[Congressional Record Volume 146, Number 155 (Friday, December 15, 2000)]
[Senate]
[Pages S11918-S11927]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. LUGAR (for himself, Mr. Gramm, Mr. Harkin, Mr. Fitzgerald, 
        Mr. Hagel, and Mr. Johnson):
  S. 3283. A bill to reauthorize and amend the Commodity Exchange Act 
to promote legal certainty, enhance competition, and reduce systematic 
risk in markets for futures and over-the-counter derivatives, and for 
other purposes; read the first time.


            THE COMMODITY FUTURES MODERNIZATION ACT OF 2000

  Mr. LUGAR. Mr. President, I am pleased to rise today with Senators 
Gramm, Harkin, Fitzgerald, Hagel, and Johnson to re-introduce the 
Commodity Futures Modernization Act of 2000. This legislation is the 
Senate companion to H.R. 5660, which Congressman Thomas Ewing 
introduced yesterday in the House of Representatives and which will be 
enacted as part of the final appropriations package today. This 
monumental legislation is the culmination of two years worth of 
hearings and hard-fought negotiations, but I am confident that the 
resulting legislation will greatly benefit the U.S. financial industry. 
I commend all the Members and staff who have contributed to this bill. 
In particular, I want to applaud Senator Gramm, Congressman Ewing and 
Senator Fitzgerald for their stewardship and determination in helping 
pass a bill this year. Its enactment would not have occurred without 
their efforts. I also want to recognize Treasury Secretary Summers, 
Commodity Futures Trading Commission, CFTC, Chairman Bill Rainer and 
Securities and Exchange Commission, SEC, Chairman Arthur Levitt as well 
as their staffs, who have played a pivotal role in bringing this bill 
together and garnering support for its passage.
  This bill, which re-authorizes the Commodity Exchange Act for five

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years, would reform our financial and derivatives laws in five primary 
ways. First, it would incorporate the unanimous recommendations of the 
President's Working Group on Financial Markets on the proper legal and 
regulatory treatment of over-the-counter, OTC, derivatives. Second, it 
would codify the regulatory relief proposal of the CFTC to ensure that 
futures exchanges are appropriately regulated and remain competitive. 
Third, this legislation would repeal the Shad-Johnson jurisdictional 
accord, which banned single stock futures 18 years ago. Fourth, this 
legislation provides certainty that products offered by banking 
institutions will not be regulated as futures contracts. Finally, this 
bill provides legal certainty for institutional equity swaps by 
providing the SEC with express but limited authorities over these 
instruments.
  Derivative instruments, both those that are exchange-traded and 
traded over-the-counter, have played a significant role in our 
economy's current expansion due to their innovative nature and risk-
transferring attributes. The global derivatives market has a notional 
value that now exceeds $90 trillion. Identified by Federal Reserve 
Chairman Alan Greenspan as the most significant event in finance of the 
past decade, the development of the derivatives market has 
substantially added to the productivity and wealth of our nation.
  Derivatives enable companies to unbundle and transfer risk to those 
entities who are willing and able to accept it. By doing so, efficiency 
is enhanced as firms are able to concentrate on their core business 
objective. A farmer can purchase a futures contract, one type of 
derivative, in order to lock in a price for his crop at harvest. 
Likewise, automobile manufacturers whose profits earned overseas can 
fluctuate with changes in currency values, can minimize this 
uncertainty through derivatives, allowing them to focus on the business 
of building cars. Banks significantly lessen their exposure to interest 
rate movements by entering into derivatives contracts known as swaps, 
which enable these institutions to hedge their risk by exchanging 
variable and fixed rates of interests.
  Signed into law in 1974, the Commodity Exchange Act, CEA, requires 
that futures contracts be traded on a regulated exchange. As a result, 
a futures contract that is traded off an exchange is illegal and 
unenforceable. When Congress enacted the CEA and authorized the CFTC to 
enforce it, this was not a concern. The meanings of ``futures'' and 
``exchange'' were relatively apparent. Furthermore, the over-the-
counter derivatives business was in its infancy. However, in the 26 
years since the statute's enactment, the OTC swaps and derivatives 
market, sparked by innovation and technology, has significantly 
outpaced the exchange-traded futures markets. Thus the definitions of a 
swap and a future began to blur.

