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For release at
10:00 a.m. EDT
April 16, 1991
Testimony by
Alan Greenspan
Chairman
Board of Governors of the Federal Reserve System
before the
Committee on Banking, Housing, and Urban Affairs
of the
United States Senate
April 16, 1991
Mr. Chairman, members of the Committee, I welcome the
opportunity to discuss Title III of S. 207, the "Futures Trading
Practices Act of 1991."
Although many of the issues presented in
this legislation are highly complex, they are important to the
competitiveness and soundness of United States financial markets.
Consequently, I commend the Committee for undertaking to explore
them fully at this time.
There are two provisions of this Title
that have been of particular interest to the Board of Governors
of the Federal Reserve System, those dealing with margins on
stock index futures and those dealing with the exclusivity
provisions of the Commodity Exchange Act ("CEA").
As I have
noted in previous testimony and Congressional correspondence, the
Board supports Federal oversight of margins on stock index
futures, which is provided for in S. 207.
While we continue to
see good reasons for vesting that authority directly with the
Commodity Futures Trading Commission ("CFTC") or the Securities
and Exchange Commission, we accept the rationale for giving this
authority to the Board with latitude to delegate this authority
to the CFTC and, of course, would endeavor to discharge that
responsibility in a careful and serious manner.
Of more relevance to the hearing today is the matter of
the exclusivity provisions of the CEA.
I understand that there
are currently three alternative approaches to this issue that may
be considered; the approach passed by the Agriculture Committee;
another approach offered by the CFTC; and a third offered by
Senators Bond and Wirth.
Each of these approaches revises the
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exclusivity provisions of the CEA somewhat differently.
I would
like to comment on each alternative, but first I would like to
review with the Committee some of the history of this issue.
Under the so-called exclusivity provisions of the CEA,
contracts for sale of a commodity for future delivery are subject
to the exclusive jurisdiction of the CFTC.
In addition,
transactions in, or in connection with, such contracts can only
be conducted on, or subject to, the rules of a contract market
designated by the CFTC.
The CEA defines the term "commodity11
broadly to include not only agricultural products and other goods
such as oil, but also services, rights and interests.
This
language has been interpreted to include contracts for the future
delivery of financial interests such as the value of Treasury
securities or stock indexes.
Although the CEA excludes a number
of transactions, including contracts for deferred shipment or
delivery and transactions in foreign currency, government
securities, and mortgages, it nonetheless can be read to be
applicable broadly to many types of financial contracts.
In recent years, a wide variety of new products have
been developed to serve the investment and risk management needs
of the public.
Many of these products have had some of the
economic attributes of futures and their legality has been called
into question by the exclusivity provisions of the CEA.
For
example, over the last ten years, the swap markets have developed
and grown to involve transactions with $3 trillion in notional
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principal amount.
The vast majority of these transactions
involve interest rates or exchange rates, but in recent years a
significant number have involved goods such as oil or precious
metals.
In a swap transaction, the parties agree to make
payments to each other based on changes in interest rates or the
value of oil or other products.
Unlike exchange traded futures
contracts, these transactions are customized to the needs of
individual customers and are negotiated on a bilateral basis.
Thus, they represent important risk management tools to shield
financial institutions and others from fluctuations in interest
rates or the prices of the goods or instruments in which they
deal.
The customizing of these transactions to individual
customer needs as to maturity, payment intervals, or other terms
can offer significant advantages over standardized exchangetraded products by allowing the customer to adjust its individual
risk positions with greater precision.
Nevertheless, the exclusivity provisions of the
Commodity Exchange Act have cast a pall over this market,
particularly in the area of swaps linked to prices for goods such
as oil.
Investors and financial institutions have been concerned
that such transactions might be interpreted to be the economic
eguivalent of contracts of sale for future delivery under the CEA
and therefore be considered illegal off-exchange futures.
Thus,
an active market in swaps related to prices of goods did not
develop until the CFTC took administrative action to indicate
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that it would not view them as illegal off-exchange futures.
Even with this exemption, there continues to be concern that
developments in the swap markets may run afoul.
This specter has almost surely inhibited innovation,
not only in the swaps markets, but also in other financial
markets.
As early as 1989, the Board expressed its concern to
the CFTC that the provisions of the CEA would prevent financial
institutions from developing and offering new instruments to
manage risk and reduce the flexibility and competitiveness of
United States financial markets.
