Good morning. I would like to thank the Futures Industry Association for inviting me to speak here this morning. I also want to thank the international regulators who flew in from around the globe to join our meeting yesterday to discuss and coordinate our financial reform efforts. I would like to use this opportunity to discuss much-needed regulatory reform of the over-the-counter derivatives marketplace as well as to update you on some of the changes we hope to make at the CFTC. I am going to discuss these issues in the context of two significant events in American history, both of which occurred in mid-19th Century Chicago.
Mrs. O’Leary’s Cow
As most of us learned as school children, in 1871, what started as a small fire quickly spread through Chicago to destroy much of the city. The story goes that it was ignited when Mrs. Catherine O’Leary’s cow kicked over a lantern in her barn. Many of the buildings in Chicago were made of wood, so the fire spread too quickly for firefighters to extinguish it. As a result of the fire, Chicago implemented new building and fire codes to prevent a repeat of the disaster. While Chicago didn’t burn down solely because of weak building codes, those new rules went on to protect the residents of Chicago from the spread of future fires.
The First Derivatives Markets
Another important event in Chicago, just six years before Mrs. O’Leary’s cow kicked over that infamous lantern, was the starting of derivatives trading. Of course everybody in this room knows these derivatives as futures, which started trading when farmers and grain merchants came together to hedge their price risk in corn, wheat and other grains. It took nearly 60 years before Congress brought regulation to this earlier derivatives marketplace to lower risk and promote transparency and market integrity. The Commodity Exchange Act, which passed after the last great financial crisis, established regulations in the futures markets to protect the American public.
Over-the-Counter Derivatives
Fast forward decades later to the 1980s and further innovations in the marketplace led to trading of derivatives that were off-exchange and thus out of sight of market participants, regulators and the public. These new over-the-counter derivatives were developed so that corporations and other entities could hedge their tailored risk in ways that the standardized futures marketplace at the time might not facilitate. Derivatives dealers were not subject to regulation when selling their products bilaterally. Nearly thirty years later, this market has exploded to $300 trillion notional amount in the U.S. – by some measures nearly ten times the size of the regulated futures markets – and yet remains unregulated.
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