Crain News Service
The futures industry's surprising progress in pushing for a legislative rollback of federal regulations might never have happened but for a low-profile truce with a group of its traditional rivals: over-the-counter derivatives dealers.
Leaders of the Chicago Board of Trade and other exchanges once derided the unregulated OTC market for causing debacles like the bankruptcy of Orange County, Calif. But now, the opposing sides practically are blowing kisses at one another as Congress sets out to rewrite the 23-year-old Commodity Exchange Act and reduce the powers of the Commodity Futures Trading Commission.
This once-improbable alliance was initiated last summer by the CBOT and a coalition of nine investment and commercial banks that dominate the OTC derivatives business.
But the futures industry's deregulatory campaign also could open a Pandora's box for U.S. futures markets if Congress unleashes competition in the market for trading all standardized futures contracts.
At issue for the futures exchanges is a proposal that would free them to launch products that would be exempt from the broad array of record-keeping and disclosure requirements now imposed on the exchanges and their sophisticated institutional customers.
By setting up so-called "pro markets" - unregulated exchanges reserved for professional traders - the CBOT could avoid costly record-keeping and disclosure requirements. But the deregulatory push also could help unfettered OTC traders to siphon even more business from the CBOT and other exchanges, especially with low-cost electronic trading.
"The exchanges have a monopoly for the products they offer," said Gary Alan DeWaal, executive vice president of the brokerage firm FIMAT Futures USA Inc., New York, which trades on the exchanges and OTC market. "Once the CFTC is relaxed . . . nothing stops the major players from banding together and forming their own clearinghouses. With the Internet and some capital, you could set up an exchange."
Although final passage of legislation isn't expected until late this year at the earliest, a CBOT-backed measure in the Senate already has won broad backing.
However, support for a regulatory rollback isn't universal. Futures brokerage firms, commodity fund managers and even a group of New York floor brokers are cautioning Congress to ensure the CFTC retains oversight powers to combat price manipulation and other types of fraud.
"We still need some level of residual oversight," stressed Robert Easton, chairman of Commodities Corp. Ltd., a Princeton, N.J., commodity pool operator. "Peel (away) the layers of inefficiency," he said, but keep the safeguards.
The CBOT and other futures exchanges have been short on details of how their pro markets would operate, in part because they've been surprised by the initial successes of the deregulatory campaign in Congress.
"We're pleased the Chicago futures exchanges have taken a constructive approach to the legislative process," said Salomon Brothers Inc. Managing Director Zachary Snow, whose firm joined last fall with Morgan Stanley & Co., Goldman Sachs & Co., Merrill Lynch & Co., Lehman Brothers Inc., Bankers Trust New York Corp., Credit Suisse First Boston, Citicorp and Chase Manhattan Corp. to provide a voice for all OTC markets in the reform effort.
In essence, the exchanges seek to hawk a panoply of products with the same stripped-down customer protections as privately negotiated derivative contracts that have thrived off the exchange markets.
That potential scenario doesn't sit well with some exchange customers.
"The exchanges would be making the rules and responding only to their self-regulatory authority," said John Damgard, president of the Washington-based Futures Industry Association. "Historically, there are people that feel that sometimes, the rulemaking at the exchanges has not always favored the customer."
Floor traders, who traditionally dominate the governing boards of U.S. futures exchanges, often have been criticized for making decisions and setting rules that don't benefit exchange users.
"We need to have some feeling about exactly what safeguards and protections there will be in a pro market envisioned by the exchanges," said Mr. Damgard.
But so far the exchanges are keeping mum on how their pro markets would operate. "We don't know what the Congress is going to (allow) us to do," said Mark Young, a CBOT attorney with Kirkland & Ellis in Washington.