an asymmetry that we need to be
clear about between the securities law issues and the
commodities law issues and that is that were these to be
subject to the commodities law, there is the possibility that
past contracts that have been entered into would be unwound and
would not be legally binding. That is why we speak about legal
certainty.
There is no parallel feature of the Securities Act that
would enable or create any possibility or nexus for past
contracts to be unwound and that is why those who have been
concerned with the legal certainty question have, until it was
recently introduced into the discussion, been focused on the
commodities issue and not focussed on the securities issue.
Second, there is nonetheless, in our judgment, a valid
objective of responding to some of the kinds of concerns that
Chairman Gramm articulated in his earlier statement that we
cannot be assured that the prudent forbearance that the SEC has
exercised with respect to these issues in recent years will be
a permanent state of affairs.
And therefore it may be appropriate for there to be
legislative clarification that the intent of the OTC legal
certainty is not to shift jurisdiction from one agency to
another but, for the reasons that the Chairman articulated in
his testimony, involving the fact that it is professional
counterparties who are involved with one another, to provide
for a structure in which these transactions would not be
subject to extensive regulation. We recognize that as a
legitimate and appropriate legislative purpose, even if one
that is not perfectly parallel with the commodities case.
The third point though, and the point that I must say, Mr.
Chairman, we feel strongly about is that there are a number of
types of issues that the securities law provides that are not
issues that are covered by the commodities law where we believe
it is very important to continue to maintain protection.
To take what may be the easiest example to explain:
functionally, through a total return swap, one can do something
that is the equivalent of purchasing a share of stock. It would
not, in my judgment, be an acceptable outcome for an individual
who had benefitted from insider information and who would be
legally prohibited from buying a stock or buying an option to
be able to engage in a total return swap that was the
functional equivalent of buying that stock.
Insider trading, fraud, manipulation, and possibly where
there is a demonstrable link, questions of retail protection,
it seems to us need to continue to be subject to regulation,
not so as to extend some net of regulation to OTC derivatives
in a way that they are not now subject to regulation, but only
to assure that the basic protections we provide in our cash
markets do not become circumvented through this legislation.
And it seems to us that the valid and important objective
of clarifying with respect to the future the limits of
regulation in this area can be achieved while, at the same
time, respecting the very necessary functions the regulation
has to perform.
The Chairman. Thank you very much.
Senator Gramm.
Senator Gramm. Thank you, Mr. Chairman.
Let me first say, Mr. Secretary and Mr. Chairman, I do not
think there are substantive differences as to what we want to
do and what you are concerned about.
The best thing you could do about the Government securities
is write the language you need and give it to us so that we can
put it in the bill and solve that problem. If it creates other
problems, obviously we can work them out. But we are in a happy
time when government borrowing is diminishing, we do not know
how long that is going to last, and we want the Government to
be able to borrow when it needs to do so.
Our whole focus to this point on legal certainty has been
related to the CFTC and its jurisdiction because it was always
believed that if someone was going to claim jurisdiction over
swaps, it would be the CFTC. If they asserted jurisdiction, as
we all know from that very unhappy period when they were trying
to do so, then the potential existed of contracts on swaps
being deemed unenforceable because they were traded off the
exchange.
But what I am concerned about is the totally different
environment where the CFTC has been banned from exercising any
jurisdiction, in essence, creating what some regulation
innovator would see as a no-man's land, and I would see as
freedom but some regulator would see as a no-man's land. An
innovative SEC might step in and say, ``well, swaps are
securities and therefore this swap is illegal because the
security was not registered with the SEC, because the security
did not meet our disclosure requirements.''
We can deal with the anti-fraud concern and the insider
trading concern, but we need this dual protection. I agree with
the Chairman that we need to work together because in an
election year, the only way anything can or should become law
is if it is bipartisan and is supported by the administration
and Congress.
So if we want to do this, we have to work it out, and I do
not see any insurmountable differences. I would like to ask
both of your staffs to look at this concern about potential SEC
action in the future.
Let me just ask one question that is not related to this,
but I ask because it is a simple yes or no answer, but you can
elaborate in the time I have left if you want to.
Recently there has been a proposal by the FDIC and a lot of
clamoring in the banking industry to raise the FDIC insurance
from $100,000 to $200,000 per account. Having lived through the
S&L debacle and having seen it first-hand in my state, I have
been very reluctant to support this because it represents to me
a shifting of risk from the investor to the Government and
ultimately to the taxpayer. And I remember that era of brokered
deposits, and knowing now that we have Internet banking, this
is something that I am concerned about.
I know that you all have looked at it and I just wanted, in
a simple, straightforward way, to see what you think about the
proposal to raise the insurance limit to $200,000.
Secretary Summers. The Chairman and I have discussed this
and I believe we have similar views but I guess we will soon
see.
We believe that such an increase would be ill advised and
would represent a serious public policy error that would
potentially increase systemic risk by eroding market discipline
and it is not, in our judgment, necessary in order to protect
small savers. So it is not a change that we would support.
Mr. Greenspan. I agree with that, Mr. Chairman. Let me just
say that there is no question arithmetically that if one looks
at the change in consumer prices since 1980 when the original
$100,000 ceiling was instituted that for purchasing power
parity with the original $100,000 change, it would require a
very significant increase.
However, I think that most economists would look back at
that $100,000 number and say it was a mistake, probably a bad
mistake.
If you go back to the $40,000 change when, in the fall or
late part of the year 1974, the ceiling was raised from $20,000
to $40,000, and then ask what is the purchasing power of that
as of today, it is just a little more than $100,000. So in that
regard, one can very readily see that the problem really gets
back to a judgment as to whether the move from $40,000 to
$100,000 was the correct move and I think, in retrospect, that
the evidence very strongly indicates that it was a mistake and
for very much the reasons that Secretary Summers argues.
We are in the process now, driven largely by technology, of
very dramatically expanding the domestic and international
financial system and it is very important that our market
processes are sound and that they are not distorted
inordinately by a subsidized structure in the financial system.
And, as a consequence of that, I think it is quite
important for all of us to be certain that if we want the
really quite extraordinary developments in the financial
system, which is what we are discussing today, to effectively
assist in what is a change in the world economy and
specifically in the United States, where standards of living
are rising in a way which we have not seen for a very long
period of time, and where we have had an economy which is being
supported by a very increasingly sophisticated financial
system, we want to be certain that, the market safeguards of
that system are not undercut.
And it has been the experience of the Federal Reserve and,
I believe, all the remaining banking regulators, and I presume
the Treasury Department, as well, that the necessity of having
a fully functioning market pricing structure as a means for
containing risk is crucial to the system.
We regulators cannot conceivably substitute for the
effectiveness of containing risk that counterparty judgments
within the market create. It is not even a close call. Anything
that we can do to sustain and enhance the viability of
counterparty surveillance and the accordingly important
strengthening of the financial structure that ensues as a
consequence of that, we should endeavor to do.
Increasing that is, doubling--deposit insurance--which
essentially would be giving increased subsidies to upper income
individuals almost by definition, is, in my judgment, a
mistake.
There is a problem, however, which is associated with this
issue, which is discussed mainly with regard to the clear
difficulties that our community banks are having with regard to
maintaining core deposits as a consequence of a very dramatic
increase in mutual funds, money market mutual funds, and the
capital markets expansion itself. And they understandably are
looking for means by which they can get an increased degree of
liability support, if I may put it that way.
I certainly sympathize with their concerns and the
community banking system is a very important vehicle in this
country and I think something which is crucial to the dual
banking system, which I, as you have known before, very
strongly support.
I do think, however, that other means to solve that
particular problem must be found. To employ a major change in
the underlying financial structure creating weakness in that
underlying financial structure for the purpose of resolving a
real problem, but a different type of problem, in my judgment,
would be a major policy mistake.
Senator Gramm. Thank you, Mr. Chairman.
The Chairman. Thank you very much, Senator Gramm.
Senator Harkin.
Senator Harkin. Thank you, Mr. Chairman.
I would like to focus my remarks and questions on this idea
of a level playing field and what this legislation might do to
that. Early on, the futures exchanges, as we started this
process several years ago, were concerned that regulatory
relief for the swaps would put them at a disadvantage. So the
futures exchanges sought relief and that is basically what this
bill provides in that regard.
Summarily, Shad-Johnson, if relief is provided for single-
stock futures trading, raises questions about the level playing
field for other market participants, namely the stock options
markets. So again it raises the general question, I think, of
the levelness of the regulatory playing field and I think that
is an important question for us and overall to the functioning
of our U.S. markets.
So I would ask both Chairman Greenspan and Secretary
Summers again to once again enlighten us on approaching these
questions of a level playing field, whether on Shad-Johnson or
in other areas, like swaps versus on-exchange transactions, or
electronic versus the traditional exchange markets.
Most of the input that I have had from people in these
fields has been along those lines. They are concerned that what
we do is going to skew it one way or the other. One will be
advantaged and one will be disadvantaged. And I just need some
enlightenment on that.
Secretary Summers. We have sought in the President's
Working Group recommendations and commenting on this
legislation to achieve exactly the principle that you stressed,
Senator Harkin, of a level playing field.
The original rationale, as you know, was legal certainty in
the OTC area. In my judgment, the suggestion that if one was to
provide legal certainty that a level playing field required
certain changes in the regulations regarding the exchanges was
valid and appropriate. And, as I indicated, the suggestions
that Chairman Rainer and his colleagues at the CFTC have put
forward seem to us to be very much broadly in the right
direction and to be leveling the playing field and subject to
the relatively minor concern around the board of trade--minor
but crucial, I hasten to say--concern that I highlighted. They
seem to us to be broadly appropriate, and I think there is a
good case for them being embodied in law and not just in
regulations.
So I think we are doing a good job on the level playing
field area in that dimension.
I think that if I might, the playing field slopes in many
different dimensions in the single-stock futures area and so
far, a universally agreed definition of a level playing field
has been illusive, precisely because you have the consideration
of the cash market, you have the consideration of the single-
stock futures market, you have the consideration of the options
market, you have the reality that much of this is going to be
traded overseas in any event.
