U.S. GOVERNMENT PRINTING OFFICE

70–514 CC WASHINGTON : 2000

S. HRG. 106–922

S. 2697—THE COMMODITY FUTURES

MODERNIZATION ACT OF 2000

JOINT HEARING

BEFORE THE

COMMITTEE ON AGRICULTURE,

NUTRITION, AND FORESTRY

UNITED STATES SENATE

AND THE

COMMITTEE ON BANKING, HOUSING,

AND URBAN AFFAIRS

ONE HUNDRED SIXTH CONGRESS

SECOND SESSION

ON

S. 2697—THE COMMODITY FUTURES MODERNIZATION ACT OF 2000

JUNE 21, 2000

Printed for the use of the

Committee on Agriculture, Nutrition, and Forestry

(

For sale by the U.S. Government Printing Office

Superintendent of Documents, Congressional Sales Office, Washington, DC 20402

COMMITTEE ON AGRICULTURE, NUTRITION, AND FORESTRY

RICHARD G. LUGAR, Indiana, Chairman

JESSE HELMS, North Carolina

THAD COCHRAN, Mississippi

MITCH MCCONNELL, Kentucky

PAUL COVERDELL, Georgia

PAT ROBERTS, Kansas

PETER G. FITZGERALD, Illinois

CHARLES E. GRASSLEY, Iowa

LARRY E. CRAIG, Idaho

RICK SANTORUM, Pennsylvania

TOM HARKIN, Iowa

PATRICK J. LEAHY, Vermont

KENT CONRAD, North Dakota

THOMAS A. DASCHLE, South Dakota

MAX BAUCUS, Montana

J. ROBERT KERREY, Nebraska

TIM JOHNSON, South Dakota

BLANCHE L. LINCOLN, Arkansas

KEITH LUSE, Staff Director

DAVID L. JOHNSON, Chief Counsel

ROBERT E. STURM, Chief Clerk

MARK HALVERSON, Staff Director for the Minority

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

PHIL GRAMM, Texas, Chairman

RICHARD C. SHELBY, Alabama

CONNIE MACK, Florida

ROBERT F. BENNETT, Utah

ROD GRAMS, Minnesota

WAYNE ALLARD, Colorado

MICHAEL B. ENZI, Wyoming

CHUCK HAGEL, Nebraska

RICK SANTORUM, Pennsylvania

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

PAUL S. SARBANES, Maryland

CHRISTOPHER J. DODD, Connecticut

JOHN F. KERRY, Massachusetts

RICHARD H. BRYAN, Nevada

TIM JOHNSON, South Dakota

JACK REED, Rhode Island

CHARLES E. SCHUMER, New York

EVAN BAYH, Indiana

JOHN EDWARDS, North Carolina

WAYNE A. ABERNATHY, Staff Director

STEVEN B. HARRIS, Democratic Staff Director and Chief Counsel

(II)

(III)

C O N T E N T S

Page

HEARING:

Wednesday, June 21, 2000, S. 2697—The Commodity Futures Modernization

Act of 2000 ............................................................................................................ 1

APPENDIX:

Wednesday, June 21, 2000 ...................................................................................... 47

DOCUMENT(S) SUBMITTED FOR THE RECORD:

Wednesday, June 21, 2000 ...................................................................................... 93

Wednesday, June 21, 2000

STATEMENTS PRESENTED BY SENATORS

Lugar, Hon. Richard G., a U.S. Senator from Indiana, Chairman, Committee

on Agriculture, Nutrition, and Forestry ............................................................. 1

Gramm, Hon. Phil, a U.S. Senator from Texas, Chairman, Committee on

Banking, Housing, and Urban Affairs ................................................................ 3

Bennett, Hon. Robert F., a U.S. Senator from Utah ............................................ 25

Fitzgerald, Hon. Peter G., a U.S. Senator from Illinois ....................................... 21

Grams, Hon. Rod, a U.S. Senator from Minnesota ............................................... 30

Harkin, Hon. Tom, a U.S. Senator from Iowa, Ranking Member, Committee

on Agriculture, Nutrition, and Forestry ............................................................. 5

Sarbanes, Hon. Paul S., a U.S. Senator from Maryland, Ranking Member,

Committee on Banking, Housing, and Urban Affairs ....................................... 11

Kerrey, Hon. J. Robert, a U.S. Senator from Nebraska ....................................... 23

Schumer, Hon. Charles E., a U.S. Senator from New York ................................. 27

WITNESSES

PANEL I

Greenspan, Hon. Alan, Chairman of the Board of Governors of the Federal

Reserve System, Washington, DC. ..................................................................... 9

Summers, Hon. Lawrence, Secretary of the U.S. Department of the Treasury,

Washington, DC. .................................................................................................. 6

PANEL II

Levitt, Hon. Arthur, Chairman of the Securities and Exchange Commission,

Washington, DC. .................................................................................................. 32

Rainer, Hon. William, Chairman of the Commodity Futures Trading Commission, Washington, DC. ......................................................................................... 34

APPENDIX

PREPARED STATEMENTS:

Lugar, Hon. Richard G. .................................................................................... 48

Fitzgerald, Hon. Peter G. ................................................................................. 50

Santorum, Hon. Rick ........................................................................................ 56

Edwards, Hon. John ......................................................................................... 57

Craig, Hon. Larry E. ........................................................................................ 59

Page

IV

PREPARED STATEMENTS—CONTINUED

Greenspan, Alan ............................................................................................... 66

Levitt, Arthur ................................................................................................... 73

Rainer, William ................................................................................................. 85

Summers, Lawrence ......................................................................................... 60

DOCUMENT(S) SUBMITTED FOR THE RECORD:

Position statement of the Bond Market Association, submitted by Frank

R. Hampton, Vice President Legislative Affairs ......................................... 94

(1)

HEARING ON S. 2697—THE COMMODITY

FUTURES MODERNIZATION ACT OF 2000

WEDNESDAY, JUNE 21, 2000

U.S. SENATE,

COMMITTEE ON AGRICULTURE, NUTRITION, AND FORESTRY,

AND THE COMMITTEE ON BANKING, HOUSING AND URBAN

AFFAIRS,

Washington, DC.

The Committees met jointly, pursuant to notice, at 10:07 a.m., in

room 106, Dirksen Senate Office Building, Hon. Richard G. Lugar,

(Chairman of the Committee on Agriculture, Nutrition and Forestry,) presiding.

Present or submitting a statement: Senators Lugar, Gramm,

Bennett, Fitzgerald, Santorum, Grams, Harkin, Sarbanes, Dodd,

Kerrey, Conrad, Johnson, and Schumer.

OPENING STATEMENT OF HON. RICHARD G. LUGAR, A U.S.

SENATOR FROM INDIANA, CHAIRMAN, COMMITTEE ON AGRICULTURE, NUTRITION, AND FORESTRY

The CHAIRMAN. This hearing of the Senate Agriculture Committee and the Senate Banking Committee, held jointly, is open for

business. Today I would simply point out the Agriculture Committee and the Banking Committees will hear testimony from members of the President’s Working Group in regard to Senate Bill

2697, legislation to provide legal certainty to the over-the-counter

derivatives market and to reauthorize and to reform the Commodity Exchange Act. The Commodity Exchange Act expires on September 30 of this year and the Senate Agriculture Committee is

charged with reauthorizing this statute.

However, we cannot accomplish this endeavor without the strong

assistance and cooperation of members of the Senate Banking Committee. I am very pleased to have the distinguished Chairman of

the Senate Banking Committee, Senator Phil Gramm of Texas,

joining me as a cosponsor of this important legislation. We look forward to working with the Banking Committee as the legislation

proceeds.

Our legislation has been several years in the making. The Senate

Agriculture Committee held a two-day roundtable of 19 industry

experts in February 1999 to discuss the policies surrounding CFTC

reauthorization. Asked to prioritize the issues of importance, most

panelists thought legal certainty to be the most pressing issue.

Others suggested repeal of the Shad-Johnson Accord and that testimony included Phil Johnson, former CFTC chairman and one-half

2

of the accord’s namesake, and several mentioned regulatory relief

for the futures exchanges as an important priority.

Today’s hearing representing our committee’s fifth public forum

on CFTC reauthorization in the last 18-months will hear testimony

regarding how all of these issues are addressed in our legislation.

Signed into law in 1974, the modern Commodity Exchange Act

requires that futures contracts be traded on a regulated exchange.

As a result, a futures contract that is traded off an exchange is illegal and unenforceable in a court of law. When Congress enacted

this act, the meaning of the terms ‘‘future’’ and ‘‘exchange’’ were

relatively apparent and the over-the-counter derivatives business

was in its in infancy.

In the 26-years since the statute’s creation, however, the definitions of a swap and a future began to blur. In 1998 the CFTC released its concept release on over-the-counter derivatives, which

was perceived by many as a precursor to regulating those instruments as futures. Just the possibility of reaching this conclusion

threatened to move significant portions of the business overseas.

This led the Treasury Department, the Federal Reserve and the

SEC to ask Congress to enact a moratorium on the CFTC’s ability

to regulate these instruments until after the President’s Working

Group could complete a study of the issue.

As a result, Congress passed a 6-month moratorium and in November 1999 the President’s Working Group completed its unanimous recommendations on derivatives and presented Congress

with those findings. This legislation adopts many of the unanimous

recommendations of the Working Group’s report, including an exclusion for over-the-counter derivatives transacted on an electronic

exchange and a clarification of the so-called Treasury Amendment.

Another important recommendation of the Working Group was to

authorize futures clearing facilities to clear over-the-counter derivatives in an effort to lessen systemic risk. This bill incorporates that

finding.

The second major section of this legislation addresses regulatory

relief for the futures market. In February, the CFTC, under the

leadership of Chairman Bill Rainer, issued a thoughtful proposal

that would provide relief to futures exchanges and their customers.

Instead of listing specific requirements for complying with the act,

the proposal would require exchanges to meet internationally

agreed upon core principles. The CFTC proposal tailors regulation

for exchanges based on whether the underlying commodity can be

manipulated or whether the users of the exchange are institutional.

Our legislation incorporates this framework.

The bill’s last major section addresses the Shad-Johnson Jurisdictional Accord, which banned single-stock futures in 1982. The

Working Group unanimously agreed that the accord can be repealed if regulatory disparities are resolved between futures and

securities. In December Senator Gramm and I sent a letter requesting that the CFTC and the SEC make recommendations on

reforming the Shad-Johnson Accord. The SEC and the CFTC responded that although progress had been made, the agencies could

not resolve these issues before October of this year.

Disappointment with this answer led Senator Gramm and me to

once again ask the agencies to attempt to resolve the problems surVerDate 11-MAY-2000 16:34 Mar 08, 2001 Jkt 070514 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 70514.TXT SAGRI1 PsN: SAGRI1
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rounding lifting the ban. Unfortunately, an agreement within our

legislative timeframe was not reached and we have decided to move

forward with our legislation.

This legislation would repeal the prohibition on single-stock

users and allow these products to trade on either a CFTC-regulated

futures exchange or an SEC-regulated securities exchange. Our bill

also would provide for joint jurisdiction with each agency maintaining its core authorities over the trading of single-stock users. The

legislation would further require that margin levels on these products be harmonized with the options market.

The goal of the legislation is to ensure that the United States remains a global leader in the derivatives marketplace. Already the

United States has lost much of its leadership role in the exchangetraded futures markets in Europe and the over-the-counter market

may not be far behind. Congress has a good opportunity at this

point to reverse this tide by enacting sound legislation this year.

For my own part, I am hopeful that the Agriculture Committee

can mark up this legislation prior to the July 4 recess, namely,

next week.

The importance of this legislation is reflected by the witnesses

assembled before us today and we are grateful for each one of

them. Our first panel consists of the head of to President’s Working

Group, the Honorable Lawrence Summers, Secretary of the United

States Department of the Treasury, and the Honorable Alan Greenspan, Chairman of the Federal Reserve System. Our second panel

will consist of the Honorable Arthur Levitt, Chairman of the SEC,

and the Honorable Bill Rainer, Chairman of the CFTC. We look

forward to their insights regarding their agencies’ discussions on

the Shad-Johnson accord, as well as on all of the other issues.

[The prepared statement of Senator Lugar can be found in the

appendix on page 48.]

It is now a privilege to turn to my distinguished colleague, Senator Gramm, for his opening remarks.

OPENING STATEMENT OF HON. PHIL GRAMM, A U.S. SENATOR

FROM TEXAS, CHAIRMAN, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

Senator GRAMM. Mr. Chairman, let me first thank you for your

leadership on this issue. Let me say for the record that it has been

a great privilege to work with you and the excellent staff of the

Agriculturee on this bill.

This is an effort that has been undertaken by the Agriculture

and Bamking Commmittees to do something that is both important

and, obviously, very difficult.

Whenever we work in areas that are cross-jurisdictional in Congress, those differences sometimes become barriers to legislative action, and I want to congratulate you for your leadership in seeing

that, that has not happened in this important area.

As I see this bill, we are trying to do three simple things that

may not create great excitement among American consumers, but

they are very important and affect the well-being, prosperity and

financial security of everybody who works, saves, invests and benefits from living and working in the greatest economy in the history

of the world.

4

We want legal certainty for swaps. Most people do not know

what swaps are. I am almost incapable of fathoming the volume of

swaps in dollar value. When I heard the number as we first started

discussing this issue, I was convinced that an error had been made

and that someone had mistakenly said trillions instead of billions;

I was wrong. This is a huge, critically important markets, and we

cannot allow uncertainty about the enforceability of these contracts

to stand.

We are all aware that uncertainty occurs because of the off-exchange trading prohibition in the Commodities Exchange Act. If

the Commodities Futures Trading Commission deemed these swaps

to be futures, that would create this legal uncertainty.

I believe that a similar uncertainty could be created if the SEC

deemed them securities and then argued that they were being traded without fulfilling the reporting requirements of the Securities

and Exchang4e Commission statute.

Also, it is important for us to note that while two of the most enlightened people who have ever served now head the CFTC and

SEC, we have no guarantee that, that leadership is going to remain

in the future and regulation doth abhor a vacuum. So, I think it

is very important that we have legal certainty as it relates to both

CFTC and the SEC

Let me also say that we had hoped, Mr. Chairman, and I know

you had hoped, that we could get the CFTC and the SEC to work

out an agreement as to how they were going to regulate the new

instruments that would be created futures on individual stocks.

The SEC and CFTC made a legitimate effort, but they were unable

to reach a conclusion as to how to share this regulatory authority.

Ultimately, I have not given up hope that this can be worked out.

It is important that it be worked out so that these two important

regulatory entities can do what they do best. We need the SEC in

all areas to exercise its authority on anti-fraud and insider trading.

