The gathering of regulators and representatives from the private financial sector in New York fittingly marks an important milestone in IOSCO’s history. Starting from an inter-American regional forum in 1965, evolving in the early 1980s into an organization with global membership, and in the 1990’s to the recognized international standard setter for capital markets, IOSCO has played a preeminent role in shaping the international financial architecture that supports the development of our global financial markets. However, IOSCO’s influence and clout is only now coming to the attention of the regulated industry as it tackles issues of immediate concern.
We regulators long have appreciated the degree to which IOSCO fosters higher regulatory standards and practices and provides a valuable forum for discussion, sharing of ideas, and building relationships of trust and confidence. These communications through IOSCO have enabled us properly to oversee our integrated markets. It is only natural that IOSCO’s value be extended to the financial community as a whole. Therefore, I am pleased that you have joined with us to learn more about the work of IOSCO, and, in particular, why that work is important to improving the efficiency and integrity of cross-border transacting.
I am pleased for another reason as well. As an economist and a professor, my focus has always been on the markets. To me, markets not only are a compelling subject of study, but also are a compelling resource for informed regulatory thinking. I began my association with the CFTC as an economist in 1990 -- a time when the burgeoning swaps market was poised for explosive growth. The impact of electronic trading systems on existing exchange structures was also a source of debate. Further, the CFTC had only a few years experience with its program of allowing foreign brokers to deal directly with U.S. customers -- a program that relied on a license granted by another regulator with a comparable and effective regulatory regime.
Today, more than a billion dollars in pays and collects cross our exchange clearing systems everyday and the notional value of exchange markets is in the trillions. Statistics released by the Futures Industry Association show that overall global futures volume in 2003 was 8.1 billion contracts—an increase of 30% over 2002. The US futures markets share of this volume was 2.2 billion contracts, which represented an increase in volume of 18% over 2002. Clearly the competition among products, markets, and brokers has boosted the market as a whole.
Similarly, the over-the-counter derivatives market has grown enormously. At the end of 2003, the notional value of these contracts stood at 197 trillion dollars. Electronic trading systems reach across borders, and markets are consolidating and forming new alliances and trading and clearing arrangements like never before. Order routing systems permit electronic access for large customers of US intermediaries to non-US markets, non-US clearing organizations operate in the US, futures exchanges that are owned by non-U.S. markets have been recognized by the CFTC and new clearing linkages have been formed. The degree of global integration is on the rise. But instead of the pie being sliced thinner, the pie has grown larger.
This growth has been an enormous benefit for business and the economy because it has expanded businesses’ and consumers’ ability to manage their risks and to diversify their portfolios. But the benefits go even beyond that. One of the unique byproducts of derivatives, particularly those traded on organized markets, is price discovery. Price discovery is really the lifeblood of a free market system. It is how the free market system is able to allocate efficiently scarce resources. It is what induces people to exchange goods and services. In essence, price discovery aids participants as they seek to assure themselves that they are getting fair prices in their transactions and benefits citizens throughout the world economy. As regulators, it is this price discovery process that we endeavor to encourage and protect--just as we protect fair and equitable markets and their proper oversight.
Encouraging regulatory awareness of the practical problems and risks faced by market participants in the day-to-day conduct of their business can improve the efficiency, credibility and effectiveness of regulatory services. Better input can help us frame the issues we should prioritize in accordance with the IOSCO Principles -- the protection of customers, ensuring that markets are fair, efficient and transparent, and the reduction of systemic risk. More importantly, examining these issues from the perspective of market users helps us to forge regulatory strategies that are solution-oriented and that operate to minimize the risks of cross-border transactions and to facilitate those transactions for consumers of our regulatory services.
In addition to fair pricing mechanisms and informed regulators, the proper functioning of markets also depends upon the capacity of market participants to make informed investment and risk management decisions that permit them to price properly the risks that they are undertaking. A global business and investment presence means, however, that market participants who engage in cross-border transactions not only encounter the legal and commercial risks common to transacting in any domestic market, but they must also navigate a complex combination of various legal, operational, market, credit, and liquidity risks associated with doing business in multiple jurisdictions. One major role of IOSCO has been to promote the transparency of rules in place around the world.