So I cannot tell you that a formal agreement has been
achieved in the Shad-Johnson area that is universally
recognized to represent a level playing field.
What I would suggest to you, however, is that it is, I
think, very unfortunate for the financial system if the
continuing debate over the precise definition of a level
playing field with respect to Shad-Johnson is to preclude us or
delay us from achieving legal certainty with respect to OTC
derivatives. And any of a variety of possible resolutions of
the Shad-Johnson issues, in conjunction with legal certainty,
would be in the Nation's interest relative to no movement
forward on legal certainty because of the outstanding Shad-
Johnson issue.
That is why I very much would join the Chairman's support
for the Congress's encouraging the parties to reach a mutually
satisfactory resolution, but in any event----
Senator Harkin. We have been trying that for a long time.
Secretary Summers. But in any event, not holding legal
certainty hostage to the resolution of the Shad-Johnson issue.
Mr. Greenspan. Senator, obviously I think the issues you
are raising are crucial and they are very simple to state and
very difficult to implement. Level playing fields,
unfortunately, are too often in the eyes of the beholder and
with one tilt in an Einsteinian way, it looks like another tilt
if you are coming from another direction.
There are a number of practical issues here which really
get down to, for example, margins. Margin requirements in
commodity exchanges are markedly lower than they are in general
for stocks and here I think there is a legitimate concern about
the issue of competitiveness, but it is very important to
distinguish between consistent margins and the same level of
margins.
Margins basically should be constructed in a manner to
protect counterparties against default or nonpayment. And in
the commodities business or in the commodities markets, where
there is a far more rapid payment of cash when prices move--
more exactly, when margins are readjusted very much more
quickly in the commodities markets in general and obviously
under those conditions, if you have a number of margin calls
during the day, which you generally do have on many occasions,
and they get paid, that clearly is an issue of having lower
margins than would necessarily be the case in securities
markets.
And how things are cleared and how things are basically
managed can differ quite significantly from one system to
another and yet competitively, they can turn out to be very
close to being identical.
I think at the end of the day we will only be able to tell
whether there are real playing field differences if we, for
example, see actual differences in markets as, for example, we
have seen a significant shift from exchange-traded derivatives
to over-the-counter derivatives and that is suggestive of the
fact that clearly there is far more regulatory burden imposed
on the exchanges because that is the reason that is often given
as to why a goodly part of businesses that could go in either
direction would tend to go over the counter.
In that case, you can see what the problems are and you can
address them as indeed they are addressed in this bill. But to
make ex ante judgments about levels of margins, merely looking
at the absolute percentages, is insufficient to make a judgment
as to whether they are consistent and indeed competitive.
Senator Harkin. I see my time is up but it just seems to me
that in the futures exchanges, where we have always had to
clear our margins on a daily basis, and if you have another one
on the option where you do not, then it skews it one way or the
other, it seems to me.
Mr. Greenspan. And it can be adjusted, however, by having
different levels of margins, and that is indeed what does
happen.
Senator Harkin. That may be true, yes. That is what you are
suggesting we do, perhaps?
Mr. Greenspan. Senator, that is actually what they do. And
the question I think we have to make a judgment on, is whether
the margins that are imposed by securities firms and/or
exchanges and commodity firms and/or exchanges are consistent.
And all I am saying is that is not the same statement as they
are identical.
Senator Harkin. Thank you, Mr. Chairman.
The Chairman. Thank you very much, Senator Harkin.
Senator Sarbanes. Thank you very much, Mr. Chairman.
Chairman Greenspan, in his statement, Secretary Summers
observes that the bill provides a broad exclusion from the
securities laws for swaps, including, in particular, swaps
based on securities. He then goes on to say, ``As a general
matter, we do not believe that swaps should be regulated as
securities. However, it is important to preserve prohibitions
against insider trading, fraud, and manipulation and also to
preserve other measures which are demonstrably necessary to
protect retail customers.''
I take it you agree with that position?
Mr. Greenspan. I do indeed, Senator.
Senator Sarbanes. I would like to ask both of you, what are
the risks of implementing the language as currently drafted in
the legislation?
Secretary Summers. I think this is an issue that is easily
remediable but nonetheless needs to be remedied because I think
the language as currently drafted would at least raise the
prospect of substantial evasion of existing predications with
respect to insider trading, with respect to fraud and with
respect to market manipulation and thereby could undermine the
integrity not just of the OTC derivatives markets but also of
the underlying markets with which they are arbitraged.
So as drafted, we would have very great concerns about the
language.
We do believe that the objective which we believe was
sought in drafting the legislation, which is to clarify that
the objective here is deregulation rather than a shift of
regulatory jurisdiction, is an objective that can be achieved
without compromising these critical objectives.
As we suggested earlier, I think we can all work together
on language that would achieve that objective, but the bill as
we understand it in its current form would, without amendment,
potentially pose a real risk to the integrity of financial
markets.
Senator Sarbanes. Mr. Chairman, do you want to add to that?
Mr. Greenspan. I would only like to say, Senator, that this
problem of the definition of swaps and securities I think is
getting us tangled up in verbose language.
I had a chance to read the legal definition of a security
that is in the 1933 and 1934 acts and I will tell you I
appreciate the difficulties that lawyers have in this world. I
defy anybody to read it and come up with a reasonably good
judgment of what it says.
Swaps are even worse. Not only are they difficult to define
but after you have defined them, you will find that everyone
has a different view of what constitutes a swap.
I think that what is important here is for the Congress to
look at the fundamental structures of the markets with which we
are dealing, try to make a judgment of what the appropriate
regulatory structure is, one, as Senator Harkin has said, that
creates a level playing field and also, as he talked in terms
of the integrity, safety and soundness of markets, which I
think is a very important issue with respect to the
competitiveness of the United States in the world markets.
I think that we should do that in trying to make judgments
of what is appropriate and try to eliminate this particular
detailed discussion of whether something is a swap or it is a
security, and therefore if it is a security, something should
happen; if it is a swap, something should happen. I think this
is a very difficult type of issue to get involved in and I am
afraid we are getting tangled up in language, and the issues
are very difficult as they are. If we are going to have those
types of problems, we are not going to get an effective
resolution of this issue.
Senator Sarbanes. That would suggest, in view of your
previous answer, that we should focus on insider trading,
fraud, manipulation, and make sure that any possibility for
those practices to take place is precluded under the regulatory
scheme. Would that be correct?
Mr. Greenspan. Exactly, Senator.
Senator Sarbanes. I think the President's Working Group on
Financial Markets was an important initiative and I know the
legislation contains a number of the recommendations that came
forward from the group, which represented a consensus judgment
by the group, unanimous, as I understand it.
My question is, what do you see as the prospects on those
remaining outstanding issues on which a consensus has not yet
been reached within the Working Group but which are resolved
one way or another in the legislation? If we continue to press
the Working Group to continue its discussions and
consultations, would they be able to come up with a consensus
position?
You have been involved in that byplay back and forth. What
are the prospects?
Secretary Summers. With the exception of Shad-Johnson and
possibly with the exception of the securities question that we
have been discussing, I believe the Working Group has
essentially agreed on all important aspects of this legislation
and that you could have full agreement on this legislation.
I believe with respect to the securities question, I would
not want to be in the position of speaking for the SEC and the
CFTC but I think you have seen the Chairman and I have
essentially identical positions with respect to that question.
With respect to Shad-Johnson, I would not want to
confidently predict that there would be a conclusion. It is an
issue, unlike some of the other issues, that is a very crucial
issue for two members of the Working Group--the SEC and the
CFTC. And my understanding is that they have worked in very
good faith to try to reach common ground and have not yet
succeeded.
I suspect that I speak for the Chairman in saying that we
are very much prepared to do anything we can do to facilitate
reaching an agreement and I thought that the Chairman's offer
in his testimony that the Federal Reserve would be prepared in
a variety of different formulations to become involved with
margin requirements for single-stock futures, if that would be
facilitating of an agreement, was a constructive and valuable
step. But I do not think I can honestly predict for you with
great optimism that an agreement will be reached in the near
future.
I would repeat the judgment that the Chairman and I both
expressed earlier that any of a variety of possible resolutions
that pave the way to the passage of this legislation would be
better than no resolution and a continuing risk to legal
certainty.
Mr. Greenspan. I might just add that in a certain sense, if
Shad-Johnson is not revised in a manner which is to the
interests of the American regulatory structure, it is going to
get revised for us because there is just little question in my
judgment that we are not all that far away from single-stock
futures on U.S. stocks trading in other countries. And if we do
not resolve this issue, Shad-Johnson will get resolved but not
in a manner which I think would be desirable for any of us.
I have worked with many SEC and CFTC Chairmen. I have never
had the pleasure of, as some of you have mentioned, working
with two committed individuals of the types we now have in
those chairmanships. If they are having trouble with this
issue, it is because it is a very difficult issue to meld very
complex regulatory structures.
My concern is that if they cannot get it resolved and we
cannot get it in a legislative vehicle, that the issue is going
to get resolved for us but not in the way that we would like it
to happen.
Senator Sarbanes. Mr. Chairman, I just make the observation
that not too long ago we were working in the Banking Committee
on an important piece of legislation and they said, ``Well, you
will never get the Treasury and the Federal Reserve to reach an
understanding on that issue.'' And in the last analysis, they
did reach an understanding, which was an important breakthrough
in moving that legislation forward. So, if we keep working at
this, maybe we can get it resolved. Thank you very much.
The Chairman. I thank you, Senator Sarbanes, for your
question and likewise both of you for your response. I will
just editorialize before I recognize my colleague that we
really are at the heart of the matter.
Without being chauvinistic, we are Americans talking about
United States markets and it is inconceivable that however
learned people are in various agencies, they cannot come to
some agreement.
Now, we are attempting to facilitate that, I think calmly.
Senator Gramm and I are not hysterical about the issue but we
are determined. This is very, very important for our country
and both of you have testified amply to that this morning in a
very technical way.