We need the CFTC doing the things it can do. I think an agreement as to how they can share regulatory responsibility on individual futures could also affect areas where there are still legitimate

regulatory concerns concerning swaps.

Second, this bill does provide a new financial instrument that in

my opinion is long overdue. There are problems in providing it in

that we have to harmonize margins, we have tax differences between options and futures, but none of these problems is insurmountable. We try to deal with them in this bill, and I am sure

we will refine the bill as we go along.

And finally, this bill does begin regulatory relief. I am hopeful

that by the end of the bill, we can go further. I do not believe that

we have done what we should do in providing regulatory relief. The

world is very different today than it was in 1934, when we were

willing to trade tremendous regulatory burden for transparency. It

was the right decision to make at the time, but with modern technology, with the evolution of markets, we have transparency at levels that never existed before.

We have competition from all over the world that would very

much like to see this goose that lays the golden egg, these financial

markets, roosting in their coop. They are trying to do things to attract it. They are unifying markets. They are reducing regulatory

5

burden. I believe that we need to do it. No one can convince me

that the regulations necessary to protect my parents are the same

regulations that are necessary to protect my children in today’s financial markets.

We would do well, Mr. Chairman, to remember the Lincoln’s

adage that to ask a society to live under old and out-moded laws,

and I think you could say the same about regulation, is like asking

a man to wear the same clothes he wore when he was a boy.

We need a comprehensive review of the regulatory burden in financial markets. We need to challenge every regulation and every

law as to benefits versus costs, and when the costs exceed the benefits, we either need to change, overturn or repeal that regulation

as law.

Mr. Chairman, you have made an important start here. I want

to congratulate you for it. We face a difficult challenge in an election year and the waning days of this Congress, but this is an important issue and, Mr. Chairman, I want to commit to you that I

intend to work hard to try to help you be successful.

The CHAIRMAN. Well, thank you very much, Chairman Gramm.

I appreciate those comments and your testimony.

Let me try to lay out a format that I hope will be agreeable. I

am going to call now upon the distinguished Ranking Member of

the Agriculture Committee for an opening statement and upon his

appearance, Senator Sarbanes as the Ranking Democratic member

on the Banking Committee.

I will ask other members, if I may, to forego opening statements

so that we may hear the witnesses. We will have a round of questioning with no more than 5-minutes per Senator because we do

have two distinguished panels and we have two committees.

So unless there are strong objections to that format, we will try

to proceed on that basis and I will call now upon Senator Harkin

for his testimony, his opening statement.

STATEMENT OF THE HON. TOM HARKIN, A U.S. SENATOR

FROM IOWA, RANKING MEMBER, COMMITTEE ON AGRICULTURE, NUTRITION, AND FORESTRY

Senator HARKIN. Thank you very much, Chairman Lugar and

Chairman Gramm. And we welcome Senator Sarbanes and other

members of the Committee on Banking, Housing and Urban Affairs.

I appreciate this opportunity to hear the views of the Members

of the President’s Working Group on Financial Markets concerning

the legislation introduced by Senators Lugar, Gramm and Fitzgerald. I especially want to commend you and thank you, Chairman

Lugar, for your conscientious work in crafting this important legislation.

I have said before that when it comes to derivatives and everything else that we are dealing with here in terms of complexity, the

subject matter of this legislation surely rivals anything that ever

comes before our committee, with the possible exception of dairy

policy. That may be more convoluted.

The issues are indeed complicated. Their resolution has tremendous ramifications in the markets. The bill that has been introduced clearly reflects the hard work that Chairman Lugar and his

6

staff has put into it. And, for the most part, it carefully follows the

recommendations of the President’s Working Group, provides legal

certainty for over-the-counter derivatives, ensures regulatory relief

for futures exchanges and brings clarity to the Treasury Amendment, finally, in the treatment of certain hybrid instruments, generally modernizes the Commodity Exchange Act to take into account the rapid pace of change in the financial markets and in

technology. It seeks to maintain and strengthen the protection of

investors in the public interest.

To be sure, there are a number of issues that require further attention. I look forward to working with the Chairman, the Regulatory agencies and other parties to resolve the remaining issues.

As we continue to work on this legislation, we, in essence, have

a balancing act to perform. To be sure, there is a real need for legal

certainty, for modernizing and reforming regulations. I just Chairman Gramm saying about the old Jeffersonian quote about—in

fact, it is engraved in the Jefferson Monument down here, about

expecting the adult to wear the clothes of childhood would be the

same as expecting the Nation to live by the laws of its ancestors.

But, at the same time, we must ensure that investors are protected and that we do not create disparities in regulation and in

competitive positions of the various types of financial markets.

Without a doubt, we now have a truly global financial market.

The regulatory climate should not hinder; should enhance the competitive position of U.S. markets and firms. However, when it

comes to international competitiveness, there is also a tremendous

value to the integrity, safety and soundness of markets, an area

where the U.S. has excelled. The cost of transactions is important

but over time, money will flow to markets where integrity, safety

and soundness are adequately protected. To me, that is the bottom

line. Thank you very much, Mr. Chairman.

The CHAIRMAN. Well, thank you very much, Senator Harkin. I

commend you again for your thoughtfulness in working with us.

Members of the Democratic staff, in a bipartisan way, have been

working on this legislation and we appreciate that.

At this point it is my privilege to recognize in the order that I

have introduced the witnesses, the distinguished Secretary of the

Treasury. He has been a good friend of our committee, coming before us not in each of these five iterations of the CFTC but in many

of them, and in his role with the Working Group has already made

a contribution, I believe, to American financial security.

Secretary Summers.

Senator DODD. Mr. Chairman, before you do that, I presume that

opening statements in which we lavish praise on you and Senator

Gramm are appropriate?

The CHAIRMAN. Oh, they would be welcome, published in full.

Thank you.

Mr. Summers.

STATEMENT OF THE HON. LAWRENCE SUMMERS, SECRETARY

OF THE U.S. DEPARTMENT OF THE TREASURY, WASHINGTON, DC.

Secretary SUMMERS. Chairman Lugar, Chairman Gramm, Ranking Members Harkin and Sarbanes, members of these Committees,

7

thank you for giving me the opportunity to testify before you once

again on the Commodities Futures Modernization Act.

This is, as your opening statements recognized, an issue that the

President’s Working Group has grappled with for some time and it

is an issue that these committees have been grappling with for

some time.

I believe it is a matter of great importance to the future of our

financial system and to the future of our economy to move ahead

with legislation that provides legal certainty for swaps and OTC

derivatives transactions. And I believe that such legislation is now

within our grasp, with the unanimous agreement of the President’s

Working Group and the very substantial consensus that has

formed in the central area of legal certainty for OTC derivatives

among members of these committees, members of the House of

Representatives and the various constituencies.

I believe that if anything, the events of the last year, as we have

seen dramatic increases in competition in the financial services

area across countries, only go to emphasize the importance of the

United States moving to provide legal certainty.

So it is our very great hope that it will be possible to move this

year on legislation that, in a suitable way, goes to create legal certainty for OTC derivatives while, at the same time, reducing systemic risk, protecting retail customers, and maintaining U.S. competitiveness.

And it is our belief that the central provisions contained in this

bill with respect to OTC derivatives make great progress in achieving these goals and are provisions that we can support as they follow very largely the recommendations of the President’s Working

Group.

I want to address, however, three remaining issues: the securities question, certain technical questions with respect to regulatory

relief for futures exchanges, and Shad-Johnson.

With respect to securities, the bill provides a broad exclusion

from the securities laws for swaps, including in particular, swaps

based on securities. As a general matter, we do not believe that

swaps should be regulated as securities. However, it is important

to preserve prohibitions against insider trading, fraud, manipulation, and also to preserve other measures which are demonstrably

necessary to protect retail customers.

We are concerned that the provisions as currently drafted could

have the unintended consequence of interfering with these vital

protections that are now in place for the securities markets. Because the provisions as currently drafted have the potential to impact the underlying securities markets, we believe that it is imperative that they be amended to address these concerns with respect

to insider trading, fraud, manipulation, and retail consumer protection.

I would hasten to point out that this is very much consistent

with the valid objective of removing unnecessary regulation. I think

it is worth emphasizing, however, that there is one important distinction between the securities laws and the commodities laws in

that the application of securities laws does not in any context create the kind of legal certainty issues that can arise under the CEA.

8

The second concern we have is with respect to the regulatory relief section that permits exempt boards of trade. Let me first say

that we have looked very carefully at the recommendations that

the CFTC has made and while we will be making a formal comment down the road, I can say that we are very much supportive

in general of the changes that Chairman Rainer has recommended

and believe that they represent a landmark achievement.

And we recognize the importance of competitive parity between

the exchange and off-exchange markets, particularly as the status

of off-exchange markets is clarified.

Our concern is with certain provisions that, as drafted, could

have the perverse consequence of creating a situation where protections that are present with respect to off-exchange trades could actually not be present with respect to transactions that took place

on an exchange. These matters are particularly important with respect to the integrity of the Government securities market, as any

reduction in the integrity of the Government securities market

could lead to higher financing costs for the Treasury and an increased burden on American taxpayers.

Let me turn finally to the question of the Shad-Johnson Accord.

We believe that as the Working Group report states, the current

prohibition on single-stock futures can and should be repealed if

issues about the integrity of the underlying securities market and

regulatory arbitrage are resolved. There are a number of concerns,

however, that the regulatory agencies consider important that have

not been resolved in the legislation. While we have no objection to

the introduction of single-stock futures, it is vitally important that

the integrity of the underlying markets be preserved and that these

instruments not be used as a means to avoid the regulation of the

cash market.

But let me be very clear on one point. We believe that this issue

should not be allowed to be an impediment to clarifying legal certainty with respect to OTC derivatives. It is our very great hope

that it can be resolved in a mutually satisfactory way but we do

not believe that it should be allowed to defer OTC derivatives legal

certainty, given the overwhelming importance of that issue.

Let me just take this opportunity to comment on an issue that

is not part of the bill before you today, and that is the question of

the treatment of OTC derivatives in instances of bankruptcy and

insolvency.

I would like to take the opportunity to strongly urge the Congress to adopt the President’s Working Group’s recommendations

regarding the treatment of certain financial contracts, including

OTC derivatives, in cases of bankruptcy or insolvency. This is a

step that could have a meaningful impact on the mitigation of systemic risk.

Mr. Chairman, let me conclude where I began. The achievement

of legal certainty and a modern legal and regulatory framework for

OTC derivatives is an issue of great importance to our financial

system, the competitiveness of our markets and businesses and our

economy. With this legislation, it appears that, that goal is within

our grasp. I urge this committee to rapidly address the remaining

concerns so that we can move forward on much-needed legal certainty in the OTC derivatives market. Thank you.

9

[The prepared statement of Secretary Summers can be found in

the appendix on page 60.]

The CHAIRMAN. Well, thank you very much, Secretary Summers,

for your comments and for your endorsement with the caveats that

you have given and we will take those seriously.

When I visited with you and with Chairman Greenspan earlier,

the Chairman noted a very, very large audience here today for

something that is very difficult to understand. I would say the audience is a tribute to the two of you. You are persons that are listened to. You make a difference in our thoughtfulness and I call

now upon Chairman Greenspan for his testimony.

STATEMENT OF THE HON. ALAN GREENSPAN, CHAIRMAN OF

THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE

SYSTEM, WASHINGTON, DC.

Mr. GREENSPAN. Thank you very much, Mr. Chairman. I should

say chairmen and Ranking Members. This, incidentally, is the first

time in all of my years testifying before the Senate that I recall,

appearing before a joint committee of this nature, and I must say

that considering the nature and presumed complexity and obscurity

of this type of legislation, it is a clear testament of how important

this issue is to the financial system of the United States, its integrity, and essentially the underlying prosperity which it has been so

important in contributing to.

I am especially pleased to be here to present the Federal Reserve

Board’s views on the Commodity Futures Modernization Act of the

Year 2000. My testimony today will be largely identical to the testimony of my colleague Patrick Parkinson delivered on behalf of the

Federal Reserve Board last week to the House Subcommittee on

Risk Management, Research, and Specialty Crops.

Let me say first that I wish to associate myself with all of the

remarks of Secretary Summers and will endeavor not to repeat and

go over similar grounds.

The Federal Reserve Board continues to believe that the Commodity Futures Modernization Act of 2000, modernizing the Commodity Exchange Act, is essential. To be sure, the CFTC has recently proposed issuing regulatory exemptions that would reduce

legal uncertainty about the enforceability of OTC derivatives transactions and would conform the regulation of futures exchanges to

the realities of today’s marketplace. These administrative actions

by no means obviate the need for legislation, however.

In my remarks today I shall focus on three of the areas that the

legislation covers: first, legal certainty for OTC derivatives; second,

regulatory relief for U.S. futures exchanges; and third, of course,

repeal of Shad-Johnson restrictions on the trading of single-stock

futures.

In its November 1999 report, the President’s Working Group concluded that OTC derivatives transactions should be subject to the

CEA only if necessary to achieve the public policy objectives of the

act, deterring market manipulation and protecting investors

against fraud and other unfair practices. In the case of financial

derivatives transactions involving professional counterparties, the

Working Group concluded that regulation was unnecessary for

these purposes because financial derivatives generally are not readVerDate 11-MAY-2000 16:34 Mar 08, 2001 Jkt 070514 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 70514.TXT SAGRI1 PsN: SAGRI1
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ily susceptible to manipulation and because professional

counterparties can protect themselves against fraud and unfair

practices. Consequently, the Working Group recommended that financial OTC derivatives transactions between professional

counterparties be excluded from coverage of the CEA.

The Federal Reserve Board continues to support the Working

Group’s conclusions and recommendations. Thus, it supports the

exclusions of OTC derivatives from CEA that are included in S.

2697 because with a few exceptions that appear readily resolvable,

they are consistent with the Working Group’s report.

The Working Group did not make specific recommendations

about the regulation of traditional exchange-traded futures markets that use open outcry trading or that allow trading by retail

investors. Nevertheless, it called for the CFTC to review the existing regulatory structures, particularly those applicable to financial

futures, to ensure that they remain appropriate in light of the objectives of the CEA.

The Federal Reserve Board supports the general approach to regulation that was outlined in the CFTC’s recent proposals. For some

time the Board has been arguing that the regulatory framework for

futures trading, which was designed for the trading of grain futures by the general public, is not appropriate for the trading of financial futures by large institutions. The CFTC’s proposals recognize that the current ’’one-size-fits-all’’ approach to regulation of futures exchanges is inappropriate, and they generally incorporate

sound judgments regarding the degree of regulation needed to

achieve the CEA’s purposes.

