Success built on security
As European fund managers look to the US for investment opportunities, they would be wise to consider the continued success of the US futures markets. Certainly the liquidity, depth and transparency of the markets have all contributed to their strength and longevity. But an equally important factor is the integrity of the marketplace achieved through the industry’s long-standing commitment to self-regulation. Since 1982, National Futures Association (NFA), the industrywide self-regulatory organisation (SRO) for the US futures industry, has personified that commitment.
Over the past two decades, NFA has implemented programmes designed to meet its four congressionally mandated areas of responsibility as an SRO: registration, compliance, dispute resolution and education. With the recent passage of the Commodity Futures Modernization Act of 2000 by the US Congress, the regulatory structure of the industry will alter radically, providing new opportunities for NFA.
These changes to the industry are not unlike what occurred in 1974, when the US Congress created the Commodity Futures Trading Commission, the first governmental agency with exclusive jurisdiction over the futures industry, and the concept of self-regulation was born.
A brief history
Beginning in the mid-1800s, agricultural producers were the primary participants in the futures markets and the US Department of Agriculture had regulatory authority with respect to futures contracts on domestic agricultural products. All other futures contracts were essentially unregulated. This arrangement lasted until the early 1970s when the futures markets began a period of rapid growth resulting from the introduction of several new products. These new products attracted many new and diverse participants looking to use these risk management tools. Trading volume increased dramatically; however, growth and success also engendered unethical business practices, fraud and regulatory uncertainty.
The industry began to realise that the regulatory scope of the industry needed to be re-evaluated and believed that self-regulation (with government oversight) would be more efficient and effective than governmental regulation.
Concern for investor protection and market integrity prompted the US Congress to conduct extensive hearings and ultimately led to the passage of the Commodity Futures Trading Commission Act of 1974. In addition to establishing the first governmental agency with exclusive jurisdiction over the futures industry, the Act provided for the creation of ‘registered futures associations’.
However, for self-regulation to be effective, every firm and individual handling public funds on any US futures exchange must be required to follow the same rules and regulations. Therefore, additional legislation was passed in 1978 requiring every firm that conducts futures trading business with public customers to be a member of a registered futures association. NFA is currently the only such organisation.
On behalf of the CFTC, NFA screens and registers all firms and individuals who wish to conduct futures-related business with the public. Applicants must meet stringent fitness requirements and demonstrate knowledge of the industry by passing the National Commodity Futures Examination. NFA also has the authority to revoke or deny registrations where appropriate.
Once a firm or individual becomes an NFA member, they must comply with a variety of rules that address all aspects of the member’s business practices, such as advertising, telemarketing solicitations, recordkeeping, supervision and disclosure documents. NFA audits all CPOs and CTAs, non-exchange member FCMs and independent introducing brokers (IBs). NFA’s objective in all of its compliance programmes is to ensure that firms are being operated professionally and that customers are protected against unscrupulous activities.
When members do not comply voluntarily with rules and requirements, NFA has the authority to enforce compliance and to take appropriate disciplinary action. Depending upon the nature of the violation and the threat it poses to the public, sanctions can take a variety of forms, up to and including expulsion from NFA.
With millions of futures contracts traded on the US futures exchanges on any business day, it is inevitable that disagreements sometimes arise between customers and the firms and individuals with which they do business. Since 1983, NFA has offered a successful arbitration programme to its members and the investing public. Over the years the programme has become the primary method of dispute resolution in the futures industry.
The approval of the Modernization Act and the continuing emergence of electronic exchanges are providing new opportunities for NFA. Several exchanges have already approached NFA about outsourcing their regulatory functions to NFA. NFA has developed electronic trade practice and market surveillance programmes that function efficiently in a screen-based trading environment and has tailored its existing enforcement, registration and dispute resolution services to meet the needs of these new e-markets. NFA has also developed a pricing model that allows it to recover costs and not put undue financial burdens on emerging exchanges.
In the area of education, NFA has established a number of resources for its membership, the investing public, other regulatory agencies and the media. NFA’s web site (www.nfa.futures.org) contains resources such as investor education materials, registration forms and membership guides.
In early 1999, NFA became the first organisation in the financial services industry to offer background checks on the firms and individuals it regulates to anyone with access to the World Wide Web. The Background Affiliation Status Information Center (BASIC) provides visitors to NFA’s web site with the opportunity to check the registration status and disciplinary history of any firm or individual that has ever been registered to conduct business with the public in the futures industry. The system contains all disciplinary actions taken by NFA and the CFTC since their inceptions and all major disciplinary actions taken by the U.S. futures exchanges since 1990. BASIC also contains limited information about CFTC reparations and NFA arbitration cases.
Benefits of self-regulation
The use of self-regulation as a regulatory technique in the US futures industry has been a resounding success, providing a multitude of benefits to both the industry and the CFTC. A primary benefit of such an arrangement is that the day-to-day practitioners in the industry, who are closest to the business and understand best how it works, are responsible for implementing and enforcing the regulatory framework. They can propose enhancements or modifications as appropriate in today’s rapidly changing environment, yet the CFTC retains its powers of independent action and review.
Another major advantage of self-regulation is a financial one. NFA is totally self-financed with revenue received primarily from transaction assessment fees, membership dues and registration fees which are paid by members and users of the futures markets. Thus, the industry being regulated assumes a greater portion of the cost of regulation and the CFTC is relieved of numerous administrative expenses.
As our business becomes more globalised, we continue to look for additional ways to add value to our organisation and to the financial services industry. We strongly believe that the expanded use of self-regulation – both in the US and internationally – is the best way to reduce regulatory burdens without reducing investor protection or market integrity.
Robert K Wilmouth is president of National Futures Association, based in Chicago