STATEMENT OF HON. PETER G. FITZGERALD, A U.S. SENATOR FROM
ILLINOIS
Senator Fitzgerald. Thank you very much, Mr. Chairman, and
I thank both of you for testifying today.
Mr. Greenspan, I appreciate your comments about Shad-
Johnson and I wholeheartedly agree with you. If we do not
repeal Shad-Johnson, we are going to be confronted with foreign
nations that are offering individual stock futures on our
American companies. I think if we can put a man on the moon, we
can repeal Shad-Johnson and get an agreement between the SEC
and the CFTC.
Mr. Greenspan, maybe you could elaborate on how the
regulators cooperate in the banking industry. We actually have
many more regulators in the banking industry than just the two
we are talking about here--the CFTC and the SEC. You have state
banking examiners examining state banks. Across the street from
a state bank in Main Street, U.S.A. there is typically a
national bank that is regulated by the OCC. Both of them, if
they offer FDIC insurance, are subject to the regulation of the
FDIC. If they have holding companies, they are monitored by
you.
Now, I notice in Mr. Levitt's testimony, reading ahead,
that he objects to provisions in this bill that require the
SEC, before taking enforcement action, to ask permission of the
CFTC. Now I do not know if any of the banking regulators, such
as the FDIC or the OCC, would have to ask permission of other
regulators if they wanted to take an enforcement action.
However, I do think that they commonly notify other regulators
as a matter of course. I do not get the impression that, that
slows down the enforcement very much.
Would you care to comment on that?
Mr. Greenspan. Yes, Senator, I think that is quite correct.
One of the vehicles that we have is an organization of all of
the regulators in which we work together in a fairly formal
systematic way. And over the years we have recognized the
various problems that inevitably arise when you have a dual
banking system, multiple regulators, and the system will either
work or it will not work. And if it will not work, what is
going to happen inevitably is clearly the Congress is going to
decide to run a single regulator bill through both houses of
the Congress and it will get passed very readily and the issue
will be resolved, frankly, to the detriment of the system.
I think that to have different regulators effectively
competing in many respects and jointly endeavoring to come up
with new ideas as to how to integrate regulation into the
market structure to get maximum efficiency has been a very
effective tool of the American regulatory system.
And I think that, despite the fact that there are
inevitable significant disagreements, and there are
unquestionably unbelievable delays in getting agreements on
certain issues, nonetheless, at the end of the day, it works.
Senator Fitzgerald. What is your super regulatory body
called?
Mr. Greenspan. It is the Federal--my problem is I have so
many acronyms in my head, I cannot unleash----
Senator Fitzgerald. Did that come in after the FIRREA
legislation or after the S&L?
Mr. Mattingly. Senator, it is Federal Financial
Institutions Examination Council and it goes back to about
1978.
Senator Fitzgerald. 1978, okay.
Mr. Greenspan. That is Virgil Mattingly, our General
Counsel, and you can see why we find him a significant source
of insight.
Senator Fitzgerald. Well, maybe the SEC and the CFTC could
just jointly put some task force together with members from
both regulatory bodies just so that they have ongoing
communication. That would seem to make sense to me.
Well, in the interest of time, I will yield to some of my
colleagues for further questions.I thank you for that positive
encouragement about how it works in banking.
[The prepared statement of Senator Fitzgerald can be found
in the appendix on page 50.]
The Chairman. Thank you very much, Senator Fitzgerald.
Senator Kerrey.
STATEMENT OF HON. J. ROBERT KERREY, A U.S. SENATOR FROM
NEBRASKA
Senator Kerrey. Mr. Chairman, first of all, I want to thank
both you and Chairman Gramm for holding this hearing and I hope
it leads to a mark-up of the bill.
It seems to me the challenge of the Committee, and I put
this to both Secretary Summers and Chairman Greenspan, the
challenge for both of the Committees is that we have to
separate out those concerns raised by individuals who simply do
not want to compete because, at the end of the day, this is
about money and that is why this room is full of people; this
is about money and it is about jurisdiction that controls who
gets to regulate.
And you can see it in the pattern of lawsuits over the last
25-years, initiated in the early 1970s. In fact, there has been
a pattern. It starts with a lawsuit filed in 1975, resolved in
favor of the CFTC. That led to Shad-Johnson. Another lawsuit
filed in 1992. That leads to another piece of legislation.
And then the most recent lawsuit filed after the SEC
objected under 2(A)(1)(b) of the CEA, to an instrument that was
being traded on the Chicago futures in a Dow-Jones utility and
transportation index. So they have objected. That is in court
and still not settled. So I do not know; maybe there is a case
to be made that we should wait until this lawsuit gets settled.
I would not, Mr. Chairman, because I think we have to
separate, and I put it to you gentleman, it seems to me we have
to separate out those concerns that are just about money and
control from those legitimate concerns having to do with what
has been raised on several occasions--risk to investors, and so
forth, including, by the way, one additional risk that was
raised after the stock market crash. The SEC claimed that one
of the reasons the stock market crashed in 1987 and perhaps
again as a consequence of concerns for making a case so they
could continue to control, that it was stock market indexes
that caused the crash. Trading and speculating in stock market
indexes, the SEC argued in 1987, caused that crash.
So I would ask you, it seems to me that we did that. This
committee heard concerns that there was regulatory uncertainty
having to do with swaps and other instruments. They were being
offered, derivative instruments, offered OTC. And we listened.
We had hearings on it and we listened to all the concerns. It
was a hot issue and I think the Agriculture Committee did a
pretty good job of sorting out and coming up with a
recommendation that would create regulatory certainty, as well
as the other piece of our legislation that codifies a lot of
the regulatory changes that CFTC has put in place.
And it seems to me that we ought to do the final thing with
these stock indexes, the stock future instruments that are
being proposed. They were proposed first by the CFTC,
challenged now in court. A, we have to decide, do we want to
wait for the court to make a decision, or do we sort of take it
into our own hands and try to decide on our own? And I would
argue the latter, frankly, that we ought to try to separate out
where we think a case is being made in a legitimate way and
where a case is being made in an illegitimate way that these
instruments should not be allowed to be traded.
So I would just ask--seek your advice on this. Do you think
we should wait for the court to make a decision or do you think
we should, in our best judgment, now that the two chairmen have
gotten us together, and some have argued that it is about money
on our side, as well, that we are concerned about losing
jurisdiction between the Agriculture and Banking Committee. I
have personally never seen any evidence of that but maybe it
exists, in fact, back in the old days.
Would you recommend that this committee take action to try
to resolve this most recent conflict that is being raised over
individual stock futures?
Secretary Summers. I basically share the impulses behind
your question, Senator Kerrey. I do not think that waiting
until particular lawsuits have wended their way through the
courts is a good way to make public policy in this area. I
think case-by-case litigation is probably, as a general
proposition, a poor way to make public policy in this type of
issue, first. And second, as both the Chairman and I have
stressed, we think that it is important that the legal
certainty issue not be delayed with respect to the Shad-Johnson
issue.
So, as I have said several times now and just to make the
point clear, any of a number of possible approaches that this
bill could take to Shad-Johnson in conjunction with legal
certainty would be better than this bill not moving forward
because of Shad-Johnson.
To be sure, one of those approaches would be simply not
treating the Shad-Johnson issue within this legislation and
leaving it to other legislation. Another possibility would be a
number of different possible resolutions of this issue. But I
think the point on which, if I can speak for him, also, the
Chairman and I feel most strongly is that it would be terribly
unfortunate if the debate over Shad-Johnson were just to
continue in a way that delayed resolution of the Shad-Johnson
question----
Senator Kerrey. I must respectfully disagree. We resolved
the one conflict and this is basically the CFTC and the SEC
fighting this thing out. That is what is going on here. We are
concerned about risk about insider trading, fraud,
manipulation, leverage and risk and potential temptation of
stock manipulation. We will factor all that into consideration
but at the end of the day, the SEC and the CFTC, they are going
to go into court and fight this thing out.
So we figured the one out, the derivative issue, the Ag
Committee figured that out, but now we have another issue that
is being raised on behalf of the SEC filing a lawsuit against
the CFTC. So on behalf of the Ag Committee and the CFTC, I have
to say that we have to do both of them together.
And if we were able to sort out and figure out what is best
for the consumer and what is best for financial risk, it seems
to me we ought to be able to do it on this issue, as well, and
we should before we move a piece of legislation.
Secretary Summers. It would certainly be very desirable to
achieve. It would certainly be very desirable----
Senator Kerrey. All the issues having to do with insider
trading, fraud, manipulation, leverage and risk and the issues
that Senator Gramm raised about having differentials in
margins, the insider trader issues that are different between
the SEC and the CFTC, all these, the tax problems, we have high
enough IQs to figure this out and it seem to me that we ought
to figure it out and we ought to include it in the legislation.
Mr. Greenspan. Senator, I think, without commenting on the
particular suit that you are raising, in this type of issue it
is a mistake to leave it to the courts to decide. The reason
basically is that what we are dealing with at this point is a
changing economy and the changing necessary regulatory
structure that would be required with it.
The courts, of necessity, are required to reach judgment on
existing statute and on existing precedent and indeed, what
they are effectively measuring is the judgments that the
Congress made in an earlier period. And it strikes me that it
is terribly important when dealing with an issue such as this
in a rapidly evolving financial industry that the Congress
should address it from scratch in a sense, to take a look at it
de novo and make judgments of an appropriate type to determine
what is the structure because there is no way that the courts
can do that; nor should they. They are there for a
fundamentally different purpose and to abandon a decision of
this nature to legal issues, in my judgment, is a mistake.
Senator Kerrey. I agree. Or to wait until we have put
another man on the moon. The last time we put a man on the moon
was before Shad-Johnson. That is the other thing we could do.
We could wait for another man to arrive on the moon and do this
thing.
I agree with you, Mr. Chairman. It seems to me that we have
enough information, we have good enough judgment that we ought
to be able to figure this thing out and we should. And I
personally would object to saying well, we will do the
derivatives, along with codifying the changes that the CFTC has
made in the regulation, but we are not going to resolve the
single-stock issue. We can do that, as well, and I think we
should.
