[House Hearing, 118 Congress]
[From the U.S. Government Publishing Office]
REAUTHORIZING THE CFTC: STAKEHOLDER
PERSPECTIVES
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HEARING
BEFORE THE
SUBCOMMITTEE ON COMMODITY MARKETS, DIGITAL
ASSETS, AND RURAL DEVELOPMENT
OF THE
COMMITTEE ON AGRICULTURE
HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTEENTH CONGRESS
SECOND SESSION
__________
JULY 25, 2024
__________
Serial No. 118-24
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
Printed for the use of the Committee on Agriculture
agriculture.house.gov
__________
U.S. GOVERNMENT PUBLISHING OFFICE
57-150 PDF WASHINGTON : 2024
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COMMITTEE ON AGRICULTURE
GLENN THOMPSON, Pennsylvania, Chairman
FRANK D. LUCAS, Oklahoma DAVID SCOTT, Georgia, Ranking
AUSTIN SCOTT, Georgia, Vice Minority Member
Chairman JIM COSTA, California
ERIC A. ``RICK'' CRAWFORD, Arkansas JAMES P. McGOVERN, Massachusetts
SCOTT DesJARLAIS, Tennessee ALMA S. ADAMS, North Carolina
DOUG LaMALFA, California ABIGAIL DAVIS SPANBERGER, Virginia
DAVID ROUZER, North Carolina JAHANA HAYES, Connecticut
TRENT KELLY, Mississippi SHONTEL M. BROWN, Ohio
DON BACON, Nebraska SHARICE DAVIDS, Kansas
MIKE BOST, Illinois ELISSA SLOTKIN, Michigan
DUSTY JOHNSON, South Dakota YADIRA CARAVEO, Colorado
JAMES R. BAIRD, Indiana ANDREA SALINAS, Oregon
TRACEY MANN, Kansas MARIE GLUESENKAMP PEREZ,
RANDY FEENSTRA, Iowa Washington
MARY E. MILLER, Illinois DONALD G. DAVIS, North Carolina,
BARRY MOORE, Alabama Vice Ranking Minority Member
KAT CAMMACK, Florida JILL N. TOKUDA, Hawaii
BRAD FINSTAD, Minnesota NIKKI BUDZINSKI, Illinois
JOHN W. ROSE, Tennessee ERIC SORENSEN, Illinois
RONNY JACKSON, Texas GABE VASQUEZ, New Mexico
MARCUS J. MOLINARO, New York JASMINE CROCKETT, Texas
MONICA De La CRUZ, Texas JONATHAN L. JACKSON, Illinois
NICHOLAS A. LANGWORTHY, New York GREG CASAR, Texas
JOHN S. DUARTE, California CHELLIE PINGREE, Maine
ZACHARY NUNN, Iowa SALUD O. CARBAJAL, California
MARK ALFORD, Missouri ANGIE CRAIG, Minnesota
DERRICK VAN ORDEN, Wisconsin DARREN SOTO, Florida
LORI CHAVEZ-DeREMER, Oregon SANFORD D. BISHOP, Jr., Georgia
MAX L. MILLER, Ohio
______
Parish Braden, Staff Director
Anne Simmons, Minority Staff Director
______
Subcommittee on Commodity Markets, Digital Assets, and Rural
Development
DUSTY JOHNSON, South Dakota, Chairman
FRANK D. LUCAS, Oklahoma YADIRA CARAVEO, Colorado, Ranking
AUSTIN SCOTT, Georgia Minority Member
DAVID ROUZER, North Carolina DONALD G. DAVIS, North Carolina
DON BACON, Nebraska JIM COSTA, California
TRACEY MANN, Kansas ANDREA SALINAS, Oregon
JOHN W. ROSE, Tennessee MARIE GLUESENKAMP PEREZ,
MARCUS J. MOLINARO, New York Washington
NICHOLAS A. LANGWORTHY, New York NIKKI BUDZINSKI, Illinois
ZACHARY NUNN, Iowa JONATHAN L. JACKSON, Illinois
LORI CHAVEZ-DeREMER, Oregon GREG CASAR, Texas
MAX L. MILLER, Ohio ANGIE CRAIG, Minnesota
JASMINE CROCKETT, Texas
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(ii)
C O N T E N T S
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Page
Caraveo, Hon. Yadira, a Representative in Congress from Colorado,
opening statement.............................................. 3
Johnson, Hon. Dusty, a Representative in Congress from South
Dakota, opening statement...................................... 1
Prepared statement........................................... 2
Thompson, Hon. Glenn, a Representative in Congress from
Pennsylvania, opening statement................................ 4
Witnesses
Lukken, J.D., Hon. Walter L., President and Chief Executive
Officer, Futures Industry Association, Washington, D.C......... 5
Prepared statement........................................... 7
Supplementary material....................................... 43
Submitted questions.......................................... 45
Sexton III, J.D., Thomas W., President and Chief Executive
Officer, National Futures Association, Chicago, IL............. 13
Prepared statement........................................... 14
Supplementary material....................................... 44
Submitted questions.......................................... 47
Antonsen, Travis, Senior Vice President, Grain Marketing, and
Rail Logistics, Agtegra Cooperative, Aberdeen, SD; on behalf of
National Council of Farmer Cooperatives........................ 17
Prepared statement........................................... 18
Thornton, J.D., Alexandra, Senior Director, Financial Regulation,
Center for American Progress, Washington, D.C.................. 21
Prepared statement........................................... 22
REAUTHORIZING THE CFTC: STAKEHOLDER PERSPECTIVES
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THURSDAY, JULY 25, 2024
House of Representatives,
Subcommittee on Commodity Markets, Digital Assets, and
Rural Development,
Committee on Agriculture,
Washington, D.C.
The Subcommittee met, pursuant to call, at 8:29 a.m., in
Room 1300 of the Longworth House Office Building, Hon. Dusty
Johnson [Chairman of the Subcommittee] presiding.
Members present: Representatives Johnson, Lucas, Austin
Scott of Georgia, Bacon, Mann, Nunn, Miller of Ohio, Thompson
(ex officio), Caraveo, Davis of North Carolina, Costa,
Budzinski, and Craig.
Staff present: Paul Balzano, Wick Dudley, Tim Fitzgerald,
Nick Rockwell, Kevin Webb, Kyle Upton, Kate Fink, Josh Lobert,
Clark Ogilvie, John Konya, and Dana Sandman.
OPENING STATEMENT OF HON. DUSTY JOHNSON, A REPRESENTATIVE IN
CONGRESS FROM SOUTH DAKOTA
The Chairman. All right. Since everybody is ready to go, we
will go ahead and get started. I call this hearing to order.
Welcome, and thanks for coming. I always delight when this
Committee does something that is important, but not necessarily
sexy. The sexy stuff gets all the headlines, but it is indeed
our job to govern a country, and sometimes that means doing
things that are really important, even if they don't grab the
headlines.
I want to welcome everybody to this Subcommittee hearing.
The hearing today, of course, is called, Reauthorizing the
CFTC: Stakeholder Perspectives.
Everybody here knows that derivatives markets are the
backbone of our global financial system, providing essential
tools for risk management, for price discovery, and for
efficient capital allocation. Those markets allow businesses
and investors to use those tools to hedge against price
volatility, to promote stability and predictability across
various sectors. We have a tendency to think about ag, but of
course, it is not just ag. It is also energy. It is finance.
In agriculture, farmers use derivatives to lock in prices
for their crops, protecting themselves against unpredictable
weather and market fluctuations. In the energy sector,
companies use derivatives to stabilize prices for oil, gas, and
electricity. That enables steady planning and operation. In
finance, derivatives help manage interest rate risk, currency
fluctuations, and credit exposure, and that contributes to the
overall stability of global markets.
The U.S. futures and swaps markets are the largest, most
liquid markets in the world, and that is not an accident. That
is in no small part because of the responsible regulation of
the Commodity Futures Trading Commission.
Each day, the Commission works to ensure the integrity, the
vibrancy, and the resiliency of the derivatives markets, and in
doing so, it protects those people we have been talking about,
the farmers, the ranchers, the manufacturers, and other end-
users who rely on these markets for robust risk management
tools.
Today, we are going to hear from stakeholders who will
provide diverse perspectives on the importance of reauthorizing
the Commission, and hopefully, they will give us a little
insight into the issues and priorities that we should consider
during this process.
This past March, CFTC Chair Behnam testified before the
Committee, and the Ranking Member asked him about the
importance of reauthorization. Chair Behnam put it well, as he
often does, when he said this. ``We have to reauthorize the
agency to ensure the public and our international partners
understand that Congress and this Committee take derivatives
markets and America's supremacy in derivatives markets very
seriously. We have the biggest markets in the world, and I
think we all want to keep it that way, and reauthorization is
one step to ensure that that condition remains the same.''
I couldn't agree more. It is our role as authorizers to
continue to examine the work of the Commission and the needs of
market users. Reauthorization is how we fill the role. That is
how we ripen these conversations. Just as this Committee passed
digital asset market structure legislation in a bipartisan
manner, both in the Committee and on the House floor, it is my
goal to achieve the same bipartisan success with the
reauthorization of the CFTC.
I want to thank our witnesses for joining us today. We look
forward to hearing from you.
[The prepared statement of Mr. Johnson follows:]
Prepared Statement of Hon. Dusty Johnson, a Representative in Congress
from South Dakota
Good morning. I want to welcome you all to the Commodity Markets,
Digital Assets, and Rural Development Subcommittee hearing titled,
Reauthorizing the CFTC: Stakeholder Perspectives.
Derivatives markets are the backbone of our global financial
system, providing essential tools for risk management, price discovery,
and efficient capital allocation.
These markets allow businesses and investors to hedge against price
volatility, promoting stability and predictability across various
sectors, from agriculture to energy to finance.
In agriculture, farmers use derivatives to lock in prices for their
crops, protecting themselves against unpredictable weather and market
fluctuations.
In the energy sector, companies use derivatives to stabilize prices
for oil, gas, and electricity, ensuring steady operations and planning.
In finance, derivatives help manage interest rate risks, currency
fluctuations, and credit exposure, contributing to the overall
stability of the economy.
The U.S. futures and swaps markets are the largest, most liquid
markets in the world, due in no small part to the work of the Commodity
Futures Trading Commission.
Each day, the Commission works to ensure the integrity, vibrancy,
and resiliency of the derivatives markets. In doing so, it protects
farmers, ranchers, manufacturers, and other end-users who rely on these
markets for robust risk-management tools and accurate pricing.
Today, we will hear from stakeholders who will provide diverse
perspectives on the importance of reauthorizing the Commission, and the
issues and priorities we should consider during this process.
This past March, CFTC Chairman Behnam testified before the
Committee. Our Ranking Member asked him about the importance of
reauthorizing the Commission. Chairman Behnam put it well when he said:
``. . . we have to reauthorize the agency to ensure the
public and our international partners understand that Congress
and this Committee takes derivatives markets and America's
supremacy in derivatives markets very serious-
ly . . . we have the biggest markets in the world, and I think
we all want to keep it that way. And reauthorization is one
step to ensure that condition remains the same.''
I could not agree more. It is our role as authorizers to continue
to examine the work of the Commission and the needs of derivatives
market users. Reauthorization is how we fulfill this role.
Just as this Committee successfully passed digital asset market
structure legislation in a bipartisan manner, both in the Committee and
on the House floor, it is my goal to achieve the same bipartisan
success with the reauthorization of the CFTC.
I would like to thank our witnesses for joining us today. We look
forward to hearing your testimony and the opportunity to discuss this
important topic.
The Chairman. We look forward to the conversation that will
flow after that, and without any further ado, I would like to
recognize the Ranking Member for her opening remarks.
OPENING STATEMENT OF HON. YADIRA CARAVEO, A REPRESENTATIVE IN
CONGRESS FROM COLORADO
Ms. Caraveo. Well thank you, Chairman Johnson, for working
together to convene this timely and important hearing.
After examining the challenging question of oversight of
digital assets, I am pleased that the Subcommittee is turning
to the matter of reauthorizing the agency we have chosen to
empower with such oversight, the Commodity Futures Trading
Commission.
For almost 50 years, the CFTC has been the cop on the beat
in protecting the integrity of our futures markets, and the
important price discovery and risk management functions they
serve. In 2010, in the wake of the financial crisis, Congress
empowered the agency to oversee the multi-trillion-dollar swaps
market, and ease the market's transition from an unregulated
environment into a more transparent and financially secure
market.
Through the years, our markets have shown themselves to be
remarkably resilient amongst global volatility from
international conflicts to extreme weather events, to the
COVID-19 pandemic. However, this agency with such important
responsibilities has not been reauthorized for more than 2
decades. For today's hearing, we will hear from a distinguished
panel of stakeholders about the importance of the CFTC and the
markets it oversees, and what Congress should consider when
reauthorizing the agency.
Thank you, witnesses, for being here this early morning to
share your testimony. I look forward to hearing from all of
you. As Ranking Member of the Subcommittee, I am particularly
interested in how we maintain strong customer protections in
our financial markets while we pursue reauthorization,
especially for the retail investor. While our nation's
financial markets are vibrant, innovative, and amongst the
strongest in the world, they will only remain that way if the
users of these markets have confidence in the customer
protections in place and these agencies, like the CFTC, that
enforce those protections.
Additionally, as we consider these discussions regarding an
agency whose oversight authority we are looking to expand to
the digital assets marketplace, we must make sure we are not
shortchanging the CFTC in our appropriations process. The
current agricultural appropriations proposal includes a cut of
$20 million to the agency's budget. Today, we will hear about
the importance of this agency, and I hope it will resonate that
such a cut will negatively impact the agency's ability to
police its derivative markets.
Again, I welcome our witnesses who are here today, and look
forward to listening to your testimony. And with that, Mr.
Chairman, I yield back.
The Chairman. Now we turn to the legend of Howard,
Pennsylvania, the Chairman of the full Committee, GT Thompson.
OPENING STATEMENT OF HON. GLENN THOMPSON, A REPRESENTATIVE IN
CONGRESS FROM PENNSYLVANIA
Mr. Thompson. Okay. Well, maybe I should just yield back at
this point. That is the nicest thing anybody has said about me
in a long time.
Good morning, everybody, and thank you to Chairman Johnson
and Ranking Member Caraveo for convening this Subcommittee
hearing. I would like to echo Chairman Johnson's sentiments and
extend my thanks to everyone for joining us today.
The U.S. derivatives markets are essential to our economy.
They allow businesses, both large and small, to manage the
risks associated with price fluctuations for their inputs and
outputs. Derivatives enable businesses to focus on their core
activities without being unduly concerned with ever-changing
commodity prices.
The CFTC--which, by the way, is celebrating its 50th
anniversary this year as an independent agency--serves a
critical function in regulating derivatives markets both
domestically and internationally. The Commission safeguards
market participants from fraud, manipulation, and abusive
practices while also promoting financial innovation and fair
competition.
Earlier this week, a bipartisan group of House Agriculture
Committee Members visited the CFTC's D.C. headquarters. We had
a terrific visit with the CFTC Chairman, the Commissioners, and
agency staff to gain a deeper understanding of how the
Commission operates, and the pressing issues that it faces.
The agency's authorization expired more than a decade ago,
making it crucial that we address reauthorization now. This
process is not merely a bureaucratic formality; it is a
reaffirmation of our commitment to robust regulatory oversight.
It ensures that CFTC has the necessary tools and resources to
adapt to the evolving financial landscape.
With technological advancements, like artificial
intelligence, and the rise of new financial products, like
digital assets, the CFTC's role is more critical than ever.
Further, reauthorization of the CFTC reinforces the global
leadership of the United States in financial regulation. It
sends a strong message that we are committed to maintaining
high standards in our markets, protecting investors, and
fostering innovation. That is why Ranking Member Scott and I
have both publicly called for the CFTC to be reauthorized this
Congress.
I look forward to hearing our witnesses's testimony, and
remain committed to working towards a successful, bipartisan
CFTC reauthorization. Together, we can ensure the CFTC remains
a cornerstone of integrity and stability in our financial
system.
With that, I thank you and I yield back.
The Chairman. The chair would request that other Members
submit their opening statements for the record so the witnesses
may begin their testimony and to ensure there is ample time for
questions. Ms. Caraveo and I will be running this hearing
together, and with that in mind, she will introduce our
witnesses.
Ms. Caraveo. Thank you, Mr. Chairman.
Our first witness today is Mr. Walter Lukken, who is the
President and Chief Executive Officer of the Futures Industry
Association.
Our next witness is Thomas Sexton, the President and Chief
Executive Officer of the National Futures Association.
Our third witness will be Mr. Travis Antonsen, who is
Senior Vice President for Grain Marketing and Logistics for the
Agtegra Cooperative, and our fourth and final witness today is
Ms. Alexandra Thornton, who is the Senior Director for
Financial Regulation at the Center for American Progress.
Thank you all so much for joining us.
The Chairman. Impressive witnesses. You all get situated.
You got 5 minutes. The timer in front of you will count down,
and when you get to red, you will get gaveled down by either
Ms. Caraveo or myself.
With that, Mr. Lukken, please begin when you are ready.
STATEMENT OF HON. WALTER L. LUKKEN, J.D., PRESIDENT AND CHIEF
EXECUTIVE OFFICER, FUTURES INDUSTRY
ASSOCIATION, WASHINGTON, D.C.
Mr. Lukken. Chairman Johnson, Ranking Member Caraveo, and
Members of the Committee, thank you for allowing me to come
today and testify on reauthorization.
Mr. Chairman, I disagree. I believe derivatives regulation
is sexy. At least, I have been trying to convince my family of
that for many years. So, hopefully by the end of my testimony,
I will have you on my side.
I am the President and CEO of FIA, which represents
futures, options, and centrally cleared derivatives markets
globally.
FIA strongly supports the reauthorization of this important
agency. As former acting Chairman of the CFTC, I believe
reauthorization serves as an exercise in good government and
provides a Congressional stamp of approval of the CFTC's
important mission. Today, I want to highlight some of the
trends that are happening in our markets that will benefit from
your deliberations on reauthorization.
First, our markets have grown significantly. Total trading
volume on CFTC-regulated exchanges in the U.S. has doubled
since 2008, the last time that this Committee reauthorized the
CFTC.
Second, post-crisis reforms have brought more derivatives
products under the CFTC's regulation, while at the same time,
making the derivatives markets safer and our financial system
safer.
Third, our markets have demonstrated tremendous resilience
and strength in the face of recent volatility. Our markets have
remained stable and working throughout recent stress events,
including COVID-19, the war in Ukraine, the Silicon Valley bank
failure, and even high inflation.
One reason for this resilience is the CFTC's principles-
based regulatory regime enacted by this very Committee. This
regulatory framework has enabled flexible oversight tools for
the CFTC to keep pace with evolving trends and technological
advancements. Now, this adaptability has reduced the need for
wholesale changes of the CFTC's statutory authority over time.
That said, while the CFTC has this flexibility that has proven
effective, the need for this Committee's oversight remains as
important as ever.
There are certain trends for this Committee's oversight
that are worth noting today. For example, as the American
public becomes more accepting of new products, like
cryptocurrencies, digital asset platforms bring novel market
structures into the traditional futures industry. Increasingly,
we are seeing more exchanges, clearinghouses, clearing brokers,
and trading firms under one legal entity. FIA has serious
concerns that collapsing the existing, multi-tiered ecosystem
with its independent checks and balances could undo valuable
customer protections of the listed derivatives markets. FIA
welcomes Chairman Behnam's comments that the agency plans to
propose a new rule to address these potential conflicts.
A second topic worth noting is the pending U.S. bank
capital proposals that would dramatically increase the amount
of capital held by U.S. banks for client clearing, those folks
that access customers in our markets. Without changes to the
proposals, the costs of hedging in our markets will likely
increase for all end-users, including production agriculture.
