Comment Text:
May 16,2010
Comments of Matthew Seligman
Before the Commodity Futures Trading Commission
Comment on a Proposal to Exempt, Pursuant to the Authority in Section 4(c) of the
Commodity Exchange Act, the Trading and Clearing of Certain Products Related to
ETFS Physical Swiss Gold Shares and EFTS Physical Silver Shares
I. Introduction
75 FR 19619
Document ID: CFTC-2010-0030-0001
Docket ID: CFTC-2010-0030
I disagree with the Commodity Futures Trading Commission's proposal to
exempt certain financial products relating to gold and silver futures from the provisions
of the Commodity Exchange Act (CEA), 7 U.S.C. 1 et seq.
In particular, I write to caution the Commodities Futures Trading Commission
(CFTC) from assuming that "encourag[ing] potential trading of Options and Securities
Futures on Gold and Silver Products through modes other than those nonnally
applicable," 75 FR 19621, will enhance market efficiency and competition. An adequate
recognition of the dangers of systemic risk may tip the balance as the CFTC "consider[s]
the costs and benefits," 7 U.S.c. 19(a), of exempting these financial products from
regulations under the CEA.
Financial innovation can serve to greatly benefit the national economy, when
there are specific inefficiencies in capital markets that can be remedied. For example, in
the late 19th and early 20th Centuries, capital was readily available in the major financial
centers on the East Coast but was scarce on the West Coast. This was problematic
because the productive capacity of capital was highest in the emerging cities and markets
in the west. The introduction of means to transport capital- either physically, or virtually
through long-distance contracts - to where it was most useful represented a major
advance in the American financial system. Similarly, the introduction of derivatives
contracts can help to more efficiently allocate risk - which, in turn, can help to allocate
capital itself to where it will be most productive. For example, allowing airline
companies to hedge against a rise in the price of jet fuel allows them to direct their
resources towards investment in growth.
In the past several years, however, the dangers of financial de-regulation have
become painfully apparent. As a result, it is no longer clear that "financial innovation" is
always and everywhere beneficial. De-regulation under the guise of "financial
innovation" carries with it significant risk. The most obvious example of this risk, of
course, is the financial panic triggered by the market in housing mortgage derivatives.
While the experience of the financial markets since 2007 should not be used as a pretext
to shut down capital markets when they can be productive and safe, regulators should be
wary of a strong presumption in favor of de-regulation. May 16,2010
Comments of Matthew Seligman
II. Faults in the CFTC's Cost-Benefit Analysis
This erroneous presumption is manifest in the CFTC's analysis under Section
15( a) of the CEA. That Section requires the CFTC to consider the costs and benefits of
the proposed order. Among the factors that the CEA requires the CFTC to consider are:
•
"efficiency, competition, and financial integrity of futures markets'"
•
"sound risk management practices,,2
•
"other public interest considerations,,3
The CFTC's analysis, as expressed in the Request for Comment, focuses on the benefits
of the proposed exemption without addressing the downsides.
First, the analysis under "efficiency, competition, and financial integrity"
speculates that the proposed exemption "may" increase market efficiency,4 without
identifying any systematic shortcomings in the allocation of capital that would be
remedied by the de-regulation. Simply put, the analysis does not indicate why or how the
existing markets are insufficient. The analysis makes cursory reference to the risks in
financial integrity, but does so only by stating that the financial products will be cleared
by a DCO- and SEC-registered clearing agency, intermediated by SEC-registered broker
dealers. This fact alone does not address the risk to financial integrity, because the
oversight provided by the SEC has been notably lacking in recent years. While there are
legitimate concerns that regulation of the metals markets in the United States would push
trading to the London markets,5 blunt de-regulation in the absence of transatlantic
coordination does not address the problems of market manipulation and systemic risk. 6
Second, the analysis under "sound risk management practices" merely states that
the financial products will be subject to "OCC's current risk-management practices
including its margining system.,,7 This does not address whether those risk-management
practices are sufficient - more than a merely hypothetical concern in light of the failure
of systemic risk assessment by the SEC and other financial regulators in recent years.
This is particularly worrisome given the possibility of large institutional investors taking
positions large enough to manipulate prices, a concern recognized by the CFTC in
proposing position limits for energy commodity markets including crude oil, gasoline,
heating oil, and natural gas. 8
, 7 U.S.C. 19(a)(2)(B)
2 7 U.S.C. 19(a)(2)(D)
3 7 U.S.C. 19(a)(2)(E)
475 FR 19621
5 See, Gregory Mayer, Dispute Over Curbs on Metal Futures, FIN. TIMES, Mar. 26, 2010.
6 See Jon Nadler, Is Market Manipulation Killing Gold, Silver Futures Markets?,
COMMODITY ONLINE, Mar. 26, 2010, available at
http://www.commodityonline.com/news/ls-manipulation-killing-gold-silver-futures-
markets-26909-3-1.html
7 75 FR 19622
8 See Gregory Mayer & Javier Bias, Regulators Cautious On Energy Shake-up, FIN.
TIMES, Jan. 14,2010. May 16,2010
Comments of Matthew Seligman
Last, the analysis under "other public interest considerations" states that the
proposed exemption "may encourage development of derivative products through market
competition without unnecessary regulatory burden.,,9 This impoverished view of the
public interest is telling. As stated above, financial innovation can be a huge benefit to
the economy by facilitating the allocation of capital in the most productive ways.
However, it is essential that the risks of under-regulation be candidly and honestly
assessed - the public interest may be served by the proposed exemption, but the CFTC's
failure to recognize or consider the weighty public interest considerations counseling
caution is deeply troubling.
III. Conclusion and Recommendation
In sum, I recommend that the exemption not be granted pending further
evaluation of systemic risk. In the alternative, it is crucial that should the CFTC grant the
exemption to these gold and silver financial products that reporting requirements, and
ideally position limits, be imposed on large investors.
Respectfully submitted,
Matthew Seligman
J.D. Candidate, 2011
Stanford Law School
9 75 FR 19622