  In 1998, the CFTC issued a document containing a concept release 
regarding OTC derivatives, which was perceived by many as a precursor 
to regulating these instruments as futures. Just the threat of reaching 
this conclusion could have had considerable ramifications, given the 
size and importance of the OTC market. The legal uncertainty 
interjected by this dispute jeopardized the entirety of the OTC market 
and threatened to move significant portions of the business overseas. 
If we were to lose this market, most likely to London, it would take 
years to bring it back to U.S. soil. The resulting loss of business and 
jobs would be immeasurable.
  This threat led the Treasury Department, the Federal Reserve, and the 
SEC to oppose the concept release and request that Congress enact a 
moratorium on the CFTC's ability to regulate these instruments until 
after the President's Working Group could complete a study on the 
issue. As a result, Congress passed a six-month moratorium on the 
CFTC's ability to regulate over-the-counter derivatives. Despite 
reservations, I supported this moratorium because it brought legal 
assurance to this skittish market and it allowed the Working Group time 
to develop recommendations on the most appropriate legal treatment of 
OTC derivatives. In November 1999, the President's Working Group 
completed its unanimous recommendations on OTC derivatives and 
presented Congress with these findings. These recommendations remain 
the cornerstone of our bill.
  Our bill contains several mechanisms for ensuring that legal 
certainty is attained and that certain transactions remain outside the 
Commodity Exchange Act. The first, the electronic trading facility 
exclusion, would exclude transactions in financial commodities from the 
Act if conducted: (1) on a principal to principal basis; (2) between 
institutions or sophisticated persons with high net worth; and (3) on 
an electronic trading facility. The second would exclude these 
transactions if (1) they are conducted between institutions or 
sophisticated persons with high net worth; and (2) they are not on a 
trading facility.
  These exclusions attempt to address the advent of electronic trading 
and the changing and innovating nature of the financial industry. 
Indeed, we are keenly aware that there are newly emerging electronic 
systems that provide for the electronic negotiation of swaps agreements 
between and among large banks and other sophisticated major financial 
institutions acting as dealers. We do not intend for these systems to 
come within the definition of trading facilities.
  The third exclusion clarifies the Treasury Amendment language already 
contained in the CEA. It would exclude all transactions in foreign 
currency and government securities from the Act unless those 
transactions are futures contracts and traded on an organized exchange. 
As recommended by the Working Group, the bill would give the CFTC 
jurisdiction over non-regulated off-exchange retail transactions in 
foreign currency. Another important recommendation of the PWG was to 
authorize futures clearing facilities to clear OTC derivatives in an 
effort to lessen systemic risk and this bill incorporates this finding.
  As part of the legal certainty provisions, this legislation also 
addresses the concern that excluding OTC derivatives from the futures 
laws will cause these products to be fully regulated as securities. 
With Senator Gramm's leadership, this legislation adopts language that 
would provide the SEC with limited authority over institutional swaps 
for fraud, manipulation and insider trading. This language will help to 
provide the legal certainty that these institutional transactions lack 
under current law.

  Title four of this bill also provides legal certainty for banking 
products. Senator Gramm has appropriately raised the concern that 
traditional banking products should not be subject to the CEA. This 
language provides an exclusion for traditional banking products as well 
as hybrid products that are predominantly banking in nature. New 
products offered by banks that are not in existence on December 5, 
2000, or are otherwise not excluded from the CEA would fall under a 
``jump ball'' provision of the bill. This section provides a mechanism 
for the CFTC and the Federal Reserve to determine whether a new non-
traditional product offered by a bank should be regulated under the 
banking laws or the futures laws.
  The second major section of this legislation addresses regulatory 
relief. In February of this year, the CFTC issued a regulatory relief 
proposal that would provide relief to futures exchanges and their 
customers. Instead of listing specific requirements for complying with 
the CEA, the proposal would require exchanges to meet internationally 
agreed-upon core principals. The CFTC proposal creates tiers of 
regulation for exchanges based on whether the underlying commodities 
being traded are susceptible to manipulation or whether the users of 
the exchange are limited to institutional customers. Unsure of whether 
this legislation would be enacted, the CFTC went ahead and finalized 
its regulatory relief proposal on November 20, 2000.
  When enacted, this legislation will largely incorporate the CFTC's 
framework. A board of trade that is designated as a contract market 
would receive the highest level of regulation due to the fact that 
these products are susceptible to manipulation or are offered to retail 
customers. Futures on agricultural commodities would fall into this 
category. This bill also sets out that in lieu of contract market 
designation, a board of trade may register as a Derivatives Transaction 
Execution

