Transcript MODERNIZATION OF US FUTURES MARKETS AND POLICY

MODERNIZATION OF
US FUTURES MARKETS AND
POLICY IMPLICATIONS
FOR TURKEY
Ferhat OZCAM
April 22, 2003
Philadelphia, PA
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Overview Of
US Futures Markets
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History
Futures contracts for agricultural commodities have been traded in
the US for more than 100 years and have been under Federal
regulation since the 1920s. In the last 20 years, futures trading has
expanded rapidly into many new markets such as electricity, seafood,
dairy products, crop yields, and weather derivatives.
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Commodity Exchange Act
CEAct is the main law regulating futures market in the US. The bases
identified in the CEAct for regulating the futures markets are the
markets' price discovery and risk shifting functions.
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Commodity Futures Trading Commission
The CFTC was created by Congress in 1974 as an independent
agency to regulate commodity futures and option markets in the US.
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Overview Of
US Futures Markets

Self-Regulation
The regulatory structure established by the CEAct and CFTC
regulations relies heavily upon self-regulation by the SROs.
The CFTC designates and supervises contract markets (i.e.,
the futures exchanges) and registered futures associations
(i.e., NFA).
Although sometimes criticized for leaving too much compliance
responsibility with the market itself, this aspect of US futures
regulation has been recognized as both a material factor in the
competitiveness of US financial markets and a means of
limiting the cost of governmental intervention and oversight.
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Market Structure
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Financial Integrity of Marketplace
Open, Competitive and Fair Transaction Execution
Transparency
Review of New Products and Exchange Rules
Market and Trade Practice Surveillance
Customer Protection
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Structural And Technological
Change in Global
Futures Markets
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New Technologies
The emergence of new computer and communication
technologies is playing a critical role in the restructuring and
redefinition of the trading environment of the futures industry.
Electronic trading vs. pit trading.
The ultimate platform or platforms on which futures trading is
based will depend on demand from the market and the ability
of exchanges to adapt themselves to those demands and offer
customers the greatest value. To the extent that pit trading
efficiently offers value to customers, that system will endure. To
the extent, however, that electronic systems can replicate the
advantages of the pit and offer them at a lower cost to
customers, then that trading system will prosper and grow.
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Structural And Technological
Change in The Global
Futures Markets
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Exchange Consolidation
By merging and forming alliances, exchanges hope to capture
scale efficiencies by combining similar functions from separate
exchanges, such as administration tasks and clearing. They
also hope to create a larger customer base by providing better
access to a greater variety of contracts than previously
available at either of the exchanges.
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CFTC Study: 1999
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Both total US and total foreign futures and option trading volume
have increased significantly.
The US share of total worldwide futures and option trading activity
appears to be stabilizing as the larger foreign markets have
matured.
The most actively traded foreign products tend to fill local or
regional risk management needs and few products offered by
foreign exchanges directly duplicate products offered by US
markets.
The increased competition among mature segments of the global
futures industry, particularly in Europe, may reflect industry
restructuring and the introduction of new technologies, particularly
electronic trading.
The distinctions in regulatory regimes between various countries
do not appear to have been a significant factor in the competitive
position of the world's leading exchanges.
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Challenge
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Neither trends in the locus of trading activity nor
regulatory developments suggest an erosion of US
futures markets' global competitive position.
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However, the continued application of new
technologies and the trend toward exchange
consolidation are likely to change significantly the
competitive structure of global futures markets in
the coming years.
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Commodity Futures
Modernization Act of 2000
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Create different categories of exchanges with different regulatory
requirements
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Authorize futures trading on single stocks and narrow-based stock
indexes
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Provide legal certainty for swaps and hybrid instruments
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Provide for the trading of wholesale OTC derivative transactions free
of oversight and regulation by the CFTC
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Legal certainty for bank derivative products
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Close a regulatory gap by giving the CFTC limited jurisdiction over
retail OTC foreign currency transactions
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Flexible Trading Structure
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Intermediated Exchanges
There are three categories of intermediated exchanges
 Contract markets
 Derivatives transaction execution facilities
 Exempt boards of trade
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Electronic Trading Facilities
There are also two categories of principal-to-principal
electronic trading facilities that are very limited in what they
can trade
 Electronic trading facilities for exempt commodities
 Excluded electronic trading facilities
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Contract Markets
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Designated contract markets are most like traditional
futures exchanges. They may list for trading contracts
based on all types of products and may allow access to
their facilities by all types of traders, including retail
customers.