Furthermore, the Board generally supports codification of the

CFTC’s proposal so as to provide the exchanges with greater certainty regarding future regulation. However, the Treasury Department is concerned that the exempt board of trade provisions might

have unintended consequences that could reduce the effectiveness

of the existing regulatory framework for the trading of government

securities. To facilitate expeditious passage of legislation, it thus

may be prudent to limit the codification of the exempt board of

trade provisions, at least so that markets currently regulated under

the Government Securities Act of 1986 are not affected. In such a

scenario, the CFTC could address any unintended consequences for

the regulation of government securities by changing the terms of

its exemptions.

The Working Group concluded that the current prohibition on

single-stock futures, part of the Shad-Johnson Accord, can be repealed if issues about the integrity of the underlyng securities markets and regulatory arbitrage are resolved. The Board believes that

S. 2697 provides an appropriate framework for resolving these

issues. Such instruments should be allowed to trade on futures exchanges or on securities exchanges with primary regulatory authority assigned to the CFTC or the SEC, respectively. However, the

bill recognizes that the SEC should have authority over some aspects of trading of these products on futures exchanges. The scope

of the SEC’s authority can and should be resolved in negotiations

between the CFTC and the SEC. The Congress should continue to

urge the two agencies to settle their remaining differences so that

investors have the opportunity to trade single-stock futures.

11

If it would facilitate repeal of the prohibition, the Federal Reserve Board is willing to accept regulatory authority over levels of

margins on single-stock futures, as provided in the bill, so long as

the Board can delegate that authority to the CFTC, the SEC, or an

Intermarket Margin Board consisting of representatives of the

three agencies.

The Federal Reserve Board understands that the purpose of such

authority would be to preserve the financial integrity of the contract market and thereby prevent systemic risk and to ensure that

levels of margins on single-stock futures and options are consistent.

The Board would note that for purposes of preserving financial integrity and preventing systemic risk, margin levels on futures and

options should be considered consistent, even if they are not identical, if they provide similar levels of protection against defaults by

counterparties.

This bill reflects a remarkable consensus on the need for legal

certainty for OTC derivatives and regulatory relief for U.S. futures

exchanges, issues that have long eluded resolution. These provisions are vitally important to the soundness and competitiveness of

our derivatives markets in what is an increasingly integrated and

intensely competitive global economy. The Federal Reserve Board

trusts that remaining differences regarding single-stock futures

and the potential application of the securities laws to OTC derivatives can be resolved quickly and this important piece of legislation

can be expedited through this Congress.

Thank you very much, Mr. Chairman.

[The prepared statement of Mr. Greenspan can be found in the

appendix on page 66.]

The CHAIRMAN. Thank you very much, Chairman Greenspan.

We have been joined by Senator Sarbanes, the Ranking Member

of the Banking Committee. As the Chair announced earlier, the

Ranking Member will be recognized for an opening statement and

then we will proceed with a round of questions for the witnesses.

Senator Sarbanes.

STATEMENT OF HON. PAUL S. SARBANES, A U.S. SENATOR

FROM MARYLAND, RANKING MEMBER, COMMITTEE ON

BANKING, HOUSING, AND URBAN AFFAIRS

Senator SARBANES. Mr. Chairman, thank you very much.

I will really forego an opening statement except simply to observe that this is a very complex issue and I think we have to proceed with considerable caution and when I have my question period, I will have an opportunity, I think, to pose some questions to

the secretary and the Chairman in this regard.

I think we have to work extra hard at trying to get the regulators, who are, after all, the experts in this area upon whom we

rely, to see if they can reach a consensus on how they would recommend proceeding with respect to these important questions.

Thank you very much.

The CHAIRMAN. Thank you very much, Senator Sarbanes.

We will have questions now. I will ask that Senators stay within

a 5-minute limit. I will ask questions. I will then defer to Chairman Gramm, then to the distinguished Ranking Members—Mr.

12

Harkin, Sarbanes—and then we will alternate back and forth, republican and Democratic Senators as they have appeared.

Secretary Summers and to some extent Chairman Greenspan has

reflected this, in a comment that you make on page 5 of your statement you say, ‘‘To be clear, there are provisions of the bill as currently drafted which could have the perverse consequences of creating the situation where protections that are present with respect

to off-exchange trades would not be present with respect to transactions that took place on the exchange. These matters have particular importance with respect to the integrity of government securities markets.’’ Could you amplify that somewhat more? That general point of

view of the Treasury, which has been fairly well known in the securities markets for the past week or so, has brought considerable

consternation and I would like for you to explore that more in your

testimony.

Secretary SUMMERS. Let me just say that I think this is an important but somewhat limited issue in the following sense. We are

supportive of the broad program that Chairman Rainer has laid out

for deregulation. We are supportive of the pillar of that broad program, which is the idea of exemption for boards of trade.

Our difficulty comes from what is almost a drafting question. In

the way the legislation is drafted, it appears to us to allow participants in the exempt boards of trade to avoid the kinds of rules that

we have had in place with respect to the Government securities

market.

You will recall that there was a major episode a decade ago in

which one major firm was involved with an excessive share of a

number of different Treasury auctions, subjecting the market to

possible manipulation. It is our intent and our desire only that

nothing in this legislation preclude the effective enforcement of

those provisions with respect to the Government securities markets.

And my understanding is that there has been considerable discussion among the affected parties and I think there is a feeling

that it is possible to find language that would address our particular and quite narrowly focused concern, which does not go to the

desirability of regulatory relief for futures trading, but only goes to

the question of whether or not it would be possible to avoid restrictions that are in place with respect to cornering and the like in the

Government securities markets by trading on one of these exempt

boards of trade.

The CHAIRMAN. I thank you for that response and I raise the

question knowing that there have been considerable efforts on the

department’s behalf with exchanges with other parties to try to

clarify this language. I think Senator Gramm and I share the

thought that the greatest hope we have with this legislation is that

you and Chairman Greenspan and others are still working with us.

This is a work in process because these clarifications are important.

This legislation might last for a long while and it would be difficult to get everybody concentrated again, so we want to do it

right. But we appreciate the flexibility that you have already demonstrated and I simply wanted to offer that thought.

13

Mr. GREENSPAN. Mr. Chairman, if I may, I think it is important

to emphasize, as the Secretary has just done, that this is a very

narrow technical amendment. It is not questioning the usefulness,

the potential usefulness of the new board of trade vehicle. There

are many different types of usefulness of that vehicle and we certainly at the Federal Reserve Board see advantages in it.

This is a very narrow issue which we fully subscribe to the

Treasury’s position on and would like to see some amendment to

this particular provision to take care of the Treasury’s concerns.

The CHAIRMAN. Well, we look forward to working with you on

that language and your proposal would be welcome.

Let me just initiate a subject I suspect that Chairman Gramm

will get into further. With regard to legal certainty, we have talked

about legal certainty that arose from the so-called Concept Paper

on Swaps that the CFTC was responsible for, so we have tried to

settle that over there.

Now Chairman Gramm has raised the question, ‘‘Well, what

about legal certainty with regard to the SEC in this sort of situation?’’ This seems to have kicked off tremors in various directions.

Let me just say that what is sauce for the goose is sauce for the

gander. I share Chairman Gramm’s thought that we need to explore really where we are headed with regard to legal certainty. It

may have started in one agency but has picked up other problems

somewhere else.

Why has this become an element of such consternation? Because

obviously it is and your testimony, you mention this, Secretary

Summers, as a point of considerable concern.

Secretary SUMMERS. Let me make three points, if I could. I will

preface them by saying that having spoken with Chairman Gramm

about this, my impression is that there are not fundamental differences that cannot be bridged on this question.

The CHAIRMAN. Well, that is reassuring.

Secretary SUMMERS. Having said that, let me make three points.

First, there is, I think, an asymmetry that we need to be clear

about between the securities law issues and the commodities law

issues and that is that were these to be subject to the commodities

law, there is the possibility that past contracts that have been entered into would be unwound and would not be legally binding.

That is why we speak about legal certainty.

There is no parallel feature of the Securities Act that would enable or create any possibility or nexus for past contracts to be

unwound and that is why those who have been concerned with the

legal certainty question have, until it was recently introduced into

the discussion, been focused on the commodities issue and not focussed on the securities issue.

Second, there is nonetheless, in our judgment, a valid objective

of responding to some of the kinds of concerns that Chairman

Gramm articulated in his earlier statement that we cannot be assured that the prudent forbearance that the SEC has exercised

with respect to these issues in recent years will be a permanent

state of affairs.

And therefore it may be appropriate for there to be legislative

clarification that the intent of the OTC legal certainty is not to

shift jurisdiction from one agency to another but, for the reasons

14

that the Chairman articulated in his testimony, involving the fact

that it is professional counterparties who are involved with one another, to provide for a structure in which these transactions would

not be subject to extensive regulation. We recognize that as a legitimate and appropriate legislative purpose, even if one that is not

perfectly parallel with the commodities case.

The third point though, and the point that I must say, Mr.

Chairman, we feel strongly about is that there are a number of

types of issues that the securities law provides that are not issues

that are covered by the commodities law where we believe it is very

important to continue to maintain protection.

To take what may be the easiest example to explain: functionally, through a total return swap, one can do something that is the

equivalent of purchasing a share of stock. It would not, in my judgment, be an acceptable outcome for an individual who had benefitted from insider information and who would be legally prohibited

from buying a stock or buying an option to be able to engage in a

total return swap that was the functional equivalent of buying that

stock.

Insider trading, fraud, manipulation, and possibly where there is

a demonstrable link, questions of retail protection, it seems to us

need to continue to be subject to regulation, not so as to extend

some net of regulation to OTC derivatives in a way that they are

not now subject to regulation, but only to assure that the basic protections we provide in our cash markets do not become circumvented through this legislation.

And it seems to us that the valid and important objective of clarifying with respect to the future the limits of regulation in this area

can be achieved while, at the same time, respecting the very necessary functions the regulation has to perform.

The CHAIRMAN. Thank you very much.

Senator Gramm.

Senator GRAMM. Thank you, Mr. Chairman.

Let me first say, Mr. Secretary and Mr. Chairman, I do not think

there are substantive differences as to what we want to do and

what you are concerned about.

The best thing you could do about the Government securities is

write the language you need and give it to us so that we can put

it in the bill and solve that problem. If it creates other problems,

obviously we can work them out. But we are in a happy time when

government borrowing is diminishing, we do not know how long

that is going to last, and we want the Government to be able to

borrow when it needs to do so.

Our whole focus to this point on legal certainty has been related

to the CFTC and its jurisdiction because it was always believed

that if someone was going to claim jurisdiction over swaps, it would

be the CFTC. If they asserted jurisdiction, as we all know from

that very unhappy period when they were trying to do so, then the

potential existed of contracts on swaps being deemed unenforceable

because they were traded off the exchange.

But what I am concerned about is the totally different environment where the CFTC has been banned from exercising any jurisdiction, in essence, creating what some regulation innovator would

see as a no-man’s land, and I would see as freedom but some reguVerDate 11-MAY-2000 16:34 Mar 08, 2001 Jkt 070514 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 70514.TXT SAGRI1 PsN: SAGRI1
15

lator would see as a no-man’s land. An innovative SEC might step

in and say, ‘‘well, swaps are securities and therefore this swap is

illegal because the security was not registered with the SEC, because the security did not meet our disclosure requirements.’’

We can deal with the anti-fraud concern and the insider trading

concern, but we need this dual protection. I agree with the Chairman that we need to work together because in an election year, the

only way anything can or should become law is if it is bipartisan

and is supported by the administration and Congress.

So if we want to do this, we have to work it out, and I do not

see any insurmountable differences. I would like to ask both of

your staffs to look at this concern about potential SEC action in the

future.

Let me just ask one question that is not related to this, but I ask

because it is a simple yes or no answer, but you can elaborate in

the time I have left if you want to.

Recently there has been a proposal by the FDIC and a lot of

clamoring in the banking industry to raise the FDIC insurance

from $100,000 to $200,000 per account. Having lived through the

S&L debacle and having seen it first-hand in my state, I have been

very reluctant to support this because it represents to me a shifting

of risk from the investor to the Government and ultimately to the

taxpayer. And I remember that era of brokered deposits, and knowing now that we have Internet banking, this is something that I

am concerned about.

I know that you all have looked at it and I just wanted, in a simple, straightforward way, to see what you think about the proposal

to raise the insurance limit to $200,000.

Secretary SUMMERS. The Chairman and I have discussed this

and I believe we have similar views but I guess we will soon see.

We believe that such an increase would be ill advised and would

represent a serious public policy error that would potentially increase systemic risk by eroding market discipline and it is not, in

our judgment, necessary in order to protect small savers. So it is

not a change that we would support.

Mr. GREENSPAN. I agree with that, Mr. Chairman. Let me just

say that there is no question arithmetically that if one looks at the

change in consumer prices since 1980 when the original $100,000

ceiling was instituted that for purchasing power parity with the

original $100,000 change, it would require a very significant increase.

However, I think that most economists would look back at that

$100,000 number and say it was a mistake, probably a bad mistake.

If you go back to the $40,000 change when, in the fall or late

part of the year 1974, the ceiling was raised from $20,000 to

$40,000, and then ask what is the purchasing power of that as of

today, it is just a little more than $100,000. So in that regard, one

can very readily see that the problem really gets back to a judgment as to whether the move from $40,000 to $100,000 was the

correct move and I think, in retrospect, that the evidence very

strongly indicates that it was a mistake and for very much the reasons that Secretary Summers argues.

16

We are in the process now, driven largely by technology, of very

dramatically expanding the domestic and international financial

system and it is very important that our market processes are

sound and that they are not distorted inordinately by a subsidized

structure in the financial system.

And, as a consequence of that, I think it is quite important for

all of us to be certain that if we want the really quite extraordinary

developments in the financial system, which is what we are discussing today, to effectively assist in what is a change in the world

economy and specifically in the United States, where standards of

living are rising in a way which we have not seen for a very long

period of time, and where we have had an economy which is being

supported by a very increasingly sophisticated financial system, we

want to be certain that, the market safeguards of that system are

not undercut.

And it has been the experience of the Federal Reserve and, I believe, all the remaining banking regulators, and I presume the

Treasury Department, as well, that the necessity of having a fully

functioning market pricing structure as a means for containing risk

is crucial to the system.

We regulators cannot conceivably substitute for the effectiveness

of containing risk that counterparty judgments within the market

create. It is not even a close call. Anything that we can do to sustain and enhance the viability of counterparty surveillance and the

accordingly important strengthening of the financial structure that

ensues as a consequence of that, we should endeavor to do.

Increasing that is, doubling—deposit insurance—which essentially would be giving increased subsidies to upper income individuals almost by definition, is, in my judgment, a mistake.