Our industry appreciates this Committee's leadership in voicing
concerns about the impact of these rules.
The last item is the SEC's treasury clearing mandate taking
effect over the next 2 years. The cleared derivatives markets
are heavy users of treasury securities and the repo markets in
the funding, margining, and collateralization of futures
trades. This Committee will play a critical role in ensuring
that there are no impediments to customers accessing these
markets or overlapping jurisdictional issues between the CFTC
and SEC with these mandates.
Now, turning to reauthorization, FIA believes the existing
CFTC regulatory framework has served as a source of strength
for our markets. I believe an appropriate approach would be a
simple and straightforward reauthorization bill, one that
provides the Congressional stamp of approval of this agency's
important mission, and legal authority.
That said, there are three minor adjustments to the Act I
would raise for your consideration.
First, FIA joins the NFA in supporting a non-controversial
legislative fix to resolve legal uncertainty around FCM
bankruptcies and the definition of customer property.
Second, FIA supports expanding the way the CFTC might
leverage funding for educating farmers about our markets,
including the risks and opportunities of derivatives.
And finally, FIA supports legislative efforts to provide
flexibility for research and development capabilities of the
CFTC in partnering with private-sector, such as those led by
Representative Austin Scott. Thank you, Congressman.
Thank you all for allowing me to testify on CFTC
reauthorization, and I look forward to your questions.
[The prepared statement of Mr. Lukken follows:]
Prepared Statement of Hon. Walter L. Lukken, J.D., President and Chief
Executive Officer, Futures Industry Association, Washington, D.C.
Chairman Dusty Johnson, Ranking Member Yadira Caraveo, and Members
of the Committee, thank you for the opportunity to testify about the
reauthorization of the Commodity Futures Trading Commission (CFTC), and
the state of derivative markets.
I am the President and Chief Executive Officer of FIA. FIA is the
leading global trade organization for the futures, options and
centrally cleared derivatives markets. FIA's membership includes
clearing firms, known in the U.S. as futures commission merchants
(FCMs), exchanges, clearinghouses, trading firms and commodities
specialists from more than 48 countries. FIA's mission is to support
open, transparent and competitive markets, protect and enhance the
integrity of the financial system, and promote high standards of
professional conduct.
Prior to FIA, I served as a CFTC Commissioner for 7 years and as
the agency's Acting Chair for 18 months during the financial crisis and
the last reauthorization of the CFTC during the 2008 Farm Bill.
I commend the Committee for continuing your important oversight
function over the CFTC and applaud you for holding this hearing to
consider the reauthorization of the CFTC. FIA strongly supports the
reauthorization of this important agency. Reauthorization is an
exercise in good government and provides a Congressional stamp of
approval on the CFTC's important mission and legal authority. It also
provides the agency, and market participants, with greater certainty
about the agency's direction and priorities.
Today, I am honored to provide my counsel to this Committee once
again as you deliberate CFTC reauthorization and changes to the
Commodity Exchange Act (CEA).
The State of Our Markets
Our Markets Are Growing
In the decade and a half since the last reauthorization in 2008,
the futures and options markets have grown significantly. Total trading
volume on CFTC-regulated exchanges in the U.S. has nearly doubled from
3.4 billion futures and options contracts in 2008 to 6.6 billion in
2023. In fact, more contracts were traded on CFTC-registered exchanges
in the first 6 months of this year than in all of 2008.
Trading volume on CFTC-regulated exchanges in the U.S. has doubled
since 2008
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
Open interest is another important metric for these markets because
it is a general proxy for commercial hedging among participants. At the
end of the second quarter of this year, open interest stands at more
than 162 million futures and options contracts at the clearinghouses
regulated by the CFTC, compared to 97 million at the same point of time
in 2008. Strong open interest is a sign of a healthy market, so these
trends are worth noting.
Open interest, which measures the risk transfer function of futures and
options markets, is up over 67% since 2008
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
Our Markets Are Safer
After the 2008 financial crisis, regulators around the world
recognized the need to move more over-the-counter derivatives into
central clearing. They understood that central clearing is one of the
most effective ways to make the financial system more stable and
resilient. After Congress passed the Dodd-Frank Act in 2010, the CFTC
implemented a new set of clearing requirements for standardized over-
the-counter (OTC) interest rate and credit default swap instruments.
Today, roughly 85% of the dollar denominated interest rate swap (IRS)
market and roughly 60% of the credit default swap (CDS) market are
cleared by central counterparties subject to CFTC oversight. That means
all of those swaps are now risk-managed by FCMs and central
counterparties, similar to the way futures markets have operated for
decades.
Illustration of the Role Played by Counterparties
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As required by Dodd-Frank, a majority of the U.S. OTC swaps has
migrated to central clearing. Asset managers and other customers
holding OTC swaps have deposited more than $150 billion in
collateral to cover the risks of these positions.
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
Our Markets Are Resilient
Several factors have introduced incredible volatility to global
commodity markets in recent years, including the onset of COVID-19, the
war in Ukraine, macroeconomic pressures including supply disruptions
and inflation, and the global transition to a low-carbon economy.
Effective operation through these powerful, real-world stress tests has
demonstrated the resilience of our industry. Market participants have
sought access to our markets to manage risk in a safe and regulated
environment because of these pressures.
This Committee deserves a lot of credit for the strength of our
markets. As noted above, the clearing mandates that were written into
law by this Committee following the 2008 financial crisis have expanded
the important role of FCMs and CCPs in reducing systemic risk in our
markets. By working in partnership with the National Futures
Association (NFA), the CFTC, and the broader industry over the last
several decades, the cleared derivatives markets have remained robust
and resilient despite the extreme market volatility and record trading
volumes. And, importantly, end-users in the real economy never lost
their ability to access these markets to manage risk and discover
prices.
Our Markets Are Global
Just as producers need access to global markets to sell their
physical commodities, they too need access to global derivatives
markets to hedge risk in times of uncertainty. Knowing they can rely on
well-regulated futures and options markets provides American farmers
the protection from price volatility they need to compete in the global
markets for corn, wheat and soybeans. The reverse is also true:
companies all over the world use the agricultural and energy contracts
listed on U.S. futures markets as the benchmarks for global trade in
these commodities. That brings additional liquidity to these markets,
and that is a win-win for both agricultural producers and consumers
here in the U.S.\1\
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\1\ In 2021 FIA took an in-depth look at cross-border flows and we
determined that roughly 25% of the trading in CME's equity index
futures and options came from outside the U.S. The ratio was 26% in
energy, 30% in agriculture, and 45% in metals. The same held true for
ICE Futures U.S. Approximately 34% of the volume in its agricultural
contracts originated from outside the U.S.
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Dating back to my time as a CFTC Commissioner and Acting Chair, and
even prior, the derivatives markets have been global. Execution,
clearing and settlement often take place in different countries and
across different time zones and continents. And, since the last
reauthorization, our markets have become even more global in nature.
Market participants benefit from the global nature of our markets. The
more participants, the stronger the market for those seeking to hedge
risks.
FIA appreciates that Members of this Committee, including Ranking
Member David Scott and Representative Austin Scott, among others, have
worked over the years to engage policymakers in other jurisdictions to
ensure a level playing field, reduce market fragmentation and improve
collaboration between the CFTC and its international counterparts.
Our Markets Are Innovative
One of the most noteworthy provisions in the Commodity Exchange Act
mandates the CFTC to promote fair competition and responsible
innovation. There are very few other parts of the Federal Government
with such an explicit mandate. I think this has benefited the CFTC
throughout its history and something to keep in mind as you consider
reauthorization.
The U.S. derivatives markets are nimble, allowing growth and
innovation. This is evidenced by the pace of new and novel contracts
being listed on our markets today. There are futures contracts based on
battery metals such as lithium and cobalt--crucial components for the
electric vehicle industry. There are futures on Bitcoin and ether, the
two most heavily traded crypto currencies. There are the so-called
``ultra'' Treasury bond and note futures, which have given asset
managers and other institutional investors more ways to hedge their
interest rate risks.
Another example is the expanded range of crude oil futures. In
2008, the U.S. was a net importer of crude oil. Today we are a net
exporter, thanks to gains in the productivity of the U.S. oil industry.
The futures industry has responded by developing new futures contracts
based on prices at the export terminals along the Gulf Coast. Those
contracts are expressly designed to help companies hedge price risks on
international flows of oil.
The biofuels market offers another example. According to the U.S.
Department of Agriculture (USDA), approximately 20% to 25% of all
soybean oil produced in the U.S. is sold to refineries and converted
into renewable diesel. Companies throughout the supply chain use the
well-established futures based on soybean oil and heating oil to hedge
the risks in this new and rapidly growing alternative to fossil fuels.
These are just a few examples of the agility, market responsiveness
and innovative spirit that has long characterized the U.S. futures
industry and will continue to characterize the industry for years to
come.
Priorities for Committee Oversight of CFTC
This Committee plays a crucial role in the oversight of the CFTC as
novel and emerging trends present themselves. As the agency's
authorizing body, this Committee can provide guidance and Congressional
intent to the agency's rulemaking authority as it considers these
evolving trends. I want to highlight some of the topics worthy of your
attention.
Evolving Market Structures
Historically, the regulation of the futures markets, as directed by
the Commodity Exchange Act, has been by functional registration
category. The statute, and its implementing regulations, require market
participants who take on certain responsibilities to register in
various categories.
Exchanges that bring together buyers and sellers and self-regulate
their markets are required to register as designated contract markets
(DCMs). Clearinghouses, with their obligations to protect the financial
integrity of the system, are required to register as designated
clearing organizations (DCOs). Clearing members, those firms that
guarantee and safeguard customer funds and serve as their agents, are
required to register as futures commission merchants (FCMs).
Given these targeted responsibilities, these registrants have
historically been housed in independent legal entities. Increasingly,
however, we are seeing more exchanges and clearinghouses that are
embedding an FCM within their legal structure.
CFTC Chairman Rostin Behnam has recognized this trend and has
indicated his desire to address this issue by rulemaking this fall. He
testified before this Committee in March,\2\ highlighting that ``we are
seeing a shift to structures, driven by technology, that combine or
compress what have historically been unique and separate activities
into a single or fewer entities. This compression raises many important
questions including those regarding conflicts of interest within
vertically integrated structures.''
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\2\ https://agriculture.house.gov/calendar/
eventsingle.aspx?EventID=7732.
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FIA has a long history of supporting innovation in the derivatives
industry. FIA also strongly believes in the fundamental regulatory
principle: same business, same risks, same rules.
In our May 2022 comment letter \3\ about the FTX U.S. Derivatives
application before the CFTC, which sought to combine several market
functions into a single entity, we identified fundamental principles of
the derivatives regulatory oversight structure that they could not
adequately address. These include principles of segregation of customer
funds, conflicts of interest of those entrusted with market operations
and customer funds, financial resourcing and capitalization of market
operators, appropriately planned and sized default resources, and
safeguards of key market operations.
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\3\ https://www.fia.org/sites/default/files/2022-05/
FIA%20FTX%20Request%20for%20A-
mended%20DCO%20Registration%20Order%205.11.22.pdf
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FIA has strong concerns that collapsing the existing multi-tiered
ecosystem--with its inherent checks and balances and customer
protections--could undo the strong foundation of the listed derivatives
markets and, ultimately, put customers at risk. We want to make sure
end-users, including those in the agricultural and energy sectors, will
continue to have the same protections as customers are guaranteed
today.
FIA welcomes Chair Behnam's desire to establish a strong regulatory
regime to cover conflicts originating from affiliated entities serving
multiple functions within these vertically integrated structures.
Emerging Technology and Artificial Intelligence (AI)
The Commission's principles-based regulatory framework and flexible
approach to regulation has a proven track record when it comes to
protecting customers, promoting innovation and preserving market
integrity. Regulators and policymakers are rightfully exploring
potential uses and risks of emerging technology, such as AI in the
derivatives markets that the CFTC regulates and beyond.
In January 2024, the CFTC Divisions of Market Oversight, Clearing
and Risk, Market Participants, and Data and the Office of Technology
Innovation issued a request for comment (RFC) to better inform them
about AI.
FIA believes \4\ the existing statute and CFTC rules and guidance
provide the controls and oversight needed for the Commission to promote
and protect the integrity and resilience of our markets. FIA urges the
CFTC to take a ``technology-neutral'' approach and focus on achieving
regulatory outcomes, rather than attempting to regulate the technology
itself, moving forward.
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\4\ https://www.fia.org/sites/default/files/2024-04/FIA-FIA%20PTG-
CME-ICE%20Response
%20to%20CFTC%20AI%20RFC%204.24.pdf.
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U.S. Bank Capital Proposals
On July 27, 2023, the Board of Governors of the Federal Reserve
System (Federal Reserve), the Office of the Comptroller of the
Currency, and the Federal Deposit Insurance Corporation--together, the
U.S. bank regulators--proposed the Basel III endgame capital framework
and, separately, the Federal Reserve requested comment on a proposal
that would make significant adjustments to the calculation of the
global systemically important bank holding companies surcharge. These
proposed rules \5\ represent a comprehensive rewrite of the regulatory
capital standards for the biggest U.S. banks.
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\5\ https://www.federalreserve.gov/newsevents/pressreleases/
bcreg20230727a.htm.
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While outside the jurisdiction of the CFTC, these rules will harm
the CFTC-regulated derivatives markets and the end-users that rely on
them. FIA contributed to a report and a set of recommendations \6\
adopted by the CFTC Global Markets Advisory Committee (GMAC) at a
recent June 2024 meeting.
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\6\ https://www.cftc.gov/PressRoom/PressReleases/8918-24.
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The report highlights excerpts from the formal comment letters
filed by the users of derivatives markets noting concerns about the
proposals, including agriculture, energy, insurance, pension funds and
others.
We also commend CFTC Chairman Rostin Behnam for his comments in
public testimony before this Committee in March 2024, emphasizing the
need to ``create incentives'' for clearing and committing to working
with his prudential regulators to ensure new bank capital rules are not
``creating unnecessary barriers to clearing and clearing services for
end-users.''
Treasury Clearing
In December 2023, the Securities Exchange Commission (SEC) adopted
final rules that will require most market participants to clear U.S.
Treasury (UST) repo and cash security transactions in the secondary
market. While these transactions are not futures contracts, our
industry and its participants utilize treasury securities and repo
contracts every day in the collateralization, settlement and cash
management of futures positions. Our industry is also exploring whether
it can take a more direct role in the clearing of these products given
the similarities to the futures and swaps markets.
The SEC's clearing mandate may seem familiar to Committee Members
who were involved in the Dodd-Frank Act that mandated the clearing of
OTC derivatives after the financial crisis. Both efforts aimed to move
these bilateral, trillion-dollar markets to a client, all-to-all
cleared market. In other words, the futures market model. That our
markets act as the model for reform demonstrates the importance of our
efficient, transparent business practices as an industry.
The incumbent, DTCC's FICC, has made the most progress to date,
having filed several rules with the SEC to build the framework for its
clearing model with more rules to come in the fall. CME and ICE also
have publicly announced an interest in providing cash treasury
clearing.
FIA finds this competition healthy because it will sharpen the
discussions with the end-users in mind. We believe we have the
expertise and experience to offer in how ``done away'' client clearing
models will work, given their similarity to the agency give-up clearing
model of the futures markets.
There are challenges ahead that may require this Committee's
attention. The CFTC and SEC will need to work together to ensure that
the Treasury clearing mandate does not conflict with CFTC regulations.
Both agencies are working collaboratively to address these concerns.
The second issue is the timeline. Several workstreams need to be
addressed before the first deadlines come into place, including
capital, accounting, cross-margining, risk and credit controls and
netting. Implementing this mandate before June 2026 will be a heavy
lift, especially considering the importance of the Treasury and repo
markets to the funding of the government and financial markets.
Regulators will need to be flexible and aligned with industry to ensure
realistic timetables.
Our industry will keep this Committee abreast as this critical
rulemaking is implemented.
FIA Views on CFTC Reauthorization
Overall
As noted earlier in my testimony, our markets have demonstrated
incredible resilience given the onset of COVID-19, the war in Ukraine,
weather and energy disruptions in the U.S. and abroad, and the
commodity market volatility associated with these events. Throughout
all these events, the U.S. regulatory framework has proved itself as a
source of strength for our markets, and the global clearing system has
worked as intended, minimizing the counterparty risk that we witnessed
during the crisis of 2008.
As a result, FIA does not believe a broad CFTC reauthorization bill
is needed now. Rather, a bill that provides a Congressional stamp of
approval on this agency's important mission and legal authority, and
that acknowledges the CFTC's proven track record through a period where
we have seen record market volatility, is the best approach.
Customer Protection
FIA joins the NFA in supporting legislative clarification to
resolve legal uncertainty in FCM bankruptcies as to the definition of
``customer property'' created by a bankruptcy court decision in the
Griffin Trading case. The sanctity of segregated customer funds remains
an important tenet of the CFTC's customer protection regime and FIA
stands ready to assist the Committee on this clarification.
Expanding Access to Educational Resources for Small- and Mid-Size
Farmers
Today's farmers and ranchers are incredibly savvy businesspeople.
They want to offset their risk where possible. But they have a lot on
their plates. And that's before the food reaches our plates.
FIA supports efforts to expand educational resources about the
opportunities and risks of risk management tools like futures and other
cleared derivatives. It would go a long way to helping the 2% that feed
the 98%--particularly for the small- and mid-size farmers, producers
and end-users.
During a March 2023 full Committee hearing titled ``Rising Risks:
Managing Volatility in Global Commodity Derivatives Markets,'' FIA's
board chair, Alicia Crighton, received a question from Representative
Jasmine Crockett about a USDA report from October 2020 that raised
concerns about a low percentage of farmers using futures or options to
hedge price risk.
FIA took interest in this report and encourages this Committee to
consider whether opportunities exist--perhaps through CFTC
reauthorization or another vehicle--to expand the manner in which the
CFTC might leverage funding through the CFTC Office of Customer
Education and Outreach (OCEO) to partner with not-for-profits, private
sector educational initiatives or other government entities, like the
USDA. Educational resources should be used to highlight both the
opportunities and the risks of risk management tools like futures and
options.
We believe this may address the concerns raised by Representative
Crockett and provide additional resources to farmers during a time when
they have experienced, and continue to experience, considerable
volatility in their markets.
Modernizing the CFTC
The last CFTC reauthorization was enacted the same year Apple
launched its App Store. The technological advancements by market
participants have been incredible since that time.
According to former Chairman of the CFTC Christopher Giancarlo,
``The CFTC lacks the legal authority to partner and collaborate with
outside entities engaging directly with fintech within a research and
testing environment, including when the CFTC receives something of
value absent a formal procurement.'' \7\
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\7\ https://www.cftc.gov/PressRoom/SpeechesTestimony/
opagiancarlo70.
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FIA supports efforts to improve the research and development
capabilities of the CFTC. This includes legislative efforts, such as
those led by Representative Austin Scott, that would provide the CFTC
transaction authority to engage in public-private partnerships with
financial technology developers. NASA, the Department of Defense, and
other Federal agencies already have this type of authority. This
authority would assist the CFTC so it can fully vet and test potential
rules and regulations on the technology being utilized by industry.
Conclusion
I am fortunate to represent a wide array of stakeholders in the
listed, cleared and regulated derivatives industry--all of whom want to
see this industry continue to support the price discovery and risk
management needs of their customers in a productive way. It is an honor
to be with you today and to work with this Committee as you craft a
reauthorization of the CFTC and explore reforms to the CEA that
strengthen our markets.
The Chairman. Very good, thank you.
Mr. Sexton, you are up.
