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Commodity Futures Trading Commission 

Office of External Affairs

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Washington, DC 20581 

 202.418.5080

Testimony 

Testimony of Terry S. Arbit 

General Counsel 

Hearing to Examine Trading on Regulated Exchanges 

and Exempt Commercial Markets 

September 18, 2007 

Introduction

Good morning. My name is Terry Arbit and I am General Counsel of the Commodity Futures 

Trading Commission. I have been asked to help frame the discussions at today’s hearing by 

providing an overview of the statutory structure for derivatives markets established under the

Commodity Exchange Act (the CEA), and describing how Exempt Commercial Markets fit into

that structure. Along the way, I will identify some common misperceptions regarding the legal 

environment in which Exempt Commercial Markets currently operate. 

CEA’s Multi-Tiered Market Structure 

In the Commodity Futures Modernization Act of 2000 (or CFMA), Congress established a tiered 

approach to regulatory oversight of derivatives markets. Each tier is subject to a varying level of 

oversight, based primarily on the commodity traded, the type of trading, and the nature of the 

participants in the market. 

Among futures markets, the designated contract market occupies the top tier, representing what 

is often described as a “fully regulated” futures exchange. A contract market may trade contracts 

based on any commodity, and may offer products to retail customers on an unrestricted basis. 

Under the CFMA’s principles-based oversight regime, contract markets are afforded significant 

flexibility in how they run their operations, but nonetheless must initially satisfy specified

designation criteria, and thereafter must demonstrate compliance with comprehensive core 

principles on an ongoing basis. 
The CFMA also created a new category of futures exchange, called a derivatives transaction

execution facility (or DTEF). There are two types of DTEF, a retail DTEF and a commercial 

DTEF. Both DTEF categories have fewer regulatory requirements than a contract market, but 

are subject to differing limitations on eligible traders and the commodities that may be traded. 

Although subject to a “lighter” regulatory regime, this alternative exchange must have 

compliance and surveillance programs, and must undertake significant self-regulatory 

responsibilities. These include a requirement to establish and enforce rules to deter trading 

abuses and to monitor trading to ensure orderly trading. To date, no trading facility has applied 

to the Commission to register as a DTEF. 

The CFMA also created a broad – and complex - array of exclusions and exemptions from 

regulation for certain derivatives products that are traded over-the-counter, either bilaterally or

on electronic trading facilities. These exclusions and exemptions reflect the view, consistent 

with various Congressional and Commission actions during the preceding decade, that offexchange transactions between sophisticated counterparties do not necessarily require the full 

weight of the protections that the CEA provides for contract markets and DTEFs. 

One such exemption, which we are gathered to discuss here today, is for transactions in exempt

commodities on electronic trading facilities that are known as Exempt Commercial Markets. 

Exempt commodities include commodities such as energy, metals, chemicals, and emission 

allowances. 

It is sometimes said that Exempt Commercial Markets are unregulated. But this is not quite 

right. Although largely exempt from Commission oversight authority under the CEA, Congress 

did subject Exempt Commercial Markets to a limited set of regulatory requirements under 

Sections 2(h)(3) through (5) of the statute. The Commission has implemented these 

requirements in its Rule 36.3. 

In recent years, derivatives trading on certain Exempt Commercial Markets has grown 

substantially, due in no small measure to the regulatory environment created by the CFMA. At 

the same time, Exempt Commercial Markets have evolved in ways that may not have been 

anticipated when the CFMA was enacted. The question arises, therefore, whether the regulatory 

line for Exempt Commercial Markets that was drawn by Congress in the CFMA remains 

appropriate today. That is, on the regulatory spectrum ranging from no regulation of bilateral 

over-the-counter transactions on the one hand, to fully-regulated futures exchanges on the other 

hand, should policy-makers adjust the line governing Exempt Commercial Markets further along 

the spectrum toward the degree of regulation applicable to contract markets and DTEFs? 

With that background, let me now discuss how Exempt Commercial Markets are regulated under 

the CEA, in four areas: 1) first, market participants; 2) second, regulatory requirements; 3) third,

differences between Exempt Commercial Markets and contract markets; and 4) finally, the 

Commission’s anti-fraud authority over Exempt Commercial Markets. 

Exempt Commercial Markets 

1. Market Participants on Exempt Commercial Markets

Exempt Commercial Markets are electronic trading facilities that restrict trading to principal-toprincipal transactions between “eligible commercial entities.” The term “eligible commercial 

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entities,” like the name “Exempt Commercial Markets,” connotes a purely commercial

marketplace among entities that can make or take delivery of the underlying commodity. But 

that also is not quite right. Under the statutory definitions of the CFMA, pooled investment 

vehicles such as hedge funds qualify as “eligible commercial entities,” and their participation on 

certain Exempt Commercial Markets has become both active and significant. 