The Chairman. Thank you very much, Senator Kerrey.
Let me just comment that Senator Kerrey deserves
congratulations, along with our colleague, Senator Roberts.
They were major proponents of a crop insurance risk management
bill that this committee worked on--tremendously complex
issues. And with our House components, the president signed the
legislation yesterday. It was not well heralded but it should
have been because it is a genuine achievement in a year in
which not much legislation is occurring that is complex and
that crosses a lot of boundaries.
So when the Senator from Nebraska speaks, we all listen and
he is energized this morning. I am grateful that, that is so.
STATEMENT OF ROBERT F. BENNETT, A U.S. SENATOR FROM UTAH
Senator Bennett. Thank you, Mr. Chairman.
I do not have the technical background to challenge any of
the discussion that has gone on. Let me ask a potentially
stupid but hopefully big picture question.
This situation is fraught with turf battles between the
CFTC and the SEC and we are going to hear from both of those
gentlemen in just a moment and each one will be very articulate
and eloquent in defending his own agency and his own position.
Do either of you have a big picture kind of sense as to
where this regulation, the center of gravity ought to come
down? Is this really an SEC kind of thing or is this really a
CFTC kind of thing? And should most of it be on one or most of
it be on the other?
Mr. Greenspan. I have just gotten laryngitis.
[Laughter.]
Senator Bennett. It is either a really dumb question or a
very good one.
Secretary Summers. It is a very good question.
Mr. Greenspan. Senator, I may just say whenever you make
those remarks I zip up my pockets and run.
Secretary Summers. It is a very good question and I am
seeking to draw on what I have learned from watching Chairman
Greenspan over the years to formulate a suitably vague, a
suitably extensively analytical but yet nondecisive answer.
Senator Sarbanes. In other words, you just got laryngitis,
as well.
Secretary Summers. I think the difficulty involves, and the
two chairmen will speak in a much more learned way to this than
I can, that what you are discussing is a future, which
naturally falls within the ambit of the CFTC. And the issues
that are of concern having to do with insider trading, having
to do certain kinds of market integrity, are issues that go
to--having to do with consumer protection--are issues that
really go to core SEC, what have been core SEC concerns for
many years. I think it is that dichotomy between where the
instrument would tend to naturally fall and where the concerns
would tend to naturally fall that creates the difficulty.
But it does, to borrow on the kind of analogies that have
been used before, it does strike me that a Nation that has been
as successful as ours has been at mediating conflicts in a
range of settings internationally ought to be able to find a
way of mediating the tensions that exist here. But I suspect
the right answers will not be ones that are heavily tilted to
either end of the spectrum.
Senator Bennett. Does that mean then that both regulators
will stay fully involved and anybody who is in this business is
going to be wondering from day to day which regulator is going
to come down hardest? Don't we want some degree of--you talk
about certainty; we talk about predictability--don't we want
some degree of unity here where you deal with one set of
regulations and you know that another regulator will not come
in and penalize you for having done that? Or can we really
split the baby and say they both still are in the arena?
Secretary Summers. At least in my judgment, Senator
Bennett, any formula that resolves this will be just as the
agreement that Chairman Greenspan and I reached with respect to
the operating subsidiary issue was one of very substantial
complexity and I think in some ways in that complexity lay its
strength. It was neither fully satisfactory nor fully
unsatisfactory to either of us and it enabled us both to feel
that our core concerns had been expressed.
I do think that a resolution which subjects these
transactions to the full weight of regulation of both agencies
would, for the reasons you suggest, be an unfortunate outcome.
I also think a resolution which subjects them to whichever was
the least regulation of the two agencies might well apply
substantial pressure in a negative direction.
So I think some more complex formula involving certain
kinds of joint rule-making might prove to be most effective.
But I think this is a question that is really better addressed
to the two agencies.
Senator Bennett. Thank you, Mr. Chairman.
The Chairman. Thank you very much, Senator Bennett.
Senator Schumer.
STATEMENT OF HON. CHARLES E. SCHUMER, A U.S. SENATOR FROM NEW
YORK
Senator Schumer. Well, thank you, Mr. Chairmen. I very much
appreciate this hearing on an issue that I am very interested
in. It obviously affects New York in a great many ways.
I think this proposal has potentially profound and dramatic
effects on our securities and future markets and I am
disappointed, frankly, with the bill's treatment of Shad-
Johnson and giving the CFTC sole jurisdiction over single-stock
futures. I am not opposed to single-stock futures. If we do not
allow U.S. exchanges to offer them we could see them offered in
London or Tokyo. And in general, when the market comes up with
new types of products, my general view is let it rip. But the
regulatory framework has to be right and the President's
Working Group recommended that Shad-Johnson be repealed and
that single-stock futures be allowed to be traded if and only
if could achieve regulatory parity for futures and their
underlying equities.
There is no way with the SEC regulating one and the CFTC
regulating the other that we will have regulatory parity. They
are different types of regulators. They have a different
regulatory structure. And this bill creates regulatory
disparity by substantially different regulatory frameworks for
regulation.
We know why we are doing this. It is always a turf war, as
you gentlemen are very familiar with from last year's
discussion of financial futures, and neither side wants to give
us their turf. And, at the end, we come up with this topsy-
turvy gyro gearless solution that satisfies turf needs and does
not make any sense from a regulatory point of view.
The SEC has always been charged with protecting investors
and providing full and fair disclosure of corporate market
information and preventing fraud and manipulation. The CFTC
regulates commercial and professional hedging and speculation
in an institutional framework. CFTC cannot regulate insider
trading. Margin requirements are different. I hate to see
investors shopping as to which instrument to use or to buy for
that reason. So neither regulation nor the lack of it should
pick winners and losers among products or exchanges and fair
competition should.
Simply put, to me, the SEC cannot fulfill its legal
obligation to oversee the securities markets if single-stock
futures, which will likely have significant effect on the
securities markets, are solely regulated by the CFTC.
And today I am going to introduce legislation that would
provide for joint jurisdiction of single-stock futures by the
SEC and the CFTC, that will create a fair framework for trading
these products while minimizing the regulatory burden on the
exchanges. Specifically, it would only apply to core securities
laws--anti-fraud sales practice requirements and harmonize
margin levels to single-stock futures. I think this represents
a fair compromise and I would like to work with the Chairmen of
both committees, as well as you gentlemen, to deal with that
issue.
So having stated my views somewhat strongly, because I feel
strongly about the issue, I would like to ask both Chairman
Greenspan and Secretary Summers your view of whether the
present bill provides a fair and even regulatory framework,
specifically whether the President's Working Group
recommendations, that we repeal it only if we could achieve
regulatory parity for futures and their underlying equities--
that is the President's own Working Group statement--is met in
the bill that was introduced by my two men I greatly respect
and work with, Chairman Gramm and Chairman Lugar.
So since it is the President's Working Group, I will call
on Secretary Summers first.
Secretary Summers. Thank you. As I have said a number of
times, Senator Schumer, we think there are a range of possible
outcomes that would be consistent with this bill advancing the
national interest, first.
Second, if I might just refer back to the analogy that you
had used of the issues that the Chairman and I worked through
successfully last year, I think it is tempting for those
looking on to these issues to see only concerns of turf, but in
that issue there were real concerns on both sides having to do
with spreading safety nets on the Fed side, having to do with
business choice on our side. And similarly with respect to this
issue, I think we are not fair to our colleagues in the two
agencies if we do not recognize that there were real issues of
principle that the agencies feel strongly about that go totally
behind and are outside of any question of turf that are
involved in these issues.
I have not studied as fully as I could the provisions, the
precise provisions of the bill as currently written but I think
I speak for all of us in saying that we would be more
comfortable with a resolution in which the SEC could feel that
its core interests with respect to insider trading and consumer
protection were addressed, and my understanding is that they do
not have that feeling about this legislation as it currently
stands.
On the other hand, I would hasten to stress I think it is
very important that there be an outcome here and that this
issue be resolved in a mutually satisfactory way and I would
not want to see us adopt a posture of handing the ability to
hold this issue hostage to multiple different parties and
therefore delaying forward movement on the OTC certainty
portion.
Mr. Greenspan. I agree with what the Secretary said and I
think that as you said, Senator, time is crucial here because
if the two agencies cannot work it out or if the Congress
cannot work it out, foreigners will. It is not a question of
whether or not there will be single-stock futures out there it
is only: traded where? And unless this issue is resolved, if it
is continuously debated endlessly, the issue will get resolved
but not to our advantage.
I think that Secretary Summers and I have recognized that
the Chairmen of the SEC and the CFTC are far more knowledgeable
than either of us on the technical details and the
ramifications and the unintended consequences of various
different types of stipulated regulatory structures and there
are certain types of issues which that type of expertise is
just not substitutable by just people's off-the-top-of-their
head opinions which, in my case, it would be the case.
So I sort of am looking to the two of them to get the issue
resolved because if they resolve it, in my judgment, I will
feel comfortable that there are no latent secondary
consequences that the less informed on these issues would
endeavor to miss.
Senator Schumer. I would just say, and I could not agree
with you more, that they ought to be resolved between the two
agencies. I will not ask you this but it seems to me that the
legislation introduced does not really attempt to resolve those
issues but rather, just goes to one side.
And I would ask both of you to use your good offices. You
do not have the expertise that the two agencies have. On the
other hand, you are both very bright people who understand
financial markets and who do not have, because maybe not all of
this is turf--clearly it is not--but it not that none of it is
turf. And we can argue about whether it is 50/50, 80/20, 20/80,
but I think you are both going to be needed to come up with
some kind of compromise that allows us to go forward with
single-stock futures which is, as I said, something I support,
but do it and avoid regulatory arbitrage.
I mean for instance, just on margins, almost inevitably you
will have people go to the less regulated market if you have
such disparities between the regulation between the one and the
other, and that may be a desirable outcome, it may not, but we
ought not to come to that conclusion by default.
We need your help. Both of you are reluctant to mix in but
my guess is we are not going to come up with a proposal that
both sides can work unless some folks like yourselves mix in. I
am gloomy about passage for this year unless some outside
forces help work out a compromise.