STATEMENT OF THOMAS W. SEXTON III, J.D., PRESIDENT AND CHIEF
EXECUTIVE OFFICER, NATIONAL FUTURES
ASSOCIATION, CHICAGO, IL
Mr. Sexton. Good morning, Chairman Johnson, Ranking Member
Caraveo, and Members of the Subcommittee. Thank you for the
opportunity for National Futures Association to appear at this
hearing on the important topic of the CFTC's reauthorization. I
am the President and CEO of NFA.
NFA is a registered futures association under the Commodity
Exchange Act and the industry-wide independent self-regulatory
organization for the derivatives industry. Our overriding
objective is to partner with and help the CFTC regulate the
derivatives markets. Our main areas of responsibility are
described in my written testimony. The CFTC oversees each and
every aspect of NFA's regulatory authority.
Our coordination efforts with the CFTC over the years, in
part, have built a strong track record of protecting retail
customers and prosecuting retail trading abuses and fraud. At
this time, I want to thank Chair Behnam for his leadership at
the CFTC and thank him and the CFTC's other Commissioners for
their support of NFA and for their willingness to work with us
to resolve the industry's regulatory issues.
Reauthorization is always an important process for the
industry as a whole, and for NFA in particular. NFA firmly
believes that customer protection issues should be front and
center as Congress works to reauthorize the CFTC. Today, I
would like to cover one significant reauthorization topic,
strengthening FCM customer protections in bankruptcy.
The 2019 reauthorization bill voted out of the House
Agriculture Committee included a key customer protection
provision relating to FCM bankruptcies, which we continue to
strongly support and believe any future reauthorization bill
should address. Over 40 years ago, the CFTC adopted rules
regarding FCM bankruptcies. Among other things, those rules
provided that if there is a shortfall in customer segregated
funds, the term customer funds would include all assets of the
FCM until customers had been made whole.
Several years ago, a district court decision cast out the
validity of the CFTC's authority to adopt this rule. Although
that decision was subsequently vacated, a cloud of uncertainty
continues to remain over this rule's efficacy. Congress should
remove that doubt and ensure that customers have priority if
there is a shortfall in segregated funds. Congress can do so by
amending Section 20 of the Commodity Exchange Act, which gives
the CFTC authority to adopt regulations regarding commodity
brokers that are debtors under Chapter 7 of the United States
Bankruptcy Code to make clear that the CFTC has the authority
to adopt the rule that it did. We believe that there is broad
industry support for this approach.
Let me turn to digital asset commodities for just a few
minutes. In 1982, Congress and the CFTC gave NFA the authority
or responsibility to regulate firms engaging in exchange-traded
derivatives. We are appreciative that over the years, Congress
and the CFTC have entrusted us with additional regulatory
responsibilities over retail forex and swaps.
The Commission's responsibilities are enormous and we will
continue to help it in any way we can. The CFTC has led efforts
among financial regulators to protect customers by tackling
fraudulent schemes associated with retail digital asset
commodities activities. We applaud this Subcommittee and under
Chairman Thompson's leadership, the House Committee on
Agriculture's collaborative work with the House Financial
Services Committee to pass legislation governing spot digital
assets, including those that are commodities. As this
Subcommittee is aware, the FIT Act includes a significant role
for an RFA in regulating the digital asset commodity market.
I would like to take this opportunity to reaffirm NFA's
willingness to assist the CFTC to the extent requested in
developing an appropriate regulatory framework for the digital
asset commodity market, if Congress moves forward with
legislation in this area.
Our member firms have engaged in spot digital asset
commodity activities for over 5 years, and we have taken steps
to regulate these members' activities to ensure that
appropriate customer protections are in place. We are fully
capable of working with the CFTC to perform the
responsibilities of an RFA as outlined in the FIT Act (H.R.
4763, Financial Innovation and Technology for the 21st Century
Act), and will continue to take a pragmatic regulatory approach
with regard to this area.
Thank you again for the opportunity to appear before you
today to discuss CFTC reauthorization. I would be happy to
answer any questions at the appropriate time.
[The prepared statement of Mr. Sexton follows:]
Prepared Statement of Thomas W. Sexton III, J.D., President and Chief
Executive Officer, National Futures Association, Chicago, IL
Chairman Johnson, Ranking Member Caraveo, and Members of the
Subcommittee, thank you for the opportunity to testify at this hearing
on the important topic of the Commodity Futures Trading Commission's
(CFTC or Commission) reauthorization. My name is Thomas Sexton, and I
am the President and Chief Executive Officer of National Futures
Association (NFA), the industry-wide independent self-regulatory
organization (SRO) for the derivatives industry.
Before turning to my substantive remarks, please let me provide
some background information about NFA. NFA is a registered futures
association (RFA) pursuant to Section 17 of the Commodity Exchange Act
(CEA). Our global membership includes CFTC registered futures
commission merchants (FCMs), swap dealers (SDs), commodity pool
operators (CPOs), commodity trading advisors (CTAs), introducing
brokers (IBs), retail foreign exchange dealers (RFEDs) and associated
persons of these entities. The CFTC requires these registered firms to
be NFA Members. We currently have approximately 2,900 NFA Member firms
and 38,000 individual Associate Members.
NFA is solely a regulatory body. We do not operate a market, and we
are not an industry trade association. Our overriding objective is to
partner with and help the CFTC regulate the derivatives markets and, in
doing so, we are a resolute customer protection organization. NFA's
responsibilities include registering all firms and industry
professionals on behalf of the CFTC, passing rules to ensure fair
dealing with customers and counterparties, monitoring Members for
compliance with those rules and taking enforcement actions against
those Members that violate our rules. Every aspect of our regulatory
authority is closely overseen by the CFTC.
As Congress expanded the CFTC's jurisdiction over the years beyond
exchange-traded derivatives to include the retail forex rolling spot
and swaps markets, Congress and the CFTC also entrusted NFA with
additional regulatory oversight responsibilities for these markets.\1\
NFA coordinates with the CFTC on a regular basis and worked very
closely with the CFTC to develop rules and regulatory programs to
effectively oversee these additional areas of regulatory jurisdiction.
In addition, the CFTC has delegated numerous responsibilities to NFA
including the industry's registration process and the review of CPO and
CTA disclosure documents, CPO annual financial filings and SD swap
valuation disputes. Our coordination efforts over the years have built
a strong track record of protecting retail customers and prosecuting
retail trading abuses and fraud. Today, customer complaints and single-
event customer arbitrations filed at NFA, as well as CFTC's reparations
cases, remain near all-time lows.
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\1\ Congress originally gave the CFTC anti-fraud jurisdiction over
the retail forex markets and expanded its jurisdiction to include
regulatory oversight in 2008. Congress gave the CFTC jurisdiction over
the swaps markets (except for security-based swaps) after the enactment
of the U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act
in 2010.
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The Commission's responsibilities are enormous, and we will
continue to help it in any way we can. At this time, I certainly want
to recognize Chair Behnam for his leadership at the CFTC and thank him
and the CFTC's other Commissioners for their support of NFA and self-
regulation and for their willingness to work with us to resolve the
industry's regulatory issues. Under Chair Behnam, the CFTC has led
efforts among financial regulators to protect customers by tackling
fraudulent schemes associated with retail digital asset commodities'
(DACs) activities. The CFTC's last formal reauthorization expired over
10 years ago. Since then, NFA, the CFTC and the derivatives industry
have established a comprehensive swap dealer regulatory oversight
program \2\ and navigated a worldwide pandemic. In doing so, we worked
collectively to protect customers and counterparties, market integrity
and confidence in the derivatives markets.
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\2\ Swap Dealers became registered with the CFTC in early 2013.
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CFTC Reauthorization
NFA has always recognized the importance of Congress reauthorizing
the CFTC and ensuring that the CFTC continues to have the tools it
needs to properly regulate the derivatives industry. As this
Subcommittee is aware, on May 22, 2024, the House of Representatives
passed the bipartisan Financial Innovation and Technology for the 21st
Century Act (FIT Act). This legislation calls upon the Commission to
regulate a new area once again--the DAC market. In the past, Congress
has used momentous changes to the CFTC's responsibilities to also
reauthorize it.\3\ In light of the CFTC's potential new
responsibilities in the DAC area, NFA strongly believes that now is an
appropriate time for Congress to reauthorize the CFTC.
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\3\ For example, the Commodity Futures Modernization Act of 2000
and Food, Conservation, and Energy Act of 2008 each made momentous
changes to the CFTC's regulatory oversight and/or jurisdiction and
reauthorized the CFTC.
---------------------------------------------------------------------------
Reauthorization is always an important process for the industry as
a whole and for NFA in particular. Today, I would like to cover one
significant reauthorization topic--strengthening FCM bankruptcy
customer protections. I would also like to take this time to reaffirm
NFA's willingness to assist the CFTC to the extent requested in
regulating the spot DAC market if Congress moves forward with
legislation in this area.
Strengthening Customer Protections in FCM Bankruptcy Proceedings
NFA firmly believes that customer protection issues should be front
and center as Congress works to reauthorize the CFTC. The 2019
reauthorization bill voted out of the House Agriculture Committee
included a key customer protection provision that clarifies the
Commission's authority to adopt rules that provide customers with
priority in the event of an FCM bankruptcy. NFA fully supports this
provision, and we believe there is broad-based industry support for
this approach. We urge this Subcommittee to include this key statutory
change in any future reauthorization bill.
Over 40 years ago, the CFTC adopted rules regarding FCM
bankruptcies. Importantly, those rules provide that in the event of a
shortfall in customer segregated funds, the term ``customer funds''
would include all assets of the FCM until customers are made whole.
Over 20 years ago, a United States district court bankruptcy decision
cast doubt on the validity of the CFTC's rule. Although that decision
was subsequently vacated after the parties in the matter settled, a
cloud of doubt continues to linger over the validity of the CFTC's
rule.
NFA strongly encourages Congress to remove that doubt and ensure
that customers have a priority in an FCM's bankruptcy if there is a
shortfall in segregated funds. In our view, this important customer
protection can be provided by amending Section 20 of the CEA, which
gives the CFTC authority to adopt regulations regarding commodity
brokers that are debtors under Chapter 7 of Title 11 of the United
States Code. We recommend that Congress amend Section 20 to clarify
that the CFTC has the authority to adopt the rule that it did.
NFA's Willingness to Assist the Commission in Regulating Digital Asset
Commodities
At the outset, we applaud this Subcommittee's and under Chairman
Thompson's leadership, the House Committee on Agriculture's
collaborative work with the House Financial Services Committee to pass
legislation governing spot digital assets, including those that are
commodities. As this Subcommittee is aware, the FIT Act includes a
significant role for an RFA in regulating the DAC market. Among other
provisions, the bill requires digital commodity brokers and digital
commodity dealers, as well as digital commodity exchanges that accept
customer funds, to be Members of an RFA. The bill also provides that
any person that files notice with the Commission of its intent to
register as a digital commodity broker, digital commodity dealer or
digital commodity exchange to be a member of an RFA and comply with the
RFA's rules. As a result, the RFA will be solely responsible for
oversight of these entities during the period between filing the notice
of intent to register and actually becoming CFTC registered.
NFA fully supports providing a role for an RFA to partner with the
Commission in developing an appropriate regulatory regime for the DAC
market. A cornerstone of effective self-regulation is mandatory
membership, and the provisions in the FIT Act that mandate membership
in an RFA are essential for ensuring that an RFA can act effectively,
and discipline and when appropriate bar Members that do not abide by
the RFA's rules. Without mandatory membership, registrants would be
able to relinquish their RFA membership if they did not want to follow
a rule or were being investigated or disciplined for failing to follow
a rule.\4\
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\4\ Effective government oversight is also essential to self-
regulation. As set forth in Section 17 of the CEA, this oversight
should cover all aspects of the SRO's regulatory activity. Today, while
we may partner with the CFTC to regulate our Members, the CFTC closely
reviews and monitors our activities to ensure that we fulfill our
regulatory responsibilities.
---------------------------------------------------------------------------
NFA looks forward to assisting the CFTC in regulating the DAC
market and is fully capable of performing the responsibilities of an
RFA as outlined in the FIT Act. The fact is our Member firms have been
engaging in spot DAC activities for over 5 years, and we have already
taken steps to regulate these Members' activities to ensure that
appropriate customer protections are in place. For example, in 2018, we
adopted DAC disclosure requirements for our Members because we wanted
to make sure that investors fully understood the nature of DACs and DAC
derivatives.
Last year, we extended our jurisdiction over Members' spot DAC
activities to ensure that NFA could take action if a Member firm
committed fraud or similar misconduct with respect to these activities.
Detecting and combating fraud is central to our mission. Therefore, our
current compliance rules impose anti-fraud, just and equitable
principles of trade and supervision requirements on NFA Members and
Associates engaged in spot DAC activities. Although we have not
observed any significant issues with our Members engaging in spot DAC
activities, we will continue to take a proactive regulatory approach
with regard to our Members' spot DAC activities.
In conclusion, thank you again for the opportunity to appear before
you today and highlight one important provision that NFA believes
should be included in any future CFTC reauthorization bill. We also
appreciate the opportunity to highlight NFA's willingness to assist the
Commission in regulating DACs. We firmly believe our successful
regulatory partnership with the CFTC is an effective structure for
regulating the derivatives markets and the rolling spot retail forex
and spot DAC markets. We look forward to working closely with this
Subcommittee to reauthorize the CFTC. I would be happy to answer any
questions.
Ms. Caraveo [presiding.] Thank you, and we will go to Mr.
Antonsen next.
STATEMENT OF TRAVIS ANTONSEN, SENIOR VICE PRESIDENT, GRAIN
MARKETING, AND RAIL LOGISTICS, AGTEGRA
COOPERATIVE, ABERDEEN, SD; ON BEHALF OF NATIONAL COUNCIL OF
FARMER COOPERATIVES
Mr. Antonsen. Good morning, Chairman Johnson, Ranking
Member Caraveo, and Members of the Subcommittee. Thank you for
holding this hearing as you work on reauthorization of the
Commodity Futures Trading Commission. I appreciate the
opportunity to discuss the role of derivatives markets that
CFTC oversees in helping farmers and agribusiness manage
commodity price risks.
I currently work for Agtegra, a cooperative owned by 6,700
farmers in the Dakotas. I am also actively engaged in my family
farming operation.
Currently, some of our agricultural markets are seeing
lower price levels driven by increased international crop
production. Mostly favorable weather this year is aiding in
crop development and futures contracts are currently pricing in
expectations for another large harvest. For example, the
futures price in the December 2024 corn contract topped out at
$6.02 a bushel in April of 2022. Yesterday, that price closed
at $4.18, so significant volatility in cash prices.
Thus far, it appears producers who previously forwarded
price contracts will likely receive higher prices. Our
cooperative is active in offering those pricing tools that
allow our members to manage their price risk well in advance of
harvesting, or even planting that crop.
To manage such large commodity price risks and movements,
we rely on highly functioning derivative markets. For example,
Agtegra uses exchange rated futures and options, OTC
derivatives, over-the-counter contracts to hedge our price risk
for us to protect our grain and storage, manage our future
sales, and offset energy and fertilizer risk. We also do this
for forward contracting options to our member owners. In the
process of buying grain from the farm to selling it to the end-
user exporter, that bushel of grain may have had to trade
futures four or five times by the time the grain reaches its
final destination. The CFTC ensures integrity of those markets.
As the Agriculture Committee has looked to reauthorize the
CFTC in the past, we have supported those efforts.
Reauthorizing CFTC is how this Committee acknowledges the
importance of the agency's critical functions.
While the CFTC's mission has expanded in recent years, we
rely on the CFTC to ensure the soundness of our commodity
markets. It is essential for the agriculture industry to have
well-functioning, commodity derivative markets, and the CFTC
performs the essential role of helping to safeguard those
markets.
While the Commission's responsibilities have expanded,
funding has been flat. While not in the scope of this
Committee, we encourage Congress to provide sufficient funding
for CFTC's important functions. However, we caution against the
imposition of any user fees on the industry to fund CFTC.
Agriculture is a high-volume global margin industry.
Incremental costs, whether passed on or imposed directly on the
participants, eventually trickle down to the end-users and
farmers. Grain represented by underlying futures contracts can
be traded multiple times, as I noted before. If there is a user
fee, then that selling price received by the producer would go
down by the amount of the fee each time the underlying futures
contract is traded. We fear a further increase in costs would
have the unintended consequences of discouraging prudent
hedging practices. To be clear, a user fee would increase risks
being absorbed by agriculture.
Additionally, we caution Congress from setting up a
situation where the CFTC would see its budget directly impacted
by the volume of trading in the products it is tasked with
regulating.
I outline several concerns we have with the Basel III
Endgame proposals in my written testimony. We appreciate
Congress's engagement on this issue, and are hopeful that those
capital requirements will be re-proposed.
Thank you again for this opportunity to testify today
before the Committee. We appreciate your role in ensuring the
industry will continue to be able to effectively hedge
commercial risk in supporting the viability of our farmers. I
look forward to answering any questions that you may have.
Thank you.
[The prepared statement of Mr. Antonsen follows:]
Prepared Statement of Travis Antonsen, Senior Vice President, Grain
Marketing, and Rail Logistics, Agtegra Cooperative, Aberdeen, SD; on
Behalf of National Council of Farmer Cooperatives
Chairman Johnson, Ranking Member Caraveo, and Members of the
Subcommittee, thank you for the invitation to testify today with
respect to the reauthorization of the Commodity Futures Trading
Commission (CFTC) and, in particular, the importance of the agriculture
industry's ability to use and offer risk management tools.
I am Travis Antonsen, Senior Vice President of Grain Marketing and
Rail Logistics of Agtegra Cooperative. Agtegra Cooperative is a local
farmer-owned agricultural cooperative headquartered in Aberdeen, South
Dakota. It is owned by over 6,700 farmers and ranchers, predominantly
in North and South Dakota, with a network of over 70 locations and 900
employees. With four main divisions, we buy grain from our farmer-
members and provide farmers and ranchers with grain, agronomy, energy
and feed products and services. In addition, I was born and raised on a
family farm in South Dakota where I continue to farm with my family. We
grow corn and soybeans and raise livestock.
Today, I am testifying on behalf of Agtegra Cooperative and the
National Council of Farmer Cooperatives (NCFC). NCFC represents roughly
1,700 farmer-owned cooperatives across the country whose members
include a majority of our nation's more than two million farmers.
Agtegra Cooperative is an NCFC member, and also a member of the
National Grain and Feed Association (NGFA). I currently serve on the
NGFA Risk Management Committee and have previously served on the NGFA
Country Elevator Committee and Board of Directors.
Farmer cooperatives--businesses owned, governed and controlled by
farmers and ranchers--are an important part of the success of American
agriculture. Through their cooperatives, producers are able to improve
their income from the marketplace, manage risk, and strengthen their
bargaining power, allowing them to compete globally in a way that would
be impossible to do individually.
Commodity price risk management tools are essential to help
mitigate commercial risk in the production, processing and selling of a
broad range of agricultural, energy and food products. America's
farmers and ranchers must continue to have access to new and relevant
risk management products that enable them to feed, clothe and provide
fuel to consumers here at home and around the world. Mostly favorable
weather this year appears to be aiding crop development and futures
contracts are pricing in expectations for large crops. Thus far it
appears producers who previously forward priced crops, which is made
possible by derivatives, will likely receive higher prices for their
crop. Not everyone forward prices crops, but having the pricing tools
available as part of a multi-layered risk management strategy is
important for agriculture.
Use of Derivative Markets
As processors and handlers of commodities and suppliers of farm
inputs, agriculture firms are commercial end-users of the futures
exchanges, as well as the over-the-counter (OTC) derivatives markets.
They use exchange-traded futures and options and OTC derivatives to
hedge the price risk of commodities they purchase, supply, process or
handle.
