Presentation to Ukraine Commodity Market Development Conference
The author of the presentation: Christa Lachenmayr, Division of Market Oversight, CFTC (US)
Exchange/Regulator interactions on commodity contracts (product approval, reporting, general cooperation and communication)
1. Christa Lachenmayr, Division of Market Oversight
Kevin Piccoli, Office of International Affairs
Tracey Wingate, Office of International Affairs
December 2017
Exchange/Regulator Interactions
U.S. COMMODITY FUTURES TRADING COMMISSION
OFFICE OF INTERNATIONAL AFFAIRS
2. IOSCOPrinciples
• Design Principles
• Correlation with the Cash Market – reflection of underlying commodity
and commercial practices to the extent that the contract is not susceptible to
manipulation
• Promotion of Convergence – ensure adequate and available deliverable
supply for contract to perform its risk management and price discovery
functions
• Regulatory Principles
• Accountability – transparent “rules of the road” for engagement with the
exchanges that provides clear framework for design/review criteria and
procedures; establishes that exchanges are held accountable for continuing
compliance
• Transparency – requires rulebook and rule changes are made available to
market authorities and participants in a timely manner.
• Responsiveness – ensures that views of potential contract users should be
taken into account in designing commodity contracts and contract changes
2
3. RegulatoryAuthority
• The CFTC implements the Commodity Exchange Act
(CEA), which has a three-pronged regulatory framework:
• Statute – law passed by Congress and signed by the President,
updated periodically with the most recent update being the Dodd-
Frank Wall Street Reform and Consumer Protection Act (“Dodd-
Frank); Includes the core principles and Section 5c(c) related to
new products and product terms/condition amendments
• Regulations – the CFTC has rulemaking authority to draft and
implement regulations to implement the Act; binding Subject to
notice-and-comment provisions
• Regulations are approved by the Commission
• Guidance – non-binding, safe-harbor provisions and best practices
3
4. Self-RegulatoryRegime
• Exchanges
• Self-regulatory organizations (SROs)
• In 1859, the Governor of IL granted CBOT corporate charter that provided
self-regulatory authority over members, standard grades and grain inspectors
whose decisions are binding
• CFTC
• Protects the public interest - Section 3 of CEA states that futures transactions
are vital to the national public interest because they are a means for managing
and assuming price risks, discovering prices and disseminating pricing
information via trading in liquid, fair and financially secure trading facilities
• Other entities
• Market Participants/Industry Organizations hold exchanges and the CFTC
accountable
• House/Senate Agriculture Committees hold CFTC accountable
4
5. Self-RegulatoryRegime
• Core principle 1: Reasonable discretion of the contract market.
Unless otherwise determined by the Commission by rule or
regulation, a board of trade … shall have reasonable discretion
in establishing the manner in which the [it] complies with the
core principles
5
Exchanges Commission
• Own and promote contracts; encourage
market participation
• Self-certify or request approval for new
contracts & changes
• Ensure continuing compliance with Act &
regulations
• Provide clear expectations
• Regulatory toolbox
• Monitor: trading, compliance with core
principles; surveillance
• Enforcement
6. Statute-Accountability
6
Section 5c(c) of the Statute provides a framework for submission and review of new products and rule changes
• Self Certification
• New contracts, new rules, and rule amendments – by a written certification that the new contract or instrument or
clearing of the new contract or instrument, new rule, or rule amendment complies with the Act and regulations
• Effective pursuant to the certification and notice 10 business days after receipt, unless exchange is notified that the
certification is stayed because of novel or complex issues that require additional time to analyze, is accompanied
by an inadequate explanation, or has a potential inconsistency with the Act and regulations
• Up to an additional 90 days from the date of the notification
• Effective pursuant to the certification at the expiration of the period unless the Commission withdraws the stay
or notifies the entity that it objects to the proposed certification for inconsistency with the Act and regulations
• Triggers a mandatory 30-day public comment period
• Approval – Two circumstances
• Voluntary request that the Commission grant approval to any new contract or other instrument, new rule, or rule
amendment within 90 days of submission of the request, unless entity agrees to an extension of the time limitation
• Amendments that materially change the terms and conditions of certain agricultural commodities that apply to
listed contracts and delivery months with have open interest
• Threshold – CFTC shall approve a new rule, or rule amendment unless it finds that the new rule, or rule amendment, is
inconsistent with the Act and regulations. The Commission shall approve a new contract or other instrument unless
the Commission finds that the new contract or other instrument would violate the Act and regulations
• Special rules for review and approval of event contracts – the Commission may determine that such agreements,
contracts, or transactions are contrary to the public interest and prohibit their trading if they involve activity that is
unlawful under any Federal or State law; terrorism; assassination; war; gaming; or other similar activity determined by
the Commission, by rule or regulation, to be contrary to the public interest.
