Testimony of James E. Newsome, Chairman
of the Commodity Futures Trading
Commission
before the U.S. Senate Committee on Agriculture, Nutrition
and Forestry
July 10, 2002
Thank you, Chairman Harkin, Ranking Member Lugar, and Members of the
Committee for the opportunity to testify before you today. I would like to
provide you with updates on several important topics, including the
Commission’s progress in working with the SEC to permit the trading of
security futures and in implementing the important anti-money laundering
provisions of the Patriot Act. First, however, I would like to directly
address certain issues regarding U.S. energy markets.
As you know, the Commission is an independent federal regulatory agency,
whose mission is to oversee the futures and options markets in the United
States. We take very seriously our mission to ensure that these platforms
provide safe, sound and transparent markets for risk management and price
discovery for a variety of commodities, including agricultural, financial,
metal and energy products.
The energy markets are among the largest and most dynamic in the United
States. Hundreds of billions of dollars in energy products - which would
include electricity, natural gas, crude oil, and gasoline - are traded each
year in the United States – both on-exchange and in the
over-the-counter (OTC) Markets. The Commission regulates the on-exchange
futures and options energy markets, which provide significant risk
management and price discovery functions for both retail and institutional
investors. Energy products are primarily traded on the New York Mercantile
Exchange, which is registered with the Commission.
There is also significant trading in energy products in the OTC markets. As
a general matter, the Commodity Futures Modernization Act of 2000 (CFMA)
provided legal certainty for OTC trading in exempt commodities – such
as energy products. In addition, the CFMA promoted the growth of electronic
trading systems for these commodities. The level of Commission involvement
in the OTC markets was tailored to the nature of the participants and
commodities. The OTC markets in energy products are generally restricted to
very large institutional investors. The CFMA authorized the Commission to
investigate and prosecute fraud and manipulation in exempt commodity
markets, with some limited exceptions. EnronOnline operated an electronic
trading platform, which accounted for a sizable percentage of the OTC energy
product market. It was not registered with the CFTC.
We are all well aware of the tragedies that occurred last fall surrounding
the collapse of Enron. For instance, there have been numerous stories in the
press regarding allegations of manipulations in energy markets. I would like
to take a few minutes today to talk about these issues as they relate to the
jurisdiction of the CFTC, and let you know what it is that we are doing to
fulfill our obligations and responsibilities in these areas.
Currently, we are in the process of pursuing a comprehensive, detailed
investigation of allegations raised by the Enron collapse, and we will
aggressively continue such investigative efforts to detect and deter any
illegal conduct in the markets we oversee.
Albert Einstein once said, “If you have seven days to solve a problem,
spend six of them defining it.” From the beginning of the discussions
on these energy issues, my position has been that we need to find the
“facts” first, before proposing or supporting a
“solution.” My position has not changed.
Allegations have been made that Enron and others manipulated the West Coast
and California energy markets. These are serious allegations. Not only are
they serious, they are jurisdictionally complex, potentially involving
multiple regulatory authorities coordinating their differing jurisdictions.
We are working actively with other authorities, cooperatively and
aggressively, to pursue any and all allegations that are within our
jurisdiction.
I have put the full resources of our Commission behind this investigation in
order to make the appropriate determinations regarding whether or not
illegal activity within our jurisdiction occurred. If indeed that proves to
be the case, we will prosecute the wrongdoers to the fullest extent
possible. I commit to keep you informed of our progress as we pursue this
complex and wide-ranging investigation and I ask for your patience while we
do so.
Looking beyond our energy investigations, I am happy to report that trading
volumes show that the commodity futures and options markets continue to grow
in their importance as providers of unique risk management tools and as a
means of price discovery. Last year represented another record year for U.S.
futures volume, up 60% over the prior year. Indeed, trading quadrupled over
the last ten years. Remarkably, September 11th had no sustained
impact on volume, which was already surging by September. In fact, September
volume was almost normal, even on the New York exchanges, which I attribute
to the foresight, resourcefulness, and tenacity of everyone at the New York
Board of Trade, the New York Mercantile Exchange, and the hundreds of firms
trading there who got these markets back up and running even before the
stock markets resumed trading.
I am also happy to report substantial progress by the Commission in
implementing the Commodity Futures Modernization Act. A great deal of rule
modernization work was accomplished last year to implement those provisions
of the new law regarding exchanges and clearinghouses. But that was only the
first step.
Security Futures:
I can now report that the Commission has adopted all final rules, including
margin rules, necessary to permit domestic trading in security futures
without further delay. I expect that the SEC will act on the margin rules
very shortly. This has been a challenging process. Each agency has its own
unique oversight tradition, applicable to the very different needs of the
capital formation markets and the risk allocation markets under our
respective jurisdictions. But I believe that the structure agreed upon,
though perhaps not ideal from any single perspective, is fair and workable.
I also believe that it faithfully adheres to Congress’ intent. I
appreciate the guidance and assistance that this Committee and its staff
provided and I am looking forward to completing the foreign participation
aspect in the very near future. I hope that you share my great interest in
seeing how and by whom these important new risk management products will be
utilized.