For example, Agtegra uses exchange-traded futures and options and
OTC derivatives to hedge the price risk for the cooperative to protect
grain in storage, manage future sales, and to offer forward contracting
options to our member-owners. In the process of buying grain from the
farm to selling it to the end-user or exporter, that bushel of grain
may have had to trade futures four or five times by the time the grain
reaches its final destination. The cooperative is also active in
offering pricing tools that allow its members to manage their price
risk well in advance of harvesting or even planting a crop.
While not used to the extent as exchange-traded contracts, the
swaps markets also play a vital role in the ability of cooperatives to
hedge in the various commodity markets, in both the agricultural and
energy markets. Swaps are especially important in times of extreme
price volatility that puts stress on the industry--and allows working
capital to be freed up so cooperatives can continue to offer forward
pricing options for farmers to manage their own production risk.
In addition, swaps serve as important tools in agriculture markets
that may not have sufficient trading volume on the futures exchanges,
as well in being able to customize hedges to address situations that
may not match up well to conventional futures contract specifications.
To access the OTC market, cooperatives use a variety of commercial
counterparties as well as registered swap dealers, including large
banking entities.
Currently some of our agricultural markets are in a period of lower
price levels driven by increasing international crop production. For
example, the futures price on the December 2024 corn futures contract
peaked at $6.02/bushel on April 25, 2022 and as of the close on July
19, 2024 is down to $4.05/bushel. To manage such large commodity price
risks and movements, cooperatives rely on highly functioning
derivatives markets.
As a producer, the ability to customize risk management tools
through OTC derivative contracts has been an invaluable tool for my
operation by giving me the confidence to price grain well before it is
planted. The ability to set a price floor and participate in future
market rallies over a timeframe that I get to choose has been a game
changer to our farm's risk management plan.
CFTC Reauthorization
As the Agriculture Committee has previously looked to reauthorize
the CFTC on a number of occasions since authorization expired in 2013,
NCFC has supported the Committee's efforts.
Reauthoring CFTC is the way in which this Committee acknowledges
the importance of the agency's critical functions. Continued delay
unnecessarily withholds that vote of confidence. While the current
trend is to focus on new shiny objects such as cryptocurrency, we
continue to rely on the CFTC to ensure the soundness of the bedrock of
our commodity markets. As outlined above, it is essential for the
agriculture industry to have sound, well-functioning commodity
derivatives markets, and appreciate that the Agriculture Committee
continues to provide that oversight. The CFTC performs the essential
role of helping to safeguard U.S. futures, options and swaps markets
that our industry relies on for critical risk management and price
discovery functions. For the U.S. agricultural and energy contracts
that are utilized extensively by our members to manage their market and
business risks, this regulatory oversight is crucial.
Throughout Dodd-Frank implementation, now a decade ago, NCFC has
advocated that the agriculture industry does not fit in a one-size-
fits-all regulatory regime meant for Wall Street. As such, we continue
to encourage you to help ensure that regulatory burdens don't impede
the ability of farmers, their cooperatives and others involved in the
agriculture industry to have access to the risk management tools they
need. Reauthorizing CFTC would reassert this Committee's oversight of
this role.
Costs to End-Users
The CFTC performs the critically important role of helping
safeguard U.S. futures and swaps markets, which benefits all Americans
with more stable prices and a sound financial system. And while the
Commission's responsibilities have continued to expand dramatically,
adequate funding has remained stagnant. While outside the jurisdiction
of this Committee, we encourage Congress to provide sufficient funding
through appropriations for CFTC to perform its important functions.
Without sufficient resources to staff the Commission and invest in
these areas, the CFTC's ability to perform these important functions,
as well as ensuring the integrity of the more traditional commodity
markets our members rely on for risk management purposes, will be
diminished.
However, aggregate regulatory costs and market liquidity are an
ongoing concern for farmers and their cooperatives. Agriculture is a
high-volume, low-margin industry, and incremental increases in costs
trickle down and impact farmers. Taken incrementally, the costs may not
seem unreasonable, but those costs are evident to those who have to
absorb or pass them on to the farmer. Even as end-users, significant
resources must be used just to comply with the additional paperwork
requirements called for under Dodd-Frank. In fact, a number of NCFC
members have had to greatly increase spending on compliance staff and
technology due to additional regulations.
Therefore, we would like to caution the Committee against
imposition of any type of user fee on the industry to fund the CFTC. We
fear a further increase in cost structure due to higher transaction
costs would discourage prudent hedging practices. While the President's
2025 budget request calls for user fees: ``CFTC fees would be designed
in a way that supports market access, liquidity, and the efficiency of
the nation's derivatives markets,'' it does not indicate how that would
be achievable. We believe the opposite to be true.
There are many users of futures contracts in the agricultural
supply chains. In grain alone, there are producers, agricultural
cooperatives, country elevators, processors, exporters and poultry and
livestock feeders who use futures contracts to reduce price risk. Grain
represented by underlying futures contracts can be traded multiple
times. If there was a user fee associated with a trade, the likely
result is the net selling price received by the producer would go down
by the amount of the fee each time the underlying futures contract is
traded.
In addition to lower farm gate prices farmers would receive, a user
fee would result in an increase in risk being absorbed in the
agriculture community in general, and would likely reduce the desire
for participants, such as agricultural producers, to hedge their price
risk.
Basel III End Game
Throughout the Dodd-Frank Act implementation process, NCFC
advocated for rules that would allow for continued access to a robust
and diverse set of hedging options, contracts and counterparties.
Therefore, NCFC echoes the concerns of the proposals (Federal Reserve,
Federal Deposit Insurance Corporation, The Office of the Comptroller of
the Currency) raised by other end-users that use derivatives to hedge
their commercial risks. While the goal of ensuring and improving
financial system integrity is strongly supported by our members, we are
concerned our industry would be subject to unintended consequences of
what has been proposed.
We appreciate CFTC's engagement with the Prudential Regulators on
this issue and are optimistic to hear that those agencies recently
signaled their willingness to take another look at those proposals. If
they were to go forward in their current form, potential impacts
include:
(A) increased end-users' costs of hedging;
(B) fewer banking organizations acting as futures commission
merchants (FCMs) to the agriculture industry and as swap
dealers in commodity OTC derivative contracts, thereby
reducing end-users' risk management options; and
(C) less liquid and more volatile markets.
The impact of increased capital costs for derivative contracts as a
result of proposals may create a disincentive for banking organizations
to continue to offer designated contract market (DCM) clearing services
through their FCMs, or act as market-makers in OTC commodity derivative
contracts, which would result in less liquidity in commodity derivative
markets, and fewer options for end-users.
Unnecessarily high capital requirements that do not match the
associated risk also will create a barrier to entry for certain market
participants, such as farmer-owned cooperatives and private companies.
Farmer cooperatives are businesses owned, governed, and controlled by
farmers and ranchers. Thus, we are particularly troubled by the
determination of ``Investment Grade'' for Unlisted Corporate Exposures
(the ``Public Listing Requirement''). The Basel III Endgame Proposal
would provide a preferential 65% risk weight for investment grade
corporate exposures based on a large banking organization's internal
assessment of creditworthiness. However, the Proposal would require
that the preferential 65% risk weight can only be applied if the
counterparty has shares that are publicly traded on a national
securities exchange or foreign equivalent.
Due to the impact of increased capital costs, we fear bank
affiliated FCMs would be disincentivized from doing business with
entities that are not publicly traded, while their swap dealing
entities reduce, or altogether eliminate, offering those hedging
services to cooperatives. Given the arbitrary nature of the public
listing requirement and the likely unintended consequences on otherwise
highly creditworthy entities, we have urged that this requirement be
eliminated.
Thank you again for the opportunity to testify today before the
Committee. We appreciate your role in ensuring our industry will
continue to be able to effectively hedge commercial risk in supporting
the viability of our farmers. I look forward to answering any questions
you may have.
Thank you.
Ms. Caraveo. And finally, Ms. Thornton.
STATEMENT OF ALEXANDRA THORNTON, J.D., SENIOR
DIRECTOR, FINANCIAL REGULATION, CENTER FOR
AMERICAN PROGRESS, WASHINGTON, D.C.
Ms. Thornton. Thank you. Chairman Johnson, Ranking Member
Caraveo, and esteemed Members of the Subcommittee, thank you
for the opportunity to appear before you today.
The CFTC plays a central role in overseeing agriculture and
other physical commodities markets which are essential to our
economy, as well as overseeing the complex financial products
known as swaps, which were at the heart of the 2007-2008
financial crisis.
The Commission oversees dozens of entities where
derivatives are traded, ten organizations that clear those
trades, and five more outside the U.S. It also oversees the
registration and compliance of thousands of derivatives markets
participants, and oversees self-regulatory organizations such
as the Chicago Mercantile Exchange and the National Futures
Association.
Yet, the CFTC is critically under-funded, and would remain
so even if Congress were to grant all the funding that it has
requested. The agency simply does not have adequate resources
to fulfill its existing mission and statutory obligations.
Because of this under-funding, many important protections and
functions that should be performed by the Commission are not
today, such as comprehensive review of designated contract
market rule changes and products to ensure their compliance
with the law and the core principles, and development and
enforcement of detailed advertising performance and fee rules.
And since the financial crisis, the markets overseen by the
CFTC, of course, have become larger, faster, and more
interconnected. The Commission's responsibilities are essential
to maintaining the integrity, resilience, and vibrancy of our
derivatives markets, and ensure that these markets never again
threaten the stability of our financial system or wreak havoc
on our economy. The Commission should be reauthorized and
adequately funded to carry out its existing responsibilities.
This is a major reason why the agency's authorized
activities should not be expanded into new areas, as proposed
recently in connection with digital assets and voluntary carbon
credits. We already know there is rampant fraud and abuse in
the crypto industry. Protecting retail investors, consumers
from this fraud and abuse should be the guiding principle of
any new special digital asset regulatory regime. Yet, the CFTC
in its self-regulatory organization currently lack
comprehensive marketing and sales practice rules like those of
FINRA and the SEC because the agency has never had to protect
retail--has seldom had to protect retail investors from the
information asymmetries they confront in financial
transactions.
In addition, digital assets are promoted by market
intermediaries that are often acting in multiple conflicting
roles. Most rules designed to reduce such conflicts of
interest, along with rules that combat terrorism, financing,
and money laundering, require transparency and accountability
that the industry does not want, but are essential to investor
protection. These are just two parts of the extensive
regulatory framework that the Commission would have to develop
in order to adequately protect retail investors in crypto. This
framework would take years to develop and absorb significant
time and energy away from the agency's existing duties, and the
rules developed could raise regulatory risk if challenged in
court. Thus, a new CFTC regime for crypto could actually
introduce more uncertainty around these assets, rather than
less. It would also be extremely inefficient and costly to
taxpayers and market participants to create a duplicate
investor protection regime at the CFTC when there is a robust
investor protection regime at the SEC that has been perfected
continuously over 9 decades. A CFTC regime could incentivize
players in the securities markets to restructure assets and
deals to take advantage of a weaker CFTC regime, which could
spread the risk to retail securities investors. Finally, a new
CFTC regime would create a new veneer of legitimacy and safety,
further confusing retail investors who are finally beginning to
understand the risks of crypto.
Any perceived gaps in the current Federal financial
regulatory framework as it applies to digital transactions
could lead to larger gaps and greater risk to our capital
markets.
The CFTC also should not be authorized to take a wider role
on voluntary carbon credit derivatives, as the agency's recent
proposal might inspire. The underlying assets, the voluntary
carbon credits themselves, cannot readily be traded in a manner
that is consistent with the core principles, primarily because
a material percentage of the underlying projects that
purportedly give rise to the credits simply do not generate the
carbon savings claimed by those who market them. That is, the
amount of carbon actually being removed and for how long is not
sufficiently known to form a reliable market, and is far beyond
the agency's expertise to fix. Until the problems are fixed by
other responsible public and private parties in a global--in a
unified global system, voluntary carbon credit derivatives
should not be listed or traded.
Thank you again for inviting me to testify today. I look
forward to answering your questions.
[The prepared statement of Ms. Thornton follows:]
Prepared Statement of Alexandra Thornton, J.D., Senior Director,
Financial Regulation, Center for American Progress, Washington, D.C.
Chairman Johnson, Ranking Member Caraveo, and esteemed Members of
the Subcommittee, thank you for the opportunity to appear before you
today to discuss reauthorization of the Commodity Futures Trading
Commission (CFTC).
I am senior director of financial regulation at the Center for
American Progress, an independent, nonpartisan policy institute
dedicated to improving the lives of all Americans through bold,
progressive ideas, as well as strong leadership and concerted action.
While reauthorization presents an opportunity to assess the funding
of an agency and ensure that those financial resources are adequate for
the responsibilities Congress has given it, as explained below we
strongly caution against using the CFTC reauthorization process to
expand the agency's authorities, into areas significantly beyond its
current expertise and capabilities.
The CFTC should be reauthorized in order to protect our economy
The CFTC plays a central role in oversight of physical commodities
markets which are essential for our economy, including our
manufacturing, transportation, and agriculture. And since the enactment
of the Dodd-Frank Act and through subsequent rule makings, it has come
to play an essential role in overseeing the complex financial products
known as swaps, which were at the heart of the 2007-2008 Financial
Crisis.
The Commission oversees 41 registered entities, including 16
designated contract markets (DCMs), 21 registered swap execution
facilities (SEFs) and four provisionally registered swap data
repositories.\1\ It currently has ten registered derivatives clearing
organizations (DCOs), two of which have been designated by the
Financial Stability Oversight Council as systemically important.\2\ And
it regulates five registered DCOs located beyond U.S. borders.\3\ The
Commission's market participants division oversees the registration and
compliance of thousands of derivatives market participants, such as
swap dealers, major swap participants, futures commission merchants,
retail foreign exchange dealers, introducing brokers, commodity trading
advisors, commodity pool operators, floor brokers, and floor
traders.\4\ In addition, it oversees futures industry self-regulatory
organizations, such as the Chicago Mercantile Exchange and the National
Futures Association.\5\
---------------------------------------------------------------------------
\1\ Commodity Futures Trading Commission, President's Budget,
Fiscal Year 2025, March 2024, available at https://www.cftc.gov/sites/
default/files/CFTC%20FY%202025%20President's%20
Budget_Final_for%20Posting.pdf.
\2\ Ibid.
\3\ Ibid.
\4\ Ibid.
\5\ Ibid.
---------------------------------------------------------------------------
Yet, the CFTC is critically under-funded and would remain so even
if Congress were to grant all the funding it has requested. Frankly,
the agency does not have adequate resources to fulfill its existing
mission and statutory obligations.
The challenge with the CFTC is that it has been so chronically
under-funded that many important protections and functions that should
be performed by the Commission are not today. For example, the
Commission does not comprehensively review all DCM rule changes and
products to ensure their compliance with the law and the Core
Principles. These changes may include changes to market data access and
costs, trading operations changes, or listing of new products. The
rules and processes adopted by the CFTC currently do not allow for
adequate Commission or public consideration of these changes now,
leading to DCM practices that unnecessarily burden market participants
with costs and complexities that are inconsistent with the law and Core
Principles.\6\
---------------------------------------------------------------------------
\6\ See, e.g., Letter from Chris Nagy, Healthy Markets Association,
to Hon. Heath Tarbert, CFTC, December 11, 2020, available at https://
healthymarkets.org/wp-content/uploads/2020/12/CME-Historical-Data-12-
11-2020-4.pdf.
---------------------------------------------------------------------------
Other functions that one might expect have also never been done,
likely because the target users of the markets it has traditionally
overseen have been sophisticated businesses. For example, the agency
and the SROs it oversees have never developed or enforced detailed
advertising, performance, and fee rules. This stands in stark contrast
to the detailed requirements imposed upon brokers and asset managers in
the securities markets.\7\
---------------------------------------------------------------------------
\7\ FINRA, Rule 221:. Communications with the Public, available at
https://www.finra.org/rule-sguidance/rulebooks/finra-rules/2210.
Notably, in those markets, registered securities exchanges are not
soliciting orders from the public for transactions or generally making
claims related to asset performance.
---------------------------------------------------------------------------
Unfortunately, the inadequate budgeting and staffing at the agency
have led to inadequate examinations, leading to several high profile,
years-long abuses and misconduct in some of its core markets, such as
U.S. Treasury futures and metals futures markets.\8\
---------------------------------------------------------------------------
\8\ See, e.g., Abhishek Manikandan and Michelle Price, ``JPMorgan
to pay $920 million for manipulating preciousmetals, Treasury market,''
Reuters, September 29, 2020, available at https://www.reuters.com/
article/business/jpmorgan-to-pay-920-million-for-manipulating-precious-
metals-treasury-market-idUSKBN26K321/ (reflecting Treasury and metals
market manipulations lasting from 2008 to 2016).
---------------------------------------------------------------------------
The 2007-2008 Financial Crisis is more than 16 years in the
rearview mirror. As this Committee considers reauthorization of the
CFTC, it should remember the details of how the Financial Crisis
happened and the devastation of the financial system and the economy
that followed. The dangerous combination of deregulation and weakening
of regulators' authorities that preceded the crisis led to a collapse
of major portions of our financial system and ultimately a lengthy
recession. Between 2008 and 2009, the U.S. lost 7.6 million jobs, and
it took until 2014 for employment to recover to pre-crisis levels.\9\
And from 2008 to 2013, more than 5 years later, gross domestic product
(GDP) per capita remained below the 2007 level.\10\ Economists at the
Federal Reserve Bank of San Francisco have estimated that the long-term
effects of the Financial Crisis led to a lifetime income loss per
capita in present discounted value terms of about $70,000 (in 2017
dollars).\11\ Wealth gaps between the middle class and wealthy
Americans worsened significantly all because the rules that placed
guardrails on risk-taking had been gutted and the agencies responsible
for overseeing the financial system had been weakened.
---------------------------------------------------------------------------
\9\ Marc Jarsulic and Lilith Fellowes-Granda, ``Project 2025 Would
Allow Financial Disaster To Bolster Wall Street's Bottom Line,'' Center
for American Progress, July 1, 2024, available at https://
www.americanprogress.org/article/project-2025-would-allow-financial-
disaster-to-bolster-wall-streets-bottom-line/.
\10\ Ibid.
\11\ Regis Barnichon, Christian Matthes, and Alexander Ziegenbein,
``The Financial Crisis at 10: Will We Ever Recover?'', Federal Reserve
Bank of San Francisco, August 13, 2018, available at https://
www.frbsf.org/research-and-insights/publications/economic-letter/2018/
08/financial-crisis-at-10-years-will-we-ever-recover/.
---------------------------------------------------------------------------
This Committee should also keep in mind that, since the crisis, the
markets overseen by the CFTC have become larger, faster, more
interconnected, and more retail in focus. In other words, the demands
on the CFTC are already greater than they have ever been.
My colleagues Marc Jarsulic and Lilith Fellowes-Granda at the
Center for American Progress recently estimated the present-day costs
of a repeat of the Great Recession.\12\ They found that a 2007-scale
financial shock today would result in 8.7 million people losing their
jobs by 2026, and employment would not recover to current levels until
2031.\13\
---------------------------------------------------------------------------
\12\ Marc Jarsulic and Lilith Fellowes-Granda, ``Project 2025 Would
Allow Financial Disaster To Bolster Wall Street's Bottom Line,'' Center
for American Progress, July 1, 2024, available at https://
www.americanprogress.org/article/project-2025-would-allow-financial-
disaster-to-bolster-wall-streets-bottom-line/.
\13\ Ibid.