7. Approval
• Prior to Dodd-Frank, the last update of the CEA was the Commodity Futures
Modernization Act (CFMA) in 2000, which transitioned from an approval
regime for products to a self-certification regime and eliminated the
economic purpose test.
• 45-day review period where the Commission took a more active role in
validating the terms and conditions of new products and rule changes. Can
be stayed for additional 45-days for “novel and complex” rules or products.
• New Products – Still in place on a voluntary basis.
• Rule changes – Still in place for agricultural products with open interest.
• Delegated authority to the Director of Division of Market Oversight
• Deemed approved at end of 45-day period
• Seriatim approval or vote at public meeting
7
8. Self-certification
• Self-certification of new products
• Submitted to commission 1 day prior to launch
• 10-days for certain provisions such as blocks
• Self-certification for rules
• 10-day review period where the Exchange provides all the necessary information to the
CFTC for a due diligence review
• Rule change goes into effect after 10 business days
• No notification by Commission
• Non-material agricultural rule changes
• Requires justification as to materiality of rule change
• 10-day review period
• Materiality determination provided by Commission
• Stays and extensions
• Delegated authority to Division of Market Oversight Director to extend review period,
stay, emergency rule changes, materiality determinations
8
9. Statute-Transparency
9
• Core Principle 7: “The board of trade shall make available to
market authorities, market participants, and the public accurate
information concerning—(A) The terms and conditions of the
contracts of the contract market.”
• Exchanges
• Rulebook containing terms and conditions of each futures contract
• New product and rule change submissions
• Periodic notifications to the markets about changes to delivery warehouses,
force majeure, variable storage rates
• Regulators
• Industry Filings page lists all pending, certified and archived contract changes;
collects public comments
• Due diligence reviews are not made public
10. Regulations
10
• Part 38 of the Commission’s regulations provides general requirements, (regulations)
for compliance with core principles
• Adopt, as is necessary and appropriate, position limitations or position
accountability for speculators. For contracts with federal limits, the board of trade
shall set the position limitation of the board of trade at a level not higher than the limit
established by the Commission
• Part 40 of the Commission’s regulations governs the submission process for new
products and rule changes
• CFTC dictates the “form and manner” for submissions
• Details the submission process and required elements for exchange submissions:
• Cover sheet
• Blackline copy of the rules (terms and conditions)
• Description, including “operation, purpose and effect”
• Implementation plan (date and contract month)
• Certification of compliance with regulations; that the submission was posted
publicly
• “Substantive opposing views”
• Request for confidential treatment (optional)
11. Guidance
11
• Appendix C Part 38 of the Commission’s regulations provides guidance (non-
binding) for compliance with core principles
• Interaction with potential market participants in contract design process
• Contracts settled by physical delivery
• Deliverable supply calculations
• Safe harbor specifications for quality standards, delivery points, deliver period and last
trading day, contract size and trading unit, delivery pack, delivery instrument, inspection
provisions, trading months, price limits, trading hours
• Contracts settled by cash-settlement
• Index’s susceptibility to manipulation
• Safe harbor specifications for commodity characteristics, contract size and trading unit,
cash settlement procedure, pricing basis and minimum price fluctuation, price limit, last
trading day, trading months, speculative limits, reportable levels
• Option terms
• Safe harbor specifications for option expiration and last trading day, speculative limits
13. • Core Principle 3 - The board of trade shall list on the contract market only
contracts that are not readily susceptible to manipulation”
• Contract terms and conditions should reflect the operation of the underlying
cash market and avoid impediments to delivery
• Detailed description of the cash market & deliverable supply analysis
• In the case of cash-settled contract, the settlement mechanism must be not
readily susceptible to manipulation - detailed description of the settlement
mechanism/index
• Core Principle 5 - “To reduce the potential threat of manipulation or
congestion, especially during trading of the delivery month, the board of trade
shall adopt position limitations or position accountability for speculators,
where necessary and appropriate”
• Spot Month Limits – not greater than 25% of deliverable supply in any
contract delivery month
• Single Month Limits
• All-months-combined Limits
• Limits on amount of the delivery instrument that can be held
13
EvaluationinRelationtoCPs
14. ReviewProcess-Initial
14
• Review – read (thoroughly) and understand products and rule changes; ensure
that the submission meets the requirements; revert to exchange for additional
information, as needed; review relevant guidance and other, similar rule changes
to discern whether applicable to established Commission policy
• Analyze – verify data and information provided; consult other market or
government data sources; discuss with market participants and other internal
subject-matter experts
• Memorialize – match the content of the rule change to the established policy or
guidance; Incorporate into the policy discussion on this topic; support or refute
exchange’s supporting data or rationale for the changes; make conclusion about
adherence to core principles and regulations
• Inform – provide briefings to senior staff and commissioners; make
documentation readily available for colleagues and successors; advise exchange
of the response; let the public know
15. Responsiveness
• Views of potential contract users.
