CAMBRIDGE, August 12, 2008—The Committee on Capital Markets Regulation (CCMR), an independent and nonpartisan research organization dedicated to improving the regulation of U.S. capital markets, has announced the results of research it commissioned by Professor Henry Hu of the University of Texas Law School and Darrell Duffie of Stanford University to study U.S. competitiveness in the global derivatives markets.
The CCMR had issued its initial report on the competitiveness of the U.S. public equity market as an Interim Report in November 2006. That report found that our public equity market was losing competitiveness with respect to private and foreign markets. And the situation has continued to deteriorate, as shown in the Committee’s latest report for the first quarter of 2008 issued May 28, 2008.
Now the CCMR has extended its competitiveness analysis to the derivatives markets.
Based on the research by Profs. Duffie and Hu, the CCMR finds that our markets for exchange-traded derivatives are far more competitive globally than are U.S. equity markets. During 2007, the notional value of the year’s turnover of such instruments on North American exchanges far exceeded that on European exchanges – approximately $1,287 trillion here to approximately $792 trillion in Europe.
The authors found that trading volumes at U.S. exchanges have been higher than those at European exchanges throughout the period 2001 to 2007. In 2001, the turnover of exchange-traded futures and options was approximately $352 trillion in North America, compared with approximately $188 trillion in Europe; by 2007, the respective turnover in the two regions was $1,287 trillion and $792 trillion. While the North American share has fallen slightly from about 59 to 56 percent during this period, the U.S. is still the dominant market. The authors note that the Chicago Mercantile Exchange (CME), with its thriving interest-rate and stock index futures and options contracts, remains the world’s dominant derivatives exchange. For those derivatives traded on the CME that are tracked by the World Federation of Exchanges, the CME in 2007 accounted for 53% of global trading (by notional value).
U.S. Competitiveness in OTC Derivatives Trading Less Clear
With respect to OTC derivatives trading, Profs. Duffie and Hu found the U.S. record is less clear. During the period from 1998 to 2007, the U.S. has gradually increased its worldwide market share of trading in traditional OTC derivatives (which include currency and interest rate derivatives) from 19% in 1998 to 24% in 2007. However, the U.S. does not appear to play as dominant a role in the markets for a number of categories of highly structured, higher margin derivative products, particularly structured equity derivatives – some of which markets have been particularly affected by the subprime crisis.
According to the researchers, a variety of factors may influence the location of derivatives trading activity. These factors include the advantages associated with a regional concentration of customers and overall financial market activity, the size of the available pool of highly skilled workers needed for derivatives trading, the status of the dollar vis-à-vis the euro on currency markets, varying accounting standards here and abroad, and the relative tax burdens and costs of living. A draft paper by Professors Duffie and Hu, based partly on their submission to the Committee, is available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1140869.
The Committee cannot but note that OTC derivatives trading – the weaker (but still viable) suit in the U.S.’s derivatives trading competitiveness – was, as a formal matter, substantially unregulated following the Commodity Futures Modernization Act of 2000 (CFMA). Yet the Commodity Futures Trading Commission (CFTC) does continue to regulate exchange-traded derivative products – the derivatives trading sector where U.S. competitiveness is strongest.
Historically the CFTC has followed a more principles-based approach to regulation than the SEC, a difference in approach that is embedded in the CFTC enabling legislation. The CFMA amended the Commodity Exchange Act to replace the traditional “one-size fits all” regulatory framework with a risk-based model in which regulation is tailored to the nature of the market and its participants. Under the CFTC’s approach, exchanges and clearinghouses must adhere to statutory “core principles” to the point that, with a few exceptions, there are no longer prescriptive regulations that dictate the exclusive means of compliance. The difference in approach between the CFTC and the SEC is further reflected in their different regulatory cultures.
The CCMR believes the distinct regulatory philosophy of the CFTC has contributed to the relative robustness of the U.S. exchange-traded derivatives market (versus the declining competitiveness of its equity trading, which takes places under a rules-based regulatory regime). Indeed, in its “Blueprint for a Modernized Financial Regulatory Structure,” the Treasury lauded the CFTC’s “principles-based regulatory philosophy” in the context of its recommended merger of the CFTC and SEC.
The CCMR, too, believes that the principles-based regulatory approach of the CFTC is an important factor in maintaining U.S. competitiveness in the derivatives markets. If the CFTC were to be subsumed within the SEC and lose its distinct regulatory philosophy, U.S. competitiveness in these markets could be significantly and adversely affected.
The Committee also notes, in addition, that the derivatives market is largely immune to securities class action lawsuits that overhang the public equities markets.
The importance of a vibrant derivatives market in the U.S. cannot be understated. As a general matter, access to a deep and rich set of derivative markets offers individual Americans, U.S. corporations, financial institutions and government entities valuable risk management opportunities. An active and efficient U.S. derivatives market contributes to U.S. economic growth, the availability of high-quality jobs and the attractiveness of the U.S. as a venue for financial-market services.
CCMR is a non-partisan committee of independent U.S. business, financial, investor and corporate governance, legal, accounting and academic leaders. It was formed in the fall of 2006 to study and report on ways to enhance the competitiveness of the U.S. capital markets.
# # #
For Further Information:
Hullin Metz & Co. LLC