Intermediaries Study:
Of course, permitting the trading of security futures was only one aspect of
the CFMA. The CFMA also mandated a review of rules affecting futures
commission merchants and other types of intermediaries that play such
important roles in the futures markets. Although the events of last fall
changed everyone’s priorities for a time, the Commission has completed
its study of intermediary rules -- following months of soliciting public
input through interviews, written comments, and a public meeting -- and
submitted that study to Congress. We will soon host several roundtables on
related issues and I look forward to working with this important segment of
the futures industry to develop appropriate rule revisions and potential
legislative recommendations.
September 11th Responses:
In the wake of September 11th, the Commission and other financial
regulators were charged implementing important anti-money-laundering
provisions of the Patriot Act. We have worked closely with the Treasury
Department, other regulators, and the futures industry to fulfill this
national responsibility. The Commission has already approved a rule on
customer identification requirements that has been sent to Treasury for its
joint approval. We are finalizing another rule on suspicious activity
reports from futures commission merchants and introducing brokers, which we
plan to share with Treasury later this week.
Implementing relevant provisions of the Patriot Act was just one of the
challenges and new responsibilities that faced the Commission in the wake of
the attacks. As you know, our New York Regional Office was located on the
37th floor of 1 World Trade Center. Thankfully, all of our
employees escaped without major physical injury. Using backup systems and
with help from staff of the Chicago Regional Office and D.C. headquarters,
we provided ongoing surveillance of the markets in the hours and days
immediately following the attack. The Commission worked steadily to fully
reestablish its permanent presence in New York City and earlier this year
moved back into permanent space in Lower Manhattan from temporary quarters
in Jersey City, New Jersey. The Commission and its staff are particularly
appreciative and grateful for the assistance of Congress in securing the
supplemental funding we needed to recover.
Two of the four largest commodity futures exchanges regulated by the CFTC
were also based in Lower Manhattan: the New York Board of Trade and the New
York Mercantile Exchange. Both were drastically impacted on September
11th and trading did not resume on either exchange for several
days. Other futures exchanges, in Chicago and elsewhere, were impacted by
events in New York, particularly by the closing of the stock markets, and
experienced temporary interruptions in trading.
But in its preparedness and by its responses to this unprecedented disaster,
the futures industry demonstrated foresight, resilience, and determination.
Steady leadership, thoughtful contingency plans, prudent investments in
redundant facilities and backup systems, the ingenuity of technical staffs,
and the courage and tenacity of everyone in the industry, made possible a
remarkably fast and effective resumption of trading, restoring for the U.S.
economy rapid access to risk management and price discovery tools uniquely
provided by the futures industry. The Commission, in coordination with local
authorities, other federal regulators within the President’s Working
Group on Financial Markets, the Congress, and the White House, strove to
assist the industry in restoring operation of these important markets. In
order to memorialize the lessons learned and to spark discussion within the
industry on how to better prepare for future disasters we hope never to
face, the Commission completed a detailed report on both its own and the
industry’s efforts to recover from the attacks.
Internal Challenges:
As busy as this Commission has been with our efforts to fully implement the
CFMA, and with unforeseen challenges like September 11th and
Enron, we have also been hard at work transforming the CFTC into what I
believe everyone will come to recognize as a more efficient, responsive, and
effective oversight regulator that is well structured to properly oversee
trading in the many innovative products and platforms that I believe will
flourish under the CFMA. On July 1st, we officially replaced the
Division of Economic Analysis and the Division of Trading and Markets with
the Division of Market Oversight and the Division of Clearing and
Intermediary Oversight. We have also added a new Office of the Chief
Economist. The Offices of Public Affairs and Legislative and
Intergovernmental Affairs have been combined to form the new Office of
External Affairs. Each new leadership position is now filled by an
experienced professional.
However, we continue to face a serious challenge in attracting and retaining
the type of highly skilled and experienced staff needed to operate
effectively with our new regulatory mandate under the CFMA. With that
mandate, the Commission is moving from the role of a front-line regulator to
a more flexible oversight role. Some might believe that, in this new
capacity, the agency will need fewer resources than in the past. Just the
opposite is true. The CFMA has opened the way for innovation that is
creating new financial products and new trading platforms and also
permitting the clearing system to respond in kind. I believe we have seen
only the beginning of this exciting process.
Although this growth and innovation in the marketplace promises to provide
real benefits to market participants and the economy as a whole, it also
places increasingly greater demands on the resources of the Commission
because our primary responsibilities have not changed. With new exchanges
and alternate trading platforms, there is no longer a “template”
to follow; rather, oversight must be tailored to fit a variety of markets
along a spectrum of regulatory classifications from basic fraud and
manipulation protections to full oversight. To continue to fulfill our
mission to promote markets that are free from congestion or manipulation and
to protect market participants from fraud and abusive practices, we must
have staff with the proper training and with solid experience in the markets
we oversee.
All too often, however, we lose good people just as they are coming into
their own as commodity lawyers, economists, and trading specialists. Our
turnover rate is more than twice the federal average. In most, if not all,
cases the CFTC’s ability to compensate such highly skilled people lags
not only far behind that of the private sector, but also well behind that of
the other federal financial regulators, where turnover rates are
significantly lower. Until recently, we were the only financial regulator
still subject to the pay restrictions of Title V. While we are immensely
grateful to the House and Senate for working so hard to successfully provide
the Commission with a pay parity provision in the farm bill and we hope you
will provide funding to fully implement this provision.
I thank you for the opportunity to testify today and will be happy to answer
any questions you may have.