---------------------------------------------------------------------------
As we all know by now, previously unregulated over-the-counter
derivatives played a central role in the Financial Crisis. Title VII of
the Dodd-Frank Wall Street Reform and Consumer Protection Act \14\
called for a comprehensive regulatory framework for these derivatives,
granting the CFTC regulatory authority over swaps and the Securities
and Exchange Commission (SEC) regulatory authority over security-based
swaps.\15\ Through transparency, business conduct standards, clearing
requirements and much more,\16\ the framework sought to eliminate or
reduce risky practices that led to the crisis, including price opacity,
the sale by large firms of credit default swaps with inadequate capital
or liquidity to back the trades, practices that undermined the ability
to net trades thus increasing counterparty risk, and the commingling of
client margins with dealer assets.\17\
---------------------------------------------------------------------------
\14\ Dodd-Frank Wall Street and Consumer Protection Act, Pub. L.
111-203, July 21, 2010, available at https://www.congress.gov/111/
plaws/publ203/PLAW-111publ203.pdf.
\15\ Michael S. Barr, Howell E. Jackson, and Margaret E. Tahyar,
Financial Regulation: Law and Policy, West Academic (St. Paul: 2021) at
pp. 1265-66.
\16\ Legal Information Institute, ``Dodd-Frank: Title VII--Wall
Street Transparency and Accountability,'' Cornell Law School, available
at https://www.law.cornell.edu/wex/dodd-frank_title_vii_-
_wall_street_transparency_and_accountability (last accessed July 2024).
\17\ Barr, 2021, at p. 1263.
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By 2021, the CFTC had fulfilled a large part of its initial
responsibility to drag implementing rules required by the Dodd-Frank
Act.\18\ But its job is still not finished. It has a responsibility to
continue overseeing swaps and other derivative markets, as well as
major market participants. The agency must monitor the markets and
market participants for compliance with its existing rules, and impose
appropriate disclosure requirements, margin and capital rules, risk
management standards, and other safeguards on the firms and products
under its jurisdiction. These responsibilities are essential to
maintaining the integrity, resilience, and vibrancy of our derivatives
markets--and ensure that these markets never again threaten the
stability of our financial system or wreak havoc on our economy.
---------------------------------------------------------------------------
\18\ ``Final Rules, Guidance, Exemptive Orders & Other Actions,''
Commodity Futures Trading Commission website, available at https://
www.cftc.gov/LawRegulation/DoddFrankAct/Dodd-FrankFinalRules/index.htm
(last accessed July 2024).
---------------------------------------------------------------------------
Recognizing the additional responsibilities it had imposed,
Congress significantly increased the budget of the CFTC after passage
of the Dodd-Frank Act and enacted several increases beyond the rate of
inflation over the years since then. The percentage change in the last
5 years--from 2019 to 2024--was 36 percent or 11 percent, when adjusted
for inflation.\19\ Still, as mentioned above, these amounts are
insufficient for the Commission to carry out its existing
responsibilities.
---------------------------------------------------------------------------
\19\ Author's calculations based on actual budget figures in annual
White House budget proposals since FY 2009, adjusted for inflation
using the Employment Cost Index.
---------------------------------------------------------------------------
For this reason and for other reasons explained below, we strongly
encourage Congress to avoid expanding the authority of the CFTC at this
time, especially for purposes of authorizing new areas of
responsibility that are beyond its current expertise and jurisdiction,
such as new authorities relating to digital assets or voluntary carbon
credits (VCCs). Expansion of the agency's jurisdiction in such areas
may lead to regulatory inefficiencies, the creation of negative market
signals and incentives, and general market confusion. More important,
it would divert the Commission's resources away from its existing
responsibilities, which are so essential to our economy.
My remaining remarks focus on the importance of avoiding
inefficiencies, disincentives, and market confusion associated with
such expanded authorities.
CFTC authorization should not be expanded for purposes of setting
up a special regime for crypto assets or regulating voluntary carbon
credits.
Proposals to expand the jurisdiction of the CFTC are often
justified on grounds of promoting innovation and the claim that rules
to protect investors stifle innovation. But this is not a binary
choice: innovation or investor protection. It is possible to have both.
The greater risk is not of stifling innovation. The greater risk is
unleashing something that puts investors or worse the financial system
and the economy at risk. That is what happened prior to the Financial
Crisis. In the Commodity Futures Modernization Act of 2000, Congress
exempted most over-the-counter (OTC) swaps from CFTC and SEC
jurisdiction, allowing the exemption as long as the participants were
sophisticated, as defined broadly in the legislation.\20\ By 2008, the
gross amount of OTC derivatives outstanding had increased by 630
percent, and credit default swaps had increased 100-fold.\21\ Financial
lobbying played a major role in this state of affairs, which severely
undermined regulators' ability to see what was going on and stem the
fallout.\22\
---------------------------------------------------------------------------
\20\ Barr, 2021, at p. 1259.
\21\ Ibid.
\22\ Ibid.
---------------------------------------------------------------------------
This lesson from recent history must guide current debates in which
financial market participants seek weaker regulation.
Agricultural markets are so important, and they depend upon the
CFTC to ensure that derivatives markets function well and are free of
fraud and manipulation. It is important for this Committee to
understand that expanded authorities of the types the agency has sought
would distract it from its foundational responsibilities.
Digital asset regulation
Whatever promise the digital asset industry may hold, we already
know for certain that it contains rampant fraud and abuse. Digital
assets are promoted by conflicted market intermediaries that are often
acting as introducing broker, executing broker, transfer agent,
custodian, and more.
If Congress is to develop a new, specialized regime for the
regulation of digital assets, ensuring some integrity of the claims
made to customers should be a top priority. But, while the CFTC does
not generally have such a regime, the Financial Industry Regulatory
Authority (FINRA), the self-regulatory organization that oversees
registered securities broker-dealer firms, and the SEC do.
Because there are many registered broker dealers that engage with
digital assets, FINRA has already begun to examine issues related to
their crypto marketing claims. In particular, in November 2022, as part
of a targeted exam, FINRA reviewed over 500 crypto asset-related retail
communications by its registered broker-dealer members.\23\ It found
that over 70 percent of those communications contained potential
substantive violations of FINRA's rule on communications with the
public.\24\ These included, for example, false statements or
implications that crypto assets functioned like cash or cash equivalent
instruments; comparisons of crypto assets to other assets, like stock
investments, without providing a sound basis to compare the varying
features and risks of these investments; failure to provide a sound
basis to evaluate crypto assets by omitting clear explanations of how
crypto assets are issued, held, transferred, or sold; and
misrepresenting that the protections of the Federal securities laws or
FINRA rules applied to crypto assets.
---------------------------------------------------------------------------
\23\ FINRA, ``FINRA Provides Update on Targeted Exam: Crypto Asset
Communications,'' January 2024, available at https://www.finra.org/
rules-guidance/guidance/targeted-examination-letters/sweep-update-
jan2024.
\24\ FINRA, Rule 221: Communications with the Public, available at
https://www.finra.org/rules-guidance/rulebooks/finra-rules/2210.
---------------------------------------------------------------------------
These findings related only to the handful of crypto firms that are
also already registered broker-dealers in the securities markets, who
would seem to be the most likely to comply with regulatory
requirements. It does not include the ``native'' crypto firms that have
declined to make such registrations.
Again, the CFTC and its self-regulatory organization lack
comprehensive marketing and sales practices rules like those of FINRA
and the SEC. This is just one part of the extensive regulatory
framework that the agency would have to develop in order to adequately
protect retail investors in crypto. Yet, developing such rules would
take years and absorb significant time and energy of the agency, and
the rules that would be developed could raise regulatory risk if
challenged in court. All of this raises the distinct possibility that
such a new CFTC regime for crypto would actually introduce more
uncertainty around these assets, rather than creating clarity.
In the 116th Congress, the last time CFTC reauthorization
legislation was considered, the drag bill at that time, H.R. 6197,
included provisions that would have provided for the regulation of
digital commodities, though the full implications of that language are
not clear. The industry has worked with like-minded legislators since
then to crag a more detailed regulatory regime under the jurisdiction
of the CFTC for digital commodities. These proposals have serious
potential ramifications for retail investors, consumers, and the
stability of the financial system. Any perceived gaps in the current
Federal financial regulatory framework as it applies to digital
transactions would pale in comparison to the potential negative impacts
of these proposals.
The crypto industry has long argued for a special regulatory regime
under the CFTC. But the CFTC by design has never focused on retail
investors. The commodity laws do not even contemplate the idea of an
issuer who is selling to a retail investor; thus, the agency has never
had to protect people from the information asymmetry that arises in
such situations. The CFTC was created in 1974 to regulate derivatives,
which are complex financial contracts that are based on the value of an
underlying asset. They are used to hedge against the risk of changing
prices in a wide range of industries, but very seldom by retail
investors and consumers. Increasingly, derivatives are used for
speculation. They are just too complicated, potentially volatile, and
risky for retail investors.
By contrast, the SEC--also by design--has focused on protecting
retail investors since it was created 90 years ago. It has decades of
experience with protecting investors and the public, and it has
developed a robust framework of rules for doing so--rules that can and
do apply to the vast majority of digital asset transactions. It would
be extremely inefficient--and costly to taxpayers and market
participants--to create a duplicate investor protection regime for
digital assets at the CFTC.
It is also highly likely that authorizing a special regulatory
regime for crypto under the CFTC would create negative market signals
and incentives, as players in other markets sought to restructure
assets and deals to take advantage of the vacuum of rules and capacity
to protect retail crypto investors. The industry has defied the SEC
rules that already apply to them,\25\ and, if the CFTC's jurisdiction
over digital assets were expanded, there is no reason to believe that
the crypto industry would not resist rules designed to accomplish
similar investor and consumer protection goals at the CFTC.
---------------------------------------------------------------------------
\25\ Chair Gary Gensler, ``Statement on the Financial Innovation
and Technology for the 21st Century Act,'' U.S. Securities and Exchange
Commission, May 22, 2024, available at https://www.sec.gov/newsroom/
speeches-statements/gensler-21st-century-act-05222024 (last accessed
July 2024).
---------------------------------------------------------------------------
If the CFTC's jurisdiction is expanded to allow it to develop a
special regulatory regime for crypto, this would likely provide a
veneer of credibility and safety around crypto. This could result in
even more harm to retail crypto investors, who may think they are fully
protected.
Finally, as alluded to above, the implementation of a comprehensive
regulatory regime for digital assets within the CFTC's jurisdiction
would be unprecedented in the agency's history, and both the burdens on
the agency and the risks to the capital markets could be exceedingly
large.
Regulation of voluntary carbon credit derivatives
Voluntary carbon credit (VCC) derivatives pose a different problem.
As the responses to the CFTC's proposed guidance for voluntary carbon
credit derivatives make clear,\26\ the underlying assets--the voluntary
carbon credits themselves--cannot readily be traded in a manner that is
consistent with the Core Principles.\27\
---------------------------------------------------------------------------
\26\ Letter to The Honorable Rostin Behnam, Center for American
Progress Comments on Commission Guidance Regarding the Listing of
Voluntary Carbon Credit Derivative Contracts, February 16, 2024,
available at https://comments.cftc.gov/PublicComments/ViewComment.aspx?
id=73324&SearchText=progress.
\27\ Designated Contract Markets (DCMs), Commodity Futures Trading
Commission website, available at https://www.cftc.gov/
IndustryOversight/TradingOrganizations/DCMs/index.htm (last accessed
July 2024).
---------------------------------------------------------------------------
It is well established that a material percentage of the underlying
projects that purportedly give rise to the credits simply do not
generate the carbon savings claimed by those who market them.\28\ They
are not certain and verifiable and thus not fungible enough to ensure
that trading in them will be consistent with the Core Principles. It
would be similar to an aluminum futures contract being traded despite
the warrant for the aluminum being tied to only half of the promised
amount, or no aluminum at all, perhaps a small hunk of granite.
---------------------------------------------------------------------------
\28\ See, e.g., Natasha White, ``Carbon Offset Gatekeepers Are
Failing to Stop Junk Credits,'' Bloomberg, March 21, 2023, available at
https://news.bloomberglaw.com/esg/carbon-offset-gatekeepers-are-
failing-to-stop-junk-credits; Patrick Greenfield, ``Revealed: more than
90% of rainforest carbon offsets by biggest certifier are worthless,
analysis shows,'' The Guardian, January 18, 2023, available at https://
www.theguardian.com/environment/2023/jan/18/revealed-forest-carbon-
offsets-biggest-provider-worthless-verra-aoe; and Debra Kahn,
``Offsets' promise and peril,'' Politico, January 1, 2023, available at
https://www.politico.com/newsletters/the-long-game/2023/01/20/offsets-
promise-and-peril-00078763.
---------------------------------------------------------------------------
Already, the commodity futures markets are occasionally rocked by
scandals where it is later revealed that the physical metal underlying
futures contracts has disappeared or of improper form or volume. But
these cases should be relatively easy to identify and quickly end,
given that the actual metal is supposed to be stored at a warehouse
that could be quickly and easily inspected. There is no credible way
for this verification function to exist either on an initial or ongoing
basis for the vast majority of projects claiming some reduction of
carbon in the air.
Worse, unlike in the physical commodities markets, where the
ultimate purchaser of a contract may take physical delivery and use the
metal, for example, that simply does not happen in the VCC markets. The
end-user in the metals markets very much wants the metal to be of the
specified quality and quantity, so as to be potentially useful.
However, there is no such market protection built into VCCs, as the
carbon saved is not directly used. To the contrary, many users of VCCs
may have incentives to accept exaggerated claims of carbon saved.
The problem cannot be solved by delegating a standard setter, which
the CFTC cannot do, or by allowing the accrediting of VCC derivatives
contracts by the exchanges, which are equally lacking in the scientific
knowledge and capacity to ensure that the underlying assets are certain
and verifiable. Under these circumstances, allowing the designated
contract markets to approve the listing of voluntary carbon credit
derivatives would only result in market confusion and fraud.
VCCs are likely to continue inviting waste and fraud. Unlike carbon
credits traded under government cap and trade regimes, by definition
VCCs do not involve governments, do not have corresponding government
emissions caps, and can be created anywhere in the world, making them
nearly impossible to verify and monitor. One recent study found that
the vast majority of voluntary carbon credits are not valid.\29\ Before
carbon credits can form the basis for derivative contracts, there must
be an independent, reliable, fact-based entity that verifies carbon
emission reductions on a global basis. To date, that does not exist,
despite efforts under the auspices of the United Nations.\30\
---------------------------------------------------------------------------
\29\ Patrick Greenfield, ``Revealed: more than 90% of rainforest
carbon offsets by biggest certifier are worthless, analysis shows,''
The Guardian, January 18, 2023, available at https://
www.theguardian.com/environment/2023/jan/18/revealed-forest-carbon-
offsets-biggest-provider-worthless-verra-aoe.
\30\ Eklavya Gupte and Agamoni Ghosh, ``COP28: Lack of progress on
Article 6 likely to further limit carbon market growth,'' S&P Global,
December 13, 2023, available at https://www.spglobal.com/
commodityinsights/en/market-insights/latest-news/oil/121323-cop28-lack-
of-progress-on-article-6-likely-to-further-limit-carbon-market-growth.
---------------------------------------------------------------------------
VCC derivatives should not be listed or traded under the auspices
of CFTC authority until there is a clear, consistent, and reliable
methodology for creating voluntary carbon credits and establishing
their permanence, as well as how to verify, register, and retire
credits in a unified global system. Without these prerequisites, the
most essential terms of a derivative contract based on those carbon
credits, the amount of carbon actually being removed and for how long,
will not be sufficiently known to form a reliable market that is
consistent with the Core Principles.
At the same time, the CFTC should aggressively pursue cases of
obvious fraud and manipulation in VCC markets that have impacts on its
derivatives markets, including for contracts that have already been
identified as being tied to credits that were awarded for fraudulent or
erroneous reasons. This should be a significant priority for the
understaffed and under-funded examinations and enforcement staff.
Again, the agency appears to not have the resources to protect its
existing jurisdictions, even though it already has sufficient existing
authorities.
To conclude, we strongly support a clean reauthorization of the
CFTC, without new authorities, so that the agency can focus on its
existing responsibilities to ensure the integrity, resilience, and
vibrancy of U.S. derivatives markets.
Thank you again for inviting me to testify today. I look forward to
answering your questions.
The Chairman [presiding.] We will now recognize Members for
questions. We will begin with my favorite portrait from the
south wall, Mr. Frank Lucas.
Mr. Lucas. Thank you, Mr. Chairman, and thank you, Ranking
Member, for holding this hearing, and the witnesses for
agreeing to testify.
The CFTC regulates markets that impact nearly every part of
the economy, and reauthorizing the Commission will give us an
opportunity to provide meaningful oversight, and give certainty
to market participants. The derivatives market faces a number
of potential stresses: the Basel Endgame, the GSIB surcharge,
the treasury market structure reform, along with substantial
SEC rulemaking agenda that will decrease market liquidity and
increase costs.
In the context of CFTC reauthorization, it is worth
considering the full regulatory environment that the markets
are confronted with. So, there is a lot to discuss.
Starting with the Basel proposal, an issue I have discussed
with Chairman Behnam, Secretary Yellen, Chairman Powell, and
all of the Prudential Regulators, is the impact this will have
on our capital markets, including reduced access to derivatives
products for end-users, and further concentrations of FCMs. It
seems like the regulators would be open to a re-proposal, but
FDIC and OCC will have to join with the Fed on that decision.
Mr. Lukken, you are no stranger to the Agriculture
Committee room, so thank you for joining us today and touching
on Basel during your testimony. Could you expand on why it is
so important that the regulators reopen the proposal for public
comment?
Mr. Lukken. Well, Congressman Lucas, you have been a leader
on this topic on capital, and this Committee has been a leader.
To point out the obvious fact from the financial crisis, which
is that our markets in clearing and essential counterparties
actually mitigate risks. They reduce risk in the financial
system, and so, the capital is an important component of the
financial reforms coming out of the financial crisis, that
banks should hold more capital for risky activity. But they
just have it wrong. I think the Prudential Regulators are
overtaxing clearing activity to make it so there is going to be
a capacity issue, that banks are going to stop offering this
service to hedgers.
We heard Travis talk about this, that end-users may have
limited access to hedging vehicles, to hedge volatility and
commodity markets as a result of Basel capital. So, our hope is
that the Prudential Regulators are listening to the reasonable
voices of the CFTC, Chair Behnam, and others that have said you
have to get this right. It has to be proportional to the risks
brought by our markets, and we are hopeful that it gets fixed
in the coming months.
Mr. Lucas. Mr. Sexton, you are a member of the CFTC's
Global Markets Advisory Committee. One suggestion, among many,
that GMAC had for the Commission last month was to hold a
roundtable with the bank regulators focused on derivatives
issues impacted by Basel.
Could you explain broadly to the importance of stakeholder
feedback on matters that will have a significant impact on the
market?
Mr. Sexton. Thank you for the question, Congressman Lucas.
I certainly endorse the concept of GMAC and its recommendation
to hold this roundtable to further determine the impacts of
these capital rules.
As Mr. Lukken and Travis have indicated, this is extremely
important to the farmers, ranchers, and end-users and hedgers
because of the consolidation that may occur among firms if
these capital rules are put into place.
So, stakeholder impact and comments are extremely
important, and something that we should be looking to do.
Mr. Lucas. The CFTC's enforcement authority has been a
closely watched issue during the past several years.
Reauthorizing the CFTC gives us the opportunity to closely
examine what the Commission is doing, and identifying
improvements that can be made.
Mr. Lukken, back to you. Do you think the Commission's
current cross-border authority is effective from a regulatory
and enforcement perspective?
Mr. Lukken. I can only speak from my experience at the
CFTC, but we were able to work closely with our regulatory
authorities overseas to partner with them to make sure they had
the appropriate information. But the important thing is, does
the CFTC have direct authority when there is a strong nexus to
the United States? And I believe they do, that they have the
ability to go after bad behavior overseas when it is a strong
nexus to the United States.
So, I think the CFTC does have appropriate authority.