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Contract markets must comply with 18 core principles
that set in Section 5(d) of the CEAct.
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Derivatives Transaction
Execution Facilities
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DTEFs are trading facilities that limit access to institutional or
otherwise eligible traders.
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DTEFs are available to eligible traders for futures and option
contracts on commodities that have a nearly inexhaustible
deliverable supply, are highly unlikely to be susceptible to the
threat of manipulation, or have no cash market, security futures
products, and futures and option contracts on commodities that
the CFTC may determine, on a case-by-case basis, are highly
unlikely to be susceptible to the threat of manipulation.
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A registered DTEF must adhere to 8 core principles set in
Section 5a(d) of the CEAct.
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Exempt Boards of Trade
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Transactions by eligible contract participants in selected
commodities may be conducted on an XBOT under the CEAct.
Exempt boards of trade are subject only to the CEAct's anti-fraud
and anti-manipulation provisions. An exempt board of trade is
prohibited from claiming that the facility is registered with, or
recognized, designated, licensed or approved by the CFTC.
The commodities eligible to be traded on an XBOT are those that
are based on underlying commodities that have:
 A nearly inexhaustible deliverable supply;
 A deliverable supply that is sufficiently large, and a cash market
sufficiently liquid, to render any contract traded on the commodity
highly unlikely to be susceptible to the threat of manipulation; or
 No cash market.
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Electronic Trading Facilities
for Exempt Commodities
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These facilities can only trade exempt commodities, trading can
only be done by eligible commercial entities on a principal-toprincipal basis, and the trading facility must be electronic.
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Exempt commodities are defined as those commodities that are
neither “excluded commodities” nor agricultural commodities e.g., energies and metals.
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The term ''excluded commodity'' means an interest rate,
exchange rate, currency, security, security index, credit risk or
measure, debt or equity instrument, index or measure of inflation,
or other macroeconomic index or measure, etc.
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Excluded Electronic
Trading Facilities
These facilities can only trade excluded commodities,
trading can only be done by eligible contract participants
on a principal-to-principal basis, and the trading facility
must be electronic. The types of commodities that qualify
as excluded commodities are listed in the Act and
primarily involve financial commodities, indexes, and
contingencies.
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Security Futures
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Shad-Johnson Accord 1982
The CFMA lifts the 18-year the Shad-Johnson Accord's ban on
single-stock futures and narrow-based security indexes (security
futures products).
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Joint Regulation by the CFTC and SEC
The amendments give the CFTC and the SEC joint regulatory
authority over security futures products. In order to trade security
futures products, contract markets and DTEFs must also be
registered as limited purpose national securities exchanges.
Securities exchanges, ECNs, and NASD must also be registered
as limited purpose contract markets or DTEFs.
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Security Futures
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Different Aims
Joint regulation could pose some challenges for the two
agencies. The SEC’s traditional focus on investor protection and
full disclosure is different from the CFTC’s emphasis on
facilitating price discovery and commercial hedging. The ability of
two agencies to cooperate and fulfill the mandates of the CFMA
will be tested as the agencies fill in the specifics of the regulatory
structure through rulemaking.
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Swaps and
Hybrid Instruments
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Swaps
The CFMA provides legal certainty for swaps by excluding from
the Act any OTC transaction (other than in agricultural
commodities) that is entered into between eligible contract
participants and subject to individual negotiation.
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Hybrid Instruments
Hybrid instruments that are predominantly securities or banking
products are also excluded from the Act. The CFMA provides a
relatively simple test for determining what predominately a
security or banking product is.
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OTC Derivatives
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Until the CFMA, off-exchange futures trading was
punishable by up to 5-years imprisonment and a $1
million fine. After the CFMA, however, it was
perfectly legal to trade most futures anywhere after
qualifying as an eligible contract participant.
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For the first time in the history of federal futures law,
trading away from the regulated markets is now
permissible under certain conditions.
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Legal Certainty for
Bank Derivative Products
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The CFMA provides protection with respect to those OTC
derivatives that are offered, sold, or traded by commercial banks.
Congress intended the broadest possible exclusion from the
commodity law for transactions entered into by commercial
banks.
The law was enacted in part as an amendment to the GrammLeach-Bliley Act, which was intended to foster competition by
dismantling many legislative and regulatory barriers between
sectors of the financial services industry. This raises the question
of whether Congress has created an unlevel playing field for
derivatives dealers by giving a measure of legal certainty to bank
products and transactions that derivatives offered by other OTC
derivatives dealers lack.