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Facility, DTEF, if the products being offered are not susceptible to 
manipulation and are traded among institutional customers or retail 
customers who use large Futures Commission Merchants, FCMs, who are 
members of a clearing facility.
  Also, a board of trade may choose to be an Exempt Board of Trade, 
XBOT, and not be subject to the Act (except for the CFTC's anti-
manipulation authority) if the products being offered are traded among 
institutional customers only (absolutely no retail) and the instruments 
are not susceptible to manipulation. Our bill would allow a board of 
trade that is a DTEF or an XBOT to opt to trade derivatives that are 
otherwise excluded from the Act on these facilities and to the extent 
that these products are traded on these facilities, the CFTC would have 
exclusive jurisdiction over them. With this provision, the intent is to 
provide these facilities that trade derivatives with a choice--if 
regulation is beneficial, the facility may choose to be regulated. If 
not, the facility may choose to be excluded or exempted from the Act.
  By refraining from altering certain sections of the Act, this 
legislation re-affirms the importance of specific authorities granted 
the CFTC, including its anti-fraud and anti-manipulation powers. 
Section 4b is the principal anti-fraud provision of the Act and the 
Commission has consistently used Section 4b to combat fraudulent 
conduct by bucket shops and boiler rooms that entered into transactions 
directly with their customers and thus did not involve a traditional 
broker-client type of relationship. There have been cases involving the 
fraudulent sale of illegal precious metals futures contracts marketed 
as cash-forward transactions (CFTC v. P.I.E., Inc., 853 F.2d 721 (9th 
Cir. 1988)) as well as cases involving boiler room operations 
fraudulently selling illegal precious metals contracts to members of 
the general public. (CFTC v. Wellington Precious Metals, Inc., 950 F.2d 
1525 (11th Cir.), cert. denied, 113 S. Ct. 66 (1992)). This 
reaffirmation is consistent with both Congress' understanding of and 
past Congressional amendments to Section 4b that confirmed the 
applicability of Section 4b to fraudulent boiler rooms and bucket shops 
that enter into transactions directly with their customers.