Mr. Lucas. Mr. Chairman, before I yield back, I would
simply note that I have spent much time screaming about the
potential impacts of the Basel capital requirements on the
American economy. This is one of those things that if we don't
get it right, the damage that would be inflicted will be
extremely difficult to address later.
With that, I yield back, Mr. Chairman.
The Chairman. One hundred percent right.
With that, we yield 5 minutes to the Ranking Member.
Ms. Caraveo. Thank you, Mr. Chairman, and thank you all
once again for being here this morning as we consider this
important reauthorization of the CFTC. Your testimony is
invaluable.
Now, the last attempt by the Committee to reauthorize the
CFTC included provisions to harmonize some of the enforcement
authorities between the CFTC and the SEC. One provision would
clarify the CFTC's authority to prosecute fraud and
manipulation outside of the United States, where such
activities impair our futures markets, and another would
establish a reckless standard for those who aid and abet
fraudsters and manipulators of our markets, the same standard
that currently applies to those who actually perpetrate the
fraud or manipulation.
For the whole panel, what are your thoughts on whether we
need to harmonize such enforcement activities, and whether
these are appropriate?
Thank you. Anyone who wants to answer, go ahead.
Mr. Sexton. [audio malfunction].
Mr. Lukken. I would just chime in; I agree with Tom that it
is important for the CFTC to have clear authority to go after
bad behavior overseas. I can't speak to the specifics of
whether harmonizing with the SEC's enforcement authorities is
the right approach. As I had mentioned, when I was chair we had
plenty of authority to go after actors. We did not feel impeded
in any way of going--
The Chairman. Mr. Lukken, is your microphone on?
Mr. Lukken. Pardon me. Sorry.
We did not have any impediments during my tenure for going
after bad behavior overseas, or if we were able to share with
foreign authorities. So, we certainly support the premise,
though, that it is important for the CFTC to have a robust
authority to go after manipulative behavior overseas.
Mr. Antonsen. I would agree with both gentlemen.
Ms. Caraveo. Perfect, thank you.
Ms. Thornton?
Ms. Thornton. We don't really have a strong opinion on
that, but I am really interested to learn more about it.
Ms. Caraveo. Perfect, thank you.
Now, Mr. Lukken, your testimony raises concerns about
conflicts of interest within vertically integrated structures,
particularly futures commission merchants owned by exchanges
and clearinghouses, and embedded in their trading and legal
structures. Can you speak more to these concerns and the impact
of such structures on our financial systems, and then Mr.
Antonsen, if you could follow up as to whether your members
have any concerns?
Mr. Lukken. We are seeing this more and more where through
efficiencies of a lot of these crypto platforms that they are
combining both being an exchange, a clearinghouse, and an FCM
into one legal entity.
The problem is that exchanges and clearinghouses have self-
regulatory authorities over FCMs. So, in essence, you would be
policing yourself and those authorities. We saw some of this,
and we raised concerns with the FTX application where they had
registered--not registered, but a trading arm within their
legal structure that were combining the exchange, the
clearinghouse, and a trading arm within their legal structure.
And that ultimately led to some of the issues we saw with their
demise.
So, we think it is good for the CFTC to take a close look
at this to see if there are conflicts of interest that need to
be addressed, if there are governance challenges we need to
implement as part of this, are we needing to separate certain
functions because of that dual role of self-regulatory agency
over these authorities.
Mr. Antonsen. Could you repeat your question for me, just
so I am clear?
Ms. Caraveo. Just whether your members have any similar
concerns around what Mr. Lukken just discussed.
Mr. Antonsen. No, I think having guardrails and double-
checks in that, I think we would agree with that. We use
multiple FCMs. At times there are options to have FCMs that are
not exchanges. So, I would agree with Walt on them.
Ms. Caraveo [presiding.] Thank you all again for your
testimony, and I will yield back the remainder of my time.
I am pleased to turn it next to our esteemed Chairman
Thompson for his questions.
Mr. Thompson. I thank the gentlelady, and once again to all
our participant panelists, thank you so much.
Mr. Lukken, in your testimony you mentioned serving as
acting Chairman of the CFTC during the last CFTC
reauthorization in 2008. You also discussed the increasingly
global nature of derivatives markets. Could you please
elaborate on how the derivatives markets have evolved since
that time, and addressing the importance of reauthorizing the
CFTC as these markets evolve?
Mr. Lukken. Well, certainly since that time it has gotten
much more global, since I was at the agency. I think the
addition of over-the-counter derivatives has added challenges
to the CFTC's legal authority. I shouldn't say challenges, but
given them--
Ms. Caraveo. Sorry. Mr. Lukken, I don't think your
microphone is on. Oh, it is.
Mr. Lukken. I am having some microphone problems today,
sorry.
But no, I think the markets are definitely more global.
They are larger. As I mentioned--but we are seeing that the
framework has upheld very well, really, since the Commodity
Futures Modernization Act of 2000 (Pub. L. 106-554, Appendix
E--H.R. 5660), which but in those flexible approaches. The CFTC
is allowed to evolve itself with these market trends, so even
though we are seeing more global volume, the CFTC has been able
to keep pace with those changes. And that is why I think many
of us, if not all of us on this dais, are saying that there
doesn't need to be a huge overhaul of the Act, that it has
actually kept pace with the big global growth.
Mr. Thompson. Yes, those core principles really have sort
of made it resilient, and adaptable to--as things have evolved.
Mr. Sexton, could you please share with us your
perspectives on this question?
Mr. Sexton. Thank you, Chairman Thompson. Certainly, I
admire you for being involved.
This is a turning point in the process. It is great that
this Committee is seeking stakeholder interest in this process,
a process that is not easy--by Congress to handle this
reauthorization process. The Act has stood up well. I do have
one recommendation with regard to Griffin, and I agree that--
with Chair Behnam and the others testimony today that
reauthorization signals the importance of our regulatory
structure here to the global derivatives markets, and it gives
that acknowledgment of the CFTC's critical role in that market.
So, I think it is very important to reauthorize the CFTC.
Mr. Thompson. Well, thank you. I think reauthorization also
reflects our responsibility to do our job, and to make sure
that we can--we should have done it before.
Mr. Sexton. Yes.
Mr. Thompson. So, I look forward to accomplishing it here,
even with just the remaining days we have in the 118th.
Mr. Antonsen, in your testimony you mentioned your concerns
regarding the negative potential impacts of Basel III Endgame
rules may have on the derivatives markets and the end-users
that rely on them. Could you please share with us some of those
negative potential impacts?
Mr. Antonsen. Yes, I think when the information first came
out, speculation was that we were going to lose many FCMs due
to the regulations. From our standpoint, we have seen FCMs get
out of the business in the last 5 years. Many of them have. We
have seen consolidation in the industry, and that--as a user of
that, again, I mentioned we use multiple FCMs. To limit our
resources and limit our options on who we can use, if one of
those goes away, it--we look at potentially higher hedging
costs, less people to do business with.
Mr. Thompson. Very good. Thank you.
Mr. Lukken, are your members concerned about the impacts of
these proposals on end-users and other market participants?
Mr. Lukken. This is one of our top concerns as an industry.
I think rarely does our industry all get on the same page on a
topic, but from end-users to FCMs to exchanges to
clearinghouses, this is going to limit the capacity of people
to hedge in our markets. And so, as Travis mentioned, we have
seen shrinking number of FCMs, those people that access
production agriculture, allow them access to our markets. And
if we lose more of those folks, it is going to make the
framework of our system less safe.
And so, we think this is incredibly important to get this
right. Give capacity to FCMs to get more access to more
farmers, more commercial end-users in this marketplace. This is
a no-brainer. Hopefully, the Prudential Regulators figure this
out and fix these proposals.
Mr. Thompson. Am I correct in saying--I mean, the root
cause of this would be increasing costs, but it would result in
more systemic impacts as you described on a derivatives market?
Mr. Lukken. Yes. You are going to see less FCMs, and as a
result, you are going to see more concentration in firms.
So, we want as broad--it is like insurance. You want as
broad of a system of FCMs out there so that there are healthy
FCMs across the board, and so that Travis has lots of choices
of where he can bring his business.
Mr. Thompson. Very good. Thank you very much.
Ms. Caraveo. Thank you, and we will go next to my colleague
from California, Mr. Costa, for 5 minutes.
Mr. Costa. Thank you very much. I think it is appropriate
that we get together this morning and discuss the future of the
CFTC.
I wanted to, folks, to begin with the question that has
been raised. I guess, Mr. Lukken, you might be the first to
respond or Mr. Sexton, about the under-funding. There was a
discussion earlier in the reauthorization effort that would
allow you to charge fees to register companies to raise
resources for the new level of oversight. The Appropriations
Committee, I understand, as was noted in the opening comment by
my colleague, cut it by $20 million from the current budget.
When we consider the reauthorization of the Commission and
discuss expansion of the authorities, what do you think we need
to do to ensure that the CFTC is an appropriately funded
regulator?
Mr. Lukken. Well, FIA supports the full and appropriate
funding of the CFTC. When I was acting Chairman of the CFTC, it
was important for us to talk to the appropriators about why our
markets matter. And so, I think for us we do have concerns with
user fees in that it would cause less hedging. As I mentioned
about capital, it is the same issue that if you are directly
taxing hedging capabilities, that is problematic for farmers.
Mr. Costa. So, the user fees then versus the reduction of
the $20 million is the tradeoff, and do you think it is--
Mr. Lukken. No, I think appropriators should find ways to
appropriately fund the CFTC and to--as they have lots of
tradeoffs they have to think about, because it is taxpayer
dollars. But we think a case should be made and is made that
the CFTC should be appropriately funded.
Mr. Costa. Yes.
Mr. Sexton, do you think the agency's lack of
reauthorization since--and this is our fault, as the Chairman
noted. Our responsibility, I guess I would say, since 2008,
could impact your current funding challenges?
Mr. Sexton. [inaudible] could impact NFA's funding
challenges? Is that the question?
Mr. Costa. Yes.
Mr. Sexton. So, we are funded in two significant ways. I
know there are two major regulatory programs. Our overall
budget is about $140 million to assist the CFTC--regulate the
markets.
Our swaps regulatory program or swaps dealers is wholly
funded by the swap dealer industry, by those dealers, and that
is about $47 million or so through membership dues paid to NFA.
Mr. Costa. Self-funded?
Mr. Sexton. Self-funded, yes.
Mr. Costa. Yes.
Mr. Sexton. The other component are futures is funded in
part by membership dues, but the large portion of that funding
program at about $82 million is from what we call an assessment
fee. We place a very small fee of what we call public trading
volume. It is about 25 percent--
The Chairman [presiding.] Mr. Sexton, your microphone isn't
working, we are being told. It is not broadcasting. So, if you
could share--or grab a microphone with--
Mr. Sexton. Sure. I don't know if I want yours, though. I
don't know. Let me see what I can do here.
So, futures assessment fee--I am sorry--is a very small
proportion, 25 percent, about a quarter of contract market
value, that is public value, and that is at 4 around turn. So,
it is a very small amount with regard to that fee.
Mr. Costa. So, if the Financial Innovation Technology for
the 21st Century, the FIT 21 were to become law, how much
additional resources would the NFA need to effectively tackle
these additional responsibilities in a new market?
Mr. Sexton. That is a great question. We would--that is
going to be dependent on how many new member firms we have and
what our oversight regulatory responsibilities are.
Each of our regulatory programs needs to self-fund,
however, and so, we will find a way with regard to our new
members to get a revenue source in order to pay for what we
need.
Mr. Costa. Ms. Thornton, you talked about crypto fraud in
your comments. How extensive do you describe it today, and what
do you think we need to do about it?
Ms. Thornton. I think it is quite substantial, and I think
it is something that really needs to be focused on is the use
of arbitrage, because these spot markets in tokens, non-crypto
asset--sorry, tokens are actually--they have different streams,
different data streams. And what that means is that when you
buy a token, if you are a consumer and a retail investor and
you buy a token, you get offered a price but you may not know
what prices are being offered on the other platforms.
Mr. Costa. So, how do we protect against that fraud?
Ms. Thornton. I am sorry?
Mr. Costa. How do we protect against that fraud?
Ms. Thornton. Well, basically, the SEC does that by
requiring a national market system. It actually was started in
1975. Congress authorized it in 1975. The idea that the
different securities platforms would have to submit data so
that a broker would know what the prices are that are being
offered for that same security across the different exchanges,
and would be able--and then also was given fiduciary duty of
best interest--best execution, excuse me, so that they would
have to execute the trade, picking the best price for the
customer. But that doesn't exist at all with respect to crypto
platforms.
Mr. Costa. Well, Mr. Chairman and the Ranking Member, my
time has expired but I think this is something that we need to
look at in greater depth. When Mr. Lukken made his comment
about prudence and overcapitalization, I am very curious about
how he measures prudence or is that in the eye of the beholder?
And then how do you measure the risk? \1\
---------------------------------------------------------------------------
\1\ Editor's note: the information referred to is located on p. 43.
---------------------------------------------------------------------------
But thank you very much. I appreciate the opportunity.
Ms. Caraveo [presiding.] Thank you. The gentleman's time
has expired.
We will go next to Mr. Miller of Ohio for 5 minutes.
Mr. Miller of Ohio. Thank you. I want to thank the Chairman
and the Ranking Member and the witnesses for being here this
morning.
American agriculture utilizes a range of tools to manage
risks. They employ vital on-farm strategies and Federal farm
bill programs, including risk management commodity support
programs, crop and livestock insurance, and disaster assistance
prove critical in today's volatile marketplace. Our farm sector
and other industries can also access vital measures such as
futures, options, and marketing contracts to manage risk from
product and input price fluctuations.
In the modern world with input and production costs soaring
and tight commodity prices, it is crucial to control the
variables we are able to through commodity derivative markets.
In the last years, conditions globally and other instabilities
have led to exceptionally large price volatility and many
commodity markets underscoring the role of the Commodity
Futures Trading Commission.
To any of the witnesses, commodities derivatives markets
are essential to help manage price risk and hedge exposures as
these vital tools assist agriculture producers in hedging
exposure to rising input costs, severe weather incidents, and
volatile prices in fuel, fertilizer, and other essentials.
Could the witnesses elaborate on the importance of derivatives
products to your operations, and to those of your end-users?
And just really quick also, if a bad actor in the derivatives
industry is causing significant harm or allowing for illegal
and unregulated activity to take place, does the CFTC have the
ability and resources to swiftly address and prevent harm from
occurring through effective enforcement?
Mr. Antonsen. I can address your first part of that
question.
Derivatives, futures, options, over-the-counter contracts
are paramount in what we do every day at Agtegra for both
ourselves and for our cooperative members. So, purchasing
grain, hedging grain, storing grain, getting all the way
through the system, it is probably the most important thing we
do from a cooperative in managing risk.
You mentioned volatility. Whether it is weather, global
markets, global geopolitical events, volatility is through the
roof and as farm margins are tightening down, it is more
important than ever to have the right tools in place and
available, and also to use them with everything that a producer
has to use, like crop insurance. You multi-layer those risk
programs in there to make that happen. So, we utilize those
every single day, and we rely on a healthy marketplace to get
in and out of those efficiently.
Mr. Miller of Ohio. Thank you for that answer.
Can anyone address the second part of that question? I can
just say it again.
The bad actor in the derivative industry is causing
significant harm. Does the CFTC have the ability and resources
to swiftly address it, prevent harm from occurring through
effective enforcement?
Mr. Sexton. Congressman, certainly we are all, as
regulators, worried about bad actors and the impact it can
have. I can tell you that NFA works very closely with the
CFTC's Division of Enforcement to ensure that we find those bad
actors, punish those bad actors, to the extent that we closely
coordinate with them. We have quarterly meetings with that
division.
So, as far as the partnership with NFA and the CFTC, we are
very focused on bad actors, and I can't say enough about the
Division of Enforcement and its dedication to doing so.
Mr. Miller of Ohio. Thank you. I really appreciate that.
Second question. Given the importance of the United States
agricultural production and the magnitude of U.S. exports of
agricultural products to global consumers, America's farmers
and global end-users are not strangers to market volatility.
Can any of you please elaborate on means to withstand these
global uncertainties in the commodities market, and tools for
agricultural producers, energy users, and others to deal with
such instability?
Mr. Antonsen. I would say, from the worldwide standpoint,
volatility is--can you repeat the question? I am sorry.
Mr. Miller of Ohio. Yes, absolutely.
So, just to get right to it. Could you elaborate on what it
means to withstand global uncertainties in the commodity
markets and the tools for agricultural producers, energy users,
and others to deal with the instability that we are currently
seeing?
Mr. Antonsen. Yes, I am sorry.
We see the days when a producer wants to sell is not the
same time that an end-user wants to buy. There are huge, huge
gaps in volatility and derivatives get us across that line. The
volatility we have seen with weather, our export markets come
and go. Being in South Dakota, we export most of our
production. We are relying on getting it at least out of the
state, and most of that goes to the world market. We get to
that point and that is our biggest challenge.
Mr. Miller of Ohio. Yes. I think if we can continue--I am
out of time, Mr. Chairman, but we can continue to hold people
accountable for agreeing to, say, the USMCA but taking
advantage of us with GMO corn, and actually bring them to a
dispute panel probably would help out as well for a little bit.
Thank you for your time. I yield back.
Ms. Caraveo. The gentleman yields back.
We will go next to the gentleman from Kansas, Mr. Mann, for
5 minutes.
Mr. Mann. Thank you, and thank you very much for having
this hearing. Thanks for the panel for being here this morning.
This is a very important topic. We have to make sure that
we get it right and it impacts not just folks all over the
country but certainly my ag producers throughout Kansas as well
that rely on markets to make sure that they are managing the
risks that are just ever present and continue to increase in
agriculture.
First question for you, Mr. Lukken. I want to circle back
to enforcement for a moment, and drill in on CFTC's existing
authorities. Do you see any current gaps in the Commission's
authorities to address overseas fraud that affects markets here
in the U.S.?
Mr. Lukken. Yes. I am not aware of any current impediments
for the CFTC going after bad behavior overseas. They have,
again, a nexus on American participants or citizens. I know
when I was acting Chairman of the agency, there were times when
we needed to use prosecutorial discretion on whether we went
after activity overseas. But if there was a strong nexus to
American consumers, of course we would take strong interest and
the CFTC would go after that. We brought several cases in the
international front on that case--on that basis. But, we
oftentimes would work in partnership. It is one of those
things--and we were talking about appropriate funds. The CFTC
should not be the police force of the world for all activity.
It really has to come back to whether there is a U.S. interest
in that, and I don't think they have a lack of authority in
that area.
Mr. Mann. Great, thank you.
Next question for you, Mr. Sexton. In your testimony, you
described a court opinion that called into question how
customer property is defined by the Commodity Exchange Act,
CEA, relative to the U.S. Bankruptcy Code. Could you please
share with us some additional background on that issue and why
it is potentially problematic for customers?
Mr. Sexton. I certainly can, and this is in the context of
FCM bankruptcies, which are rare, thank God. And the importance
of the proposal with regard to reauthorization that we are
making is that in the Griffin Trading Co. case, the one that I
am referencing, there was a hole in customer segregated funds
caused by a rogue trader many years ago. And obviously, the
firm did not have sufficient funds to make customers whole at
that point in time, and the issue was whether or not customers
would step in front of the firm's general creditors in the
bankruptcy in order to get whatever funds existed from the
company to go into segregated funds in order to make customers
whole. Very important with regard to customer protections in
our view, and the court in that case, the district court
essentially said that the CFTC has a rule that would say yes,
customers can step in front of the general creditors. They
called into question the CFTC's legal authority with regard to
making that rule in the context of some provisions of the
Bankruptcy Code.
So, what we are asking for is just that that cloud of
uncertainty be removed and extremely important from a customer
funds safeguard perspective we believe.