• Required to be taken into account as part
of certification or request for approval
• Substantive comments – not voting
• Exchanges have either a research
department or committee structure;
advisory committees
• Surveillance and Market regulatory
function
“When a
contract is out
of balance the
disadvantaged
side ceases
trading and the
contract
disappears.”
- Thomas A.
Hieronymus
(1977)
15
16. ReviewProcess–On-going
16
• Part 38 of the Commission’s regulations provides general requirements,
(regulations) for compliance with core principles
• Core Principle 4 - “The board of trade shall list have the capacity and
responsibility to prevent manipulation, price distortion, and
disruptions of the delivery or cash-settlement process through market
surveillance, compliance, and enforcement practices and procedures…”
• Continually monitor the appropriateness of a contract’s terms and
conditions, including the delivery instrument, the delivery locations and
locational differentials and the commodity characteristics and related
differentials
• Demonstrate a good-faith effort to resolve conditions that are interfering
with convergence of its physical-delivery contract to the price of the
underlying commodity or causing price distortions or market disruptions,
including, when appropriate, changes to contract terms
• Appendix C to Part 38 - Demonstration of Compliance That a Contract Is Not
Readily Susceptible to Manipulation
17. Responsiveness
• Physical markets adapt and change, so the exchanges and the Commission need to continuously
monitors contract performance, particularly for physically delivered contracts, for issues:
• Persistent lack of convergence between the cash and futures prices
• Deliveries/lack of deliveries
• Structural Changes in Cash Market Practices
• Comments/complaints from market participants, industry groups, policymakers
• Exchange/Regulator Interactions
• Prepare – be cognizant of effects of proposed changes, how and who
• Clarify expectations – maintain consistency
• Support the process – find the most expeditious way to process changes
• Develop good working relationships – with exchanges & market participants so that issues
can be addressed and deficiencies corrected sooner, but…aim for transparency, not
confusion, in the market
• Too early, too often – data on market trends may not be sufficient or be the result of
temporary anomaly instead of a structural shift; adds confusion and uncertainty
• Too late – asymmetry of information; market may have absorbed misinformation;
corrections to mis-specified contracts take a long time to show effectiveness
• Logistics around setting implementation date
17
18. RegulatoryToolbox
• Informal: “Jawboning”
• Formal: Authority to ask exchanges to provide information and justify
rules or products that raise concerns before or after implementation
• §40.2(b): “At the request of Commission staff, a registered entity
shall provide additional evidence, information or data that
demonstrates that the contract meets, initially or on a continuing
basis, the requirements of the Act or the Commission’s regulations
or polices thereunder”
• §38.5(b): “Upon request by the Commission, a designated contract
market must file with the Commission a written demonstration,
containing supporting data, information and documents, …that the
DCM is in compliance with one or more core principles or that is
requested by the Commission to show that the DCM satisfies its
obligations under the Act”
18
19. StatutoryToolbox
• Emergency Authority - Section 8a(9) authority to “direct the registered entity, whenever
it believes an emergency exists, to take such action as in the Commission’s judgement is
necessary to maintain or restore orderly trading…”
• Authority to Alter or Supplement Rules – Section 8a(7)
• After making request in writing to the exchange that they alter the rules themselves
• After notice and opportunity for a hearing
• After Commission determination that exchange response is inadequate
• After Commission determination that changes are necessary or appropriate for the protection of persons
producing, handling, processing, or consuming any commodity, or its product or byproduct; for the
protection of traders; or to insure fair dealing in traded commodities
• And only with respect to the following rules—
• Product terms or conditions
• The form or manner of execution of purchases and sales for future delivery;
• Other trading requirements;
• Margin requirements, provided that the rules, regulations, or orders shall— (i) be limited to protecting the
financial integrity of the DCO; (ii) be designed for risk management purposes to protect the financial
integrity of transactions; and (iii) not set specific margin amounts; (E) safeguards with respect to the
financial responsibility of members; (F) the manner, method, and place of soliciting business, including the
content of such solicitations; and (G) the form and manner of handling, recording, and accounting for
customers’ orders, transactions, and accounts
19
20. MissionAccomplished?
20
• Discern the role of the market and market participants in
contract performance
• How does convergence occur and who causes it?
• What is the role of storage (and storage facilities) in price
discovery?
• Are there unintended consequences to a contract change?
• Measuring Success – if a contract is functioning properly:
• Hedging effectiveness restored
• Convergence occurs
• Liquidity – a well-functioning contract may attract more
volume and open interest, but that is not a demonstration of
compliance in and of itself