Re: Implementation of the Commodity Futures Modernization Act of 2000
June 19, 2003
Thank you, Chairman Moran, and members of the Subcommittee. I appreciate the opportunity to testify on behalf of Chicago Mercantile Exchange Inc. I have served as Chairman of CME since April of 2002. This has been a time of growth and change for our exchange. On Dec. 6, 2002, we completed our initial public offering and became the first publicly traded financial exchange in the United States.
This has also been a very challenging political and economic period for our country and the world. In these uncertain economic times, we at Chicago Mercantile Exchange fulfill the essential role of helping institutions, corporations and individuals efficiently manage their financial risk.
The CFMA: Successful landmark legislation:
In the judgment of CME, the Commodity Futures Modernization Act of 2000 (CFMA) represents successful landmark legislation. Our futures markets are stronger and more vibrant today as the direct result of Congress' enactment of the CFMA and, equally importantly, the CFTC's judicious and deliberate implementation of those reforms. Innovation has been encouraged and made less costly and more rewarding. The time between conception of a new product or trading system and its implementation has gone from years to days. Today, the vast majority of CME's investment in innovation is for improvement and testing, rather than paperwork and bureaucratic review.
I want to highlight some of our many achievements under the CFMA regime and indicate some important initiatives now under way by CME.
- During June, our average daily volume thus far has exceeded 3 million, a healthy 43 percent increase from the 2002 average daily volume. Our open interest reached an all-time record of more than 25 million contracts.
- Volume on our GLOBEX® electronic trading platform has grown from hundreds of contracts per day to more than one million contracts per day, while the open outcry trading floor continues to serve its core customers who prefer that trading venue.
- CME's E-miniTM S&P 500® futures contract reached a new record of 116 million contracts in 2002, an increase of 194 percent from the prior year. Our E-mini S&P remains the fastest-growing product in the history of CME.
The latest major development at CME is the recently signed definitive agreement with the Chicago Board of Trade to establish the CME/CBOT Common Clearing Link. Under this agreement, CME will provide clearing services for all CBOT products beginning on Jan. 2, 2004. We expect that the CFTC's regulatory review will be efficient and expeditious, free of the time-consuming processes that would have been standard prior to CFMA. Naturally, we also expect the CFTC to grant all regulatory approvals in order to maintain our targeted roll-out date of Jan. 2, 2004.
By clearing CME and CBOT products through our Clearing House, we will offer extended portfolio margining. In other words, we will recognize the positions held at both exchanges and reduce performance bonds as appropriate. This exemplifies our efforts to provide value to our customers and shareholders at the same time. This new clearing agreement also signals CME's ability to provide transaction processing services to third parties.
Our new publicly traded status will help us achieve the key elements of our long-term business strategy. I want to dispel a myth about publicly owned exchanges: Some regulators have speculated that a for-profit business model may pressure exchanges to reduce spending on self-regulation. We strongly disagree. While we were a mutual membership-owned not-for-profit corporation, we never wavered from our commitment to funding regulatory systems, programs, operations and staffing levels. Despite significant budget pressures, we never reduced our commitments to this important area because we understood its importance to our overall success.
Rather than detracting from our ability as an effective self-regulator, CME's incentives and capability to maintain an effective program of self-regulation have been enhanced by its reorganization as a for-profit public company. The regulatory staff's independence and empowerment have been cemented by this new corporate structure. CME is subject to the disclosure and reporting requirements imposed by the Securities Act of 1933 and by Securities and Exchange Commission regulations. CME's ownership base has been expanded to include institutional investors. Professional securities analysts who are unaffiliated with CME and/or its bankers follow every action of the company. Any failure to maintain and effectively implement prudential regulatory programs will cause these analysts and shareholders to adopt a negative view of our performance, and our stock price could decline. The scrutiny of these shareholders and analysts ensures that we have sufficient inducement to maintain the effective regulatory programs that are so critical to our brand name and our success.
