SEC vs CFTC: There Can Be Only One
Note: The sweeping regulatory reforms currently being proposed in the financial markets have brought the contrast between the SEC & CFTC into stark relief. As a result, we have decided to republish an article examining this regulatory conflict that first appeared on our site early last year.
The derivatives industry is currently engaged in a bitter struggle. Onone side, you have the turbulent and increasingly restive optionsindustry. Opposing them is the assembled might of the futures industry.
What has driven these two complementary marketplaces apart and settheir members at each otherís throats? Has one of the usual suspectslike payment for order flow or penny pricing once again reared its uglyhead? Not this time. The cause of this latest conflict can be tracedback to one of the oldest open wounds in the derivatives world ñregulation.
THE CONFLICT BEGINS
Strife is nothing new to the options markets. Ever since the dawn ofmultiple listing in 1999, the options exchanges have been locked in ano-holds-barred struggle for dominance. Compared to the Wild Westfree-for-all that is the options markets, the futures markets seemrelatively tame. Why is there such a dissonance between the twomarketplaces? It can all be traced back to that ever-present bogeymanknown as regulation.
AND THEN THERE WERE TWO
While most countries treat the two product classes the same forregulatory purposes, the U.S. regulates options and futures as separateproducts. To make matters worse, the U.S. has assigned two differentregulatory bodies to oversee these markets. As you can imagine, thisdual regulatory system has caused no shortage of headaches and remainsthe source of a great deal of consternation.
Although this dual regulatory structure is unpopular in the optionsindustry, it has proven to be a distinct competitive advantage for thefutures industry. While the options exchanges battle over virtuallyidentical products, the futures exchanges have carved out shelteredfiefdoms for their product lines. This is because futures, unlikeoptions, are non-fungible products.
IT'S GOOD TO BE THE KING
Futures exchanges trade distinct contracts that are notinterchangeable. In essence, they are monopolies in their particularproduct lines. This lack of strategic competitors within the U.S. hasnot gone unnoticed by the options industry.
With every major options exchange struggling to maintain its marketshare against identical competitors, the lure of monopolistic productsis quite compelling. They have begun churning out wave after wave offutures products in the hopes of capturing some of that monopolisticmagic.
As a result, the derivatives marketplace has been flooded withproprietary products that blur the line between futures and options.These new products donít fall under the purview of either the SEC orthe CFTC. Instead, they are dual-regulatory products that require theoversight of both regulatory organizations.
PROBLEMS WITH THE SEC
This wave of dual-regulatory products has re-opened some very oldwounds in the derivatives industry. For decades, the futures industryhas been overseen by the CommodityFutures Trading Commission (CFTC), a specialized regulatory body whosesole purpose is to govern the futures markets.
However, the options markets have languished for decades under theoversight of the Securities & Exchange Commission (SEC), aregulatory body whose primary focus is the equity markets. The lack ofa specialized regulatory body for options has left many in the industryfeeling like second-hand citizens when it comes to regulatoryresources.
With most of the SECís knowledge and expertise centered on equities,they have been slow to adapt to the competitive realities of theoptions marketplace.
This is hardly a new complaint. After all, it took the CBOT five yearsjust to get the concept of options past the SEC back in the 1970s. Allthese years later, options exchanges still have to struggle to gettheir regulator to understand the unique needs of their marketplace.
Continued in Part Two
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