  It is the intent of Congress in retaining Section 4b of the Act that 
the provision not be limited to fiduciary, broker/customer or other 
agency-like relationships. Section 4b provides the Commission with 
broad authority to police fraudulent conduct within its jurisdiction, 
whether occurring in boiler rooms and bucket shops, or in the e-
commerce markets that will develop under this new statutory framework.
  The bill's last section addresses the Shad-Johnson jurisdictional 
accord. In 1982, SEC Chairman John Shad and CFTC Chairman Phil Johnson 
reached an agreement on dividing jurisdiction between the agencies for 
those products that had characteristics of both securities and futures. 
Known as the Shad-Johnson Accord, this agreement prohibited single 
stock futures and delineated jurisdiction between the SEC and the CFTC 
on stock index futures.
  Meant as a temporary agreement, many have suggested that the Shad-
Johnson accord should be repealed. The President's Working Group 
unanimously agreed that the Accord should be repealed if regulatory 
disparities are resolved between the regulation of futures and 
securities. In March 2000, the General Accounting Office released a 
report that found that there is no legitimate policy reason for 
maintaining the ban on single stock futures since these products are 
being traded in foreign markets, in the OTC market, and synthetically 
in the options markets. Chairman Gramm and I sent a letter requesting 
the CFTC and the SEC to make recommendations on reforming the Shad-
Johnson ban. On September 14, 2000, the SEC and CFTC reached an 
agreement on the proper regulatory treatment of these instruments, and 
we have incorporated this agreement into our legislation.
  Under the legislation, the SEC and the CFTC would jointly regulate 
the market for single stock futures and narrow-based stock index 
futures. These products will be allowed to trade on both futures and 
securities exchanges. Single stock futures and narrow-based stock index 
futures (i.e., security futures) would be statutorily defined as both 
securities and futures, allowing the agencies the authority to regulate 
these instruments. However, to avoid redundancy, our legislation 
exempts these products from a series of regulations and requirements 
under both the securities and futures laws.
  Margin levels, listing standards, and other key trading practices 
would be jointly supervised by the SEC and CFTC. At the outset, margin 
levels for security futures products could not be lower than comparable 
margin levels required in the options markets. The tax treatment of 
these products would be comparable to the tax treatment of options on 
securities to ensure a level playing field between the markets.
  Futures on broad-based indices would be under the exclusive 
jurisdiction of the CFTC. The agreement sets out a ``bright-line'' 
formula for determining when an index is broad-based using the number 
and weighting of the securities contained in the index. This formula 
would allow a broad-based index to contain as few as 9 securities.
  The goal of this legislation is to ensure that the United States 
remains a global leader in the derivatives marketplace and that these 
markets are appropriately and effectively regulated. I believe that 
this legislation meets these objectives while ensuring that the 
public's interest in the financial markets is protected.
  This long legislative journey began two years ago when the Senate and 
House Agriculture Committees held a two day roundtable, in which 
distinguished individuals from the financial community participated. 
One of those individuals was Merton H. Miller, the Nobel Prize winning 
professor of economics from the University of Chicago, who passed away 
this summer. Professor Miller, known for his disarming sense of humor, 
his plain-spokenness and his generosity, is dearly missed by his 
family, friends and colleagues. The impact of his death has been 
particularly hard felt by the community of friends at the Chicago 
futures markets. Professor Miller was the primary intellectual force 
behind the development of the modern financial futures market and a 
staunch defender of the free market system. His body of work helped 
bring academic legitimacy to these markets, and he is sorely missed by 
them. As part of our roundtable discussion, we allowed each of the 
participants to make one wish for the coming 106th Congress. True to 
his life's work in this area, Professor Miller told us that Congress 
needed to lessen the cost of regulation on the futures and other 
financial markets in order to allow these markets to survive and 
compete in the global economy. I find it particularly satisfying that 
we are able to pass this historic legislation at the end of the 106th 
Congress and provide Professor Miller with his wish. I am confident 
that his legacy will live on through the success and growth of the 
markets that are benefitted by this legislation.
  Mr. GRAMM. Mr. President, today I join with Senator Lugar, Chairman 
of the Senate Agriculture Committee, and several others of our 
colleagues to introduce the Commodity Futures Modernization Act of 
2000. The formal purpose of this legislation is to reauthorize the 
Commodity Exchange Act, the legal authority for the Commodity Futures 
Trading Commission. As important as that is, this legislation does far 
more.
  This is a landmark bill that addresses the two major purposes that 
Senator Lugar and I set out to achieve when we first began discussing 
this legislation. First of all, this bill would repeal the so-called 
Shad-Johnson Accord, the 18-year-old temporary prohibition on the 
trading of futures based on individual stocks. Second, the bill 
eliminates the legal uncertainty that today hangs as an ominous cloud 
over the $60 trillion financial swaps markets.
  We are introducing the bill today as the finished product of years of 
work involving half a dozen committees in both Houses of Congress, and 
as many agencies of the Federal government. This bill is identical to, 
and is the Senate companion to, H.R. 5660, introduced yesterday in the 
House and which will be approved by the House and the Senate today. We 
introduce this bill in the Senate to demonstrate the bicameral 
authorship and support for this important legislation.
  For legislative history, I would direct my colleagues to statements 
made

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elsewhere in the Record in connection with House and Senate action on 
the House companion, part of the package of legislation approved 
together with the Labor HHS appropriations bill for fiscal year 2001.
  I would take this opportunity to thank Chairman Lugar and all who had 
a hand in forming this important legislation. All who had a hand in it 
deserve to be proud of this product.
                                 ______