The reauthorisation of the US regulator should be a formality, but the combination of Dodd-Frank implementation and the MF Global failure have made for a deeper discussion of the agency’s future.

What’s happening?

The US Commodity Futures Trading Commission (CFTC) is not a permanent institution, but must instead be reauthorised by Congress every five years. The next renewal is due in September 2013, and Congress has given interested parties until the start of May to present their views.

What price good regulation?

The Dodd-Frank Act has fundamentally altered the role of the CFTC, requiring it to build a regulatory regime for most of the previously unregulated over-the-counter (OTC) swaps market. This is also a much larger market than the CFTC’s traditional futures domain, and used by a broader range of participants. The agency must fulfil that expanded role with about 650 staff, compared with the 3000 available to the Securities and Exchange Commission (SEC). On the basis of advice from CFTC chairman Gary Gensler, president Barack Obama has called for an increase of 54% in the CFTC’s budget for the next procurement year, to $308m. Mr Gensler indicated that this would correspond to a 44% increase in staff spending, and a 62% increase in information technology spending.

More speed, less haste?

Possibly driven by the need to prove itself every five years, the CFTC has moved more quickly than the SEC in many areas. This has resulted in rule-making followed by published 'no-action' letters and guidance in response to specific questions from market participants adversely affected by the new rules.

Opinion is divided on the wisdom of this approach. Marc Horwitz, partner and head of the derivatives practice at DLA Piper, says market participants welcome the CFTC’s willingness to listen to concerns and tweak rules accordingly. But Susan Ervin, partner at Davis Polk and a former lawyer at both the CFTC and SEC, says the SEC had a more established infrastructure to work with, and appeared more confident in deciding that the deadlines proposed for Dodd-Frank implementation were unrealistic.

“At the CFTC, the deadlines imposed were extraordinarily compressed and the staff resources available were stretched to breaking point. As a result, the rulemakings often did not take account of the huge implementation issues created by the new rules, which called for massive changes in market structures and operations. Extensive follow-on relief has been required, often on the eve of regulatory deadlines. For example, the April 10 reporting deadline for end-users was extended only on April 9, in recognition of the technology challenges entailed in establishing reporting systems,” says Ms Ervin. 

Acceptance

Who’s in charge?

Financial institutions dealing in both listed and OTC products are under the dual jurisdiction of both the SEC and the CFTC. The Senate Committee on Financial Services subcommittee on oversight and investigations painted an unflattering picture of the two agencies in relation to the 2011 failure of MF Global, at the time the country’s largest independent futures broker. The November 2012 report concluded that “the SEC and the CFTC failed to share critical information about MF Global with one another, leaving each regulator with an incomplete understanding of the company’s financial health”.

The new regulatory regime for products is also split between the two agencies, with the SEC responsible for anything classified as “securities-based swaps”. This includes single-name equity derivatives and credit default swaps. However, the CFTC is responsible for any index-based products, including credit default swap indices. An index is defined as any product referencing more than nine individual securities. Both agencies will be responsible for regulating certain hybrid swap products under rules that have yet to be drafted.

“If the CFTC and SEC were implementing rules in the same way, it would not be so complex, but there are differences of approach, for example on cross-border rules and swap execution facilities. At a time when financial products, intermediaries and markets are converging, to have two separate regulatory regimes is unduly confusing and creates the potential for regulatory arbitrage,” says Kathleen Hamm, managing director at regulatory consultancy Promontory and a former chief regulatory officer for an electronic futures exchange.

Time to pool resources?

This is a strong argument to merge the two agencies to build a more efficient regime for end-users and hopefully cut costs for the overstretched US government. But the consensus is that the CFTC will be reauthorised as a separate entity. On a purely political level, the agencies are overseen by separate Senate committees – agriculture for the CFTC, banking for the SEC.

“Dodd-Frank has highlighted the issue of split regulators, but commodities regulations historically existed to protect commodity futures customers who tended to be quite different from the securities market participants regulated by the SEC, and the view has always been that this group might not be adequately protected if the two regulators were to merge,” says Mr Horwitz.

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