I believe strongly that we, as regulators, should strive to promote transparency and clarity of rules. Clarity and transparency increases certainty among users, wherever located, about the applicable rules and their application. Such certainty also promotes increased efficiency and can ultimately enable markets to function seamlessly, so that market participants can execute their investment preferences globally and markets themselves can innovate and deliver the range of products and services demanded by their customers.
One way for regulators to develop their programs in ways that foster such a seamless global marketplace is to be good listeners—that is, to listen to those who use and operate the markets, to understand the risks and concerns they face in cross-border transactions, and to include those considerations into our regulatory analysis. By holding this event, IOSCO is demonstrating that its membership values the benefits of enhancing consultation with the markets and market participants.
During this event you will learn the many ways in which IOSCO sets standards for multinational disclosure and accounting, the supervision of markets, intermediaries and collective investment schemes, cooperative enforcement, and information sharing. The IOSCO Principles, which represent the distillation of many years of IOSCO’s work product, are one of 12 standards and codes that were highlighted by the Financial Stability Forum as key to sound financial systems and deserving priority implementation. Moreover, the extent to which a country’s financial system meets the IOSCO standards is one component of the World Bank and International Monetary Fund’s Financial Sector Assessment Program.
The value of these standards to regulators is clear -- because they are at a high level, such standards dramatically benefit cross-border transacting . For example, as early as 1990, IOSCO developed a set of 10 principles that established a methodology for supervisors to assess the soundness of screen-based derivatives trading systems. These 10 principles – in whose development the CFTC played an active role -- have shown remarkable staying power as they continue to guide regulators in assessing the integrity of screen-based trading systems 14 years later. Application of the screen-based principles has had a very practical significance to users of electronic systems. The principles not only facilitate approval of an electronic system by its national regulator, they also facilitate the recognition of that system by other IOSCO member jurisdictions. This recognition is predicated on the confidence the host jurisdiction has that the system went through a common rigorous analysis.
Greater harmonization of standards also fosters more effective oversight and enforcement by encouraging cooperation and by providing assurance that necessary authorities to address misconduct are available to a regulator. The IOSCO Principles help to achieve harmonization by creating a structure to which all jurisdictions should aspire. IOSCO’s recent emphasis on encouraging members to conduct self-assessments under the Principles and take action to correct any gaps will also accelerate the trend towards greater harmonization.
IOSCO also has helped to establish a structure of common regulatory assumptions and an environment conducive to cooperation. Its work product has emerged from a consensus of over 100 member jurisdictions. The IOSCO process and output has provided a model that contributes to the movement by global market regulators to coordinate and unify the development and oversight of markets and to eliminate duplicative and complicated regulatory barriers to cross-border business.
Again, this had practical significance for the CFTC when our agency embarked on a program in the late 1980s of permitting foreign brokers to deal directly with U.S. customers on the basis of complying with their home country’s licensing schemes for intermediaries. The regulatory consensus fostered by IOSCO’s work program contributed to a high standard of regulation so that the CFTC could have confidence in relying on the efforts of those foreign regulators. This confidence has been validated by the fact that since 1989, when the first round of exemptions were issued, over 160 brokers originating from 15 different jurisdictions have carried accounts for U.S. persons without any loss of funds or enforcement actions. Our confidence in foreign supervision based upon a knowing inquiry into its foundations and the negotiation of necessary cooperative arrangements has similarly allowed the CFTC to permit foreign electronic systems to offer direct access to U.S. persons and to open our markets to innovative linkages and cross-border arrangements.
I am happy to note that there is an increasingly active interest in cooperative arrangements that work to build on our regulatory relationships. Such relationships are key to assuring the ability to supervise successfully an ever-increasing cross-border business. For example, just last week the CFTC executed a statement of intent with the Committee of European Securities Regulators to work more closely on matters of common concern and to keep each other informed of activities of common interest to promote a better cross-Atlantic understanding of each others regulatory programs and activities. We have also worked closely with the Australian Securities Investment Commission to work toward ways to access their markets in reliance on notification and local scrutiny, subject to CFTC licenses and good standing, and in compliance with applicable rules. Yet another example of our cooperative program is our arrangement through the National Futures Association to assist other regulators in knowing the status of a CFTC registrant’s US license on a “real time” basis.