The Chairman. Let me just thank you very much, Senator, and
commend you for that request of our two witnesses. I would
share that desire for counsel and likewise, your own counsel
with regard to this.
I am not so gloomy. I think we need to proceed and before
introducing Senator Grams, I just want to mention I just
received word that the House Subcommittee on Risk Management
and Specialty, perhaps stimulated by our hearing this morning,
has announced a mark-up for tomorrow on their bill.
Senator Gramm. They have obviously solved all these
problems.
The Chairman. The full committee, Agriculture Committee of
the House, will mark up their work next Tuesday, so that offers
at least some incentive for us to move ahead.
Senator Grams.
STATEMENT OF HON. ROD GRAMS, A U.S. SENATOR FROM MINNESOTA
Senator Grams. Thank you very much, Mr. Chairman.
Gentlemen, thank you for being here, of course. Just a
couple of brief questions. I know you have been at the panel
for a long time this morning.
Chairman Greenspan, you indicated in your statement that
over-the-counter derivatives could remain free from regulation
so long as the transaction involved professional
counterparties. How do you define professional counterparties?
Mr. Greenspan. There are legal definitions of that but
essentially, somebody who is in the business of dealing with
securities and has sufficient net worth to segregate them from
what we would want to determine are retail customers whose
basic activities do not give them the level of knowledge which
people who are in the business have. By professional, we mean
somebody who is a professional securities or commodities
person.
Of necessity, it is clearly a somewhat arbitrary legal
definition, but indeed in legislation and in regulation, we do
make those distinctions and we make them in a very rigid form.
We do not always get it exact, but for 98-percent of the
problem that we would have with respect to making that
division, I suspect we are successful.
Senator Grams. And second, we go to some length to try to
assure that stock futures have a similar type of oversight as
do the stock options. This gets to the heart of the Shad-
Johnson debate. When we turn our attention to legal certainty
for OTC derivatives, do we need to have the same level of
oversight for the over-the-counter swaps involving stocks or
other forms of equity?
Mr. Greenspan. Well, I think that if the basic purpose is
to have a sound market, the first judgment you have to make is
does the market structure itself have in it the means for
stabilization? In other words, as the issue I raised before, it
has been our experience that having effective counterparties in
transactions, people who understand the financial statement of
the people with whom they are dealing is unquestionably the
most important aspect which keeps risk at a minimum level in
the system.
Regulation can only substitute at the margins and oversee,
so far as over-the-counter securities are concerned, in a
professional manner very broad notions of guarding against
systemic risk. When you get to questions of retail markets, it
is a wholly different issue and I think there is general
agreement amongst all of us about how that should be handled.
Our major concern is to make certain that these very
effective over-the-counter derivatives markets which have been
so important to the financial development of this country can
operate in the most effective manner. In our judgment, that is
best maintained with a minimum of regulation, largely because
any regulation which is imposed, which would undercut
counterparty surveillance does, far more damage than good.
Senator Grams. Thank you, Mr. Chairman.
Secretary Summers, we have heard this morning about losing
derivative markets to Europe. If this bill passed, the legal
environment for derivatives?
Secretary Summers. I should give you a detailed answer, a
more detailed answer than I can give you right now to that
question in writing. But the core of that answer would be that
the failure to pass this bill would create a situation where
derivatives contracts entered into in the United States would
be subject to more risk, to be sure, an extremely remote risk,
but more risk of being arbitrarily unwound because of a
regulatory action than in Europe.
And in a world where it is easy to change the location at
which contracts are booked, that residual uncertainty could
become an important feature of competitive disadvantage. So the
core of the answer would be greater residual uncertainty
associated with OTC swaps in the United States.
Senator Grams. Maybe if you can provide a more detailed
written answer.
And just one final quick question. In your concern,
Secretary Summers, about exempting swaps from securities laws,
are you suggesting that all swaps be given the same treatment,
regardless of the underlying financial instrument involved?
Secretary Summers. No. I am suggesting that one craft the
set of provisions that are necessary to assure that--I think
the most prominent examples of this will be those that involve
individual equities--that one craft the minimal set of
provisions that assures that there will not be circumvention of
the existing regulatory protections with respect to the factors
that we have enumerated--insider trading, manipulation, fraud,
and protection of retail investors.
There are also, and this is not something we have commented
on so far, there are also certain questions having to do with
the technical definition of a swap in portions of this
legislation which on some readings could lead it to be called a
swap if a transaction took place in what we today regard as
ordinary financial instruments on an off-exchange basis and
would therefore nullify the regulation that would apply to
that. That is a concern that we believe should also be
addressed in clarifying the language that is contained in these
provisions.
It is not my impression that, that is anyone's intent and
so we do not believe that should be a difficult clarification
to accomplish.
Senator Grams. Thank you very much, Mr. Chairman.
The Chairman. Thank you very much, Senator Grams.
Secretary Summers, Chairman Greenspan, we are grateful to
you for your testimony, for your forthcoming responses to our
questions, and we look forward especially in these next few
days to working with you and your associates very carefully.
Thank you very much for coming.
The Chair would like to call now the Chairman of the SEC,
Mr. Arthur Levitt, and the Chairman of the CFTC, Mr. William
Rainer.
We are grateful that the two Chairmen are with us. We
appreciate your being here to hear the testimony that has
preceded yours, but we look especially to your thoughts this
morning and I would like to call upon now Chairman Levitt for
his testimony.
STATEMENT OF HON. ARTHUR LEVITT, CHAIRMAN OF THE SECURITIES AND
EXCHANGE COMMISSION, WASHINGTON, DC.
Mr. Levitt. Chairman Gramm, Chairman Lugar and members of
the Committees, thank you for the opportunity to address the
Committees concerning Senate Bill 2697. This bill would provide
important legal certainty for over-the-counter derivatives and
would lift the ban on single-stock futures. As you know, the
Commission fully supports both of these objectives. In other
important respects, however, I believe that the bill presents a
number of serious risks to the investing public and to our
securities markets.
As we consider the implications of the bill, it serves us
well to remember both the wisdom embodied in our securities
regulatory framework and the extraordinary prosperity it has
fostered. Its wisdom, I think, is simple--a recognition that
protecting investors is not just the right thing to do, but the
smart thing to do; that it is investor confidence that
ultimately fuels competition, that vibrant markets rest on a
foundation of integrity. I strongly believe that the
unequivocal commitment to protecting investors made by your
predecessors and mine has been critical to the success our
securities markets have enjoyed for more than half a century.
The bill before you, consistent with the Working Group's
recommendations, goes a long way towards providing greater
legal certainty for over-the-counter derivatives by excluding
certain products from the Commodity Exchange Act.
The bill, however, goes well beyond this objective. Indeed,
it would place all swap agreements beyond the reach of the
securities laws. In doing so, it might result in a wholesale
removal of SEC oversight of a wide array of securities
products.
For example, one could potentially avoid long-established
investor and market integrity protections applicable to equity
securities by merely documenting an equity transaction as a
``swap.'' In my judgment, the risk of this regulatory approach
is simply unacceptable for America's investors. Moreover, I
think there is no apparent public policy justification for this
far-reaching provision.
The bill also lifts the ban on single-stock futures
contained in the Shad-Johnson Accord. I certainly have no
interest in justifying the historical origins of that ban here
today. I have made clear my view that market demand--and not
regulatory fiat--should determine the availability of
investment vehicles. But I would hope we face squarely the fact
that single-stock futures are an economic substitute for the
underlying security. We should not ignore the fabric of
protections that retail securities investors rely upon and the
confidence that these protections engender.
Some may dismiss this concern as a guise for protection of
turf. I assure you, the questions surrounding how best to
ensure that regulatory disparities do not erode investor
confidence are profoundly serious and substantive to me.
Chairman Rainer and I, and our staffs, have spent a great
deal of time exploring how single-stock futures might trade.
Although we did not reach agreement on all aspects of a
regulatory framework, we did agree that we should jointly
regulate these products. Building upon that recognition, my
staff has crafted a plan under which these products could
trade. In my judgment, an enduring regulatory framework must
have the following elements.
First, single-stock futures are undeniably a substitute for
stocks and stock options. Thus, the framework must recognize
the legitimate interests of both the SEC and the CFTC in
regulating these products.
Second, the framework must encourage fair competition among
markets by, for example, including mechanisms to harmonize the
regulatory requirements across the securities and commodities
markets, particularly those related to margin. Competitive
market forces, rather than government regulation, should pick
winners and losers.
Legislation also should facilitate the listing of the same
single-stock futures on multiple exchanges. This avoids any one
market having an exclusive franchise by forcing all markets to
compete for investors' business. The history of our securities
markets makes it crystal clear that vibrant competition between
markets is the surest path to protecting investors as well as
the guardian of our global competitive edge.
Third, the framework must acknowledge that single-stock
futures will be retail products. While extremely complex
derivative products might not attract retail customers, a
simple future on a share of a blue chip stock is the type of
product that is sure to do so. Investor protection is therefore
essential, as is clear and direct SEC authority over market
participants that trade single-stock futures.
The alternative is neither workable nor wise. Consider for
a moment a corporate insider who learns that his company is
about to receive an unsolicited bid to be taken over. The
insider buys a substantial amount of single-stock futures on a
futures exchange and earns huge profits on the transaction,
which he plans to send to an off-shore bank.
Without direct authority over the futures exchange and
direct access to the information we need to detect insider
trading, the SEC might learn of the futures purchase by the
insider either late or never. Even if the SEC was notified of
the suspicious futures transactions, our enforcement staff
would be forced, under the current bill, to seek CFTC
permission to proceed. Needless to say, enforcement is an area
where dispatch is essential and delays are fatal to the cause
of securing relief.
Or consider the disparity in obligations that would apply
to a broker authorized to sell both stocks and single-stock
futures to clients. If he sells the future, he need provide no
more than a one-time risk disclosure document that, in effect,
tells customers that futures are risky. If he sells the stock,
on the other hand, he takes on a duty to tailor the
recommendation to the specific needs of the client. One does
not have to be a cynic to spot his incentive to sell the
product offering less protection and it is hardly apocalyptic
to recognize the danger. Should the protections given a
brokerage client really depend on which product the broker
chooses to sell? Ignoring these obvious questions today, it
seems to me, will almost certainly result in disillusioned
investors tomorrow.