There is a problem, however, which is associated with this issue,

which is discussed mainly with regard to the clear difficulties that

our community banks are having with regard to maintaining core

deposits as a consequence of a very dramatic increase in mutual

funds, money market mutual funds, and the capital markets expansion itself. And they understandably are looking for means by

which they can get an increased degree of liability support, if I may

put it that way.

I certainly sympathize with their concerns and the community

banking system is a very important vehicle in this country and I

think something which is crucial to the dual banking system, which

I, as you have known before, very strongly support.

I do think, however, that other means to solve that particular

problem must be found. To employ a major change in the underlying financial structure creating weakness in that underlying financial structure for the purpose of resolving a real problem, but a different type of problem, in my judgment, would be a major policy

mistake.

Senator GRAMM. Thank you, Mr. Chairman.

The CHAIRMAN. Thank you very much, Senator Gramm.

Senator Harkin.

Senator HARKIN. Thank you, Mr. Chairman.

I would like to focus my remarks and questions on this idea of

a level playing field and what this legislation might do to that.

Early on, the futures exchanges, as we started this process several

17

years ago, were concerned that regulatory relief for the swaps

would put them at a disadvantage. So the futures exchanges

sought relief and that is basically what this bill provides in that

regard.

Summarily, Shad-Johnson, if relief is provided for single-stock

futures trading, raises questions about the level playing field for

other market participants, namely the stock options markets. So

again it raises the general question, I think, of the levelness of the

regulatory playing field and I think that is an important question

for us and overall to the functioning of our U.S. markets.

So I would ask both Chairman Greenspan and Secretary Summers again to once again enlighten us on approaching these questions of a level playing field, whether on Shad-Johnson or in other

areas, like swaps versus on-exchange transactions, or electronic

versus the traditional exchange markets.

Most of the input that I have had from people in these fields has

been along those lines. They are concerned that what we do is

going to skew it one way or the other. One will be advantaged and

one will be disadvantaged. And I just need some enlightenment on

that.

Secretary SUMMERS. We have sought in the President’s Working

Group recommendations and commenting on this legislation to

achieve exactly the principle that you stressed, Senator Harkin, of

a level playing field.

The original rationale, as you know, was legal certainty in the

OTC area. In my judgment, the suggestion that if one was to provide legal certainty that a level playing field required certain

changes in the regulations regarding the exchanges was valid and

appropriate. And, as I indicated, the suggestions that Chairman

Rainer and his colleagues at the CFTC have put forward seem to

us to be very much broadly in the right direction and to be leveling

the playing field and subject to the relatively minor concern around

the board of trade—minor but crucial, I hasten to say—concern

that I highlighted. They seem to us to be broadly appropriate, and

I think there is a good case for them being embodied in law and

not just in regulations.

So I think we are doing a good job on the level playing field area

in that dimension.

I think that if I might, the playing field slopes in many different

dimensions in the single-stock futures area and so far, a universally agreed definition of a level playing field has been illusive, precisely because you have the consideration of the cash market, you

have the consideration of the single-stock futures market, you have

the consideration of the options market, you have the reality that

much of this is going to be traded overseas in any event.

So I cannot tell you that a formal agreement has been achieved

in the Shad-Johnson area that is universally recognized to represent a level playing field.

What I would suggest to you, however, is that it is, I think, very

unfortunate for the financial system if the continuing debate over

the precise definition of a level playing field with respect to ShadJohnson is to preclude us or delay us from achieving legal certainty

with respect to OTC derivatives. And any of a variety of possible

resolutions of the Shad-Johnson issues, in conjunction with legal

18

certainty, would be in the Nation’s interest relative to no movement forward on legal certainty because of the outstanding ShadJohnson issue.

That is why I very much would join the Chairman’s support for

the Congress’s encouraging the parties to reach a mutually satisfactory resolution, but in any event——

Senator HARKIN. We have been trying that for a long time.

Secretary SUMMERS. But in any event, not holding legal certainty

hostage to the resolution of the Shad-Johnson issue.

Mr. GREENSPAN. Senator, obviously I think the issues you are

raising are crucial and they are very simple to state and very difficult to implement. Level playing fields, unfortunately, are too

often in the eyes of the beholder and with one tilt in an Einsteinian

way, it looks like another tilt if you are coming from another direction.

There are a number of practical issues here which really get

down to, for example, margins. Margin requirements in commodity

exchanges are markedly lower than they are in general for stocks

and here I think there is a legitimate concern about the issue of

competitiveness, but it is very important to distinguish between

consistent margins and the same level of margins.

Margins basically should be constructed in a manner to protect

counterparties against default or nonpayment. And in the commodities business or in the commodities markets, where there is a far

more rapid payment of cash when prices move—more exactly, when

margins are readjusted very much more quickly in the commodities

markets in general and obviously under those conditions, if you

have a number of margin calls during the day, which you generally

do have on many occasions, and they get paid, that clearly is an

issue of having lower margins than would necessarily be the case

in securities markets.

And how things are cleared and how things are basically managed can differ quite significantly from one system to another and

yet competitively, they can turn out to be very close to being identical.

I think at the end of the day we will only be able to tell whether

there are real playing field differences if we, for example, see actual differences in markets as, for example, we have seen a significant shift from exchange-traded derivatives to over-the-counter derivatives and that is suggestive of the fact that clearly there is far

more regulatory burden imposed on the exchanges because that is

the reason that is often given as to why a goodly part of businesses

that could go in either direction would tend to go over the counter.

In that case, you can see what the problems are and you can address them as indeed they are addressed in this bill. But to make

ex ante judgments about levels of margins, merely looking at the

absolute percentages, is insufficient to make a judgment as to

whether they are consistent and indeed competitive.

Senator HARKIN. I see my time is up but it just seems to me that

in the futures exchanges, where we have always had to clear our

margins on a daily basis, and if you have another one on the option

where you do not, then it skews it one way or the other, it seems

to me.

19

Mr. GREENSPAN. And it can be adjusted, however, by having different levels of margins, and that is indeed what does happen.

Senator HARKIN. That may be true, yes. That is what you are

suggesting we do, perhaps?

Mr. GREENSPAN. Senator, that is actually what they do. And the

question I think we have to make a judgment on, is whether the

margins that are imposed by securities firms and/or exchanges and

commodity firms and/or exchanges are consistent. And all I am saying is that is not the same statement as they are identical.

Senator HARKIN. Thank you, Mr. Chairman.

The CHAIRMAN. Thank you very much, Senator Harkin.

Senator SARBANES. Thank you very much, Mr. Chairman.

Chairman Greenspan, in his statement, Secretary Summers observes that the bill provides a broad exclusion from the securities

laws for swaps, including, in particular, swaps based on securities.

He then goes on to say, ‘‘As a general matter, we do not believe

that swaps should be regulated as securities. However, it is important to preserve prohibitions against insider trading, fraud, and

manipulation and also to preserve other measures which are demonstrably necessary to protect retail customers.’’

I take it you agree with that position?

Mr. GREENSPAN. I do indeed, Senator.

Senator SARBANES. I would like to ask both of you, what are the

risks of implementing the language as currently drafted in the legislation?

Secretary SUMMERS. I think this is an issue that is easily remediable but nonetheless needs to be remedied because I think the language as currently drafted would at least raise the prospect of substantial evasion of existing predications with respect to insider

trading, with respect to fraud and with respect to market manipulation and thereby could undermine the integrity not just of the

OTC derivatives markets but also of the underlying markets with

which they are arbitraged.

So as drafted, we would have very great concerns about the language.

We do believe that the objective which we believe was sought in

drafting the legislation, which is to clarify that the objective here

is deregulation rather than a shift of regulatory jurisdiction, is an

objective that can be achieved without compromising these critical

objectives.

As we suggested earlier, I think we can all work together on language that would achieve that objective, but the bill as we understand it in its current form would, without amendment, potentially

pose a real risk to the integrity of financial markets.

Senator SARBANES. Mr. Chairman, do you want to add to that?

Mr. GREENSPAN. I would only like to say, Senator, that this problem of the definition of swaps and securities I think is getting us

tangled up in verbose language.

I had a chance to read the legal definition of a security that is

in the 1933 and 1934 acts and I will tell you I appreciate the difficulties that lawyers have in this world. I defy anybody to read it

and come up with a reasonably good judgment of what it says.

20

Swaps are even worse. Not only are they difficult to define but

after you have defined them, you will find that everyone has a different view of what constitutes a swap.

I think that what is important here is for the Congress to look

at the fundamental structures of the markets with which we are

dealing, try to make a judgment of what the appropriate regulatory

structure is, one, as Senator Harkin has said, that creates a level

playing field and also, as he talked in terms of the integrity, safety

and soundness of markets, which I think is a very important issue

with respect to the competitiveness of the United States in the

world markets.

I think that we should do that in trying to make judgments of

what is appropriate and try to eliminate this particular detailed

discussion of whether something is a swap or it is a security, and

therefore if it is a security, something should happen; if it is a

swap, something should happen. I think this is a very difficult type

of issue to get involved in and I am afraid we are getting tangled

up in language, and the issues are very difficult as they are. If we

are going to have those types of problems, we are not going to get

an effective resolution of this issue.

Senator SARBANES. That would suggest, in view of your previous

answer, that we should focus on insider trading, fraud, manipulation, and make sure that any possibility for those practices to take

place is precluded under the regulatory scheme. Would that be correct?

Mr. GREENSPAN. Exactly, Senator.

Senator SARBANES. I think the President’s Working Group on Financial Markets was an important initiative and I know the legislation contains a number of the recommendations that came forward from the group, which represented a consensus judgment by

the group, unanimous, as I understand it.

My question is, what do you see as the prospects on those remaining outstanding issues on which a consensus has not yet been

reached within the Working Group but which are resolved one way

or another in the legislation? If we continue to press the Working

Group to continue its discussions and consultations, would they be

able to come up with a consensus position?

You have been involved in that byplay back and forth. What are

the prospects?

Secretary SUMMERS. With the exception of Shad-Johnson and

possibly with the exception of the securities question that we have

been discussing, I believe the Working Group has essentially

agreed on all important aspects of this legislation and that you

could have full agreement on this legislation.

I believe with respect to the securities question, I would not want

to be in the position of speaking for the SEC and the CFTC but

I think you have seen the Chairman and I have essentially identical positions with respect to that question.

With respect to Shad-Johnson, I would not want to confidently

predict that there would be a conclusion. It is an issue, unlike some

of the other issues, that is a very crucial issue for two members of

the Working Group—the SEC and the CFTC. And my understanding is that they have worked in very good faith to try to reach common ground and have not yet succeeded.

21

I suspect that I speak for the Chairman in saying that we are

very much prepared to do anything we can do to facilitate reaching

an agreement and I thought that the Chairman’s offer in his testimony that the Federal Reserve would be prepared in a variety of

different formulations to become involved with margin requirements for single-stock futures, if that would be facilitating of an

agreement, was a constructive and valuable step. But I do not

think I can honestly predict for you with great optimism that an

agreement will be reached in the near future.

I would repeat the judgment that the Chairman and I both expressed earlier that any of a variety of possible resolutions that

pave the way to the passage of this legislation would be better than

no resolution and a continuing risk to legal certainty.

Mr. GREENSPAN. I might just add that in a certain sense, if ShadJohnson is not revised in a manner which is to the interests of the

American regulatory structure, it is going to get revised for us because there is just little question in my judgment that we are not

all that far away from single-stock futures on U.S. stocks trading

in other countries. And if we do not resolve this issue, Shad-Johnson will get resolved but not in a manner which I think would be

desirable for any of us.

I have worked with many SEC and CFTC Chairmen. I have

never had the pleasure of, as some of you have mentioned, working

with two committed individuals of the types we now have in those

chairmanships. If they are having trouble with this issue, it is because it is a very difficult issue to meld very complex regulatory

structures.

My concern is that if they cannot get it resolved and we cannot

get it in a legislative vehicle, that the issue is going to get resolved

for us but not in the way that we would like it to happen.

Senator SARBANES. Mr. Chairman, I just make the observation

that not too long ago we were working in the Banking Committee

on an important piece of legislation and they said, ‘‘Well, you will

never get the Treasury and the Federal Reserve to reach an understanding on that issue.’’ And in the last analysis, they did reach an

understanding, which was an important breakthrough in moving

that legislation forward. So, if we keep working at this, maybe we

can get it resolved. Thank you very much.

The CHAIRMAN. I thank you, Senator Sarbanes, for your question

and likewise both of you for your response. I will just editorialize

before I recognize my colleague that we really are at the heart of

the matter.

Without being chauvinistic, we are Americans talking about

United States markets and it is inconceivable that however learned

people are in various agencies, they cannot come to some agreement.

Now, we are attempting to facilitate that, I think calmly. Senator

Gramm and I are not hysterical about the issue but we are determined. This is very, very important for our country and both of you

have testified amply to that this morning in a very technical way.

22

STATEMENT OF HON. PETER G. FITZGERALD, A U.S. SENATOR

FROM ILLINOIS

Senator FITZGERALD. Thank you very much, Mr. Chairman, and

I thank both of you for testifying today.

Mr. Greenspan, I appreciate your comments about Shad-Johnson

and I wholeheartedly agree with you. If we do not repeal ShadJohnson, we are going to be confronted with foreign nations that

are offering individual stock futures on our American companies. I

think if we can put a man on the moon, we can repeal Shad-Johnson and get an agreement between the SEC and the CFTC.

Mr. Greenspan, maybe you could elaborate on how the regulators

cooperate in the banking industry. We actually have many more

regulators in the banking industry than just the two we are talking

about here—the CFTC and the SEC. You have state banking examiners examining state banks. Across the street from a state bank

in Main Street, U.S.A. there is typically a national bank that is

regulated by the OCC. Both of them, if they offer FDIC insurance,

are subject to the regulation of the FDIC. If they have holding companies, they are monitored by you.

Now, I notice in Mr. Levitt’s testimony, reading ahead, that he

objects to provisions in this bill that require the SEC, before taking

enforcement action, to ask permission of the CFTC. Now I do not

know if any of the banking regulators, such as the FDIC or the

OCC, would have to ask permission of other regulators if they

wanted to take an enforcement action. However, I do think that

they commonly notify other regulators as a matter of course. I do

not get the impression that, that slows down the enforcement very

much.

Would you care to comment on that?

Mr. GREENSPAN. Yes, Senator, I think that is quite correct. One

of the vehicles that we have is an organization of all of the regulators in which we work together in a fairly formal systematic way.

And over the years we have recognized the various problems that

inevitably arise when you have a dual banking system, multiple

regulators, and the system will either work or it will not work. And

if it will not work, what is going to happen inevitably is clearly the

Congress is going to decide to run a single regulator bill through

both houses of the Congress and it will get passed very readily and

the issue will be resolved, frankly, to the detriment of the system.

