The House Agriculture Committee last Thursday approved by voice vote legislation that would give the Commodity Futures Trading Commission (CFTC) the authority to carry out criminal prosecution of fraud and manipulation of commodity futures markets, but only in cases where the Department of Justice decides not to take action. The CFTC's existing authority is limited to investigation and prosecution of administrative and civil violations of the Commodity Exchange Act (CEA).
"Currently the Department of Justice has the sole power to initiate criminal proceedings against an alleged violator [of the CEA]. About one-third of these criminal activities are not being prosecuted," said Committee Chairman Collin Peterson (D-MN), chief author of the "Derivatives Markets Transparency and Accountability Act of 2009."
This bill (HR 977) also "brings long overdue transparency and managed risk to the over-the-counter [OTC] credit derivatives market by using the clearing model that has served the futures market well for decades," he said.
Under the measure, clearing of OTC transactions can occur through a CFTC-regulated facility or through a clearinghouse regulated by the Securities and Exchange Commission. But the measure prohibits the Federal Reserve from regulating clearing of OTC transactions. As an alternative to clearing, OTC transactions may be reported to the CFTC as long as reporting parties demonstrate financial integrity and abide by net capital regulations established by the CFTC.
The measure does not "outlaw" credit default swaps (CDS), but it does give the CFTC the authority to suspend CDS trading temporarily, with the consent of the president. CDS transactions are a form of insurance against the default of debt securities, which contributed significantly to the turmoil in the credit markets (see NGI, Dec. 15, 2008).
One day after the comittee approved the bill, CME Group bashed the legislation, saying it would drive "a significant portion" of OTC trading offshore and outside of the U.S. government's jurisdiction.
While CME commended the committee for attempting to ensure that the regulated exchange-traded futures and options markets and the OTC derivative markets serve the best interests of the investing public, CME does not support the bill.
"The legislation requires the imposition of hard position limits in already-regulated commodity and energy futures markets that will significantly impair liquidity necessary for commercial hedgers and market professionals such as farmers, energy producers and airline and transportation companies seeking to legitimately transfer business risks," CME said. "The bill is directly antithetical to its own purposes in that it will divert trading in highly regulated commodity and energy futures markets to less regulated OTC and foreign markets accessible to U.S. investors but beyond the reach or jurisdiction of the U.S. government."
CME said the legislation also imposes "artificial constraints" on the definition of hedge transactions that will impair OTC dealers from facilitating more complex hedging transactions and hedging their own net exposures from their swap dealing activities in regulated futures markets with the consequential result of further impairing hedging and risk transfer opportunities for U.S. investors. The trading exchange conglomerate added that the bill "effectively requires the mandatory clearing of virtually all OTC derivative contracts and will therefore drive a significant portion of OTC business offshore, lessening the regulatory effectiveness of the CFTC."
CME said it is open to working with lawmakers to continue to discuss proposals to "ensure a sound regulatory financial system."
The bill nearly mirrors legislation that Peterson introduced last year in an attempt to tame speculation in the energy markets. That measure (HR 6604) was approved by the House in July, but never cleared the Senate. A companion bill has been introduced in the Senate by Sen. Tom Harkin (D-IA), chairman of the Senate Agriculture Committee. It seeks to bring all OTC financial transactions, which currently are traded without federal oversight, onto regulated exchanges.
Like its predecessor, the new House agriculture panel bill also would require international exchanges that host U.S.-based commodities to share trading data with the CFTC and adopt speculative position limits similar to those impose by regulated exchanges in the United States.
The measure further requires the CFTC to disaggregate and publicly report the number and total value of positions of index funds -- and other passive long-only and short-only investors -- in all regulated markets, as well as data on speculative positions relative to their bona fide hedgers.
It calls on the CFTC to set trading limits for all physically deliverable commodities in order to prevent excessive speculation, and it would subject OTC transactions for all commodities to reporting and recordkeeping requirements. Traders would be required to keep records for five years.
Moreover, it proposes that the CFTC hire new full-time employees to carry out its enforcement activities, which would require an increase in the agency's annual budget. The CFTC told Congress last year that it needed $157 million or more annually to carry out its regulatory duties (see NGI, June 9, 2008).
The legislation requires the CFTC to study and report on the effects of potential position limits on OTC trading and aggregate limits across the OTC market, designated contract markets and derivative transaction execution facilities for agriculture and energy commodities. And it orders the agency to determine whether fungible OTC agreements have the potential to disrupt market liquidity and price discovery functions. If they do, the agency would be authorized to impose and enforce position limits for speculators trading the involved agreements.
Peterson's proposal also would require the Government Accountability Office to study and report on the international regulatory regime for energy commodity futures and derivatives trading.
CFTC Commissioner Bart Chilton last Tuesday urged Congress to give the agency the authority to pursue criminal prosecution of abuses in commodity futures markets.
"If the CFTC were to be given criminal prosecution authority, I think it would significantly enhance the deterrent effects of the existing regulatory scheme. The likelihood of criminal prosecution would increase and wrongdoers would have to raise their concern about the potential consequences of criminal conviction and penalties," Chilton told the Agricultural Roundtable of the Brookings Institution in Washington, DC.
"Other financial regulators around the world, including the Financial Services Authority in the United Kingdom and the regulator in Australia, already have such criminal authorities. I've spoken recently with several of my colleagues, current and former commissioners, Republicans and Democrats. This proposal makes sense to them and I'm hopeful that it will be considered by Congress," he said.
"When people violate the law and fleece folks out of their money, they should go to jail. We should have the ability to do more than simply [assess] civil penalties. I think the American people are sick and tired of letting swindlers get away without proper punishment."
While the CFTC currently can prosecute administrative and civil violations of the CEA. only the Department of Justice (DOJ) has the authority to prosecute criminal violations of the act. This "bifurcation of civil and criminal authority between the CFTC and DOJ creates obstacles to effective enforcement," Chilton said.
He noted that violations of the CEA often involve highly technical and complicated trading schemes. "Because of the complexity of cases under the CEA, DOJ prosecutors have been reluctant to take on these matters or have required that CFTC staff be assigned to assist DOJ prosecutors," Chilton said.
And since "DOJ prosecutors are responsible for a broad array of cases, including violent crime and money laundering, it is difficult to get them to commit scarce resources to prosecute complicated financial fraud and manipulation cases."
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