The Commodity Futures Trading Commission has been nervously anticipating its upcoming reauthorization hearings for months, if not years. Since William Rainer took over as chairman last year, the word from within the CFTC has been that the commission would embrace a diminution of its powers—if that meant leveling the playing field for U.S. markets and improving the legal certainty of various over-the-counter products.

In February, the CFTC unveiled a plan to accomplish at least one of those goals. In a release called "A New Regulatory Framework,” the commission introduces the vision it has for futures regulation in the next century. The plan recasts the commission from a direct regulator into an oversight body with various levels of authority calibrated to various levels of market sophistication. The commission believes the new structure will "promote innovation, maintain U.S. competitiveness, reduce systemic risk and protect derivatives customers”—all big selling points when Congress considers CFTC reauthorization later this year.

The proposal's biggest innovation: it would replace the current one-size-fits-all approach with broad, flexible "core principles,” tailored to the various markets in question, since financial futures are clearly different from pork bellies and thus require different regulatory approaches.

All exchanges operating as "recognized futures exchanges” will benefit from more relaxed rules. But beyond this, the plan proposes varying levels of regulation. For certain commodities, the new plan would allow exchanges to act as "exempt multilateral transaction facilities.” For financial futures, meanwhile, exchanges can declare themselves "derivatives transaction facilities,” geared toward sophisticated institutional traders. The chart below illustrates the core-principal approach.

MTEFs

The biggest boon under the new plan would go to financial futures markets, which would be considered exempt multilateral transaction execution facilities (exempt MTEFs). As long as markets are "sufficiently large and deep to render a contract traded on them highly unlikely to be susceptible to the threat of manipulation,” the markets would be exempt from all of the Commodity Exchange Act and CFTC's requirements except for antifraud and antimanipulation rules; a stipulation that an exchange must live up to its status as a provider of price discovery by publicly disseminating price and trading data on a daily basis; and a provision that violations of the various rules of exemption would not invalidate the transactions in question.

According to the proposal, the rationale behind the move was simple: Protecting market participants from market manipulation by approving contract terms, monitoring position sizes, imposing position limits and performing market surveillance are quite unnecessary when the contracts cannot be manipulated in the first place. Similarly, because institutional players bring to the market a great ability to understand the risks involved in trading, customer protection is unnecessary.

The Basics of the CFTC's New Regulatory Framework Proposal
Market	Characteristics	New Requirements
Recognized Futures Exchange	Any commodity, any trader	15 core regulatory principles
Recognized Derivatives Transaction Facility	Only commodities with nearly inexhaustible supplies, no underlying cash market or individual contracts on a case-by-case basis; or Only commercial traders	7 core regulatory principles
Exempt Multilateral Transaction Facility	Only commodities with nearly inexhaustible deliverable supplies or no underlying market; and Only institutional traders	No core regulatory principles, as long as the following are adhered to: The antifraud section of the Commodity Exchange Act The antimanipulation section of the CEA The antifraud rule The facility may not present itself as regulated

The reaction

At face value, the plan seems to improve futures regulation immensely, letting the characteristics of particular markets and players determine the appropriate level of regulatory scrutiny. But not everyone sees it that way. A few weeks after the plan was announced, House Banking Committee chairman Jim Leach (R–Iowa) said it raised "a number of serious concerns” in the oversight of over-the-counter swaps.

Leach praised the release overall in a speech before the Institute of International Bankers, calling it "probably the most conscientious and creative rethinking by a regulatory agency of its role in recent memory.” But, he said vaguely, "its actions may implicitly expand the agency's jurisdiction in such a way that legal uncertainties increase rather than decrease.” He added that "Any attempt by the CFTC to grant relief through administrative action lends credence to the legal argument that swaps are somehow fixtures under the CEA. Asking the CFTC to fix the legal uncertainties surrounding derivatives is like asking the Fed to administer farm policy.”

Leach may simply have been posturing, however, since the plan actually addresses swaps explicitly. "The swaps exemption,” reads the proposal, "...is not changed in any way. It remains in effect as promulgated, reinforcing the certainty that transactions undertaken in reliance upon the exemption are assured that the exemption itself will remain in force as originally adopted.”

Later, the proposal says that "even though there are no changes to the...swaps exemption, legal certainty for such instruments would be enhanced under the framework.” First, the new framework would clarify in a separate rule that swaps can be cleared. Second, the paper promises to clarify in a separate provision that transactions entered into based on the swaps exemption would not be void as a result of the exemption's requirements.

Leach also criticized the CFTC for not talking enough with other regulators. "What they did in this particular round was they talked now and again with the other agencies but they did not run their language by them,” he said. "I think that was an error and they would be wise to reconsider.”

The CFTC says its proposal is a work in progress, but urged quick action. In a speech before the Futures Industry Association last month, chairman Rainer cited Eurex as an example of the technological challenges facing the U.S. futures industry. "We must work together expeditiously to reach conclusions suitable for these markets and the public interest,” he said. "While we are confident that we will be able to devise appropriate answers, we know that the process entails consultation with the industry and that well-intentioned efforts may result in occasional starts. If a particular feature of our proposal creates more problems than it solves, we will reject it.”

Since Leach is an important player in the CFTC reauthorization debate, you can bet the proposal will be tweaked considerably before the hearings start.