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Foreign Currency Transactions
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The Treasury Amendment, which was added to the Act in 1974,
exempts certain commodities -including foreign currencies- from the Act
unless they are traded on a board of trade. The courts have interpreted
the Treasury Amendment to exempt all off-exchange transactions in
these products from the Act.
The CFMA amends the Treasury Amendment to provide that only
certain regulated entities can be parties to off-exchange foreign
currency futures and options transactions with customers who are not
eligible contract participants. Those regulated entities are:
- banks and other financial institutions,
- broker-dealers and their associated persons,
- futures commission merchants and their affiliated persons,
- insurance companies and their regulated subsidiaries and affiliates,
- financial holding companies, and
- investment bank holding companies.
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Futures Market in
Turkey
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Regulatory Framework
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The Capital Market Law: Article 22/j
“Duties and Authorities
Article 22 – The principal duties and authorities of the Capital Market
Board are indicated below:
…
j) To make regulations on the specifications and sale and purchase
principles of any derivative instruments, including futures and options
contracts based on economic and financial indicators, capital market
instruments, commodities, precious metals and foreign currency; the
rules and principles relating to supervision, obligations and activities
of those who shall be employed at the exchanges and markets where
these instruments shall be traded; and the principles for margining,
clearing and settlement system;”
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Futures Market in
Turkey
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Regulatory Framework
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The Capital Market Law: Article 40
“Exchanges and Other Organized Markets
Article 40 – …
Exchanges formed as legal entities exclusively for the trading of
futures and options contracts based on economic and financial
indicators, capital market instruments, commodities, precious metals
and foreign currency and for the capital market instruments
composed of all kinds of derivative instruments may be established
upon the suggestion of the Board and proposal of the Related
Minister and with the approval of the Council of Ministers. The
establishment, organization, operations, supervision, membership
rules and principles of these exchanges shall be determined by
regulations promulgated by the Related Ministry. If these exchanges
are established as joint stock corporations, they may not distribute
more than 20 percent of their annual profit. Capital market
instruments in the scope of this subparagraph are exempt from the
stamp tax.”
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Futures Market in
Turkey
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Current Market Structure
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Istanbul Gold Exchange
Futures and Options Market in the IGE was launched
on August 15, 1997. The gold futures contracts are
available for 100 troy oz and 1 kg of gold of 995
fineness. But few contracts were traded in this market
and it is inactive for a long time.
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Futures Market in
Turkey
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Current Market Structure
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Istanbul Stock Exchange
On August 15, 2001, the first futures contract on
TL/USD rate for $ 100,000 was launched. But after a
few contracts were traded, the market became
inactive.
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Futures Market in
Turkey
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Future Plan:
Izmir Futures and Options Exchange, Inc.
 The Capital Market Law: Article 40
 Decree of Council of Ministers on October 19, 2001
 Joint stock company
 The foundation of the exchange named Izmir Futures
and Options Exchange, Inc. then completed as a legal
entity but has not yet begun its operations.
 The exchange will apply to the CMB in order to
commence operation following the completion of
technical infrastructure.
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Policy Implications
for Turkey
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Single Exchange vs. Flexible Trading Structure
 Two unsuccessful contracts were tried to launch within relatively
matured cash markets, i.e. IGE and ISE. These exchanges have
been operating relatively for a long time and have expertise in
their markets. So, it shouldn’t be expected an institutional failure
in the success unless there is an evidence.
 So it shouldn’t be relied solely on a separate futures exchange
for the success of futures markets. Where the market structures
require, flexible trading structures ought to be considered. Article
40 of the Capital Market Law allows establishing such trading
structures.
 In fact, the challenge by these trading structures is not far with
the speed of technological developments.
 Later, it may be easier to consolidate these trading structures by
market forces internally or by regulation externally.
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Policy Implications
for Turkey
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Over-the-counter Market
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There is a substantial over-the-counter contract market in
Turkey especially among banks.
The Capital Market Law does not explicitly states that whether
these transactions are in the scope of the Capital Market Law
or not.
From the standpoint of prudential supervision, it is natural to
be taken into account these transactions by the respected
regulatory agencies
But this raises both the financial risks of individual
transactions and regulatory arbitrage issues stemming from
lack of uniform regulation. So, the status of the over-thecounter transactions and the banks’ position with regard to
these transactions should be clarified.
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