Commodity Exchange Act: Issues Related to the Regulation of Electronic Trading Systems

GGD-00-99 Published: May 05, 2000. Publicly Released: May 05, 2000.
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Highlights

Pursuant to a congressional request, GAO reviewed issues related to the regulation of electronic trading systems, focusing on: (1) how technology is being used in the exchange-traded futures market, and what concerns this use raises under the Commodity Exchange Act (CEA); (2) how technology is being used in the over-the-counter (OTC) derivatives market, and what concerns this use raises under the CEA; and (3) what alternatives have been suggested for addressing the concerns raised under the CEA by the use of technology in the exchange-traded futures and OTC derivatives markets.

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Recommendations

Recommendations for Executive Action

Agency Affected Recommendation Status
Department of the Treasury Recognizing the difficulty of ensuring that regulations appropriately address market risks in stable periods and the additional challenges that are likely to be presented by ongoing and rapid advances in technology, the Secretary of the Treasury; the Chairman, CFTC; the Chairman, Board of Governors of the Federal Reserve System; and the Chairman, SEC, as members of the President's Working Group on Financial Markets, should monitor and report to Congress, as appropriate, on regulatory concerns related to the application of technology in the derivatives markets. Such efforts should address: (1) the implementation status and market impact of the Working Group's 1999 recommendations related to electronic trading in the OTC derivatives and exchange-traded futures markets; (2) the need to impose a regulatory regime on OTC derivatives that are electronically traded to enhance market transparency and efficiency; and (3) the desirability of regulatory or legislative action to address concerns associated with electronic trading.
Closed - Implemented
In an August 30, 2000 letter to the Honorable Ted Stevens, Chairman of the Senate Committee on Appropriations, the member agencies of the President's Working Group on Financial Markets stated that they would follow GAO's recommendation to monitor the use of technology in derivatives markets and report to Congress, as appropriate, if any regulatory concerns arise. In December 2000, the Commodity Futures Modernization Act was passed. The Act incorporated a regulatory framework proposed by CFTC that was designed to incorporate most of the recommendations from the Working Group's 1999 report. The Act bases regulation of different trading facilities on the nature of the commodities traded and the sophistication of the participants, and should resolve the disparities in the treatment of electronic trading systems for exchange-traded derivatives and over-the-counter derivatives noted in the GAO report. CFTC is expected to issue final regulations based on the Act by September 2001.
Commodity Futures Trading Commission Recognizing the difficulty of ensuring that regulations appropriately address market risks in stable periods and the additional challenges that are likely to be presented by ongoing and rapid advances in technology, the Secretary of the Treasury; the Chairman, CFTC; the Chairman, Board of Governors of the Federal Reserve System; and the Chairman, SEC, as members of the President's Working Group on Financial Markets, should monitor and report to Congress, as appropriate, on regulatory concerns related to the application of technology in the derivatives markets. Such efforts should address: (1) the implementation status and market impact of the Working Group's 1999 recommendations related to electronic trading in the OTC derivatives and exchange-traded futures markets; (2) the need to impose a regulatory regime on OTC derivatives that are electronically traded to enhance market transparency and efficiency; and (3) the desirability of regulatory or legislative action to address concerns associated with electronic trading.
Closed - Implemented
In an August 30, 2000 letter to the Honorable Ted Stevens, Chairman of the Senate Committee on Appropriations, the member agencies of the President's Working Group on Financial Markets stated that they would follow GAO's recommendation to monitor the use of technology in derivatives markets and report to Congress, as appropriate, if any regulatory concerns arise. In December 2000, the Commodity Futures Modernization Act was passed. The Act incorporated a regulatory framework proposed by CFTC that was designed to incorporate most of the recommendations from the Working Group's 1999 report. The Act bases regulation of different trading facilities on the nature of the commodities traded and the sophistication of the participants, and should resolve the disparities in the treatment of electronic trading systems for exchange-traded derivatives and over-the-counter derivatives noted in the GAO report. CFTC is expected to issue final regulations based on the Act by September 2001.
