Commodity Futures Trading Commission 

Office of External Affairs

Three Lafayette Centre 

 1155 21st Street, NW 

Washington, DC 20581 

 202.418.5080

Speech 

The Keys to Smart Regulation 

CFTC Acting Chairman Walt Lukken

FIA Expo 2007 

November 27, 2007 

(As Prepared for Delivery) 

I’d like to thank John Damgard and the FIA for inviting me to speak and commend them on yet

another successful EXPO. There have been several important changes at the CFTC since the last

EXPO. We have two new commissioners – Jill Sommers and Bart Chilton. I know I speak for 

Commissioner Dunn in saying they have been welcome additions to the Commission for their 

unique experiences and insights. 

To say the least, it has been a busy time since taking over as Acting Chairman in July. In those 

four short months, I testified three times before Congress, the Commission held two public

hearings and provided an extensive report to Congress on the regulation of exempt commercial 

markets, Congress is actively debating the CFTC’s reauthorization, the markets have 

experienced a major credit crunch resulting from the sub-prime crisis, a large FCM imploded, the 

CFTC and FERC filed their respective cases against Amaranth, and the CFTC and Department

of Justice reached a record settlement with BP for manipulating the propane market. Although 

my wife wishes otherwise, I do not see the pace of things slowing down any time in the near

future. 

Much of the job of regulating is reacting to such situations as they arise. This is inevitable given

the nature of the financial markets and its broad array of participants. But regulators should not 

be content to just play defense—we must be ready to anticipate trends as our industry and 

markets evolve. 

I was born in Chicago and lived here for several years so I know how big of a sports town it is. 

Having gone to Indiana University, my game is basketball. Even so, I have always been 

impressed with NHL Hall of Famer, Wayne Gretzky. One Gretzky quote has struck me for its 

insightfulness: “A good hockey player plays where the puck is. A great hockey player plays

where the puck is going to be.” 
Like hockey players, what differentiates average regulators from exceptional regulators is the 

ability to anticipate and adapt to change—to play where the markets are going, not where the 

markets have been. 

You cannot talk about the direction of our markets without addressing the most significant driver

of change--globalization. And I don’t think I need to convince any of you that it’s happening 

quickly. No where are the “flattening” forces of globalization more evident than in the financial 

services sector. This is aptly described in the recent IBM study regarding the long-term trends in

our industry. Not surprisingly, this survey found that technology is leveling the information and 

speed advantages that firms have traditionally enjoyed and as a result, profits are being 

squeezed. Technology has democratized the markets, bringing enhanced data, speed and market 

transparency to all end users, lessening the value added by the traditional intermediation model. 

The IBM study foresees that market participants will increasingly seek profits through either 

assuming more risk or mitigating the risk of other market users. 

As firms take advantage of these new opportunities, the lines of financial businesses are blurring 

significantly. From a functional vantage, it is difficult to tell the difference between brokers, 

hedge funds and exchanges as each tries to compete for each other’s business. Exchanges have 

begun to bypass brokers to directly connect large market users—many of them hedge funds. 

Similarly, brokerage firms want a piece of the risk assumption and mitigation business as many 

of them now own exchanges, clearing houses and hedge funds in order to compete for this 

business. The recent sub-prime crisis has exposed this functional convergence as well as the 

difficulties faced by regulators in properly overseeing the markets. 

As these major structural changes occur, how do regulators keep pace? To be honest, keeping 

pace is optimistic—realistically, regulators are fortunate to keep the industry’s taillights in view. 

While the private sector views globalization as an opportunity, regulators are grudgingly 

adapting to the modern economy. In another survey by IBM, 95 percent of the financial industry 

interviewed thought globalization to be a growth opportunity rather than a threat. Of the five

percent who felt threatened, nearly all were regulators. Why is this? Because regulators 

understand that globalization shakes the foundation of their regulatory models. 

Regulators no longer live in a “bright-line” jurisdictional world. Determining where an exchange 

or firm is located is difficult, if not impossible, with subsidiaries, boards of directors, customers, 

clearinghouses and self-regulators scattered around the globe. To say the least, it is difficult—but 

I think the key for regulators is not only to work harder, but work smarter. It is this idea of 

“smart regulation” that will better aid regulators in anticipating trends in this cyber-driven and

borderless environment. 