Mr. Mann. Okay, thank you.
Next question, back you to you, Mr. Lukken. In your
testimony, you discuss the globalization of our derivatives
markets. How important is it for global regulators to be able
to coordinate and share information with one another as they
surveil and regulate these markets?
Mr. Lukken. It is incredibly important. Information is
really the currency for the regulatory authorities around the
world, and so, the CFTC, by statutory grant from this Committee
has the ability to get a lot of information from our
[inaudible]. This ensures [inaudible] to see trends in the
markets. And so, it is important that they are able to share
that information globally, as long as it is for an enforcement.
It is not just an information grab, but it is for an
enforcement purpose, and that happens quite frequently.
Mr. Mann. In your mind, would detailing staff to and from
foreign regulators, the EU or the UK, support the global
sharing of knowledge and experience?
Mr. Lukken. Yes, that would be helpful. I think I sent
details from the CFTC over to the UK when I was chair. We
benefitted from that because during the crisis, we were able to
utilize those folks to help with what was happening in European
markets. So, that kind of information and personnel sharing is
incredibly important.
Mr. Mann. Thank you. I yield back the 3 seconds of my time.
Thanks.
Ms. Caraveo. Thank you. The gentleman yields back.
And with that, I will hand the steering wheel back to our
esteemed chair.
The Chairman [presiding.] Just in time for me to yield
myself time. How very exciting.
I will go with Ms. Thornton for just a little bit. Ms.
Thornton, you talked a fair amount about how creating this new
regulatory regime and duplicative efforts with the SEC might be
complicated, troublesome, problematic. What agency today has
jurisdiction over fraud and manipulation in commodity spot
markets?
Ms. Thornton. That is the CFTC, of course.
The Chairman. Okay. So, that is the CFTC. What about who
has jurisdiction over derivatives for non-securities, those
markets?
Ms. Thornton. CFTC.
The Chairman. The CFTC. When we look at Bitcoin, have there
been any reports that have held that Bitcoin is a security?
Ms. Thornton. No, there is just one--no.
The Chairman. Has the SEC ever asserted jurisdiction over
Bitcoin?
Ms. Thornton. It should have.
The Chairman. Has the SEC ever asserted jurisdiction over
Bitcoin?
Ms. Thornton. I don't believe so.
The Chairman. Do you know what volume of the digital assets
trading Bitcoin constitutes?
Ms. Thornton. Roughly 90 percent.
The Chairman. Okay.
Ms. Thornton. But there are hundreds of other tokens.
The Chairman. There are, there are. Does the legislation--
of those hundreds of other tokens that are not generally
considered to be commodities, would FIT 21 continue to place
the jurisdiction over those other tokens with the SEC?
Ms. Thornton. I think the problem with FIT 21 is it is a
way of resolving the jurisdiction between the CFTC and the SEC
so that it makes no difference what the SEC thinks because by
the time it weighs in, the tokens are already being traded on
the spot market and the CFTC has to unwind something. And there
are hundreds of other tokens--
The Chairman. Ma'am, I just--I don't think that is an
accurate description, and in fact, alleging that the creation
of this brand-new regime is problematic is just not consistent
with the facts on the record. What we know now is by your own
answers, the CFTC already has a robust role in this arena, and
in fact, in the wake of Dodd-Frank when they were provided
grand new authorities to deal with OTC swaps, there were no
failures. There were no problems. I think the broad-based
assessment by industry is that they did a magnificent job
stepping up and filling that gap, because it built on their
already existing expertise. That is--they are already doing so
much of this. Again, 90 percent of the volume, I probably would
have said 70 or 80, but we can take your assertion at face
value.
And so, I just want to provide greater context around the
robust role the CFTC is already playing in commodity spot
markets, and in digital assets, the overwhelming majority of
digital assets.
Sir, Travis, I would like to come to you. We are South
Dakotans so we get to be buddies with one another.
You noted that CFTC reauthorization would really be a vote
of confidence. Tell me more of what you mean by that.
Mr. Antonsen. Yes. I think knowing that whether it is
farmers or agribusinesses knowing that we get to come to the
table and talk about changes that need to be made, adjustments
that should happen, that that is happening from the
reauthorization process. I think from our standpoint I think we
are happy with--we are okay with the regulatory environment
around what is going on with--in the markets and in the
regulations around that. So, I think just knowing, giving us
the confidence that there is going to be integrity in the
marketplace and it is going to be efficient.
The Chairman. Very good.
Mr. Sexton and Mr. Lukken, share you thoughts on this vote
of confidence idea. Do the markets really care? Do market
participants really care?
Mr. Lukken. There is some uncertainty out there. I mean, I
just think the lack of confidence for the CFTC, as Chairman
Behnam noted, going overseas to his colleagues knowing that
there hasn't been a Congressional blessing of the agency in
over 15 years. I mean, that is something I think that it would
be easy to do for this Committee, straightforward to do for
this Committee, and long overdue.
Mr. Sexton. I would agree that reauthorization recognizes
the critical role of the CFTC, both domestically as well as
internationally, and it is very important for Congress to do.
The Chairman. We have a couple of other Members on their
way who I know want to ask some questions, so I may exceed my
time a little bit here, because I do--we want to fill out the
record--oh, Mr. Nunn is here. Very good.
I have questions about the bankruptcy thing, the issues
that you brought up, Mr. Sexton. Mr. Lukken, I think you
mentioned it as well. But let's go to Mr. Nunn and we can
always double back.
[The information referred to is located: for Mr. Lukken, p.
43; Mr. Sexton, p. 44.]
Mr. Nunn. Well, I want to thank the chair, and I believe
strongly here that CFTC does have an important role here,
particularly when it comes to those lanes in the road that our
industry is asking for, particularly when it comes to digital
assets. I think that CFTC has a better role to play than where
the SEC has tried to insert itself. So, I will begin with that.
I also want to thank everybody here from the Commodity
Futures Trading Commission to ensure that our markets are safe
and strong. I know you are each committed to this.
Our derivatives markets remain the envy of the world, and
that is something we should be very proud of. We should also
work to maintain. I want to thank the stakeholders of this
Committee who have helped our marketplace weather some pretty
tough storms in recent years. Our markets are stronger, more
resilient, but there is more to be done to make sure that we
don't unintentionally hinder them.
With that, I want to move to farmers in my district in
Iowa. One of the programs that I think has really worked well
here has been this Internal Whistleblower Program that CFTC
oversees. The program is crucial for the accountability and
protecting of agricultural and financial markets. It also
benefits Iowans and all Americans.
Just last month, they uncovered a corruption at a company
thanks to a whistleblower that resulted in a $55 million fine,
meaning the American taxpayers aren't paying for this. We are
calling out bad actors and those bad actors then have to pay
for their own policing. As I understand it, a large bulk of the
policing comes from the Whistleblower Program. If we don't act
before October 1, though, this Whistleblower Program could
become defunct due to it not having enough funds to continue.
So, I introduced, along with Representative Don Davis from
North Carolina, a colleague on the other side of the aisle, and
my senior senator, Senator Chuck Grassley, H.R. 4935, the CFTC
Whistleblower Fund Improvement Act, to permanently address this
accounting flaw.
Very quickly, I want to ask each member of the panel, do
you see yourselves committing to make sure the Whistleblower
Program remains solvent? Could I get a yes, or if there is an
equivocation, let me know that.
Mr. Lukken. Yes.
Mr. Sexton. Yes.
Mr. Antonsen. Yes.
Ms. Thornton. It is an important program, but obviously the
details would need to be clear before we would have a strong
opinion.
Mr. Nunn. Let me ask then, what things would you see
needing to be done to make sure the program remains solvent,
Ms. Thornton?
Ms. Thornton. Well, I just think one should consider
whether it is sustainable as a long-term way to fund
enforcement and find enforcement. That is more along the lines
of what I am thinking.
Mr. Nunn. If not for this program, how would we discover
more of the bad actors inside? I mean, I think that is the
fundamental part where both of us would agree, this is highly
important. We don't want to incentivize folks to have to go out
there and police themselves, but we do want to recognize there
has got to be a clean pathway for folks to be able to raise
their hand and say, the Federal Government or my agency is not
working. I need somebody to come and investigate this.
Ms. Thornton. Yes, that is certainly a fair question, but I
also think that the CFTC needs more funding to carry out its
existing duties, one of which is enforcement.
Mr. Nunn. Well, I think that bad actors have a
responsibility in helping shoulder that far more than the
taxpayer, but I hear what you are saying there.
Mr. Antonsen, I would like to now turn to capital market
formation. I share your concerns about the potential impact
here of rules proposed by some unelected bureaucrats in
Washington making a lot more red tape for everyday working
Americans and farmers.
With the average price of one tractor in my home State of
Iowa at nearly $\1/2\ million, this is a major investment for
anyone, whether you are a small farmer or whether you are a
beginning farmer, and it directly hurts our ability to grow.
Let me ask this. How can we ensure that the CFTC operates in a
way that supports the markets while avoiding unnecessary
burdensome red tape coming out of Washington?
Mr. Antonsen. That is a good question. I mean, we are
coming today that we don't really have an ask, right, on CFTC
reauthorization. We feel it is working correctly. I agree with
you as a farmer in South Dakota, I know the economics of that
as well. So, I think current status quo is okay for regulations
on agribusinesses and those trading with farmers to make sure
the system works well.
I feel it is--we are getting into tougher times. I think
the next year or two is going to be even tougher than the past
couple years at the farm-gate, so I would agree with you.
Mr. Nunn. As we highlighted with our Chairman, my home
state a bushel of corn, $3.89. A break-even point is $4.85.
Three years ago, we were over $8 a bushel. America's farmers,
farming communities, and the entire country is going to
experience a spike in costs if regulation is one of the reasons
that it causes an American farmer to have to spend more time
filling out paperwork than actually being in the field. I know
you know that.
Thank you very much, Mr. Chairman. I yield the remainder of
my time.
The Chairman. Of course, we care about Iowa corn farmers
and the prices your folks have, Mr. Nunn, but coming from a
state where our yields are 30 percent less than yours, would
you just stop? We are not going to feel bad for you.
Mr. Nunn. Mr. Chairman, you have an entire palace to corn.
I appreciate everything you do.
The Chairman. Well, that is true.
Mr. Nunn. Thank you.
The Chairman. I think we are prepared to close the hearing.
With that, I would offer the Ranking Member to make any closing
comments she would have.
Ms. Caraveo. Well, thank you again to the witnesses for
your testimony. It is really important to hear from you all as
we consider this very important reauthorization, and I would
like to thank the Chairman again for his collaborative
approach, not just to the way that this Subcommittee is run,
but in the way that he approaches legislation, and I look
forward to continuing to collaborate as we look at this very
important reauthorization as the CFTC--as we look at the CFTC's
need to regulate all commodities, including digital assets.
The Chairman. Yes, so many of our colleagues--not on this
Committee, of course, this Committee is great. But so many of
our other colleagues, they like fighting more than they like
governing, and of course, people on this dais actually
understand that it is our job to try and govern a country. And
of course, our panelists have helped with that today. You have
all to a person provided good, specific recommendations for how
we can advance and we are going to take that under advisement.
Obviously, it will be an ongoing conversation. It is not just
like your 5 minutes under the clear lights are the only way
that you can feed into this process.
So, with that, I would note that under the Rules of the
Committee the record of today's hearing will remain open for 10
calendar days. That gives us an opportunity to receive
additional material and written responses from the witnesses,
to the extent that any Member wants to follow up for the
record.
The hearing of the Subcommittee on Commodity Markets,
Digital Assets, and Rural Development is adjourned.
[Whereupon, at 9:45 a.m., the Subcommittee was adjourned.]
[Material submitted for inclusion in the record follows:]
Supplementary Information Submitted by Hon. Walter L. Lukken, J.D.,
President and Chief Executive Officer, Futures Industry Association
Insert 1
The Chairman. We have a couple of other Members on their way
who I know want to ask some questions, so I may exceed my time
a little bit here, because I do--we want to fill out the
record--oh, Mr. Nunn is here. Very good.
I have questions about the bankruptcy thing, the issues that
you brought
up . . .
In your testimony, you discussed the bankruptcy
protections afforded to derivatives contract customers
and futures commission merchants beyond that provided
by the U.S. Bankruptcy Code. Can you please describe
the bankruptcy protection framework provided by the
Commodity Exchange Act and Commission regulations, and
the importance of this framework from your perspective?
The sanctity of segregated customer funds in the event of an FCM
bankruptcy is a critical tenet of the CFTC's customer protection
regime.
There are various rules enacted by the CFTC that ensure that
customer funds are--at all times--segregated and protected in the event
of a default. These include a prohibition of an FCM from using the
funds of one customer to meet the obligations of another customer. FCMs
are also required daily to ``top-up'' customer margin amounts under a
given CFTC ``residual interest'' formula to serve as a buffer against a
shortfall in the customers' accounts. Under CFTC rules, FCMs guarantee
their customers' trades by stepping into the shoes of a customer during
a default and using the FCM's funds to meet a failing customer's
obligations to a DCO.
If one or more customers of an FCM default on their obligations to
the FCM and the loss is so great that, notwithstanding the application
of the FCM's available funds, there is a shortfall in the amount of
customer funds, the FCM will likely default and be placed into
bankruptcy.
In these circumstances, the Bankruptcy Code and Commission rules
provide that, in the event of an FCM's bankruptcy, losses within each
fund--the U.S. Customer Segregated Account, the Foreign Exchange
Customer Account, and the Cleared Swaps Customer Account--are walled
off and treated separately from other customer account classes.
The Bankruptcy Code also provides that all FCM customers with funds
in each account class with losses, including non-defaulting customers,
shall share in any shortfall pro rata. However, customers whose funds
are held in another account class that has not incurred a loss will not
be required to share in such a shortfall.
This segregation of account classes allows failing FCMs to ``port''
these protected customer account classes to another healthy FCM--
another important feature of clearing that prevents the fire sale of
positions during stressed markets.
The collective attributes of clearing, in combination with these
noted bankruptcy protections, have been shown to protect customers and
the clearing system from disorderly defaults and contagion during
market turmoil.
Insert 2
Mr. Costa. Well, Mr. Chairman and the Ranking Member, my time
has expired but I think this is something that we need to look
at in greater depth. When Mr. Lukken made his comment about
prudence and overcapitalization, I am very curious about how he
measures prudence or is that in the eye of the beholder? And
then how do you measure the risk?
Post financial crisis, the G20 nations came together on certain
pillars of reform of the financial markets to improve the safety and
integrity of the financial system. Congress enacted these reforms as
part of the Dodd-Frank Act, which sought to bring more products onto
regulated clearinghouses, increase capital for certain bank activities,
and improve the transparency of over-the-counter trades through
centralized trade repositories. Since Dodd-Frank's enactment, we have
seen tremendous growth in the number of OTC trades that clear in a
safer and more predictable manner. This has been positive for the
integrity of the markets and has led to other clearing mandates, such
as the recent SEC requirement to clear certain U.S. treasury securities
and repo transactions. The Basel capital reforms also aimed to increase
the amount of bank capital post-financial crisis and align the capital
levels with the riskiness of the activity.
Unfortunately, recent ``End Game'' Basel Capital proposals by
Prudential Regulators failed to recognize the risk mitigation effects
of clearing, suggesting reforms that disincentivized clearing. This
could lead to higher costs for hedgers and less clearing capacity in
the system. There has been broad consensus among derivatives end-users
and commodity producers that these capital reforms impacting hedgers'
ability to clear need to be amended. Recent remarks by Federal Reserve
Vice Chair Barr indicate that the Federal Reserve plans to revise the
proposed Basel reforms on client clearing to better recognize the risk
reducing effect of this activity. FIA strong supports these changes.
______
Supplementary Information Submitted by Thomas W. Sexton III, J.D.,
President and Chief Executive Officer, National Futures Association
Insert
The Chairman. We have a couple of other Members on their way
who I know want to ask some questions, so I may exceed my time
a little bit here, because I do--we want to fill out the
record--oh, Mr. Nunn is here. Very good.
I have questions about the bankruptcy thing, the issues that
you brought
up . . .
In your testimony, you discussed the bankruptcy
protections afforded to derivatives contract customers
and futures commission merchants beyond that provided
by the U.S. Bankruptcy Code. Can you please describe
the bankruptcy protection framework provided by the
Commodity Exchange Act and Commission regulations, and
the importance of this framework from your perspective?
Section 20 of the CEA gives the Commission the authority to
promulgate regulations regarding the bankruptcy of certain CFTC
registrants. The Commission has promulgated bankruptcy regulations
pursuant to this authority under Part 190 of the CFTC's regulations.
The CFTC's Part 190 regulations contain key provisions that govern FCM
bankruptcies and are designed to provide critical customer protections.
Part 190 contains an overriding objective for a bankruptcy trustee
to transfer customer assets including open futures contracts to a
solvent FCM rather than liquidating the customers' assets--a key
protection that helps ensure market stability and protects customers
from losses related to a sudden liquidation event. However, in certain
instances (e.g., a shortfall in customer funds), a bankruptcy trustee
may not be able to effectuate this transfer. Therefore, in the event
there is a shortfall in customer funds in an FCM bankruptcy, Part 190
provides a critical customer protection that gives FCM customers
priority over essentially all other claimants (e.g., general creditors)
until bankruptcy estate assets are available to make customers whole.
As noted in NFA's written testimony, NFA believes there is one
aspect of the CEA that needs to be strengthened by Congress to better
protect customers in the event of an FCM bankruptcy. While the Part 190
regulations provide that customers shall have priority over essentially
all other claimants, a bankruptcy court in the past found that the
Commission lacked statutory authority to give this protection by
regulation to customers. See In re Griffin Trading Company, 245 B.R.
291 (Bankr. N.D. Ill. 2000). Although this decision was subsequently
vacated on other grounds, 270 B.R. 882 (N.D. Ill 2001), a cloud of
doubt continues to linger over the validity of the CFTC's rule. NFA,
the CFTC and industry participants have consistently urged Congress to
include a fix to this Griffin issue in any CFTC reauthorization
legislation. We believe an effective solution is to amend Section 20 of
the CEA, which gives the CFTC authority to adopt regulations regarding
commodity brokers that are debtors under Chapter 7 of Title 11 of the
United States Code, to clarify that the CFTC has the authority to adopt
the regulation providing customers with priority over essentially all
other claimants (e.g., general creditors) until bankruptcy estate
assets are available to make customers whole. A proposed amendment to
Section 20 of the CEA has been included in previous reauthorization
bills voted out of both the Senate and House Agriculture Committees,
and NFA believes there is a broad base of industry support for this
approach.
______
Submitted Questions
Response Submitted by Hon. Walter L. Lukken, J.D., President and Chief
Executive Officer, Futures Industry Association
Questions Submitted by Hon. Dusty Johnson, a Representative in Congress
from South Dakota
Question 1. Could you please comment on the adequacy of the
examinations carried out by both the CFTC's and NFA, whether they have
suffered from a lack of funding, and whether those examinations should
or could uncover all market abuse?
Answer. The CFTC and NFA are important `cops on the beat' in their
oversight of our growing risk management markets. These complementary
regulators partner with other self-regulatory organizations, such as
exchanges and central counterparties, to provide broad oversight
coverage of the markets and their participants. While it is difficult
to comment on the adequacy of the examinations carried out by both the
CFTC and NFA, I have found this self-regulatory model to be an
incredibly cost-effective way to police these markets for fraud,
manipulation, and abuse. I am not aware of instances where funding has
caused a lapse in examinations or adequate oversight using this
structure.
Question 2. As both a member of the Commission and as the head of a
major trade association, you've had a front row seat to the
Commission's activities for over twenty years. Are you familiar with
any instance where the Commission failed to fulfill its mission and
statutory obligations because of a lack of funding?