Finally, the framework must avoid any harm to existing
capital markets. In lifting the ban on single-stock futures and
reopening jurisdictional issues, legislative changes should not
take away existing SEC authority over financial products. The
Shad-Johnson Accord clarified the SEC's jurisdiction over
securities options, and that jurisdiction should not be
diminished in any way. Nor should legislation eliminate the
SEC's existing role in evaluating products such as stock
indices.
Achieving these four principles will leave U.S. markets for
these products better positioned to compete against their
foreign counterparts. As markets around the world compete for
customers and capital, one overriding principle will serve as
our competitive advantage: the quality of our markets.
Unfortunately, as written, the bill ultimately does not
vindicate those principles.
I look forward to providing additional technical assistance
to help you reach the right answer for our markets. Thank you.
[The prepared statement of Mr. Levitt can be found in the
appendix on page 73.]
The Chairman. Thank you very much, Mr. Chairman.
Chairman Rainer.
STATEMENT OF THE HON. WILLIAM RAINER, CHAIRMAN OF THE COMMODITY
FUTURES TRADING COMMISSION, WASHINGTON, DC.
Mr. Rainer. Thank you, Chairman Lugar, Chairman Gramm,
Senator Sarbanes, Senator Harkin and Members of the Committee.
I am pleased to appear before you this morning and thank you
for inviting me as I represent the CFTC.
The Commission commends your efforts to modernize the
Commodity Exchange Act and to provide legal certainty for over-
the-counter derivatives, remove impediments to innovation, and
to reduce systemic risk. This bill responds to the President's
Working Group's request for urgent legislative action on its
recommendations so that the U.S. may retain its leadership in
these rapidly developing markets.
The Commission welcomes your proposal to enhance legal
certainty for over-the-counter derivatives by excluding from
the CEA certain bilateral transactions enter into on a
principal-to-principal basis by eligible parties.
The market for derivatives has expanded dramatically over
the past two decades as financial institutions rely
increasingly on these transactions to manage interest rate and
foreign exchange risk.
The Commission has reservations, however, about the bill's
exclusion of OTC energy derivatives from the CEA and I would
like to take a moment to expand on that if I may. On this point
the bill diverges from the recommendations of the President's
Working Group, which limited the proposed exclusion to
financial derivatives. The Commission believes the distinction
drawn by the Working Group between financial and nonfinancial
transactions was a sound one and respectfully urges the
Committees to give weight to that distinction.
Most dealers in the financial swaps market are either
institutions subject to supervision by bank regulatory agencies
or affiliates of broker-dealers regulated by the SEC or
affiliates of FCMs subject to CFTC oversight. The same cannot
be said of trading in energy derivatives. The decision to
extend the exclusion in 2697 to energy derivatives would leave
these OTC products in a regulatory gap neither directly
regulated as financial products nor indirectly regulated by an
agency with jurisdiction over commercial participants in the
energy market.
The Working Group's recommended exclusion from CEA for
financial contracts focussed on the facts that such contracts
are not susceptible to manipulation and do not serve a price
discovery function. The consensus exists within the markets and
among financial regulators that trading in financial OTC
derivatives is not susceptible to manipulation. That case has
not been made with energy products.
The unanimous recommendation for an exclusion for financial
products resulted from months of deliberation by Federal
financial regulators. No comparable coordination has occurred
between the CFTC and any of the other Federal entities and
programs with jurisdiction over cash markets for energy. An
exclusion for trading in energy contracts may create incentives
for existing exchanges to convert to restricted, institutional
markets or, more likely, may lead large traders to migrate to
unregulated markets. Either event would threaten the important
price discovery role played by regulated energy futures. A step
of this magnitude should be preceded by public discussion.
The CFTC therefore believes that there is insufficient
evidence to support the bill's exclusion of energy products.
Regulatory relief is more appropriately provided through the
commission's exemptive authority. We have a substantial history
of responsiveness in this area.
For example, the commission's staff has issued two no-
action letters within the past 6-months to electronic trading
platforms, the sponsors of which include several of the largest
participants in the energy markets. And, as the Committees are
aware, bilateral OTC energy trading between commercials,
dealing with each other on a principle-to-principle basis, has
been exempted from all but anti-manipulation provisions of the
CEA since 1993.
As the discussion over the treatment of energy commodities
progresses, the Commission will be pleased to continue working
with the Chairmen and members of these committees to find an
acceptable resolution of this issue.
The Commission supports 2697's exclusion for electronic
trading facilities for OTC financial derivatives which will
promote an environment in which innovative systems can flourish
without undue regulatory constraints. Electronic trading
systems have the potential to foster efficiency and
transparency and such systems should be permitted to develop
unburdened by an anticipatory regulatory structure.
The bill also permits clearing of OTC derivatives and
authorizes a mechanism for the CFTC to regulate facilities that
clear OTC derivative contracts. Again the President's Working
Group specifically recommended removing the legal obstacles to
the development of appropriately regulated clearing systems to
reduce systemic risk, and we support this recommendation with
the following reservation. The bill would allow securities
clearinghouses to clear a broader range of contracts than
futures clearinghouses. Futures clearinghouses would have to
register in a dual capacity--as futures and as securities
clearinghouses--to clear the same mix of contracts available to
securities clearinghouses holding a single registration. By
declining to grant futures clearinghouses equal opportunity to
compete, the bill may put the Government in the position of
determining winners and losers. We recombined that the
Committees avoid placing futures clearinghouses at a
competitive disadvantage.
The Commission supports the bill's revision of the Treasury
Amendment to make clear our jurisdiction over transactions
entered into between retail customs and unregulated entities,
including so-called bucket shops. We have long sought legal
clarity in this area in order to protect fully the public from
foreign currency fraud.
Earlier this month the Commission approved for publication
in the Federal Register its comprehensive regulatory reform
package which alters fundamentally the Commission's regulation
of futures and options markets. This bill attempts to codify
much of the Commission's regulatory reform proposal and we
welcome your support of the Commission's initiative.
The CFTC staff is undertaking a comparative analysis of our
proposed framework as released on June 8 and the relevant
provisions of this legislation and we would be pleased to
submit the results of that review to the Committees in the very
near future.
S. 2697 addresses the issue of equity futures contracts and
reflects efforts to develop a plan to amend the Shad-Johnson
Accord. The Working Group recommended, as we have heard a lot
today, that the CFTC and SEC work together to determine how the
accord should be amended. We agree in principle that equity
futures should be available to the marketplace. Agency staffs
have agreed on many specific areas related to lifting the ban,
such as harmonizing margin requirements, restricting dual
trading, testing for sales and supervisory personnel,
establishment of uniform listing standards for single-stock
futures, among others, such as notice registration for
exchanges and intermediaries. We acknowledge, however, a
fundamental disagreement concerning the appropriate legislative
approach.
The CFTC has sought to avoid creating a framework that
potentially could result in overregulation of markets and
intermediaries and therefore have advocated identifying those
core principles from each regulatory regime necessary to ensure
an appropriate level of oversight for trading these products.
While the agencies agreed that duplicative regulation must be
avoided, the CFTC staff expressed concern that an ``umbrella''
approach, meaning the application of the panoply of both
securities and commodities regulations to these products, could
result in overburdensome regulation. The SEC staff insists that
defining equity futures products as securities is essential to
its regulatory functions. This fundamental difference in
approach has led an impasse.
With respect to this bill, S. 2697, we, the CFTC, have no
objection to the Shad-Johnson provisions that bear on
regulatory issues related to the CFTC's oversight of single-
stock futures.
Again we appreciate the opportunity to present our views
and I will be happy to answer questions. Thank you.
[The prepared statement of Mr. Rainer can be found in the
appendix on page 85.]
The Chairman. Well, thank you very much, Mr. Chairman.
Let me just begin this round of questions. We will have a
5-minute limit again for Senators to raise questions with
witnesses.
Chairman Levitt, you mention in your testimony that the
Commission staff of the SEC has prepared a discussion draft
that incorporates the legislative goals that you have
enumerated in your testimony with regard to the single-stock
option situation, Shad-Johnson Accord repeal.
Unfortunately, given the pendency of this bill, as well as
bills in the House, the CFTC has not apparently had a chance to
review or comment on our draft in detail.
Chairman Rainer indicates, not really to respond to that,
that there appear to be some fundamental disagreements with
regard to regulation or overregulation, a panoply or umbrella,
as he discussed it.
I am just simply curious really, to both of you. It is
obvious this is important legislation. The Committee has been
intent upon moving toward conclusions and we appreciate the
discussions that you have held and cited the meeting of May 23
with Chairman Gramm and myself in which you indicated you have
been making headway but, as you stated last winter, I guess, it
was going to be this winter before you could arrive at it.
This is not meant, I am certain, to be disrespectful to the
Committee or to show a casual approach but it should have been
apparent to the two of you that we are intent upon passing a
bill.
Now, is the strategy you have in mind to stop the bill? Is
really your intent simply to indicate to members of the
Congress that whatever we have is unacceptable and therefore
you are prepared to continue at your own pace, sort of in your
own sweet time, to work it out--November, December, January,
whenever you get around to it?
In other words, I really cannot understand, given the
gravity of this situation of markets in the United States and
the intent of this committee to try to work with the Banking
Committee, why the two of you and your commissions are not
equally arduous, have not set a priority to get on with it and
to come to agreement.
Now obviously you have not, so we have. Now, you objected
to that and indicated that you are still passing papers back
and forth, but you are not listening to each other apparently
or have no intent upon reaching an agreement.
I just ask simply why not?
Mr. Levitt. Mr. Chairman, I respect the effort you have put
into this, and I certainly share your feeling about the
importance of aspects of this bill. I think Chairman Rainer and
I have worked very hard, as have our staffs, on dealing with an
issue that most of the members of the Committee agree is
terribly complex issues that we have not, of our own volition,
raised, issues that we have inherited, that courts have dealt
with and others have argued about for a quarter of a century.