Single Stock Futures: CFMA's Unfulfilled Promise
The CFMA broke new and important ground in authorizing the trading of single stock futures. The discussions between the CFTC and the SEC with regard to the regulatory regime pertaining to single stock futures have taken a considerable amount of time, and we understand that the agencies believe they are coming to the end of that process. Nonetheless, we want to bring to the Subcommittee's attention what we consider to be a very important problem we have experienced in the initial efforts to bring single stock future products to market.
Our experience as a notice registered security exchange and our view of the regulatory burdens to which our joint venture, OneChicago, has been subjected, lead us to question whether the CFMA provisions respecting joint jurisdiction over exchanges that trade security futures products are being misapplied by the SEC. After a protracted effort to list a security futures product, CME withdrew its submission rather than subjecting itself to confusing and costly dual regulation.
The details of this story are included in my written testimony. In brief, Congress granted the CFTC and SEC jurisdiction over exchanges that list and trade security futures products, but clearly determined that an exchange's principal registration status should decide which agency should take the lead. In the case of CME and OneChicago, the CFTC is the primary regulator. The SEC has asserted authority that effectively puts it on a par with the CFTC and creates a system of active dual regulation contrary to the clear intent of Congress. If unaddressed, this problem threatens to undermine Congress' intent that dually regulated exchanges not be burdened by duplicative regulation.
Fixed-Income Futures: CFMA's Orphan
While we applaud the many improvements made by the CFMA's re-write of the Shad/Johnson Accord and other major parts of the CEA, there is one area in which it was a step backward, or at best a step sideways. That is the areas of index futures on non-equity securities. The rules distinguishing between broad-based and narrow-based security indexes apply to all securities, but were drafted without clear consideration of the significant differences in size and trading velocity between equities and fixed income securities. The U.S. fixed income securities are not typically traded on organized exchanges, and their trading volume is significantly smaller than stock volume. The CFMA does not distinguish between the two very different classes of securities with the result that the same criteria are applied in determining which cash instruments can be the basis for futures contracts. We urge Congress, the CFTC and the SEC to use all available means to remedy this situation.
Recent Issues Involving Importation of Cattle:
Country of Origin Labeling (COOL) is part of the 2002 Farm Bill. It will require, among other things, all meat sold at retail (grocery stores) to carry a label showing the country (or countries) in which the animal was born, raised and processed. This labeling requirement becomes effective Sept. 30, 2004, and retailers are subject to a $10,000 fine for each violation. While we are aware of the ongoing controversy among affected elements of the industry as to whether Congress should revisit COOL - perhaps delaying or modifying the provision or even repealing it - under the current circumstances, CME will need to bring our Live Cattle contract into compliance with COOL. We are experiencing a number of serious timing and design issues for our 2004 cattle complex contracts, which I detailed in my written testimony. We are working with the USDA and the industry to find solutions, and the CFTC has signaled that it understands the problems and will work with us to find a solution. CME looks forward to working with the CFTC to come to the most efficient response to the several serious challenges raised by the COOL mandate. We will keep the Subcommittee informed on developments as we proceed.
New Concerns Not Addressed in the CFMA: Foreign Ownership or Control of a U.S. Exchange.
CME strongly supported the CFMA and its philosophy of expanding our opportunities to compete, while simultaneously challenging us by permitting new market structures and easing barriers to entry of new competition. As much deliberation as Congress gave the CFMA over the several years preceding its enactment, no consideration was given to the question of foreign control of a U.S.-based derivatives exchange. CME welcomes fair competition from all sources, but is concerned that the CFMA's lack of specific focus on foreign ownership may be taken as a signal that significant issues arising out of such control are irrelevant to the statutory standards for designation of a contract market.
Conclusion:
The enactment of the CFMA has brought a wide variety of constructive and beneficial reforms to the regulation of America's derivative markets. The nation and all the market participants, including CME, are better off as a result of the CFMA. The CFTC has administered the CFMA responsibly, but new challenges remain to be addressed if the full promise of the CFMA is to be realized. We look forward to continuing to work with the Congress and the CFTC in finding appropriate answers to these challenges.
