Accounting and Regulation: Two Parts of Reform Bill Shine for CFTC

June 11, 2010

CFTC supports position limits and more clarity in OTC markets; looks for more authority.

As one would expect, the US Commodities Futures Trading Commission supports all the pieces of the financial regulatory reform taking shape in Congress. But it has taken a particular liking to two, according to CFTC Commissioner Bart Chilton: position size limits and derivatives oversight.

Commissioner Chilton, speaking at a dinner hosted by Reval in New York City on June 10, said he had the previous day sent a letter to Congress in lauding the passage of the financial reform bill, specifically highlighting its support for the parts it particularly likes. Also in the letter was a request for assurance from lawmakers that the CFTC will be given the authority to go after disruptive trading practices. “For many years the Commission labored under an impossibly difficult legal standard required to prove manipulation in court,” Commissioner Chilton said.

Not addressing the problems and regulating the markets adequately will lead to more “flash crashes” and another financial meltdown.

Reasonable limits
As far as limitations on big positions go, Commissioner Chilton said that they were necessary, although he acknowledged that they would be a challenge to impose. For one, he said, pinpointing what should be considered “big” is difficult. He cited, however, what he called the “massive passives,” those speculators who were responsible for injecting up to $200 billion into the futures market in the years leading up to the financial crisis. He calls them this because they are “big and have a passive, price-indifferent, long-only strategy,” and have the ability to upend the market very quickly. To monitor this, he said the futures markets need some sort of “sensible, well-calibrated limits to give us a handle” on them. “This is a common-sense, reasonable solution to a real-life, real-world, real-time problem,” the commissioner said. “It has worked in the past and it can work again.” He said the CFTC and others would work hard not to make any rules “over the top or ill-conceived.”

Better OTC oversight
One of the main issues leading up to the financial crisis was that the government didn’t have a good view of the derivatives market, according to Commissioner Chilton. In the past few years, he said, regulators could only see a fraction of the derivatives market, or only about $5 trillion. Meanwhile, the unregulated OTC market was over $600 trillion. He added that he and fellow regulators had a good handle on the $5 trillion portion. However, it was the $600 trillion market, “where credit default swaps—bets upon bets that bundled mortgages would fail—had their home,” ran wild and of course needed the oversight.

This is why in his letter the commissioner put his full weight behind the piece of legislation that would give regulators supervision over the “dark” OTC markets. “The transparency provided by this legislation, and the protections against systemic risk, are critically important to our national economy and to the protection of the public,” he said.

More sting
Commissioner Chilton also hoped Congress would give the CFTC more power to go after disruptive traders. As it stands now, there is a high legal standard required to prove any market manipulation. The commissioner wants that lowered somewhat – but not so low as to “chill the price discovery process” – but low enough to go after conduct that rises to the level of manipulation. Currently in the reform bill is a measure that would “harmonize the CFTC manipulation law with the SEC’s statute.”

Commissioner Chilton said the agency is also looking to get more funding to upgrade its own technology and detection systems; it is also looking to hire more people. All this would go toward preventing market disruptions and not toward overly clamping down on trade. He acknowledged that there remained many unanswered questions regarding that reform, however, such as how to bring many of the varying OTC products onto a regulated exchange or how clearinghouses would be structured.

But in the end, he said, “reform legislation is going to help. We’re not going to overly regulate or we’re not going to be nutty. We just want to implement efficient and effective measures to help prevent fraud and abuse.”

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