What is “smart regulation?” In my view, there are three key components to the “smart 

regulation” concept. First, it must be outcome-driven; second, it must be risk-based; and third, it

must be globally collaborative. 

There has been much debate recently on the relative benefits of outcome-based principles versus

rules. There is a developing consensus in the U.S. that principles-based regulation is a model

worthy of study, noting that the UK markets are flourishing under such an approach. But rather

than fly to London, Washington policymakers need only visit the Windy City where the U.S. 

futures industry has been thriving under principles since the passage of the Commodity Futures 

Modernization Act (CFMA) in 2000. 

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A principles-based system requires markets to meet certain public outcomes in conducting their 

business operations. For example, U.S. futures exchanges must continuously meet 18 core 

principles in order to uphold their good standing as a regulated contract market—ranging from 

maintaining adequate financial safeguards to conducting market surveillance. Such an approach 

has the advantage of being flexible for both regulator and regulated. As technology and market 

conditions change, exchanges may discover more effective ways to meet a mandated principle in 

their self-regulatory roles. 

It is important to note that a principles approach does not obviate the need for rules. Rather, a

principles system is a hybrid of desired public outcomes complimented by specific rules aimed at 

achieving those ends. Each regulatory authority—depending on the maturity of its markets—

will need to find the optimal balance between the flexibility of principles and the legal certainty

of rules. 

But smart regulation extends beyond the debate over rules versus principles. Not all principles 

and rules are created equally. Authorities must have a regulatory thermostat to adjust the 

agency’s focus as critical threats to the public rise. 

Risk analysis serves as that calibrating tool and is the second key to smart regulation. Riskbased regulation is advantageous because it inherently requires regulators to incorporate costbenefit judgments into their decision making. This provides greater certainty that both industry 

and public funds are utilized appropriately. Instead of a one-size-fits-all approach, regulators can 

assign their staff according to risk, spending more time on firms that pose the greatest threat to 

the integrity of the marketplace. 

Risk factors were certainly the key consideration in the CFMA’s tiered regulatory design for

exchanges that tailors oversight depending on the nature of the products traded and the

sophistication of the market participants. A highly liquid market limited to only institutional 

investors may require different regulatory considerations than one involving retail participants

and products that are more susceptible to manipulation. The CFTC is one of the first exchange 

regulators to have developed this tiered approach to oversight and I applaud the E.U. and Japan 

for adopting a similar risk-based structure. 

The last point is that smart regulation requires close collaboration and information sharing 

among regulators. I term it “relationship regulation” as jurisdictions strive to bridge the 

informational and legal divides that separate them. But like all relationships, they require a lot of 

work. 

No matter the size of the agency, individual regulators do not have the resources to sufficiently 

monitor the breadth of the global marketplace. We must rely on the expertise of other regulators,

both domestic and foreign, in fulfilling our public mission. This does not mean that agencies

should abdicate their interests. Quite the opposite—each must continue to vigorously pursue its

public mission. However, in today’s global economy, the means to this end must involve close 

coordination among regulators. 

The CFTC has long been an international leader for coordinating its efforts with its foreign 

counterparts. The CFTC was one of the first to embrace the “mutual recognition” concept for 

foreign jurisdictions dating back twenty years for foreign brokers and ten years for foreign 

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exchanges. However, global competition led the Commission to recently revisit its foreign 

board of trade recognition policy to ensure that it was working appropriately. 

Last year, ICE Futures exchange, headquartered in London and regulated by the FSA, began 

trading a crude oil futures contract in direct competition with New York Mercantile Exchange 

(NYMEX), utilizing a 1999 CFTC “no action” recognition letter. Listing of the pegged ICE

Futures contract caused regulatory concern because the CFTC could not observe the entirety of a 

trader’s position in both markets, widening the possibility of trading abuses across borders. 

Under a less flexible approach, the CFTC might have required ICE Futures to register in the U.S. 

regardless of its regulatory status in the UK. Such a path would have resulted in duplicative

regulation without furthering the aggregate public mission. But the smart regulation philosophy 

allows for more tailored solutions, enabling the CFTC to determine whether British law is

broadly comparable to the principles set out for U.S. exchanges. 