I think that to have different regulators effectively competing in

many respects and jointly endeavoring to come up with new ideas

as to how to integrate regulation into the market structure to get

maximum efficiency has been a very effective tool of the American

regulatory system.

And I think that, despite the fact that there are inevitable significant disagreements, and there are unquestionably unbelievable

delays in getting agreements on certain issues, nonetheless, at the

end of the day, it works.

Senator FITZGERALD. What is your super regulatory body called?

Mr. GREENSPAN. It is the Federal—my problem is I have so many

acronyms in my head, I cannot unleash——

Senator FITZGERALD. Did that come in after the FIRREA legislation or after the S&L?

23

Mr. MATTINGLY. Senator, it is Federal Financial Institutions Examination Council and it goes back to about 1978.

Senator FITZGERALD. 1978, okay.

Mr. GREENSPAN. That is Virgil Mattingly, our General Counsel,

and you can see why we find him a significant source of insight.

Senator FITZGERALD. Well, maybe the SEC and the CFTC could

just jointly put some task force together with members from both

regulatory bodies just so that they have ongoing communication.

That would seem to make sense to me.

Well, in the interest of time, I will yield to some of my colleagues

for further questions.I thank you for that positive encouragement

about how it works in banking.

[The prepared statement of Senator Fitzgerald can be found in

the appendix on page 50.]

The CHAIRMAN. Thank you very much, Senator Fitzgerald.

Senator Kerrey.

STATEMENT OF HON. J. ROBERT KERREY, A U.S. SENATOR

FROM NEBRASKA

Senator KERREY. Mr. Chairman, first of all, I want to thank both

you and Chairman Gramm for holding this hearing and I hope it

leads to a mark-up of the bill.

It seems to me the challenge of the Committee, and I put this

to both Secretary Summers and Chairman Greenspan, the challenge for both of the Committees is that we have to separate out

those concerns raised by individuals who simply do not want to

compete because, at the end of the day, this is about money and

that is why this room is full of people; this is about money and it

is about jurisdiction that controls who gets to regulate.

And you can see it in the pattern of lawsuits over the last 25-

years, initiated in the early 1970s. In fact, there has been a pattern. It starts with a lawsuit filed in 1975, resolved in favor of the

CFTC. That led to Shad-Johnson. Another lawsuit filed in 1992.

That leads to another piece of legislation.

And then the most recent lawsuit filed after the SEC objected

under 2(A)(1)(b) of the CEA, to an instrument that was being traded on the Chicago futures in a Dow-Jones utility and transportation index. So they have objected. That is in court and still not

settled. So I do not know; maybe there is a case to be made that

we should wait until this lawsuit gets settled.

I would not, Mr. Chairman, because I think we have to separate,

and I put it to you gentleman, it seems to me we have to separate

out those concerns that are just about money and control from

those legitimate concerns having to do with what has been raised

on several occasions—risk to investors, and so forth, including, by

the way, one additional risk that was raised after the stock market

crash. The SEC claimed that one of the reasons the stock market

crashed in 1987 and perhaps again as a consequence of concerns

for making a case so they could continue to control, that it was

stock market indexes that caused the crash. Trading and speculating in stock market indexes, the SEC argued in 1987, caused that

crash.

So I would ask you, it seems to me that we did that. This committee heard concerns that there was regulatory uncertainty havVerDate 11-MAY-2000 16:34 Mar 08, 2001 Jkt 070514 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 70514.TXT SAGRI1 PsN: SAGRI1
24

ing to do with swaps and other instruments. They were being offered, derivative instruments, offered OTC. And we listened. We

had hearings on it and we listened to all the concerns. It was a hot

issue and I think the Agriculture Committee did a pretty good job

of sorting out and coming up with a recommendation that would

create regulatory certainty, as well as the other piece of our legislation that codifies a lot of the regulatory changes that CFTC has put

in place.

And it seems to me that we ought to do the final thing with these

stock indexes, the stock future instruments that are being proposed. They were proposed first by the CFTC, challenged now in

court. A, we have to decide, do we want to wait for the court to

make a decision, or do we sort of take it into our own hands and

try to decide on our own? And I would argue the latter, frankly,

that we ought to try to separate out where we think a case is being

made in a legitimate way and where a case is being made in an

illegitimate way that these instruments should not be allowed to be

traded.

So I would just ask—seek your advice on this. Do you think we

should wait for the court to make a decision or do you think we

should, in our best judgment, now that the two chairmen have gotten us together, and some have argued that it is about money on

our side, as well, that we are concerned about losing jurisdiction

between the Agriculture and Banking Committee. I have personally

never seen any evidence of that but maybe it exists, in fact, back

in the old days.

Would you recommend that this committee take action to try to

resolve this most recent conflict that is being raised over individual

stock futures?

Secretary SUMMERS. I basically share the impulses behind your

question, Senator Kerrey. I do not think that waiting until particular lawsuits have wended their way through the courts is a good

way to make public policy in this area. I think case-by-case litigation is probably, as a general proposition, a poor way to make public policy in this type of issue, first. And second, as both the Chairman and I have stressed, we think that it is important that the

legal certainty issue not be delayed with respect to the Shad-Johnson issue.

So, as I have said several times now and just to make the point

clear, any of a number of possible approaches that this bill could

take to Shad-Johnson in conjunction with legal certainty would be

better than this bill not moving forward because of Shad-Johnson.

To be sure, one of those approaches would be simply not treating

the Shad-Johnson issue within this legislation and leaving it to

other legislation. Another possibility would be a number of different possible resolutions of this issue. But I think the point on

which, if I can speak for him, also, the Chairman and I feel most

strongly is that it would be terribly unfortunate if the debate over

Shad-Johnson were just to continue in a way that delayed resolution of the Shad-Johnson question——

Senator KERREY. I must respectfully disagree. We resolved the

one conflict and this is basically the CFTC and the SEC fighting

this thing out. That is what is going on here. We are concerned

about risk about insider trading, fraud, manipulation, leverage and

25

risk and potential temptation of stock manipulation. We will factor

all that into consideration but at the end of the day, the SEC and

the CFTC, they are going to go into court and fight this thing out.

So we figured the one out, the derivative issue, the Ag Committee figured that out, but now we have another issue that is being

raised on behalf of the SEC filing a lawsuit against the CFTC. So

on behalf of the Ag Committee and the CFTC, I have to say that

we have to do both of them together.

And if we were able to sort out and figure out what is best for

the consumer and what is best for financial risk, it seems to me

we ought to be able to do it on this issue, as well, and we should

before we move a piece of legislation.

Secretary SUMMERS. It would certainly be very desirable to

achieve. It would certainly be very desirable—— Senator KERREY. All the issues having to do with insider trading,

fraud, manipulation, leverage and risk and the issues that Senator

Gramm raised about having differentials in margins, the insider

trader issues that are different between the SEC and the CFTC,

all these, the tax problems, we have high enough IQs to figure this

out and it seem to me that we ought to figure it out and we ought

to include it in the legislation.

Mr. GREENSPAN. Senator, I think, without commenting on the

particular suit that you are raising, in this type of issue it is a mistake to leave it to the courts to decide. The reason basically is that

what we are dealing with at this point is a changing economy and

the changing necessary regulatory structure that would be required

with it.

The courts, of necessity, are required to reach judgment on existing statute and on existing precedent and indeed, what they are effectively measuring is the judgments that the Congress made in an

earlier period. And it strikes me that it is terribly important when

dealing with an issue such as this in a rapidly evolving financial

industry that the Congress should address it from scratch in a

sense, to take a look at it de novo and make judgments of an appropriate type to determine what is the structure because there is

no way that the courts can do that; nor should they. They are there

for a fundamentally different purpose and to abandon a decision of

this nature to legal issues, in my judgment, is a mistake.

Senator KERREY. I agree. Or to wait until we have put another

man on the moon. The last time we put a man on the moon was

before Shad-Johnson. That is the other thing we could do. We could

wait for another man to arrive on the moon and do this thing.

I agree with you, Mr. Chairman. It seems to me that we have

enough information, we have good enough judgment that we ought

to be able to figure this thing out and we should. And I personally

would object to saying well, we will do the derivatives, along with

codifying the changes that the CFTC has made in the regulation,

but we are not going to resolve the single-stock issue. We can do

that, as well, and I think we should.

The CHAIRMAN. Thank you very much, Senator Kerrey.

Let me just comment that Senator Kerrey deserves congratulations, along with our colleague, Senator Roberts. They were major

proponents of a crop insurance risk management bill that this committee worked on—tremendously complex issues. And with our

26

House components, the president signed the legislation yesterday.

It was not well heralded but it should have been because it is a

genuine achievement in a year in which not much legislation is occurring that is complex and that crosses a lot of boundaries.

So when the Senator from Nebraska speaks, we all listen and he

is energized this morning. I am grateful that, that is so.

STATEMENT OF ROBERT F. BENNETT, A U.S. SENATOR FROM

UTAH

Senator BENNETT. Thank you, Mr. Chairman.

I do not have the technical background to challenge any of the

discussion that has gone on. Let me ask a potentially stupid but

hopefully big picture question.

This situation is fraught with turf battles between the CFTC and

the SEC and we are going to hear from both of those gentlemen

in just a moment and each one will be very articulate and eloquent

in defending his own agency and his own position.

Do either of you have a big picture kind of sense as to where this

regulation, the center of gravity ought to come down? Is this really

an SEC kind of thing or is this really a CFTC kind of thing? And

should most of it be on one or most of it be on the other?

Mr. GREENSPAN. I have just gotten laryngitis.

[Laughter.]

Senator BENNETT. It is either a really dumb question or a very

good one.

Secretary SUMMERS. It is a very good question.

Mr. GREENSPAN. Senator, I may just say whenever you make

those remarks I zip up my pockets and run.

Secretary SUMMERS. It is a very good question and I am seeking

to draw on what I have learned from watching Chairman Greenspan over the years to formulate a suitably vague, a suitably extensively analytical but yet nondecisive answer.

Senator SARBANES. In other words, you just got laryngitis, as

well.

Secretary SUMMERS. I think the difficulty involves, and the two

chairmen will speak in a much more learned way to this than I

can, that what you are discussing is a future, which naturally falls

within the ambit of the CFTC. And the issues that are of concern

having to do with insider trading, having to do certain kinds of

market integrity, are issues that go to—having to do with consumer protection—are issues that really go to core SEC, what have

been core SEC concerns for many years. I think it is that dichotomy between where the instrument would tend to naturally fall

and where the concerns would tend to naturally fall that creates

the difficulty.

But it does, to borrow on the kind of analogies that have been

used before, it does strike me that a Nation that has been as successful as ours has been at mediating conflicts in a range of settings internationally ought to be able to find a way of mediating

the tensions that exist here. But I suspect the right answers will

not be ones that are heavily tilted to either end of the spectrum.

Senator BENNETT. Does that mean then that both regulators will

stay fully involved and anybody who is in this business is going to

be wondering from day to day which regulator is going to come

27

down hardest? Don’t we want some degree of—you talk about certainty; we talk about predictability—don’t we want some degree of

unity here where you deal with one set of regulations and you

know that another regulator will not come in and penalize you for

having done that? Or can we really split the baby and say they

both still are in the arena?

Secretary SUMMERS. At least in my judgment, Senator Bennett,

any formula that resolves this will be just as the agreement that

Chairman Greenspan and I reached with respect to the operating

subsidiary issue was one of very substantial complexity and I think

in some ways in that complexity lay its strength. It was neither

fully satisfactory nor fully unsatisfactory to either of us and it enabled us both to feel that our core concerns had been expressed.

I do think that a resolution which subjects these transactions to

the full weight of regulation of both agencies would, for the reasons

you suggest, be an unfortunate outcome. I also think a resolution

which subjects them to whichever was the least regulation of the

two agencies might well apply substantial pressure in a negative

direction.

So I think some more complex formula involving certain kinds of

joint rule-making might prove to be most effective. But I think this

is a question that is really better addressed to the two agencies.

Senator BENNETT. Thank you, Mr. Chairman.

The CHAIRMAN. Thank you very much, Senator Bennett.

Senator Schumer.

STATEMENT OF HON. CHARLES E. SCHUMER, A U.S. SENATOR

FROM NEW YORK

Senator SCHUMER. Well, thank you, Mr. Chairmen. I very much

appreciate this hearing on an issue that I am very interested in.

It obviously affects New York in a great many ways.

I think this proposal has potentially profound and dramatic effects on our securities and future markets and I am disappointed,

frankly, with the bill’s treatment of Shad-Johnson and giving the

CFTC sole jurisdiction over single-stock futures. I am not opposed

to single-stock futures. If we do not allow U.S. exchanges to offer

them we could see them offered in London or Tokyo. And in general, when the market comes up with new types of products, my

general view is let it rip. But the regulatory framework has to be

right and the President’s Working Group recommended that ShadJohnson be repealed and that single-stock futures be allowed to be

traded if and only if could achieve regulatory parity for futures and

their underlying equities.

There is no way with the SEC regulating one and the CFTC regulating the other that we will have regulatory parity. They are different types of regulators. They have a different regulatory structure. And this bill creates regulatory disparity by substantially different regulatory frameworks for regulation.

We know why we are doing this. It is always a turf war, as you

gentlemen are very familiar with from last year’s discussion of financial futures, and neither side wants to give us their turf. And,

at the end, we come up with this topsy-turvy gyro gearless solution

that satisfies turf needs and does not make any sense from a regulatory point of view.

28

The SEC has always been charged with protecting investors and

providing full and fair disclosure of corporate market information

and preventing fraud and manipulation. The CFTC regulates commercial and professional hedging and speculation in an institutional framework. CFTC cannot regulate insider trading. Margin

requirements are different. I hate to see investors shopping as to

which instrument to use or to buy for that reason. So neither regulation nor the lack of it should pick winners and losers among

products or exchanges and fair competition should.

Simply put, to me, the SEC cannot fulfill its legal obligation to

oversee the securities markets if single-stock futures, which will

likely have significant effect on the securities markets, are solely

regulated by the CFTC.

And today I am going to introduce legislation that would provide

for joint jurisdiction of single-stock futures by the SEC and the

CFTC, that will create a fair framework for trading these products

while minimizing the regulatory burden on the exchanges. Specifically, it would only apply to core securities laws—anti-fraud sales

practice requirements and harmonize margin levels to single-stock

futures. I think this represents a fair compromise and I would like

to work with the Chairmen of both committees, as well as you gentlemen, to deal with that issue.

So having stated my views somewhat strongly, because I feel

strongly about the issue, I would like to ask both Chairman Greenspan and Secretary Summers your view of whether the present bill

provides a fair and even regulatory framework, specifically whether

the President’s Working Group recommendations, that we repeal it

only if we could achieve regulatory parity for futures and their underlying equities—that is the President’s own Working Group

statement—is met in the bill that was introduced by my two men

I greatly respect and work with, Chairman Gramm and Chairman

Lugar.