2. Regulatory Requirements for Exempt Commercial Markets

Exempt Commercial Markets are subject to certain recordkeeping and reporting requirements 

under the CEA. The CEA requires that an Exempt Commercial Market must maintain for five 

years, and make available for inspection upon request by the Commission, records of its 

activities related to its business as a trading facility. More specifically, under Rule 36.3, an 

Exempt Commercial Market must identify to the Commission those transactions which averaged

five trades per day or more over the most recent calendar quarter. For all such transactions, the 

Exempt Commercial Market must provide to the Commission weekly reports showing certain 

basic trading information, or provide the Commission with electronic access that would allow the 

Commission to compile the same information. 

The CEA also gives the Commission the authority to require an Exempt Commercial Market to

provide, upon special call, information relating to its business as the Commission may determine

appropriate to enforce the anti-fraud and anti-manipulation provisions of the CEA, to evaluate a 

systemic market event, or to obtain information on behalf of another federal financial regulator. 

Commission staff has issued several special calls to the InterContinental Exchange, an Exempt

Commercial Market generally referred to as “ICE,” requesting information on trader positions in

ICE natural gas contracts that are directly linked to NYMEX futures prices. The purpose of

these special calls was not to surveil ICE, as the Commission has no statutory authority to do so. 

Rather, these special calls were issued to support surveillance of the NYMEX natural gas

contracts. 

The Commission has imposed one further recordkeeping requirement on Exempt Commercial 

Markets in its Rule 36.3. That rule requires an Exempt Commercial Market to maintain a record 

of allegations or complaints that it receives concerning suspected fraud or manipulation, and to 

provide the Commission with a copy of the record of each complaint that alleges facts that would

constitute a violation of the CEA or Commission regulations. 

3. Differences between Exempt Commercial Markets and Contract Markets

Though Exempt Commercial Markets are subject to these limited regulatory requirements, the 

CEA does not subject them to the level of transparency and Commission oversight associated

with contract markets. Contract markets must satisfy specified criteria to become designated, 

and then demonstrate compliance with core principles on a continuing basis. These core

principles require regulated futures exchanges to undertake significant supervisory responsibility 

with respect to trading on their markets. For example, contract markets may trade only those 

contracts that are not readily susceptible to manipulation, and must have rules and procedures for 

preventing market manipulation. Furthermore, contract markets are required to adopt position 

limit or accountability rules in order to address the potential for market manipulation or 

congestion. Contract markets must have compliance and surveillance programs, which the 

Commission evaluates through its rule enforcement reviews. 

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These statutory requirements, however, do not apply to Exempt Commercial Markets. An 

Exempt Commercial Market is not required to monitor trading on its facility. Nor does the 

Commission have the same authorities to address problems on Exempt Commercial Markets as it 

does for contract markets. For example, the Commission’s statutory emergency authority, and 

its authority to force a reduction or liquidation of positions and to alter or supplement a trading 

facility’s rules, where appropriate, do not extend to Exempt Commercial Markets. 

The CEA does provide that the Commission may determine that an Exempt Commercial Market 

performs a significant price discovery function for transactions in an underlying cash market. 

Such a determination does not trigger additional self-regulatory responsibilities or additional 

oversight authority for the Commission. Rather, it triggers an obligation by the Exempt

Commercial Market to publicly disseminate certain specified information such as contract terms 

and conditions, trading volume, open interest, and opening and closing prices or price ranges. 

4. Commission Anti-Fraud Authority over Exempt Commercial Markets

Exempt Commercial Markets are subject to the CEA’s anti-fraud and anti-manipulation 

provisions. In November 2000, the Seventh Circuit Court of Appeals suggested in the CTS case 

that Section 4b of the CEA, the Commission’s primary anti-fraud tool, is limited to intermediated 

transactions—that is, those involving a broker.1

 As part of its ongoing Reauthorization process 

in Congress, the Commission has proposed an amendment to Section 4b, the terms of which 

have been agreed to by the various sectors of the futures industry. This important legislative 

amendment would clarify the Commission’s authority to bring fraud actions involving principalto-principal transactions that occur on Exempt Commercial Markets. 

 

Conclusion 

Now, with this summary of the statutory structure for derivatives markets in mind, let me turn it

over to my colleagues for a discussion of the Commission’s work with respect to Exempt 

Commercial Markets in practice. 

 

1 Commodity Trend Service, Inc. v. CFTC, 233 F.3d 981, 991-992 (7th Cir. 2000). 

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