Answer. I fully support ensuring the CFTC is fully funded to
accomplish its mission and oversee our growing markets. From my time as
a Commissioner and Acting Chair of the Commission, and now as the
President and CEO of FIA, I am not aware of an instance where the
Commission failed to fulfill its mission and statutory obligations
because of a lack of funding.
Question 3. Could you please explain for us the process under the
Commodity Exchange Act (CEA) and Commission regulations for exchanges
seeking to list new contracts or make changes to their rulebooks?
Answer. With the passage of the Commodity Futures Modernization Act
of 2000, Designated Contract Markets (DCMs) were allowed to list for
trading new contracts or make changes to their rules by self-certifying
with the Commission that the new contracts or rules comply with the
core principles of the Commodity Exchange Act (CEA) and the
Commission's regulations. The Congressional enactment of self-
certification was meant to address concerns that U.S. exchanges were at
a competitive disadvantage to foreign exchanges caused by lengthy
delays in contract or rule approvals. To ensure compliance with the
CFTC's core principles, Congress required DCMs to file a written self-
certification with the CFTC that shows the rule or contract filings
comply with the core principles except for such files that are seen as
complex or novel. This process has proven to be a cost-effective way
for U.S.-registered exchanges to innovate and stay competitive with
foreign competitors while also ensuring compliance with the core
principles of the Act.
Question 3a. Are you familiar with any instance where the CFTC
failed to meet its requirements under the CEA and regulations with
respect to the listing of new contracts or rule changes because it
didn't have the funding to do so?
Answer. I am not aware of any instance where the CFTC failed to
meet its requirements under the CEA and regulations with respect to the
listing of new contracts or rule changes because it didn't have the
funding to do so. In fact, I would contend the self-certification
process has freed up valuable staff time of the CFTC to focus on more
substantive abuses in the markets, instead of the administrative tasks
associated with product or rule approvals.
Question 3b. Do you or your members find that the CEA's processes
for listing contracts and making rule changes ``unnecessarily burden
market participants with costs and complexities that are inconsistent
with the law and core principles?''
Answer. Generally, the self-certification process for exchanges to
list new products or amend their rules has served the markets and
industry well, allowing for greater innovation and enhanced
competition.
Regarding rule changes, specifically, I would like to flag a
discrepancy in the current process for Systemically Important
Derivatives Clearing Organizations (SI-DCOs) and Derivatives Clearing
Organizations that are not deemed to be systemic. Under CFTC Rule 40.6,
non-systemic DCOs that submit rules or rule amendments that raise novel
or complex issues for approval require an opportunity for public
comment. However, SI-DCOs are not required to seek public comment for
novel and complex rule changes that affect their members.
FIA believes the Commission's approval process for SI-DCO rules
under CFTC Rule 40.10 should require an opportunity for public comment
when a SI-DCO rule raises novel or complex issues similar to non-
systemic DCOs. This is particularly important for rule changes
impacting the risk profile and responsibilities of a DCO's clearing
members who are charged to collect margin from customers and contribute
to a mutualized default fund aimed at protecting the clearing system
from contagion risk. We believe a time-limited comment period would
result in a more informed and deliberative rulemaking process that
ultimately benefits both DCOs and market participants and we encourage
the CFTC to reconcile these rules accordingly.
Question 4. Could you please describe for us the marketing and
other restrictions placed upon market participants in their
solicitation and servicing of customers under the CEA, CFTC
regulations, and NFA regulations?
Answer. The NFA and CFTC have robust rules in place related to
marketing and other restrictions placed upon market participants in
their solicitation and servicing of customers. This includes NFA
regulatory obligations around sales practices and promotional
materials, NFA disclosure requirements for Members engaging in
activities related to virtual currencies or virtual currency
derivatives, and CFTC rules for introducing brokers to maintain tape
records of all oral communication with clients.
Question 5. Could you please explain the requirements that the CEA
imposes on the CFTC with respect to how it manages the confidential
information from market participants that it holds?
Answer. Section 8(a) of the CEA prohibits the Commission from
disclosing information that would separately disclose the business
transactions or market positions of any person or trade secrets or
names of customers. This section is incredibly important because of the
sensitive market information the CFTC receives from large traders in
our markets, which, if not protected and publicly disclosed, could
distort prices and harm the public. For this reason, the CFTC must be
diligent in its enforcement of Section 8 protections and periodically
review the information it collects to ensure the information continues
to meet a public need.
Question 6. Could you provide your thoughts on if elevating the
position of Chief Information Security Officer at the CFTC would ensure
that information security issues are front of mind for the Chairman and
Commissioners?
Answer. For the reasons stated in the previous answer, I would
support elevating the position of Chief Information Security Officer at
the CFTC so that the position reports directly to the Chairman.
Questions Submitted by Hon. David Rouzer, a Representative in Congress
from North Carolina
Question 1. Mr. Lukken, you mention we have seen an increase in new
technologies under the CFTC's purview, such as digital assets and
artificial intelligence. To me, the best approach when it comes to
these novel technologies is for the CFTC to set clear, enforceable
rules of the road while also knowing when to get out of the way and
allow firms the flexibility to innovate. I fear failing to provide
clarity will only lead to uncertainty and firms looking elsewhere to
create--a loss for American industry and consumers.
In a previous hearing, I asked Chairman Behnam about the
possibility of the CFTC creating an AI sandbox to allow firms to test
products. He mentioned that there could be legal limitations on
creating such a sandbox.
As we look towards reauthorization, how could Congress help give
the CFTC the tools it needs to allow firms to responsibly experiment
with emerging technologies?
Answer. According to former Chairman of the CFTC Christopher
Giancarlo, ``The CFTC lacks the legal authority to partner and
collaborate with outside entities engaging directly with fintech within
a research and testing environment, including when the CFTC receives
something of value absent a formal procurement.'' \1\ *
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\1\ https://www.cftc.gov/PressRoom/SpeechesTestimony/
opagiancarlo70.
* Editor's note: the link refers to Mr. Giancarlo's prepared
statement submitted for the May 1, 2019, hearing before the
Subcommittee on Commodity Exchanges, Energy, and Credit of the House
Committee on Agriculture entitled, The State of the Commodity Futures
Trading Commission, pp. 8-15. The hearing, in its entirety, is retained
in Committee file.
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FIA supports efforts to improve the research and development
capabilities of the CFTC. This includes legislative efforts, such as
those led by Representative Austin Scott, that would provide the CFTC
transaction authority to engage in public-private partnerships with
financial technology developers.
Jurisdictions outside of the U.S., like the Monetary Authority of
Singapore, have established FinTech Regulatory Sandboxes. Singapore has
established a framework that enables financial institutions and FinTech
players to experiment with innovative financial products or services in
a live environment but within a well-defined space and duration.
Question 2. Agriculture is an industry that can carry a lot of risk
and heavy up-front costs, especially for a new or young farmer starting
from scratch. I wonder if more can be done to educate our next
generation of farmers about the derivative products that may be
available to them to manage their risk and avoid catastrophic losses,
one of the major barriers for many looking at entering the industry.
This is especially important today as slumping crop and livestock
prices, record high input and labor prices, and increasingly volatile
markets have pushed many out of production.
You mention FIA's support of efforts to expand educational
resources for producers. How could Congress encourage additional
partnership between the CFTC, organizations and governmental entities
such as Farm Credit or the Farm Service Agency to help better inform
our farmers about these available tools?
Answer. FIA strongly supports additional education for farmers and
ranchers on the use of the derivatives markets for hedging market risk
in production agriculture. This can be improved by expanding the CFTC's
ability to partner with not-for-profits, private sector educational
initiatives or other government entities, like the USDA, to provide
educational resources about the opportunities and risks of these
hedging tools like futures and other cleared derivatives. FIA believes
the CFTC Office of Customer Education and Outreach (OCEO) would be a
good place for Congress to target. We understand this office is, by
statute, able to pay for ``customer education initiatives designed to
help customers protect themselves from fraud or other violations.'' We
have heard concerns that this narrow language limits the OCEO's ability
to provide education to help customers beyond protecting them from
``fraud or other violations.'' Congress could consider expanding the
mandate of the OCEO beyond fraud or other violations to areas designed
to educate farmers on the use of these risk management tools.
Response Submitted by Thomas W. Sexton III, J.D., President and Chief
Executive Officer, National Futures Association
Questions Submitted by Hon. Dusty Johnson, a Representative in Congress
from South Dakota
Question 1. Could you please comment on the adequacy of the
examinations carried out by both the CFTC and NFA, whether they have
suffered from a lack of funding, and whether those examinations should
or could uncover all market abuse?
Answer. NFA's examinations, in conjunction with our day-to-day
oversight activities, are designed to identify instances of NFA Member
non-compliance with NFA's rules and CFTC regulations, which include
instances of Members engaging in market abuse.\1\ In instances in which
our examinations uncover fraud, NFA and the CFTC work together to
promptly address any ongoing fraudulent activity and limit customer
harm. While no oversight program can guarantee that all instances of
market abuse and fraud will be uncovered, NFA's rigorous risk-based
Member monitoring program is designed to detect fraud and market abuse
as early as possible, take immediate action to stop fraudulent
activity, and ensure that bad actors are appropriately disciplined.
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\1\ NFA is not responsible, nor do we have access to the
information necessary, for overseeing trading activity on the
derivatives exchanges. Instead, derivatives exchanges have their own
self-regulatory responsibilities and surveil their markets. If our
examination work uncovers any indicia of market abuse occurring on an
exchange, we would refer that information to the relevant exchange and
the CFTC for follow-up.
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NFA's ability to conduct examinations has never been impacted by a
lack of funding. The CFTC relies primarily upon NFA to conduct
examinations of NFA Member firms. See NFA's response to Question 4
regarding the CFTC's oversight of NFA.
NFA is not in a position to answer this question's funding part,
which we opine should be directed to the CFTC.
Question 2. You've been with the NFA for over 33 years and have
served as President and CEO for 7 years. NFA clearly has a very close
relationship with the CFTC and are keenly aware of its operations. Are
you familiar with any instance over the past 33 years where the
Commission failed its mission and statutory obligations because of a
lack of funding?
Answer. NFA is not in a position to answer this question, which we
opine should be directed to the CFTC.
Question 3. Can you elaborate on how NFA uses mandatory membership
requirements to police the derivatives markets and impose essential
customer protections?
Answer. Part 170 of the CFTC's Regulations requires that, with few
exceptions, each registered futures commission merchant (FCM), swap
dealer (SD), introducing broker (IB), commodity pool operator (CPO) and
commodity trading adviser (CTA) become and remain a member of a
registered futures association (RFA). Section 2(c)(2)(B) of the CEA
imposes a similar requirement for retail foreign exchange dealers
(RFEDs). As a result, these industry participants are prohibited from
conducting derivatives business unless they are NFA Members.
A mandatory membership requirement is essential for NFA to oversee
derivatives market participants. NFA's basic mission is to impose
ethical and business conduct standards on its Member firms, and take
disciplinary actions against those Members that fail to abide by those
standards. In the absence of a mandatory membership requirement, firms
most in need of NFA's oversight would evade it by choosing not to
become NFA Members.
Question 4. How does the CFTC work to ensure that NFA is
effectively carrying out its regulatory responsibilities?
Answer. Given the important role that NFA plays in the U.S.
financial regulatory structure, it is essential that NFA's activities
are closely reviewed and monitored by the CFTC to ensure NFA is
fulfilling its regulatory responsibilities. The Commission's oversight
of NFA includes both formal actions, required by the statute or
regulations, and informal actions, which have evolved over time.
Formally, NFA's most significant actions are subject to the CFTC's
direct review and approval. For example, NFA is required to submit all
new and amended NFA rules to the Commission prior to implementation,
and the Commission may prevent NFA from making a rule effective.
Additionally, the Commission has the authority, in part, on its own
motion to review NFA disciplinary and registration/membership
decisions.
The CFTC also performs rule enforcement reviews (RERs) to ensure
that NFA is effectively carrying out its regulatory responsibilities.
In the last 2 years, the CFTC has performed several RERs covering NFA's
registration processes; FCM, CPO, CTA and IB programs including
examinations, processing of financial statements, FCM notice filings
and SD disciplinary actions; and the SD oversight program including
exams, staffing and disciplinary actions.
Informally, NFA is in daily contact with the CFTC to discuss
ongoing investigations, registration applications, examinations,
rulemaking issues or any myriad of issues that can arise. Further, we
generally meet quarterly with the CFTC's Chair and Commissioners to
discuss NFA's activities and industry regulatory issues. We also have
regularly scheduled coordination meetings with the Division of
Enforcement (DOE), Market Participants Division (MPD), Division of
Market Oversight (DMO), Office of International Affairs (OIA), Office
of Public Affairs (OPA), Office of Legislative and Intergovernmental
Affairs (OLIA), and the Office of Technology Innovation (OTI).
Question 5. Could you please explain for us the process under the
CEA and Commission regulations for NFA rule changes? Are you familiar
with any instance where the CFTC failed to fulfill its duties under the
CEA and regulations with respect to NFA rule changes because it didn't
have the funding to do so?
Answer. When NFA staff or our Member firms identify an issue or a
problem that may require additional rulemaking, we work with NFA Member
Advisory Committees, industry trade associations and the CFTC to draft
proposed rules and then present those rule proposals to NFA's Board of
Directors.
Section 17(j) of the CEA sets forth the requirements for NFA to
adopt a new rule or amend an existing rule (Rule Proposal). NFA is
required to submit all Rule Proposals to the Commission. In most
instances, NFA will submit the Rule Proposal and notify the Commission
that we intend to make it effective as early as 10 days after
submission unless the Commission notifies us that it has determined to
review the Rule Proposal for approval. NFA may also submit a Rule
Proposal and specifically ask for Commission review and approval of the
Rule Proposal. The Commission is required to approve the Rule Proposal
if the Commission determines that it is consistent with Section 17 and
not otherwise in violation of the CEA or regulations. The Commission
must approve a Rule Proposal or institute disapproval proceedings
within 180 days after receiving the Rule Proposal or such longer period
that the Commission and NFA agree upon.
NFA is not in a position to answer this question's funding part,
which we opine should be directed to the CFTC.
Question 6. Could you please describe for us the marketing and
other restrictions placed upon market participants in their
solicitation and servicing of customers under the CEA, CFTC
regulations, and NFA regulations?
Answer. NFA and the CFTC work collaboratively to oversee market
participants' customer-facing activities. NFA initially adopted
requirements in 1985 regarding its Members' solicitation activities and
promotional material usage. Further, NFA's rules require FCM and IB
Members to provide customers with Commission Regulation 1.55's risk
disclosure statement.
NFA's solicitation and promotional material rules govern our
Members' conduct with both retail and institutional (i.e., eligible
contract participant) customers and counterparties. NFA Compliance Rule
2-29 and its numerous related interpretive notices addressing specific
issues are the cornerstone of NFA's solicitation and promotional
material requirements. This rule prohibits Members from engaging in any
communications related to commodity interests that are fraudulent,
deceitful, employ or are part of a high-pressure approach or make any
statement that commodity interest trading is appropriate for all
persons. Further, the rule establishes specific requirements that are
designed to ensure that promotional material is not deceptive,
appropriately addresses trading risks and provides all material
information. The rule also sets forth specific requirements regarding
the use of hypothetical trading results, statements of opinion, and
audio and video promotional material that makes specific
recommendations.
Over the last 40 years, NFA has adopted numerous interpretive
notices related to NFA Compliance Rule 2-29, which address solicitation
and promotional material abuses, many of which involved retail
customers. These notices prohibit a Member from touting a strong
likelihood of profits to customers when its actual trading experience
does not support those claims and from using high-pressure sales
tactics. Further, they place restrictions upon Members' use of radio
and television advertisements and website and electronic
communications. Additionally, we require FCMs and other intermediaries
to disclose the full costs of trading to customers.
Question 7. Can you please describe the retail-focused markets that
the CFTC and NFA oversee? Please describe the customer protection
requirements that the CFTC and NFA impose on intermediaries in these
markets.
Answer. Both the exchange-traded derivatives and retail foreign
exchange (forex) markets include retail participants. Investor
protection is a critical component of NFA's mission. Today, industry-
wide interest in discussing retail participation and related topics
remains high. To facilitate discussion across the industry, NFA co-
hosted FIA's second annual Retail Roundtable event in February 2024,
which was attended by representatives from NFA Member firms with
significant retail customer bases, exchanges, law firms and clearing
firms. Topics addressed at the event included proposed significant
market structure changes like direct clearing DCOs, gamification, new
products, the need for further customer education and more.
A slight rise in retail interest and participation may be
occurring, but protecting investors has been part of the CFTC's and
NFA's mandate since inception. NFA and the CFTC have numerous customer
protection requirements, which we impose on intermediaries engaging in
exchange-traded derivatives. These requirements focus on the following:
anti-fraud and anti-manipulation protections; associated person
registration requirements; business conduct standards (e.g.,
solicitation and advertising); conflicts of interest prohibitions and
management; customer asset protections (e.g., segregated funds;
qualified third-party custodians hold customer assets/property and
acknowledge they are holding customer assets/property; limitations on
how customer funds may be invested; and bankruptcy protections); know-
your-customer and appropriate risk disclosure; maintenance of books and
records; minimum FCM and IB capital requirements; risk management
procedures; supervision requirements; trade practice surveillance
(e.g., detect abusive and manipulative trading practices); and full fee
disclosures.
NFA and the CFTC also apply, as permitted by law, many of these
customer protection requirements to RFEDs that act as a counterparty to
retail participants. Moreover, NFA has requirements in place to monitor
RFED trading platforms, which are designed to ensure that RFEDs execute
customer orders fairly and at prices that reasonably accord with
prevailing forex market prices.
Question 8. How does NFA help the Commission meet its regulatory
obligations? How important is NFA's cooperative role providing
oversight in new markets? What efficiencies and cost savings does NFA's
regulatory efforts provide to the CFTC?
Answer. NFA partners with the CFTC to regulate our Members'
derivatives activities. Our FY 2025 operating budget is approximately
$145M, and we have approximately 525 employees. NFA began operations in
1982 when Congress and the CFTC gave us the responsibility to regulate
firms engaging in activities with customers in the exchange-traded
derivatives markets. As Congress expanded the CFTC's jurisdiction over
the years to include the retail rolling forex spot and swaps markets,
Congress and the CFTC also entrusted NFA with additional regulatory
oversight responsibilities for these markets. If future legislation
establishes a CFTC regulatory framework for spot digital asset
commodities (DAC) and a role for a registered futures association, then
NFA looks forward to assisting the CFTC in regulating the DAC market
and is fully capable of performing the responsibilities required of an
RFA.
NFA works very closely with the CFTC to develop rules and
regulatory programs to effectively oversee our Members. NFA currently
has seven primary functions--registration, rulemaking, monitoring
Members, enforcement, market regulation, investor protection and
education and dispute resolution. Our successful regulatory partnership
with the CFTC is an effective structure for regulating the derivatives
markets and the rolling spot retail forex and spot DAC markets. In the
absence of this critical partnership, the CFTC would need to undertake
NFA's current functions.
Question 9. Could you provide your thoughts on if elevating the
position of Chief Information Security Officer at the CFTC would ensure
that information security issues are front of mind for the Chairman and
Commissioners?
Answer. NFA's Information Security staff meets regularly with the
CFTC's Information Security group, and based on our interactions, NFA
believes that the CFTC recognizes the significant security risks posed
to the agency and has measures in place designed to mitigate these
risks. Moreover, NFA believes that the CFTC Chair and Commissioners
currently recognize the magnitude of security threats. We are not able
to opine about the CFTC's Chief Information Security Officer's
reporting lines but believe this individual should work closely with
the CFTC's Chief Information Officer to mitigate any security threats.
[all]