I think that had we a greater amount of time, we could move
further toward a solution. But when, as you full well know, you
have the political imperatives of the process that we have,
together with constituent pressures, together with agency
habits and traditions, that makes it difficult. But I honestly
believe that, because of the nature of the relationship of the
Chairs that sit before you, we certainly do not wish to
frustrate the Congress or the bill. But I would say to you in
fairness that I regard one portion of the bill with respect to
certainty--legal certainty for derivatives--as being absolutely
critical to the national interest.
I place a lower priority with respect to Shad-Johnson, even
though I firmly support giving up the prohibitions of Shad-
Johnson. But one is a matter, in my judgment, of great national
economic necessity; the other simply is not.
The Chairman. Chairman Rainer, do you have a comment?
Mr. Rainer. Yes, thank you.
First of all, from the CFTC's perspective, your bill is one
that we do not object to. We think that our interests, the
CFTC's interests, are adequately covered by the bill.
However, as you know, I have said several times that we
recognize the legitimate interest of the SEC and we think that
it would be very important for the structure that goes out the
door to be one that both agencies can support.
I guess that the longer story is that we have two wonderful
industries--the securities industry, with its exchanges and
associations, and the futures industry--and they have grown up
in different regulatory environments. It would be one solution
for the CFTC to walk away from what I consider its obligation
and say well, just let the SEC do it. What happens there is you
have opened up a potentially large--we've used the word unlevel
playing field several times, but a large unlevel playing field
because the apparatus, the costly regulatory apparatus in place
with the futures industry is not organized to meet SEC issues.
And I felt that the CFTC should do everything it could to
analyze those issues that would be duplicative, that we they
already do a good job meeting regulatory tests, and we simply
have not had time using the SEC approach to make sure that any
recommendation that the CFTC endorses for these committees is
the recommendation that is the least cost approach and does not
attach unnecessary costs.
Now, if there are burdens that are necessary, so be it.
That is just the way it is. But we have not been able to find
that answer yet.
The Chairman. Well, I thank both of you for those
thoughtful responses.
Chairman Levitt, I just disagree with you profoundly that
there is one aspect of this bill that has national interest.
That dismays me with regard to the thought about the markets in
this country, the importance of this. That is, I think, a very
narrow view, but it is an interesting one, one that you hold
strongly, but it leads me to believe that we have a problem
here.
Now, there is going to be a presidential election, a
congressional election. We may have a different president--
probably will have, given the fact that there are two different
candidates running, no incumbent. A lot of new cabinet people,
a whole new working group, maybe some new appointees to
regulatory commissions, a lot of new Senators, maybe new
chairman.
Senator Gramm. Now wait a minute. You have gone too far.
The Chairman. Phil will still remain.
But it is not a cavalier approach that somehow this can all
be settled out in the fullness of time, given the agencies'
ability, their staffs to get together, to shuffle the papers
and think through the issues. I am confounded. This has gone on
for months.
We have had five different hearings here. We have had all
sorts of sessions about emergencies. So we finally come to a
meting and everybody is asking Chairman Greenspan, Secretary
Summers, to get the two of you together and somehow mediate
this dispute, to give their judgment. Chairman Greenspan gets
laryngitis at the thought of trying to mediate what seems to
have been an impossible predictable in Washington to do. So
this committee is going to try.
Now, you can try to stop us if you want to but by and
large, I think the public interest is on our side, and I hope
you get that picture.
Mr. Levitt. Mr. Chairman, I have absolutely no interest in
trying to frustrate the will of the Senate, but I think we must
recognize that what is happening in this bill with respect to
Shad-Johnson is taking basically an institutional product, a
product that has been used by professional investors, and
turning it into a retail vehicle.
At this level of the market, with the amount of leverage in
our system today, for me to look away from the responsibility
of protecting a different segment of the market than is now
available to these products would be irresponsible, in my
judgment. That is not a political judgment; that is a
conviction based upon my years in the securities industry and
my firm belief that there are limits to regulation, but that
protection of that individual investor is fundamental to the
glorious success of our equities markets.
And I must raise my hand if I feel that those interest are
being jeopardized. I believe that a Shad-Johnson bill allowing
investors to buy a leveraged product of that kind without the
basic protections that the securities laws have provided
through the years is just unacceptable.
The Chairman. Thank you.
Senator Gramm.
Senator Gramm. Mr. Chairman, thank you. I will be brief.
I want to thank each of you for appearing today and for
your hard work as we try to put the bill together.
Obviously, it is easy for us to ask ``why can't these two
guys get together and work this thing out?'' Now, I can work
out anything with anybody, but there are people who think they
have trouble working things out with me, so I have some
understanding of your problem.
I also understand that you are representing institutions
that have long and proud histories, and I also understand the
basic fact that part of what your staff is doing, and they are
going to be there long after you are gone, is protecting their
jurisdiction, their turf, and their jobs. I never understood
jurisdiction till I became the Chairman of a committee. I now
understand it very, very well. And if I forgot it, my staff
would remind me.
The only point I want to make is that this is an important
bill. It is easy for each of us to go down the list of items in
the bill and identify what we think is the most important. I
have my own set of priorities, but my guess is that if we are
going to have any success, we have to move forward with the
overall thrust of the bill.
Now, the only plea I would make--a plea instead of a
question--is that as we continue to move forward and work on
this, both of you and your two agencies continue to work
together. I would like to ask each of you formally to give us
your review of the bill and your proposed changes so that we
can go ahead and do the things we can agree on.
And, as we go through the legislative process, if you would
continue to pray over this thing, in an effort to work it out.
Also please think about the possibility of a mandate, similar
to the provision that we are now talking about in terms of
harmonization of margins, where we give the Federal Reserve,
working with your two agencies, the ability to set regulations
that harmonize margins. It may very well be at some point that
the best we can do--unless our prayers are answered and you
work these things out in advance--is to establish a mechanism
for you to work them out.
My fear is double regulation. I think that in some areas,
the SEC has expertise that ought to dominate in this market. I
do believe futures on individual stocks are predominantly
equities. What I would like to be able to do is work out a way
of sharing jurisdiction in those areas where you have a
legitimate legislated interest.
So continue to work it out. Think about ways we might
actually set a mandate in place that it be worked out in the
future if, all else failing, that is the only way we can do it.
It is not a terribly good way to legislate, but it is often
better than not legislating when there are other major items.
So Mr. Chairman, I want to thank you and the heads of our
two agencies.
The Chairman. Thank you, Senator Gramm.
Senator Sarbanes.
Senator Sarbanes. Mr. Chairman, I want to sort of sound
some words of caution here. First of all, it seems to me that
the quickest way to get to a solution may be to continue to
push hard on the track of the two chairmen before us working
out between themselves a resolution of this matter. That
essentially is what, I think, both Chairman Greenspan and
Secretary Summers suggested.
I am mindful of what Senator Gramm said at the outset, that
at this point in the legislative process, it is going to be
very hard to move legislation through if it does not rise to
the level of consensus.
Now, I happen to think that this perspective that is being
imposed on this difference that it is just a turf war, a fight
over jurisdiction, misses the mark. I frankly do not attribute
that basic motivation to either of these two chairmen that are
now before us and they obviously have a public interest to
serve that transcends any jurisdictional or tough turf
considerations. I do not think this can be viewed as well, we
have met the CFTC interests but we have not met the SEC
interests, or vice versa. The question is have we met the
public interest? And the premise, I think, with which most of
us are approaching it is that if the two agencies can reach an
agreement, that it is highly likely that the public interest
has been met, although obviously we will review that. We do
not, in the end, give away that judgment. But that
significantly heightens the ability to conclude that the public
interest has been met and I think investor protections are very
important.
It is all fine to talk about this thing prospectively but
if we do something that, in the end, results in eroding or
undermining the investor protections that have been at the
heart of making the U.S. security market so attractive and the
leaders worldwide, we have done real harm and real damage.
Now, it seems to me it ought to be possible to move ahead
on this issue without jeopardizing that important
accomplishment, which has sustained not only our markets but, I
think, been a tremendous boost to the functioning of our
economy. And if we are now going to move off on a legislative
path and, in effect, bring to a halt or sort of undercut the
effort for the agencies to see if they cannot reach an
understanding, and I gather they have made some progress; is
that correct? I gather from what you have both said you have
made progress from when you started out wrestling with this
issue. Am I correct in that assertion?
Mr. Rainer. That is a very safe assertion.
Senator Sarbanes. All right.
So I think that sometimes haste makes waste. Obviously if
there is an agreement amongst the president's committee, all
four of the people who appeared this morning, in the light of
such an agreement, it ought to be possible to move pretty
quickly here in the Congress.
Now, how quickly you can move in the Congress if you do not
have that agreement is another question, which I think we need
to be very mindful of because the issues that are at stake
here, in my perception, at least, are not simply some kind of
turf fight and we ought to sort of dismiss one or the other or
come down hard on both. They are issues that go to very
important national and public interests and I think we need to
be mindful of that every step of the way.
Thank you very much.
The Chairman. Well, thank you very much, Senator Sarbanes.
Let me just comment that I agree with you. Very clearly the
work of the Agriculture Committee and the Banking Committee,
working with the SEC and CFTC, has been to not only protect the
integrity of the markets, to offer protection to individuals
and groups, but really to recognize that the integrity of those
markets is our strength.
Now the predicament I think we all have to weigh, and this
is a judgment call, is that during the last year I visited the
New York Stock Exchange; I have visited the NASDAQ people. I
have been in the Chicago markets. There are a lot of changes
going on in these markets. People who are making a living out
there, tens of thousands of employees, face erosion of their
job potential.
We face competition in the world. There are other people
who are doing all sorts of things. In the course of our
hearings we had an electronic demonstration and transacted a
trade right in front of us on his computer on a European market
and demonstrated really, I suppose, the benefit of our
regulation one way or another was irrelevant to all of that.