So since it is the President’s Working Group, I will call on Secretary Summers first.

Secretary SUMMERS. Thank you. As I have said a number of

times, Senator Schumer, we think there are a range of possible outcomes that would be consistent with this bill advancing the national interest, first.

Second, if I might just refer back to the analogy that you had

used of the issues that the Chairman and I worked through successfully last year, I think it is tempting for those looking on to

these issues to see only concerns of turf, but in that issue there

were real concerns on both sides having to do with spreading safety

nets on the Fed side, having to do with business choice on our side.

And similarly with respect to this issue, I think we are not fair to

our colleagues in the two agencies if we do not recognize that there

were real issues of principle that the agencies feel strongly about

that go totally behind and are outside of any question of turf that

are involved in these issues.

I have not studied as fully as I could the provisions, the precise

provisions of the bill as currently written but I think I speak for

all of us in saying that we would be more comfortable with a resolution in which the SEC could feel that its core interests with respect to insider trading and consumer protection were addressed,

29

and my understanding is that they do not have that feeling about

this legislation as it currently stands.

On the other hand, I would hasten to stress I think it is very important that there be an outcome here and that this issue be resolved in a mutually satisfactory way and I would not want to see

us adopt a posture of handing the ability to hold this issue hostage

to multiple different parties and therefore delaying forward movement on the OTC certainty portion.

Mr. GREENSPAN. I agree with what the Secretary said and I

think that as you said, Senator, time is crucial here because if the

two agencies cannot work it out or if the Congress cannot work it

out, foreigners will. It is not a question of whether or not there will

be single-stock futures out there it is only: traded where? And unless this issue is resolved, if it is continuously debated endlessly,

the issue will get resolved but not to our advantage.

I think that Secretary Summers and I have recognized that the

Chairmen of the SEC and the CFTC are far more knowledgeable

than either of us on the technical details and the ramifications and

the unintended consequences of various different types of stipulated regulatory structures and there are certain types of issues

which that type of expertise is just not substitutable by just people’s off-the-top-of-their head opinions which, in my case, it would

be the case.

So I sort of am looking to the two of them to get the issue resolved because if they resolve it, in my judgment, I will feel comfortable that there are no latent secondary consequences that the

less informed on these issues would endeavor to miss.

Senator SCHUMER. I would just say, and I could not agree with

you more, that they ought to be resolved between the two agencies.

I will not ask you this but it seems to me that the legislation introduced does not really attempt to resolve those issues but rather,

just goes to one side.

And I would ask both of you to use your good offices. You do not

have the expertise that the two agencies have. On the other hand,

you are both very bright people who understand financial markets

and who do not have, because maybe not all of this is turf—clearly

it is not—but it not that none of it is turf. And we can argue about

whether it is 50/50, 80/20, 20/80, but I think you are both going to

be needed to come up with some kind of compromise that allows

us to go forward with single-stock futures which is, as I said, something I support, but do it and avoid regulatory arbitrage.

I mean for instance, just on margins, almost inevitably you will

have people go to the less regulated market if you have such disparities between the regulation between the one and the other, and

that may be a desirable outcome, it may not, but we ought not to

come to that conclusion by default.

We need your help. Both of you are reluctant to mix in but my

guess is we are not going to come up with a proposal that both

sides can work unless some folks like yourselves mix in. I am

gloomy about passage for this year unless some outside forces help

work out a compromise.

The CHAIRMAN. Let me just thank you very much, Senator, and

commend you for that request of our two witnesses. I would share

30

that desire for counsel and likewise, your own counsel with regard

to this.

I am not so gloomy. I think we need to proceed and before introducing Senator Grams, I just want to mention I just received word

that the House Subcommittee on Risk Management and Specialty,

perhaps stimulated by our hearing this morning, has announced a

mark-up for tomorrow on their bill.

Senator GRAMM. They have obviously solved all these problems.

The CHAIRMAN. The full committee, Agriculture Committee of the

House, will mark up their work next Tuesday, so that offers at

least some incentive for us to move ahead.

Senator Grams.

STATEMENT OF HON. ROD GRAMS, A U.S. SENATOR FROM

MINNESOTA

Senator GRAMS. Thank you very much, Mr. Chairman.

Gentlemen, thank you for being here, of course. Just a couple of

brief questions. I know you have been at the panel for a long time

this morning.

Chairman Greenspan, you indicated in your statement that overthe-counter derivatives could remain free from regulation so long

as the transaction involved professional counterparties. How do you

define professional counterparties?

Mr. GREENSPAN. There are legal definitions of that but essentially, somebody who is in the business of dealing with securities

and has sufficient net worth to segregate them from what we would

want to determine are retail customers whose basic activities do

not give them the level of knowledge which people who are in the

business have. By professional, we mean somebody who is a professional securities or commodities person.

Of necessity, it is clearly a somewhat arbitrary legal definition,

but indeed in legislation and in regulation, we do make those distinctions and we make them in a very rigid form. We do not always

get it exact, but for 98-percent of the problem that we would have

with respect to making that division, I suspect we are successful.

Senator GRAMS. And second, we go to some length to try to assure that stock futures have a similar type of oversight as do the

stock options. This gets to the heart of the Shad-Johnson debate.

When we turn our attention to legal certainty for OTC derivatives,

do we need to have the same level of oversight for the over-thecounter swaps involving stocks or other forms of equity?

Mr. GREENSPAN. Well, I think that if the basic purpose is to have

a sound market, the first judgment you have to make is does the

market structure itself have in it the means for stabilization? In

other words, as the issue I raised before, it has been our experience

that having effective counterparties in transactions, people who understand the financial statement of the people with whom they are

dealing is unquestionably the most important aspect which keeps

risk at a minimum level in the system.

Regulation can only substitute at the margins and oversee, so far

as over-the-counter securities are concerned, in a professional manner very broad notions of guarding against systemic risk. When you

get to questions of retail markets, it is a wholly different issue and

31

I think there is general agreement amongst all of us about how

that should be handled.

Our major concern is to make certain that these very effective

over-the-counter derivatives markets which have been so important

to the financial development of this country can operate in the

most effective manner. In our judgment, that is best maintained

with a minimum of regulation, largely because any regulation

which is imposed, which would undercut counterparty surveillance

does, far more damage than good.

Senator GRAMS. Thank you, Mr. Chairman.

Secretary Summers, we have heard this morning about losing derivative markets to Europe. If this bill passed, the legal environment for derivatives?

Secretary SUMMERS. I should give you a detailed answer, a more

detailed answer than I can give you right now to that question in

writing. But the core of that answer would be that the failure to

pass this bill would create a situation where derivatives contracts

entered into in the United States would be subject to more risk, to

be sure, an extremely remote risk, but more risk of being arbitrarily unwound because of a regulatory action than in Europe.

And in a world where it is easy to change the location at which

contracts are booked, that residual uncertainty could become an

important feature of competitive disadvantage. So the core of the

answer would be greater residual uncertainty associated with OTC

swaps in the United States.

Senator GRAMS. Maybe if you can provide a more detailed written answer.

And just one final quick question. In your concern, Secretary

Summers, about exempting swaps from securities laws, are you

suggesting that all swaps be given the same treatment, regardless

of the underlying financial instrument involved?

Secretary SUMMERS. No. I am suggesting that one craft the set

of provisions that are necessary to assure that—I think the most

prominent examples of this will be those that involve individual equities—that one craft the minimal set of provisions that assures

that there will not be circumvention of the existing regulatory protections with respect to the factors that we have enumerated—insider trading, manipulation, fraud, and protection of retail investors.

There are also, and this is not something we have commented on

so far, there are also certain questions having to do with the technical definition of a swap in portions of this legislation which on

some readings could lead it to be called a swap if a transaction took

place in what we today regard as ordinary financial instruments on

an off-exchange basis and would therefore nullify the regulation

that would apply to that. That is a concern that we believe should

also be addressed in clarifying the language that is contained in

these provisions.

It is not my impression that, that is anyone’s intent and so we

do not believe that should be a difficult clarification to accomplish.

Senator GRAMS. Thank you very much, Mr. Chairman.

The CHAIRMAN. Thank you very much, Senator Grams.

Secretary Summers, Chairman Greenspan, we are grateful to

you for your testimony, for your forthcoming responses to our quesVerDate 11-MAY-2000 16:34 Mar 08, 2001 Jkt 070514 PO 00000 Frm 00035 Fmt 6633 Sfmt 6633 70514.TXT SAGRI1 PsN: SAGRI1
32

tions, and we look forward especially in these next few days to

working with you and your associates very carefully. Thank you

very much for coming.

The Chair would like to call now the Chairman of the SEC, Mr.

Arthur Levitt, and the Chairman of the CFTC, Mr. William Rainer.

We are grateful that the two Chairmen are with us. We appreciate your being here to hear the testimony that has preceded

yours, but we look especially to your thoughts this morning and I

would like to call upon now Chairman Levitt for his testimony.

STATEMENT OF HON. ARTHUR LEVITT, CHAIRMAN OF THE

SECURITIES AND EXCHANGE COMMISSION, WASHINGTON, DC.

Mr. LEVITT. Chairman Gramm, Chairman Lugar and members of

the Committees, thank you for the opportunity to address the Committees concerning Senate Bill 2697. This bill would provide important legal certainty for over-the-counter derivatives and would lift

the ban on single-stock futures. As you know, the Commission fully

supports both of these objectives. In other important respects, however, I believe that the bill presents a number of serious risks to

the investing public and to our securities markets.

As we consider the implications of the bill, it serves us well to

remember both the wisdom embodied in our securities regulatory

framework and the extraordinary prosperity it has fostered. Its

wisdom, I think, is simple—a recognition that protecting investors

is not just the right thing to do, but the smart thing to do; that

it is investor confidence that ultimately fuels competition, that vibrant markets rest on a foundation of integrity. I strongly believe

that the unequivocal commitment to protecting investors made by

your predecessors and mine has been critical to the success our securities markets have enjoyed for more than half a century.

The bill before you, consistent with the Working Group’s recommendations, goes a long way towards providing greater legal

certainty for over-the-counter derivatives by excluding certain products from the Commodity Exchange Act.

The bill, however, goes well beyond this objective. Indeed, it

would place all swap agreements beyond the reach of the securities

laws. In doing so, it might result in a wholesale removal of SEC

oversight of a wide array of securities products.

For example, one could potentially avoid long-established investor and market integrity protections applicable to equity securities

by merely documenting an equity transaction as a ‘‘swap.’’ In my

judgment, the risk of this regulatory approach is simply unacceptable for America’s investors. Moreover, I think there is no apparent

public policy justification for this far-reaching provision.

The bill also lifts the ban on single-stock futures contained in the

Shad-Johnson Accord. I certainly have no interest in justifying the

historical origins of that ban here today. I have made clear my

view that market demand—and not regulatory fiat—should determine the availability of investment vehicles. But I would hope we

face squarely the fact that single-stock futures are an economic

substitute for the underlying security. We should not ignore the

fabric of protections that retail securities investors rely upon and

the confidence that these protections engender.

33

Some may dismiss this concern as a guise for protection of turf.

I assure you, the questions surrounding how best to ensure that

regulatory disparities do not erode investor confidence are profoundly serious and substantive to me.

Chairman Rainer and I, and our staffs, have spent a great deal

of time exploring how single-stock futures might trade. Although

we did not reach agreement on all aspects of a regulatory framework, we did agree that we should jointly regulate these products.

Building upon that recognition, my staff has crafted a plan under

which these products could trade. In my judgment, an enduring

regulatory framework must have the following elements.

First, single-stock futures are undeniably a substitute for stocks

and stock options. Thus, the framework must recognize the legitimate interests of both the SEC and the CFTC in regulating these

products.

Second, the framework must encourage fair competition among

markets by, for example, including mechanisms to harmonize the

regulatory requirements across the securities and commodities

markets, particularly those related to margin. Competitive market

forces, rather than government regulation, should pick winners and

losers.

Legislation also should facilitate the listing of the same singlestock futures on multiple exchanges. This avoids any one market

having an exclusive franchise by forcing all markets to compete for

investors’ business. The history of our securities markets makes it

crystal clear that vibrant competition between markets is the surest path to protecting investors as well as the guardian of our global competitive edge.

Third, the framework must acknowledge that single-stock futures

will be retail products. While extremely complex derivative products might not attract retail customers, a simple future on a share

of a blue chip stock is the type of product that is sure to do so. Investor protection is therefore essential, as is clear and direct SEC

authority over market participants that trade single-stock futures.

The alternative is neither workable nor wise. Consider for a moment a corporate insider who learns that his company is about to

receive an unsolicited bid to be taken over. The insider buys a substantial amount of single-stock futures on a futures exchange and

earns huge profits on the transaction, which he plans to send to an

off-shore bank.

Without direct authority over the futures exchange and direct access to the information we need to detect insider trading, the SEC

might learn of the futures purchase by the insider either late or

never. Even if the SEC was notified of the suspicious futures transactions, our enforcement staff would be forced, under the current

bill, to seek CFTC permission to proceed. Needless to say, enforcement is an area where dispatch is essential and delays are fatal

to the cause of securing relief.

Or consider the disparity in obligations that would apply to a

broker authorized to sell both stocks and single-stock futures to clients. If he sells the future, he need provide no more than a onetime risk disclosure document that, in effect, tells customers that

futures are risky. If he sells the stock, on the other hand, he takes

on a duty to tailor the recommendation to the specific needs of the

34

client. One does not have to be a cynic to spot his incentive to sell

the product offering less protection and it is hardly apocalyptic to

recognize the danger. Should the protections given a brokerage client really depend on which product the broker chooses to sell? Ignoring these obvious questions today, it seems to me, will almost

certainly result in disillusioned investors tomorrow.

Finally, the framework must avoid any harm to existing capital

markets. In lifting the ban on single-stock futures and reopening

jurisdictional issues, legislative changes should not take away existing SEC authority over financial products. The Shad-Johnson

Accord clarified the SEC’s jurisdiction over securities options, and

that jurisdiction should not be diminished in any way. Nor should

legislation eliminate the SEC’s existing role in evaluating products

such as stock indices.

Achieving these four principles will leave U.S. markets for these

products better positioned to compete against their foreign counterparts. As markets around the world compete for customers and

capital, one overriding principle will serve as our competitive advantage: the quality of our markets. Unfortunately, as written, the

bill ultimately does not vindicate those principles.

I look forward to providing additional technical assistance to help

you reach the right answer for our markets. Thank you.

[The prepared statement of Mr. Levitt can be found in the appendix on page 73.]