In a number of administrative actions, the CFTC has
taken steps to alleviate some of the problems created by the
exclusivity provisions of the CEA.
These actions have included a
Policy Statement indicating that the Commission would not
consider interest rate swaps and certain commodity swaps to be
illegal off-exchange futures.
In addition, the Commission
adopted rules excluding certain hybrid instruments, including
bank deposits, from the CEA provided that these transactions met
certain financial tests.
While these were constructive steps,
for which we commend the CFTC, administrative actions by
themselves cannot eliminate the uncertainty created by the
exclusivity provisions, and, therefore, remove the existing
impediments to innovation.
Administrative actions leave open the
possibility that exemptions will be revoked or that private
parties will raise the statutory prohibition in an attempt to
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invalidate specific transactions.
This uncertainty impedes the
development of new financial products.
S. 207, as passed by the Agriculture Committee,
attempts to address these issues, but does so in a way that is
less than satisfactory.
The Agriculture Committee version would
provide the CFTC with the authority to exempt certain
transactions including swap agreements and deposits from the CEA.
In order to exempt swap agreements, the CFTC would have to find,
after notice and the opportunity for a hearing, that the
exemption was in the public interest, the transactions are
entered into by a limited class of participants and that they
meet a number of restrictions.
The Agriculture Committee version
also would provide the CFTC with the authority to exempt bank
deposits if it determines, after notice and the opportunity for a
hearing, that the exemption would not be contrary to the public
interest.
While providing for certain exemptive authority, the
Agriculture Committee version would perpetuate impediments to
innovation in hybrid's and risk management products and would
forestall developments in swap markets that could reduce systemic
risk.
For example, some of the restrictions on the swap
exemption included in the Agriculture Committee version have the
potential to limit the exemption of some swap agreements
currently traded, as well as to inhibit the development of new
transactions.
The Board also is particularly concerned about the
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potential of these provisions to impede the development of
multilateral netting arrangements that are designed to reduce
counterparty credit risk and the resulting systemic risk to the
financial markets.
The importance of such arrangements was
recently recognized in a report released last November by the
Governors of the central banks of the Group of Ten Countries.
Moreover, such restriction lead to swap activity and any
associated netting arrangements moving offshore.
Further, the general exemptive authority in the
Agriculture Committee version is narrow and the CFTC may not be
able to make appropriate exemptions and the requirement for a
hearing would create a burdensome process that would in itself
limit the usefulness of the exemptive authority.
In addition,
the Agriculture Committee version also suggests that the CFTC
would have jurisdiction over some depository instruments and
lending transactions, even though banks are subject to a
comprehensive system of federal regulation designed to ensure the
safety of the institutions and to protect their depositors.
The alternative developed by the CFTC goes further in
expanding the CFTC's exemptive authority than the provisions of
the Agricultural Committee version, and might be viewed as an
improvement over the current law.
Nevertheless, this alternative
continues to rely on discretionary, and potentially restrictive,
exemptive procedures for dealing with swaps and bank deposits
rather than the more certain exclusionary approach of the Bond-
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Wirth alternative.
Further, it does not address lending
transactions at all.
The alternative language offered by Senators Bond and
Wirth, on the other hand, excludes certain swap transactions as
well as certain deposit and lending transactions from the
coverage of the CEA altogether, thus avoiding problems that may
arise from a cumbersome exemptive process and the potential for
revocation of any exemptions that may be granted for these
transactions.
It also would provide the CFTC with broader
discretionary authority to exempt any instrument if the CFTC
determines the exemption is consistent with the public interest.
The approach taken by this proposed alternative goes further to
alleviate the difficulties for the financial markets created by
the provisions of the CEA than the Agriculture Committee or CFTC
versions and therefore is in our judgment preferable,
particularly in the areas of swaps, bank deposits and lending
instruments.
The exclusion approach also would remove possible
conflicts in regulatory jurisdiction that might arise from
continued CFTC jurisdiction over swaps.
At the same time the
limitations on the exclusions ensure that these transactions are
subject to Federal oversight or
are limited to sophisticated
investors.
In conclusion, I believe that it is important that
Congress act to clarify the limits of the CEA in a way that
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permits innovation in United States financial markets so that
they can continue to be strong and competitive.
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