Board of Governors Recognizing the difficulty of ensuring that regulations appropriately address market risks in stable periods and the additional challenges that are likely to be presented by ongoing and rapid advances in technology, the Secretary of the Treasury; the Chairman, CFTC; the Chairman, Board of Governors of the Federal Reserve System; and the Chairman, SEC, as members of the President's Working Group on Financial Markets, should monitor and report to Congress, as appropriate, on regulatory concerns related to the application of technology in the derivatives markets. Such efforts should address: (1) the implementation status and market impact of the Working Group's 1999 recommendations related to electronic trading in the OTC derivatives and exchange-traded futures markets; (2) the need to impose a regulatory regime on OTC derivatives that are electronically traded to enhance market transparency and efficiency; and (3) the desirability of regulatory or legislative action to address concerns associated with electronic trading.
Closed - Implemented
In an August 30, 2000 letter to the Honorable Ted Stevens, Chairman of the Senate Committee on Appropriations, the member agencies of the President's Working Group on Financial Markets stated that they would follow GAO's recommendation to monitor the use of technology in derivatives markets and report to Congress, as appropriate, if any regulatory concerns arise. In December 2000, the Commodity Futures Modernization Act was passed. The Act incorporated a regulatory framework proposed by CFTC that was designed to incorporate most of the recommendations from the Working Group's 1999 report. The Act bases regulation of different trading facilities on the nature of the commodities traded and the sophistication of the participants, and should resolve the disparities in the treatment of electronic trading systems for exchange-traded derivatives and over-the-counter derivatives noted in the GAO report. CFTC is expected to issue final regulations based on the Act by September 2001.
United States Securities and Exchange Commission Recognizing the difficulty of ensuring that regulations appropriately address market risks in stable periods and the additional challenges that are likely to be presented by ongoing and rapid advances in technology, the Secretary of the Treasury; the Chairman, CFTC; the Chairman, Board of Governors of the Federal Reserve System; and the Chairman, SEC, as members of the President's Working Group on Financial Markets, should monitor and report to Congress, as appropriate, on regulatory concerns related to the application of technology in the derivatives markets. Such efforts should address: (1) the implementation status and market impact of the Working Group's 1999 recommendations related to electronic trading in the OTC derivatives and exchange-traded futures markets; (2) the need to impose a regulatory regime on OTC derivatives that are electronically traded to enhance market transparency and efficiency; and (3) the desirability of regulatory or legislative action to address concerns associated with electronic trading.
Closed - Implemented
In an August 30, 2000 letter to the Honorable Ted Stevens, Chairman of the Senate Committee on Appropriations, the member agencies of the President's Working Group on Financial Markets stated that they would follow GAO's recommendation to monitor the use of technology in derivatives markets and report to Congress, as appropriate, if any regulatory concerns arise. In December 2000, the Commodity Futures Modernization Act was passed. The Act incorporated a regulatory framework proposed by CFTC that was designed to incorporate most of the recommendations from the Working Group's 1999 report. The Act bases regulation of different trading facilities on the nature of the commodities traded and the sophistication of the participants, and should resolve the disparities in the treatment of electronic trading systems for exchange-traded derivatives and over-the-counter derivatives noted in the GAO report. CFTC is expected to issue final regulations, based on the Act, by September 2001.
Commodity Futures Trading Commission Recognizing the difficulty of ensuring that regulations appropriately address market risks in stable periods and the additional challenges that are likely to be presented by ongoing and rapid advances in technology, the Chairman, CFTC, should monitor and report to Congress, as appropriate, on: (1) the status of the National Futures Association and Futures Industry Institute efforts to develop best practices for order routing that address AORS and the adequacy of industry efforts to implement these practices; and (2) the status and market impact of efforts to implement the regulatory framework proposed by the CFTC task force in its February 2000 report.
Closed - Implemented
Regarding the recommendation that CFTC monitor and report on industry efforts to develop and implement best practices for order routing systems, a CFTC-funded industry study was completed in March 2001. According to a CFTC official, the National Futures Association (NFA) incorporated the best practices identified by the study into industry guidelines that were approved by CFTC in June 2002. The CFTC official stated that these guidelines should be implemented by the end of 2002, and that CFTC is monitoring their implementation. CFTC's 2002 Annual Report to Congress describes how the agency is continuing to work with NFA on the implementation of these guidelines. Regarding the recommendation to monitor the status and impact of the regulatory framework proposed by the CFTC task force in February 2000, CFMA was passed in December 2000. The Act incorporated the regulatory framework proposed by the CFTC task force, which was designed to incorporate most of the recommendations of the President's Working Group. According to a CFTC official, the majority of the regulations implementing the Act have been implemented, and CFTC will continue to monitor the market impact of these regulations.

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