The CHAIRMAN. Thank you very much, Mr. Chairman.

Chairman Rainer.

STATEMENT OF THE HON. WILLIAM RAINER, CHAIRMAN OF

THE COMMODITY FUTURES TRADING COMMISSION, WASHINGTON, DC.

Mr. RAINER. Thank you, Chairman Lugar, Chairman Gramm,

Senator Sarbanes, Senator Harkin and Members of the Committee.

I am pleased to appear before you this morning and thank you for

inviting me as I represent the CFTC.

The Commission commends your efforts to modernize the Commodity Exchange Act and to provide legal certainty for over-thecounter derivatives, remove impediments to innovation, and to reduce systemic risk. This bill responds to the President’s Working

Group’s request for urgent legislative action on its recommendations so that the U.S. may retain its leadership in these rapidly developing markets.

The Commission welcomes your proposal to enhance legal certainty for over-the-counter derivatives by excluding from the CEA

certain bilateral transactions enter into on a principal-to-principal

basis by eligible parties.

The market for derivatives has expanded dramatically over the

past two decades as financial institutions rely increasingly on these

transactions to manage interest rate and foreign exchange risk.

The Commission has reservations, however, about the bill’s exclusion of OTC energy derivatives from the CEA and I would like

to take a moment to expand on that if I may. On this point the

bill diverges from the recommendations of the President’s Working

Group, which limited the proposed exclusion to financial derivatives. The Commission believes the distinction drawn by the WorkVerDate 11-MAY-2000 16:34 Mar 08, 2001 Jkt 070514 PO 00000 Frm 00038 Fmt 6633 Sfmt 6633 70514.TXT SAGRI1 PsN: SAGRI1
35

ing Group between financial and nonfinancial transactions was a

sound one and respectfully urges the Committees to give weight to

that distinction.

Most dealers in the financial swaps market are either institutions subject to supervision by bank regulatory agencies or affiliates of broker-dealers regulated by the SEC or affiliates of FCMs

subject to CFTC oversight. The same cannot be said of trading in

energy derivatives. The decision to extend the exclusion in 2697 to

energy derivatives would leave these OTC products in a regulatory

gap neither directly regulated as financial products nor indirectly

regulated by an agency with jurisdiction over commercial participants in the energy market.

The Working Group’s recommended exclusion from CEA for financial contracts focussed on the facts that such contracts are not

susceptible to manipulation and do not serve a price discovery function. The consensus exists within the markets and among financial

regulators that trading in financial OTC derivatives is not susceptible to manipulation. That case has not been made with energy

products.

The unanimous recommendation for an exclusion for financial

products resulted from months of deliberation by Federal financial

regulators. No comparable coordination has occurred between the

CFTC and any of the other Federal entities and programs with jurisdiction over cash markets for energy. An exclusion for trading in

energy contracts may create incentives for existing exchanges to

convert to restricted, institutional markets or, more likely, may

lead large traders to migrate to unregulated markets. Either event

would threaten the important price discovery role played by regulated energy futures. A step of this magnitude should be preceded

by public discussion.

The CFTC therefore believes that there is insufficient evidence

to support the bill’s exclusion of energy products. Regulatory relief

is more appropriately provided through the commission’s exemptive

authority. We have a substantial history of responsiveness in this

area.

For example, the commission’s staff has issued two no-action letters within the past 6-months to electronic trading platforms, the

sponsors of which include several of the largest participants in the

energy markets. And, as the Committees are aware, bilateral OTC

energy trading between commercials, dealing with each other on a

principle-to-principle basis, has been exempted from all but antimanipulation provisions of the CEA since 1993.

As the discussion over the treatment of energy commodities progresses, the Commission will be pleased to continue working with

the Chairmen and members of these committees to find an acceptable resolution of this issue.

The Commission supports 2697’s exclusion for electronic trading

facilities for OTC financial derivatives which will promote an environment in which innovative systems can flourish without undue

regulatory constraints. Electronic trading systems have the potential to foster efficiency and transparency and such systems should

be permitted to develop unburdened by an anticipatory regulatory

structure.

36

The bill also permits clearing of OTC derivatives and authorizes

a mechanism for the CFTC to regulate facilities that clear OTC derivative contracts. Again the President’s Working Group specifically

recommended removing the legal obstacles to the development of

appropriately regulated clearing systems to reduce systemic risk,

and we support this recommendation with the following reservation. The bill would allow securities clearinghouses to clear a

broader range of contracts than futures clearinghouses. Futures

clearinghouses would have to register in a dual capacity—as futures and as securities clearinghouses—to clear the same mix of

contracts available to securities clearinghouses holding a single

registration. By declining to grant futures clearinghouses equal opportunity to compete, the bill may put the Government in the position of determining winners and losers. We recombined that the

Committees avoid placing futures clearinghouses at a competitive

disadvantage.

The Commission supports the bill’s revision of the Treasury

Amendment to make clear our jurisdiction over transactions entered into between retail customs and unregulated entities, including so-called bucket shops. We have long sought legal clarity in this

area in order to protect fully the public from foreign currency

fraud.

Earlier this month the Commission approved for publication in

the FEDERAL REGISTER its comprehensive regulatory reform package which alters fundamentally the Commission’s regulation of futures and options markets. This bill attempts to codify much of the

Commission’s regulatory reform proposal and we welcome your

support of the Commission’s initiative.

The CFTC staff is undertaking a comparative analysis of our proposed framework as released on June 8 and the relevant provisions

of this legislation and we would be pleased to submit the results

of that review to the Committees in the very near future.

S. 2697 addresses the issue of equity futures contracts and reflects efforts to develop a plan to amend the Shad-Johnson Accord.

The Working Group recommended, as we have heard a lot today,

that the CFTC and SEC work together to determine how the accord should be amended. We agree in principle that equity futures

should be available to the marketplace. Agency staffs have agreed

on many specific areas related to lifting the ban, such as harmonizing margin requirements, restricting dual trading, testing for sales

and supervisory personnel, establishment of uniform listing standards for single-stock futures, among others, such as notice registration for exchanges and intermediaries. We acknowledge, however,

a fundamental disagreement concerning the appropriate legislative

approach.

The CFTC has sought to avoid creating a framework that potentially could result in overregulation of markets and intermediaries

and therefore have advocated identifying those core principles from

each regulatory regime necessary to ensure an appropriate level of

oversight for trading these products. While the agencies agreed

that duplicative regulation must be avoided, the CFTC staff expressed concern that an ‘‘umbrella’’ approach, meaning the application of the panoply of both securities and commodities regulations

to these products, could result in overburdensome regulation. The

37

SEC staff insists that defining equity futures products as securities

is essential to its regulatory functions. This fundamental difference

in approach has led an impasse.

With respect to this bill, S. 2697, we, the CFTC, have no objection to the Shad-Johnson provisions that bear on regulatory issues

related to the CFTC’s oversight of single-stock futures.

Again we appreciate the opportunity to present our views and I

will be happy to answer questions. Thank you.

[The prepared statement of Mr. Rainer can be found in the appendix on page 85.]

The CHAIRMAN. Well, thank you very much, Mr. Chairman.

Let me just begin this round of questions. We will have a 5-

minute limit again for Senators to raise questions with witnesses.

Chairman Levitt, you mention in your testimony that the Commission staff of the SEC has prepared a discussion draft that incorporates the legislative goals that you have enumerated in your testimony with regard to the single-stock option situation, Shad-Johnson Accord repeal.

Unfortunately, given the pendency of this bill, as well as bills in

the House, the CFTC has not apparently had a chance to review

or comment on our draft in detail.

Chairman Rainer indicates, not really to respond to that, that

there appear to be some fundamental disagreements with regard to

regulation or overregulation, a panoply or umbrella, as he discussed it.

I am just simply curious really, to both of you. It is obvious this

is important legislation. The Committee has been intent upon moving toward conclusions and we appreciate the discussions that you

have held and cited the meeting of May 23 with Chairman Gramm

and myself in which you indicated you have been making headway

but, as you stated last winter, I guess, it was going to be this winter before you could arrive at it.

This is not meant, I am certain, to be disrespectful to the Committee or to show a casual approach but it should have been apparent to the two of you that we are intent upon passing a bill.

Now, is the strategy you have in mind to stop the bill? Is really

your intent simply to indicate to members of the Congress that

whatever we have is unacceptable and therefore you are prepared

to continue at your own pace, sort of in your own sweet time, to

work it out—November, December, January, whenever you get

around to it?

In other words, I really cannot understand, given the gravity of

this situation of markets in the United States and the intent of this

committee to try to work with the Banking Committee, why the

two of you and your commissions are not equally arduous, have not

set a priority to get on with it and to come to agreement.

Now obviously you have not, so we have. Now, you objected to

that and indicated that you are still passing papers back and forth,

but you are not listening to each other apparently or have no intent

upon reaching an agreement.

I just ask simply why not?

Mr. LEVITT. Mr. Chairman, I respect the effort you have put into

this, and I certainly share your feeling about the importance of aspects of this bill. I think Chairman Rainer and I have worked very

38

hard, as have our staffs, on dealing with an issue that most of the

members of the Committee agree is terribly complex issues that we

have not, of our own volition, raised, issues that we have inherited,

that courts have dealt with and others have argued about for a

quarter of a century.

I think that had we a greater amount of time, we could move further toward a solution. But when, as you full well know, you have

the political imperatives of the process that we have, together with

constituent pressures, together with agency habits and traditions,

that makes it difficult. But I honestly believe that, because of the

nature of the relationship of the Chairs that sit before you, we certainly do not wish to frustrate the Congress or the bill. But I would

say to you in fairness that I regard one portion of the bill with respect to certainty—legal certainty for derivatives—as being absolutely critical to the national interest.

I place a lower priority with respect to Shad-Johnson, even

though I firmly support giving up the prohibitions of Shad-Johnson. But one is a matter, in my judgment, of great national economic necessity; the other simply is not.

The CHAIRMAN. Chairman Rainer, do you have a comment?

Mr. RAINER. Yes, thank you.

First of all, from the CFTC’s perspective, your bill is one that we

do not object to. We think that our interests, the CFTC’s interests,

are adequately covered by the bill.

However, as you know, I have said several times that we recognize the legitimate interest of the SEC and we think that it would

be very important for the structure that goes out the door to be one

that both agencies can support.

I guess that the longer story is that we have two wonderful industries—the securities industry, with its exchanges and associations, and the futures industry—and they have grown up in different regulatory environments. It would be one solution for the

CFTC to walk away from what I consider its obligation and say

well, just let the SEC do it. What happens there is you have

opened up a potentially large—we’ve used the word unlevel playing

field several times, but a large unlevel playing field because the apparatus, the costly regulatory apparatus in place with the futures

industry is not organized to meet SEC issues.

And I felt that the CFTC should do everything it could to analyze

those issues that would be duplicative, that we they already do a

good job meeting regulatory tests, and we simply have not had time

using the SEC approach to make sure that any recommendation

that the CFTC endorses for these committees is the recommendation that is the least cost approach and does not attach unnecessary costs.

Now, if there are burdens that are necessary, so be it. That is

just the way it is. But we have not been able to find that answer

yet.

The CHAIRMAN. Well, I thank both of you for those thoughtful responses.

Chairman Levitt, I just disagree with you profoundly that there

is one aspect of this bill that has national interest. That dismays

me with regard to the thought about the markets in this country,

the importance of this. That is, I think, a very narrow view, but

39

it is an interesting one, one that you hold strongly, but it leads me

to believe that we have a problem here.

Now, there is going to be a presidential election, a congressional

election. We may have a different president—probably will have,

given the fact that there are two different candidates running, no

incumbent. A lot of new cabinet people, a whole new working

group, maybe some new appointees to regulatory commissions, a lot

of new Senators, maybe new chairman.

Senator GRAMM. Now wait a minute. You have gone too far.

The CHAIRMAN. Phil will still remain.

But it is not a cavalier approach that somehow this can all be

settled out in the fullness of time, given the agencies’ ability, their

staffs to get together, to shuffle the papers and think through the

issues. I am confounded. This has gone on for months.

We have had five different hearings here. We have had all sorts

of sessions about emergencies. So we finally come to a meting and

everybody is asking Chairman Greenspan, Secretary Summers, to

get the two of you together and somehow mediate this dispute, to

give their judgment. Chairman Greenspan gets laryngitis at the

thought of trying to mediate what seems to have been an impossible predictable in Washington to do. So this committee is going

to try.

Now, you can try to stop us if you want to but by and large, I

think the public interest is on our side, and I hope you get that picture.

Mr. LEVITT. Mr. Chairman, I have absolutely no interest in trying to frustrate the will of the Senate, but I think we must recognize that what is happening in this bill with respect to Shad-Johnson is taking basically an institutional product, a product that has

been used by professional investors, and turning it into a retail vehicle.

At this level of the market, with the amount of leverage in our

system today, for me to look away from the responsibility of protecting a different segment of the market than is now available to

these products would be irresponsible, in my judgment. That is not

a political judgment; that is a conviction based upon my years in

the securities industry and my firm belief that there are limits to

regulation, but that protection of that individual investor is fundamental to the glorious success of our equities markets.

And I must raise my hand if I feel that those interest are being

jeopardized. I believe that a Shad-Johnson bill allowing investors

to buy a leveraged product of that kind without the basic protections that the securities laws have provided through the years is

just unacceptable.

The CHAIRMAN. Thank you.

Senator Gramm.

Senator GRAMM. Mr. Chairman, thank you. I will be brief.

I want to thank each of you for appearing today and for your

hard work as we try to put the bill together.

Obviously, it is easy for us to ask ‘‘why can’t these two guys get

together and work this thing out?’’ Now, I can work out anything

with anybody, but there are people who think they have trouble

working things out with me, so I have some understanding of your

problem.

40

I also understand that you are representing institutions that

have long and proud histories, and I also understand the basic fact

that part of what your staff is doing, and they are going to be there

long after you are gone, is protecting their jurisdiction, their turf,

and their jobs. I never understood jurisdiction till I became the

Chairman of a committee. I now understand it very, very well. And

if I forgot it, my staff would remind me.

The only point I want to make is that this is an important bill.

It is easy for each of us to go down the list of items in the bill and

identify what we think is the most important. I have my own set

of priorities, but my guess is that if we are going to have any success, we have to move forward with the overall thrust of the bill.

Now, the only plea I would make—a plea instead of a question— is that as we continue to move forward and work on this, both of

you and your two agencies continue to work together. I would like

to ask each of you formally to give us your review of the bill and

your proposed changes so that we can go ahead and do the things

we can agree on.