Ultimately, the CFTC reached the right decision and affirmed its recognition policy for foreign 

exchanges with certain minor enhancements. And with over ten years of experience and 19 

foreign exchanges recognized, this regime appears to be working well with no major market 

mishaps or reports of customer abuse. 

Even more imperative is the need for collaboration among domestic regulators given the 

convergence of the financial markets. As the world of securities and futures encroach upon each 

other, there is much work that the CFTC and SEC can do to coordinate their differing approaches

to regulation. Such important matters as hybrid product approval and portfolio margining need 

to be addressed by our agencies. While admittedly difficult, resolving these problems could

bring enormous benefits and efficiencies to the marketplace. I have spoken to SEC Chairman

Cox regarding these issues of mutual concern and am committed to working with him over the

coming year on these difficult problems. 

There has also been much attention recently on the competitiveness of the U.S. financial services

sector and whether changes need to occur in their oversight as markets converge. Treasury 

Secretary Paulson put forth 30 questions open to public comment on the regulation of US 

financial markets. I am pleased that Treasury recognized in its release the benefits of the 

CFTC’s principles approach and tiered regulatory structure. Treasury hopes to unveil their 

findings in the form of a “blueprint” for regulatory structure early in 2008. 

I agree with many commentators that the multitude of financial laws need to be rationalized so

that regulators are better able to achieve the public and economic goals of this nation. Some

have even suggested merging the SEC and CFTC as a structural means for attaining this aim. 

While all ideas should be thoughtfully considered, in my view, policymakers should first focus 

on “How” we regulate rather than “Who” is regulating. No matter the Washington zip code, our

agencies have differing public missions and approaches to regulation. Although not as eye 

grabbing as discussions of merger, reconciling these differences in how we regulate should be 

the first focus of our attention and will better equip our agencies to collaborate in achieving our

respective mandates. 

Earlier this month, the Financial Services Roundtable, whose membership includes the 100 

largest financial services companies, released a report called, “The Blueprint for U.S. Financial 

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Competitiveness.” Much to my pleasure, but not to my surprise, the report mentions the CFTC’s 

principles-based regulatory approach as a beneficial regulatory model that is already working

here in the U.S. Quoting from the report, it states: “By moving to a more principles-based 

regulatory regime, the CFTC is also more compatible globally and better able to work

cooperatively with other regulators based on mutual recognition of comparable standards. Its 

principles have enabled the CFTC to become more of a prudential supervisor, encouraging a 

more collaborative relationship with regulated entities while reserving its rights as an enforcer in

the case of fraud, manipulation, or trade practices abuse, for example.” 

In addition to recommending a principles model for regulating, the report suggests that a 

regulatory advisory board could help ensure that all financial regulators are abiding by one set of 

sound regulatory principles. This model would enable regulatory agencies to maintain their 

specific market expertise, their nimbleness in decision making and their tailored public mission 

while closely coordinating efforts with other regulators to avoid overlap and gaps that currently

plague the system. 

This “coordinated specialist” model also reflects how some private firms are organizing to be 

effective in the global financial markets. Today’s successful global corporations are attempting 

to push greater autonomy to lower levels of the organization where the expertise and local

knowledge exists with tight coordination at the top. In IBM’s recent study on global financial 

markets, executives rated these specialized international firms as more effective in certain global 

capabilities than multinational, universal firms due to their niche capabilities and speed of

decision-making. Certainly such attributes should also be reflected in those regulating these 

complex and fluid markets. 

This brings me back to the wisdom of Wayne Gretzky. Whether you are a smart hockey player 

or a smart regulator, the ability to anticipate is the key to success. But in a financial crowd, 

success is measured in numbers. From the passage of the CFMA in 2000 to 2006, volume on the

U.S. futures exchanges has grown 328 percent, compared to the 16 percent volume increase on

the three major U.S. stock markets over that time. Today, the largest U.S. exchange as valued by 

shareholders is located in Chicago with CME’s market capitalization over $33 billion. While 

recent years have seen U.S. capital markets losing IPO business overseas, U.S. market share on

global futures trading volume has grown from 34 percent in 2000 to 43 percent in 2006. 

By all measures, the U.S. futures industry has enjoyed enormous success competing on a global 

scale under this progressive regulatory regime. I appreciate your attention this morning and I 

hope the CFTC’s experience with smart regulation can be a worthy model for others to consider. 

Thank you again. 

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