Congress should reinvigorate the CFTC so it can regulate shadowy financial markets
By Todd Phillips
Regulators must get the authority and resources to better supervise existing products and address new ones like carbon-offset
The Commodity Futures Trading Commission, or CFTC, is the federal regulatory agency that is charged with regulating derivatives, the complex financial products that helped cause the 2007-08 financial crisis and subsequent recession. Despite its importance in ensuring the stability of the nation’s financial system, the CFTC’s authorization lapsed in 2013. After a decade and several failed attempts, Congress should reauthorize the CFTC this year, perhaps as part of the farm bill.
The CFTC has consistently been at the forefront of identifying and working to address market changes–such as the use of financial derivatives, algorithmic trading, and cryptocurrencies — but has often been blocked by restrictive statutes, political opposition, and limited funding.
Reauthorization is an opportunity for Congress to take stock of the CFTC’s mission and markets and give the CFTC new authorities to address developing concerns.
OTC markets have ballooned
Much has changed since the CFTC’s authorizing statute, the Commodity Exchange Act, was updated by the Dodd-Frank financial reform law in 2010.
The derivatives markets have ballooned between 2010 and 2022: open interest in exchange-traded futures and options nearlydoubled; the over-the-counter (OTC) foreign-exchange market more than doubled; the OTC interest-rate market nearly tripled; and, since the agency gained authority to regulate cleared swaps, they have become a more than $350 trillion market.
High-frequency trading has gained market share. The exchanges and clearinghouses that support the derivatives markets have become increasingly consolidated. Businesses depend on contracts related to weather and other real-world events to hedge their risks and rely on carbon offsets to achieve their climate goals. The CFTC has repeatedly been asked to decide whether to permit contracts related to elections. And the CFTC has antifraud authority over crypto commodities, including bitcoin, which is nearly 40% of the crypto market capitalization and over 50% of its daily trading volume.
Changes that should be addressed
CFTC reauthorization would be an opportune time to address these market changes and more.
First and foremost, Congress should use reauthorizing legislation to increase the CFTC’s funding. The CFTC is significantly underfunded. Between 2010 and 2021, the size of the CFTC’s staff increased by only 14.5% as the agency began overseeing a new $350 trillion market. And if funding increases are too much today, Congress could permit the CFTC to collect transaction fees that would open the door to increased funding in the future, as has been done for the SEC.
Even if funding changes are not included, there is still much more that can be done to improve the CFTC’s abilities to protect the nations’ markets. The dwindling competition between platforms means that the two largest players in the derivatives infrastructure industry have a practical duopoly, enabling them to raise prices and have a lobbying presence on CFTC policy that looms larger than all others.
To address this lack of competition, reauthorization could implement policies to require competition between platforms and prevent vertical or horizontal integration.
To further encourage competition, Congress could require exchanges to exclusively use central limit order book systems, or, at minimum, require contracts meeting a certain daily trade volume to trade on central order books. And since transparent pricing data is necessary for effective markets, Congress could prohibit exchanges from charging fees for data that are contrary to the public interest or are anticompetitive, similar to the securities laws, or simply require public disclosure of the information with equal access.
Congress could also address issues related to diversity. Unlike all other financial regulators, statute does not require the CFTC to have an Office of Minority and Women Inclusion. Although the CFTC currently has such an office, Congress should put a requirement into law so a future commission cannot abolish it.
Additionally, the law currently requires some, but not all, exchanges to “endeavor” to recruit “culturally diverse” individuals for their boards. There is no reason that Congress should not require racial diversity for the boards of all exchanges.
While Congress is addressing this issue, it could also address the fact that statute only requires some exchanges to have chief compliance officers; all exchanges should have these officers, and they should be made independent of business functions.
New markets, new risks
Additionally, there are several asset classes that require Congress’s attention. First are events contracts. The CFTC is frequently asked to decide whether to permit trading of contracts on election outcomes, which some have equated to gambling. This decision should ideally be made by the people’s elected representatives, and Congress should make its voice clear on the matter.
There are also many problems with voluntary carbon offsets such that businesses and consumers cannot trust their guarantees. The CFTC–which can address fraud and manipulation in cash commodity markets and regulate commodity derivatives–is the only regulator with even limited jurisdiction over offsets. Congress could expressly require that issuers provide audited, CFTC-regulated disclosures so that customers can trust the products they are purchasing.
Finally, Congress could regulate crypto commodities. While the CFTC has recently encountered criticism for its interactions with the failed crypto exchange FTX, its oversight of FTX’s LedgerX subsidiary appears to have successfully kept that entity out of bankruptcy. Further, the Financial Stability Oversight Council has called on Congress to enact legislation governing the cash market for crypto commodities–authority which Congress could grant to the CFTC during reauthorization. Nevertheless, Congress may wish to tackle crypto in separate legislation.
Certainly, not all of these suggestions will have bipartisan support, and reauthorization has failed previously due to insurmountable disagreements. However, differences on some matters should not stop Congress from acting on matters where there is agreement. Democrats and Republicans should figure out where there is agreement and work to make CFTC reauthorization a reality. Doing so would be an opportunity to give the CFTC the tools and resources to effectively police the markets it regulates.
Todd Phillips is principal with Phillips Policy Consulting, LLC and previously served as a member of the CFTC’s Market Risk Advisory Committee.
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