And, as we go through the legislative process, if you would continue to pray over this thing, in an effort to work it out. Also please

think about the possibility of a mandate, similar to the provision

that we are now talking about in terms of harmonization of margins, where we give the Federal Reserve, working with your two

agencies, the ability to set regulations that harmonize margins. It

may very well be at some point that the best we can do—unless

our prayers are answered and you work these things out in advance—is to establish a mechanism for you to work them out.

My fear is double regulation. I think that in some areas, the SEC

has expertise that ought to dominate in this market. I do believe

futures on individual stocks are predominantly equities. What I

would like to be able to do is work out a way of sharing jurisdiction

in those areas where you have a legitimate legislated interest.

So continue to work it out. Think about ways we might actually

set a mandate in place that it be worked out in the future if, all

else failing, that is the only way we can do it. It is not a terribly

good way to legislate, but it is often better than not legislating

when there are other major items.

So Mr. Chairman, I want to thank you and the heads of our two

agencies.

The CHAIRMAN. Thank you, Senator Gramm.

Senator Sarbanes.

Senator SARBANES. Mr. Chairman, I want to sort of sound some

words of caution here. First of all, it seems to me that the quickest

way to get to a solution may be to continue to push hard on the

track of the two chairmen before us working out between themselves a resolution of this matter. That essentially is what, I think,

both Chairman Greenspan and Secretary Summers suggested.

I am mindful of what Senator Gramm said at the outset, that at

this point in the legislative process, it is going to be very hard to

move legislation through if it does not rise to the level of consensus.

Now, I happen to think that this perspective that is being imposed on this difference that it is just a turf war, a fight over jurisdiction, misses the mark. I frankly do not attribute that basic motiVerDate 11-MAY-2000 16:34 Mar 08, 2001 Jkt 070514 PO 00000 Frm 00044 Fmt 6633 Sfmt 6633 70514.TXT SAGRI1 PsN: SAGRI1
41

vation to either of these two chairmen that are now before us and

they obviously have a public interest to serve that transcends any

jurisdictional or tough turf considerations. I do not think this can

be viewed as well, we have met the CFTC interests but we have

not met the SEC interests, or vice versa. The question is have we

met the public interest? And the premise, I think, with which most

of us are approaching it is that if the two agencies can reach an

agreement, that it is highly likely that the public interest has been

met, although obviously we will review that. We do not, in the end,

give away that judgment. But that significantly heightens the ability to conclude that the public interest has been met and I think

investor protections are very important.

It is all fine to talk about this thing prospectively but if we do

something that, in the end, results in eroding or undermining the

investor protections that have been at the heart of making the U.S.

security market so attractive and the leaders worldwide, we have

done real harm and real damage.

Now, it seems to me it ought to be possible to move ahead on this

issue without jeopardizing that important accomplishment, which

has sustained not only our markets but, I think, been a tremendous boost to the functioning of our economy. And if we are now

going to move off on a legislative path and, in effect, bring to a halt

or sort of undercut the effort for the agencies to see if they cannot

reach an understanding, and I gather they have made some

progress; is that correct? I gather from what you have both said

you have made progress from when you started out wrestling with

this issue. Am I correct in that assertion?

Mr. RAINER. That is a very safe assertion.

Senator SARBANES. All right.

So I think that sometimes haste makes waste. Obviously if there

is an agreement amongst the president’s committee, all four of the

people who appeared this morning, in the light of such an agreement, it ought to be possible to move pretty quickly here in the

Congress.

Now, how quickly you can move in the Congress if you do not

have that agreement is another question, which I think we need to

be very mindful of because the issues that are at stake here, in my

perception, at least, are not simply some kind of turf fight and we

ought to sort of dismiss one or the other or come down hard on

both. They are issues that go to very important national and public

interests and I think we need to be mindful of that every step of

the way.

Thank you very much.

The CHAIRMAN. Well, thank you very much, Senator Sarbanes.

Let me just comment that I agree with you. Very clearly the work

of the Agriculture Committee and the Banking Committee, working

with the SEC and CFTC, has been to not only protect the integrity

of the markets, to offer protection to individuals and groups, but

really to recognize that the integrity of those markets is our

strength.

Now the predicament I think we all have to weigh, and this is

a judgment call, is that during the last year I visited the New York

Stock Exchange; I have visited the NASDAQ people. I have been

in the Chicago markets. There are a lot of changes going on in

42

these markets. People who are making a living out there, tens of

thousands of employees, face erosion of their job potential.

We face competition in the world. There are other people who are

doing all sorts of things. In the course of our hearings we had an

electronic demonstration and transacted a trade right in front of us

on his computer on a European market and demonstrated really,

I suppose, the benefit of our regulation one way or another was irrelevant to all of that.

So, on the one hand, we are trying to think through how do we

offer these assurances and more of them and, at the same time,

how do we retain at least the ability to see what is going on in the

world and retain the strength and the vitality of our markets that

have all these protections, and that is a difficult thing to do.

Now one item that is unacceptable, it seems to me, is to do nothing. If we do that, the markets will run their course without regard

to what the Congress has to say and there will be winners and losers but I think the American people will be the losers.

Now, the case has been made that the American people will lose

if somehow protections are taken away from them and that is a

very good point and it is an important one. But again and again

we have tried to come, I think, to a conclusion, are the kinds of persons who are involved in the markets, as Alan Greenspan said

today, the countervailing market forces that eyeball each other,

that bring transparency, that bring competition—he made the point

that regulators are never a match for all of the competing forces

in markets, that at best, they sort of have a safety net after really

those who are competitors have had a go at it.

So that is the problem.

Senator SARBANES. Well, the problem is if we are going to continue this dialogue, and I am quite happy to do it, the problem to

some extent is a process problem.

Now, we have this President’s Working Group. I gather that the

President’s Working Group limited the proposed exclusion to financial derivatives. The bill before us now is going to exclude energy

derivatives, if I am correct.

Is that right, Mr. Rainer, as you read the bill?

Mr. RAINER. Yes.

Senator SARBANES. You are opposed to that. Is that right? I

mean that is counter to the recommendation of the Working Group.

Mr. RAINER. My position is that the case has just not been made

that is a good idea.

Senator SARBANES. Yes. And therefore it ought not to be done at

this point.

Now, we discussed earlier the swaps question and it is very clear

from that conversation that significant changes have to be made in

the swaps provision. Everyone acceded to that.

Now, I understand that the CFTC put a proposal out on a regulatory framework for future markets and clearing organizations on

June 8. Is that correct?

Mr. RAINER. Yes.

Senator SARBANES. Now, that proposal is contained in this legislation; is that right?

Mr. RAINER. In large part, yes.

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Senator SARBANES. Well, it may be all right; it may not be all

right. But you are putting the proposal out to have a comment period. Is that right?

Mr. RAINER. Yes.

Senator SARBANES. And further hearings.

Mr. RAINER. Yes.

Senator SARBANES. The premise of those further hearings and

the comment proposal is the possibility that you would revise the

proposal, correct?

Mr. RAINER. Yes.

Senator SARBANES. That is why you do that.

Mr. RAINER. Yes.

Senator SARBANES. And you approach it with an open mind so

that people who make comments have confidence that they will be

considered on the substance and a judgment will be made.

Now, where does that leave you if this legislation passes that

contains the proposal you have submitted but does not reflect the

comment period and the hearings that subsequently take place in

shaping that? I mean it renders it all sort of meaningless in a

sense. Plus it then puts you in a straightjacket in the future if you

want to revise the regulations because they have been statutorily

codified. So at that point if you wanted to make changes, you would

have to come back to the Congress and get a legislative change.

Now, that is only to underscore the haste makes waste observation that I made earlier. But in the end, we are going to come back.

I appreciate that the industry wants to move and I am not unsympathetic to that, but it ought to be possible to do that and, at the

same time, assure ourselves that these very important protections

for investors that have been at the heart, in my judgment, at the

heart of these very successful markets are not lost. And to the extent we short-circuit this process and make it less likely we are

going to reach this kind of consensus, I think the problem becomes

more difficult, not less difficult.

The CHAIRMAN. The Senator makes a good point. I would just

simply say that everybody is struggling, given the amount of time

that Senators, regulators, what have you have to give to these particular issues, to get our focus. We have comment from everybody

today on language that might be incorporated. That is a serious

proposal because we are in the process of heading toward a markup in which something is going to happen in the Committee, and

then we hope to proceed.

You have not had an opportunity to get into this round, Senator

Schumer. Would you like to raise questions or make a comment?

Senator SCHUMER. Thank you, Senator Lugar. Yes, I have some

questions relating to my concern.

I guess the first one is to Chairman Levitt. Do you worry about

the effect that introducing single-stock futures will have on the underlying equity markets if it SEC has no jurisdiction over the product? What will be the worst case scenario?

Mr. LEVITT. I do worry about it. I worry a great deal about it.

I think there are some irrationalities in this process, and I guess

the very fact that we have two regulators regulating similar segments of the market provides us with some irrationalities to begin

with. Then when you suggest in a bill that has something as naVerDate 11-MAY-2000 16:34 Mar 08, 2001 Jkt 070514 PO 00000 Frm 00047 Fmt 6633 Sfmt 6633 70514.TXT SAGRI1 PsN: SAGRI1
44

tionally urgent as giving legal certainty to swaps and you combine

that with creating a new vehicle for investors, you have to ask

yourself what is the importance of that new vehicle? That new vehicle, has dramatic importance to the liquidity of our markets with

respect to institutions that are used to trading highly leveraged

products. You are now opening that market to the retail investor,

who does not have the slightest idea about this.

We found in surveys, in terms of an understanding of the risks

of investment products, many do not understand the risks of products even that have been with us for many years. We are now

opening up this new product, which essentially is leverage on leverage.

Is this in the national interest to begin with? If you say it is, if

this new product is offering America’s investors something they can

get no place else, which I absolutely categorically deny, then you

have to say are we giving them the same protection that they

would have when they buy IBM or General Motors or any other equity?

And remember at what point in the market cycle we ask ourselves this question. Is this the time to introduce yet an even more

highly leveraged product into a market which, in my judgment, has

an abundance of leverage today?

Senator SCHUMER. Well, there is a little ad that I would like to

submit for the record from—I do not know who they are—Lynd

Waldock. It says, ‘‘There are lots of reasons you should consider online stock index futures trading’’—this may be an example of what

you are talking about for a broader-based product. ‘‘At Lynd

Waldock you get’’—it says, ‘‘Stocks are great for the long term but

for short-term trading, try stock index futures. At Lynd Waldock

you get a of bang for your commission buck. One stock’s index future commission is equivalent to trading 2,000 to 3,000 shares of

stock at $30 a stock at about half a penny a share.’’

And that will be nothing compared to what happens unless we

have, as you say, a level regulatory field here. Does the Gramm–

Lugar proposal, as written, provide that field? To me it certainly

does not.

Mr. LEVITT. I think it leaves the retail investor with an absence

of basic protections. I think, working closely with the Committees

and with the CFTC, it is possible for us to develop such protections

for investors from the things that I fear the most.

Senator SCHUMER. What is the rationale for an option being governed by the SEC and a future being governed by the CFTC of an

equity? Options are now governed by the SEC.

Mr. LEVITT. They should not be. You know, I hate to criticize a

bill that has been sponsored by someone whom I admire so much,

but, with respect to the kind of regulation that we are talking

about, Senator, it is split regulation, and that is very different from

shared regulation.

Senator SCHUMER. Correct.

Mr. LEVITT. And if collectively we could work toward shared regulation, you would remove many of my feelings about this bill,

which are not motivated by any issue other than the protection of

investors.

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Senator SCHUMER. Would you agree with that, Chairman Rainer?

Right now the bill has—Chairman Levitt put it right, at least as

far as I can tell—split regulation. Would you agree that a shared

regulation formula could work and would you be willing to entertain that?

Mr. RAINER. Senator Schumer, I have been from the outset in

favor of both joint regulation and the ability for both markets—the

equity markets and the futures markets—to be able to offer these

products.

Senator SCHUMER. The issue is not who offers the products. The

issue is who regulates the product. Would you be willing to say

that shared regulation is, if not the best, certainly a good way to

go, particularly if it can break the deadlock that we seem to have?

Mr. RAINER. Senator, I think that when I say joint regulation, I

mean shared regulation, but I am not 100-percent sure I know

what you mean by a definition of shared versus split.

My position, which I have mentioned, is that this bill, strictly

from the perspective of the CFTC, adequately addresses our concerns. Having said that, I have said in other venues that I recognize the important and significant interests of the SEC and that

I believe that any final regulatory structure should be one that

both agencies can support.

Senator SCHUMER. OK. So you would, if Chairman Levitt has in

his delicate way—he is more delicate than I am—indicated he has

real troubles with the bill as proposed, as much as he respects

Chairman Lugar and Chairman Gramm, and let’s put that in the

record 10 times, would you then encourage that we wait and see

if we can come up with something that you and he can agree upon,

provided it can be done in a relatively short frame of time? Would

you agree that we should not move forward with this bill, which

seems to me is not a shared regulatory regime at all?

Mr. RAINER. Senator, I am going to withhold that for right now.

Let me get back to you on that.

Senator SCHUMER. If you could submit that in writing.

And one other thing I would ask that you submit in writing is

your comments, your objections to the—you cannot know much

about it yet but the proposal that I have put in today, which I

think is a shared regulatory regime that I think would be fair and

sort of go right down the middle, as opposed to this bill, which I

think does not really do that.

Mr. RAINER. Of course, Senator.

Senator SCHUMER. Great.

Thank you, Mr. Chairman.

The CHAIRMAN. Well, thank you very much, Senator Schumer. I

appreciate your comments likewise and will examine your legislation, too. It is an important factor. I just ask from you, as well as

everyone else, some appreciation of the time frame that we all have

to work in because the Senate session will be over soon, the window of opportunity to deal with this at all, whatever its merit.

So my hope, and this is obvious in terms of trying to press this

issue on this morning, is that there is a certain season for these

things to happen. If we are not able to, why, we will all have a lot

of time, but there will be maybe different players, a different situation and different position of our markets, for better or for worse.

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So it seems to me that this is an appropriate time for us to focus

as our two committees have attempted to do so this morning and

will be doing so in a concerted way in the next few days.

Senator SCHUMER. The only thing I would say, Mr. Chairman, I

agree with you but I would rather—if there were a choice and I

agree with you I hope there is not a choice or a division, but I

would rather do it right than do it quickly. I am sure you would

agree with that.

The CHAIRMAN. I do agree with that and we are most hopeful we

can do both, always.

Senator SCHUMER. Great.

The CHAIRMAN. We thank both of the Chairmen for your patience. It has been an extended hearing this morning but you have

been with us all the way and we appreciate that. Thank you.

The hearing is adjourned.

[Whereupon, at 1:03 p.m., the joint Committee hearing was adjourned.]

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