In addition to supporting cooperative regulatory initiatives, I am also a strong supporter of common enforcement efforts. In this area, IOSCO has been a pathfinder among supervisory authorities. The CFTC has worked aggressively to combat fraud, especially in the foreign exchange area, collecting more than $241 million in fines and restitution since 2000. Retail foreign exchange fraud is a plague that confronts regulators around the world and affects the confidence that markets are properly managed and operated. In our work within IOSCO, the CFTC has been proud to participate in the creation of a “second generation” multilateral MOU that eliminates the need to negotiate bilateral arrangements in many instances and, most importantly, conditions participation upon a demonstration that the regulator has the authority and demonstrated history of providing the cooperation the MOU contemplates. This document bears testament to a common will among regulators to share information necessary to police our markets and to protect customers. These protections enhance market confidence and also promote business growth. Good citizens of the marketplace benefit also from a high standard of integrity being established and maintained. A culture of industry accountability prevents the adoption of inappropriate or overly constricting or prescriptive regulation.
While cooperation is essential and common enforcement maximizes our combined effectiveness, I am nonetheless very pleased that the IOSCO Principles do not confuse common regulatory objectives and core standards with having identical, homogenized regulation, which could stifle innovation. On the contrary, the Principles explicitly recognize that”there often is no single correct approach to a regulatory issue.”
As an advocate of global markets and the economic potential that such markets create, I wholeheartedly support efforts by IOSCO to seek solutions that are grounded in IOSCO’s belief that “risk taking is essential to an active market and regulation should not unnecessarily stifle legitimate risk taking,” that “regulation should facilitate capital formation and economic growth” and that “in the context of regulation, there should also be a recognition of the benefits of competition in the marketplace.”
Borrowing from economics thought, I believe firmly that there is a kind of optimal regulation that recognizes a “mapping” from the regulatory structure to the market, its products and its participants --- or in other words, a calibration of regulation to fit the particular risk characteristics of the market and market participants.
The U.S. the Commodity Futures Modernization Act of 2000 (CFMA) incorporates this “mapping” concept. The CFMA instituted a principles-based approach that allows the CFTC to tailor rules to the sophistication of market participants, the risk characteristics of the products being traded, and the manner in which they are traded. The CFMA freed the CFTC to regulate the derivatives industry in a more flexible and targeted fashion, as opposed to being bound by prescriptive and overly burdensome rules. However, in order to calibrate rules correctly, a regulator needs to understand fully its regulatory target. Therefore, the CFTC believes that consultation with persons affected by regulation is important to “getting it right.”
Significantly, the IOSCO Principles similarly recognize the importance of tailoring the scope of regulation to the type of market in question, as they state that: “The level of regulation will depend upon the proposed market characteristics, including the structure of the market, the sophistication of market users and rights of access and the types of products traded.
As an economist and financial regulator, I cannot overemphasize how important it is for regulators to take into account the concerns of markets and market participants. Although IOSCO has had a long tradition of reaching out to the industry – for example, a recent initiative between IOSCO and the Committee on Payments and Settlement Systems (CPSS) to develop Recommendations for Central Counterparties involved a very extensive consultation with the industry – many of us believe that it is time to enhance those efforts. I am pleased that at the most recent IOSCO Technical Committee meeting, members discussed the importance of increasing mechanisms to enhance consultation, something that we at the CFTC endorse.
In my view, a regulatory structure that promotes the seamless transaction of global business and the elimination of duplicative or unnecessary burdens is best achieved through the development of a sound regulatory program and vigorous enforcement framework. Let me conclude with the hope that this event will initiate an ongoing partnership of interests and expertise between the financial industry and IOSCO.
Thank you for your kind attention.