So, on the one hand, we are trying to think through how do
we offer these assurances and more of them and, at the same
time, how do we retain at least the ability to see what is
going on in the world and retain the strength and the vitality
of our markets that have all these protections, and that is a
difficult thing to do.
Now one item that is unacceptable, it seems to me, is to do
nothing. If we do that, the markets will run their course
without regard to what the Congress has to say and there will
be winners and losers but I think the American people will be
the losers.
Now, the case has been made that the American people will
lose if somehow protections are taken away from them and that
is a very good point and it is an important one. But again and
again we have tried to come, I think, to a conclusion, are the
kinds of persons who are involved in the markets, as Alan
Greenspan said today, the countervailing market forces that
eyeball each other, that bring transparency, that bring
competition--he made the point that regulators are never a
match for all of the competing forces in markets, that at best,
they sort of have a safety net after really those who are
competitors have had a go at it.
So that is the problem.
Senator Sarbanes. Well, the problem is if we are going to
continue this dialogue, and I am quite happy to do it, the
problem to some extent is a process problem.
Now, we have this President's Working Group. I gather that
the President's Working Group limited the proposed exclusion to
financial derivatives. The bill before us now is going to
exclude energy derivatives, if I am correct.
Is that right, Mr. Rainer, as you read the bill?
Mr. Rainer. Yes.
Senator Sarbanes. You are opposed to that. Is that right? I
mean that is counter to the recommendation of the Working
Group.
Mr. Rainer. My position is that the case has just not been
made that is a good idea.
Senator Sarbanes. Yes. And therefore it ought not to be
done at this point.
Now, we discussed earlier the swaps question and it is very
clear from that conversation that significant changes have to
be made in the swaps provision. Everyone acceded to that.
Now, I understand that the CFTC put a proposal out on a
regulatory framework for future markets and clearing
organizations on June 8. Is that correct?
Mr. Rainer. Yes.
Senator Sarbanes. Now, that proposal is contained in this
legislation; is that right?
Mr. Rainer. In large part, yes.
Senator Sarbanes. Well, it may be all right; it may not be
all right. But you are putting the proposal out to have a
comment period. Is that right?
Mr. Rainer. Yes.
Senator Sarbanes. And further hearings.
Mr. Rainer. Yes.
Senator Sarbanes. The premise of those further hearings and
the comment proposal is the possibility that you would revise
the proposal, correct?
Mr. Rainer. Yes.
Senator Sarbanes. That is why you do that.
Mr. Rainer. Yes.
Senator Sarbanes. And you approach it with an open mind so
that people who make comments have confidence that they will be
considered on the substance and a judgment will be made.
Now, where does that leave you if this legislation passes
that contains the proposal you have submitted but does not
reflect the comment period and the hearings that subsequently
take place in shaping that? I mean it renders it all sort of
meaningless in a sense. Plus it then puts you in a
straightjacket in the future if you want to revise the
regulations because they have been statutorily codified. So at
that point if you wanted to make changes, you would have to
come back to the Congress and get a legislative change.
Now, that is only to underscore the haste makes waste
observation that I made earlier. But in the end, we are going
to come back. I appreciate that the industry wants to move and
I am not unsympathetic to that, but it ought to be possible to
do that and, at the same time, assure ourselves that these very
important protections for investors that have been at the
heart, in my judgment, at the heart of these very successful
markets are not lost. And to the extent we short-circuit this
process and make it less likely we are going to reach this kind
of consensus, I think the problem becomes more difficult, not
less difficult.
The Chairman. The Senator makes a good point. I would just
simply say that everybody is struggling, given the amount of
time that Senators, regulators, what have you have to give to
these particular issues, to get our focus. We have comment from
everybody today on language that might be incorporated. That is
a serious proposal because we are in the process of heading
toward a mark-up in which something is going to happen in the
Committee, and then we hope to proceed.
You have not had an opportunity to get into this round,
Senator Schumer. Would you like to raise questions or make a
comment?
Senator Schumer. Thank you, Senator Lugar. Yes, I have some
questions relating to my concern.
I guess the first one is to Chairman Levitt. Do you worry
about the effect that introducing single-stock futures will
have on the underlying equity markets if it SEC has no
jurisdiction over the product? What will be the worst case
scenario?
Mr. Levitt. I do worry about it. I worry a great deal about
it. I think there are some irrationalities in this process, and
I guess the very fact that we have two regulators regulating
similar segments of the market provides us with some
irrationalities to begin with. Then when you suggest in a bill
that has something as nationally urgent as giving legal
certainty to swaps and you combine that with creating a new
vehicle for investors, you have to ask yourself what is the
importance of that new vehicle? That new vehicle, has dramatic
importance to the liquidity of our markets with respect to
institutions that are used to trading highly leveraged
products. You are now opening that market to the retail
investor, who does not have the slightest idea about this.
We found in surveys, in terms of an understanding of the
risks of investment products, many do not understand the risks
of products even that have been with us for many years. We are
now opening up this new product, which essentially is leverage
on leverage.
Is this in the national interest to begin with? If you say
it is, if this new product is offering America's investors
something they can get no place else, which I absolutely
categorically deny, then you have to say are we giving them the
same protection that they would have when they buy IBM or
General Motors or any other equity?
And remember at what point in the market cycle we ask
ourselves this question. Is this the time to introduce yet an
even more highly leveraged product into a market which, in my
judgment, has an abundance of leverage today?
Senator Schumer. Well, there is a little ad that I would
like to submit for the record from--I do not know who they
are--Lynd Waldock. It says, ``There are lots of reasons you
should consider on-line stock index futures trading''--this may
be an example of what you are talking about for a broader-based
product. ``At Lynd Waldock you get''--it says, ``Stocks are
great for the long term but for short-term trading, try stock
index futures. At Lynd Waldock you get a of bang for your
commission buck. One stock's index future commission is
equivalent to trading 2,000 to 3,000 shares of stock at $30 a
stock at about half a penny a share.''
And that will be nothing compared to what happens unless we
have, as you say, a level regulatory field here. Does the
Gramm-Lugar proposal, as written, provide that field? To me it
certainly does not.
Mr. Levitt. I think it leaves the retail investor with an
absence of basic protections. I think, working closely with the
Committees and with the CFTC, it is possible for us to develop
such protections for investors from the things that I fear the
most.
Senator Schumer. What is the rationale for an option being
governed by the SEC and a future being governed by the CFTC of
an equity? Options are now governed by the SEC.
Mr. Levitt. They should not be. You know, I hate to
criticize a bill that has been sponsored by someone whom I
admire so much, but, with respect to the kind of regulation
that we are talking about, Senator, it is split regulation, and
that is very different from shared regulation.
Senator Schumer. Correct.
Mr. Levitt. And if collectively we could work toward shared
regulation, you would remove many of my feelings about this
bill, which are not motivated by any issue other than the
protection of investors.
Senator Schumer. Would you agree with that, Chairman
Rainer? Right now the bill has--Chairman Levitt put it right,
at least as far as I can tell--split regulation. Would you
agree that a shared regulation formula could work and would you
be willing to entertain that?
Mr. Rainer. Senator Schumer, I have been from the outset in
favor of both joint regulation and the ability for both
markets--the equity markets and the futures markets--to be able
to offer these products.
Senator Schumer. The issue is not who offers the products.
The issue is who regulates the product. Would you be willing to
say that shared regulation is, if not the best, certainly a
good way to go, particularly if it can break the deadlock that
we seem to have?
Mr. Rainer. Senator, I think that when I say joint
regulation, I mean shared regulation, but I am not 100-percent
sure I know what you mean by a definition of shared versus
split.
My position, which I have mentioned, is that this bill,
strictly from the perspective of the CFTC, adequately addresses
our concerns. Having said that, I have said in other venues
that I recognize the important and significant interests of the
SEC and that I believe that any final regulatory structure
should be one that both agencies can support.
Senator Schumer. OK. So you would, if Chairman Levitt has
in his delicate way--he is more delicate than I am--indicated
he has real troubles with the bill as proposed, as much as he
respects Chairman Lugar and Chairman Gramm, and let's put that
in the record 10 times, would you then encourage that we wait
and see if we can come up with something that you and he can
agree upon, provided it can be done in a relatively short frame
of time? Would you agree that we should not move forward with
this bill, which seems to me is not a shared regulatory regime
at all?
Mr. Rainer. Senator, I am going to withhold that for right
now. Let me get back to you on that.
Senator Schumer. If you could submit that in writing.
And one other thing I would ask that you submit in writing
is your comments, your objections to the--you cannot know much
about it yet but the proposal that I have put in today, which I
think is a shared regulatory regime that I think would be fair
and sort of go right down the middle, as opposed to this bill,
which I think does not really do that.
Mr. Rainer. Of course, Senator.
Senator Schumer. Great.
Thank you, Mr. Chairman.
The Chairman. Well, thank you very much, Senator Schumer. I
appreciate your comments likewise and will examine your
legislation, too. It is an important factor. I just ask from
you, as well as everyone else, some appreciation of the time
frame that we all have to work in because the Senate session
will be over soon, the window of opportunity to deal with this
at all, whatever its merit.
So my hope, and this is obvious in terms of trying to press
this issue on this morning, is that there is a certain season
for these things to happen. If we are not able to, why, we will
all have a lot of time, but there will be maybe different
players, a different situation and different position of our
markets, for better or for worse.
So it seems to me that this is an appropriate time for us
to focus as our two committees have attempted to do so this
morning and will be doing so in a concerted way in the next few
days.
Senator Schumer. The only thing I would say, Mr. Chairman,
I agree with you but I would rather--if there were a choice and
I agree with you I hope there is not a choice or a division,
but I would rather do it right than do it quickly. I am sure
you would agree with that.
The Chairman. I do agree with that and we are most hopeful
we can do both, always.
Senator Schumer. Great.
The Chairman. We thank both of the Chairmen for your
patience. It has been an extended hearing this morning but you
have been with us all the way and we appreciate that. Thank
you.
The hearing is adjourned.
[Whereupon, at 1:03 p.m., the joint Committee hearing was
adjourned.]
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A P P E N D I X
June 21, 2000
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