By Todd Phillips
Regulators need to be given the power and resources to better monitor existing products and tackle new products like carbon offsetting
The Commodity Futures Trading Commission, or CFTC, is the federal regulator tasked with regulating derivatives, the complex financial products that contributed to the 2007-08 financial crisis and subsequent recession. Despite its importance in ensuring the stability of the national financial system, the CFTC’s authorization expired in 2013. After a decade and several failed attempts, Congress was scheduled to authorize the CFTC again this year, perhaps as part of the farm bill.
The CFTC has always been at the forefront of identifying and managing market changes – such as the use of financial derivatives, algorithmic trading, and cryptocurrencies – but has often been blocked by restrictive laws, political resistance, and limited funding.
The reauthorization is an opportunity for Congress to take stock of the CFTC’s mission and markets and give the CFTC new powers to address evolving concerns.
The OTC markets have exploded
Much has changed since the CFTC’s enabling statute, the Commodity Exchange Act, was updated in 2010 by the Dodd-Frank Financial Reform Act.
Derivatives markets have exploded between 2010 and 2022: open interest in exchange traded futures and options nearly doubled; the over-the-counter (OTC) foreign exchange market has more than doubled; the OTC rates market has nearly tripled; and since the agency gained the power to regulate cleared swaps, they have grown into a more than $350 trillion market.
High-frequency trading has gained market share. The exchanges and clearing houses that support the derivatives markets have become increasingly consolidated. Businesses rely on contracts related to weather and other real-world events to hedge their risks and rely on carbon offsets to meet their climate goals. The CFTC has repeatedly been asked to decide whether to allow contracts related to elections. And the CFTC has authority to fight fraud related to crypto commodities, including Bitcoin, which accounts for almost 40% of the crypto market cap and over 50% of its daily trading volume.
Changes that should be addressed
A new CFTC approval would be an opportune time to address these market shifts and more.
First and foremost, Congress should use reauthorization legislation to increase funding for the CFTC. The CFTC is significantly underfunded. Between 2010 and 2021, the CFTC’s workforce increased by just 14.5% as the agency began overseeing a new $350 trillion market. And if funding increases today are too high, Congress could allow the CFTC to impose transaction fees that would open the door to higher funding in the future, as was done for the SEC.
Even ignoring changes in funding, there is still much more that can be done to enhance the CFTC’s ability to protect nations’ markets. The dwindling competition between platforms means that the two biggest players in the derivatives infrastructure industry have a virtual duopoly, allowing them to raise prices and have a bigger lobbying presence in CFTC politics than anyone else.
To counteract this lack of competition, re-authorization could implement policies that require competition between platforms and prevent vertical or horizontal integration.
To further encourage competition, Congress could require exchanges to use only central limit order book systems, or at least require contracts with a certain daily trading volume to be traded in central order books. And since transparent pricing data is necessary for effective markets, Congress could ban exchanges from charging for data that is contrary to the public interest or anti-competitive, similar to securities laws, or simply require public disclosure of the information with equal access.
Congress could also address issues related to diversity. Unlike all other financial regulatory agencies, the law does not require the CFTC to have an office for minorities and women’s inclusion. Although the CFTC currently has such an office, Congress should include a requirement in legislation so that a future commission cannot abolish it.
Additionally, the law currently requires that some, but not all, exchanges “make an effort” to recruit “culturally diverse” individuals to serve on their boards. There’s no reason why Congress shouldn’t call for racial diversity on the boards of all exchanges.
While Congress is addressing this issue, it might also address the fact that the law only requires some exchanges to have chief compliance officers; all exchanges should have these officers and they should be made independent of business functions.
New markets, new risks
In addition, there are several asset classes that require Congressional attention. Event contracts come first. The CFTC is frequently asked to decide whether to allow trading in contracts on election results, which some have equated with gambling. Ideally, this decision should be taken by the elected representatives of the people, and Congress should express itself clearly on the matter.
There are also many problems with voluntary carbon offsetting, so companies and consumers cannot trust their guarantees. The CFTC — which can act against fraud and manipulation in commodity cash markets and regulate commodity derivatives — is the only regulator with even limited jurisdiction over offsets. Congress could specifically require issuers to provide audited, CFTC-regulated disclosures so customers can have confidence in the products they buy.
Eventually, Congress could regulate crypto commodities. While the CFTC has recently drawn criticism for its interactions with failed crypto exchange FTX, its oversight of FTX’s LedgerX subsidiary appears to have successfully bailed that company out of bankruptcy. Additionally, the Financial Stability Oversight Council has asked Congress to enact legislation governing the cash market for crypto commodities — a power Congress could grant to the CFTC if reauthorized. Still, Congress might want to tackle crypto in separate legislation.
Certainly not all of these proposals will garner bipartisan support, and re-approval has previously failed due to irreconcilable disagreements. However, disagreements on some matters should not prevent Congress from acting on matters on which there is consensus. Democrats and Republicans should find out where there is agreement and work to make CFTC reauthorization a reality. This would be an opportunity to give the CFTC the tools and resources to effectively oversee the markets it regulates.
Todd Phillips is a Principal at Phillips Policy Consulting, LLC and was previously a member of the CFTC’s Market Risk Advisory Committee.
More about controls
US regulators are cracking down on DeFi. It’s actually a bullish sign, says Moody’s
Crypto Regulation: After a chaotic year for digital assets, 2023 faces two big questions
Opinion: An antiquated US regulatory regime allowed SBF to make mistakes
-Todd Phillips
(ENDS) Dow Jones Newswires
1/28/23 1053ET
Copyright (c) 2023 Dow Jones & Company, Inc.
Comments are closed.