WASHINGTON - The Chicago Board of Trade, backed by a coalition of banks, and the Chicago Mercantile Exchange are squaring off over futures deregulation, and one of the issues at the center of the debate is the regulation of futures contracts in government securities.
Officials at each exchange late Thursday released letters sent to Sen. Richard Lugar, R-Ind., expressing completely opposite positions. Lugar is the main sponsor of S. 257, legislation that would strip a significant amount of the Commodity Futures Trading Commission's authority over the futures and derivatives markets and clarify how certain financial instruments are regulated.
CBOT supports having the CFTC regulate clearinghouses for future contracts on Treasury securities, while the CME opposes it.
Meanwhile, over-the-counter derivatives dealers, speaking at a seminar here, urged minimal state market regulation, supplemented by voluntary initiatives and self-regulation. The seminar was sponsored by the American Enterprise Institute for Public Policy.
Some market participants have expressed concern that one of the central legislative issues - whether the CFTC should regulate the clearing of futures contracts on Treasuries - could have a significant impact on the municipal bond market.
Treasury securities are used for future delivery in several different municipal structures, such as rolling Treasury bill products that governments purchase for debt service reserve funds. Almost every municipal advance refunding involves the future delivery of Treasury securities, such as in a repurchase agreement.
However, a June 30 concept paper drafted by the staff of Lugar and other senators that proposes giving the CFTC this power specifically states: "Transactions widely considered to be forwards rather than futures (e.g., when-issued securities and repurchase agreements)" would not be subject to CFTC regulation upon clearing.
The aim of the measure is to ensure that the CFTC has some oversight of Treasury cash clearinghouses once they start clearing a substantial amount of futures, not to impose CFTC oversight on repos and Treasury forwards, a CBOT source said. Treasury bond futures are CBOT's most popular contract.
CBOT strongly supports giving the CFTC this power, among other provisions contained in the concept paper, and is backed by the ad-hoc coalition of commercial and investment banks, according to a letter sent to Lugar on July 17 by CBOT chairman Patrick H. Arbor and president Thomas R. Donovan.
"From government's perspective, keeping the CBOT and other organized markets in government securities competitive will result in continuing efficiency in marketing the government's debt and avoiding increased costs for U.S. taxpayers," Arbor and Donovan wrote.
Under this proposal, "exchanges could sponsor new, innovative markets in government securities amongst institutional participants under rules issued by the Treasury Department and enforced by the CFTC," they wrote. The CBOT source said this provision is designed to parallel the regulation of the Treasury cash markets.
However, the Mercantile Exchange, where a number of currency futures trade, considers the regulatory scheme proposed in the concept paper discriminatory and unfair. Contracts on government securities are one of several so-called Treasury Amendment products, which are allowed to trade outside of a CFTC-regulated futures exchange.
"We believe that the enactment of such a proposal would be a disservice to futures exchanges, their users, and the investing public," wrote CME chairman John F. Sandner, chairman emeritus Leo Melamed, and president T. Eric Kilcollin in a July 14 letter to Lugar.
"It is competitively unfair to established futures exchanges," they wrote. "It is inconsistent and discriminatory between futures contracts in various Treasury Amendment products. We urge you to oppose it, as we will if it is included in S. 257."
CFTC chairwoman Brooksley Born and Securities and Exchange Commission chairman Arthur Levitt have spoken out against Lugar's bill in the past, specifically because of a provision that would allow exchanges to operate professional markets limited to large investors, which would be exempt from most CFTC regulations. But futures exchanges say they need the pared-back regulation to effectively compete with overseas and OTC markets.
Some observers have suggested that additional powers the concept paper would grant regulators could help win over CFTC support.
Many market participants seek legislation to clarify the Treasury Amendment - specifically, whether certain transactions are futures contracts and must be traded on an exchange. They worry that financial products with any future component, such as swaps and repurchase agreements, are open to challenge because of the legal uncertainty.
"These legal uncertainties cause a spreading out of capital," said Thomas A. Russo, a managing director and chief legal officer at Lehman Brothers, speaking at the AEI panel.
Other provisions in the concept paper that CBOT and the coalition of banks - which includes Merrill Lynch & Co. and Goldman, Sachs & Co. - support, and which the CME opposes, would:
* Clarify that equity swaps are not subject to CFTC oversight and direct the president's working group to devise a regulatory structure for trading single-stock and narrow-based futures.
* Permit electronic trading of futures contracts when dealers are trading on their own accounts - including those on foreign currency - outside of CFTC regulation, for exchanges and non-exchanges.
OTC market participants speaking at the AEI seminar last week touted the value of self-regulation and market discipline.
"This is a marketplace best regulated by the participants in the marketplace, and the imposition of a governmental regulatory scheme on the marketplace has to be done with great care," said John P. Davidson, a principal with Morgan Stanley & Co., who added that the CBOT-coalition proposal is a good model.
Industry groups must focus on the narrowest changes they need from legislation, and not simply cut each other down, said Mark Brickell, a managing director at J.P. Morgan & Co.
"If the initial objective of bold deregulation is thwarted, the legislators may be beseiged by requests to: 'beggar our competitors,' " Brickell said. "If Congress responds by giving a little bit to everybody, they may harm rather than help the marketplace."
He urged focusing on the most important issues, saying: "It may be necessary to narrow the bill and try to achieve a little bit less. It surely is better to take a smaller step in the right direction than it would be to reverse course completely."
And Brickell acknowledged that market participants within a single company are often at odds over certain provisions. "If the traders on the swap desk are so eager for legal certainty that they're willing to accept greater regulation of other activities - say, government securities - it may cause tensions within the firm," he said.
