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Chapter 3 Heading Down the Highway

      On a straight but undulating road, you don't concentrate on the next brow, but the one after that, and anything in between you will (or should) have taken account of long before you reach it.

      —Michael Costin (auto racing engineer), describing the racing state of mind, Trackrod Motor Club Newsletter, Dec. 1973

The Layout

      The US government formed administrative agencies to regulate commercial activity in the late 1800s, with the creation of the Interstate Commerce Commission. Applying powers delegated by Congress, these agencies publish rules and regulations; determine whether laws, rules, or regulations have been broken in particular cases; and impose fines and other sanctions on transgressors.

To perform these functions, Congress has conferred upon these agencies both quasi-legislative and quasi-judicial powers. They can issue licenses, set rates, and shape or even outlaw business practices.

      Some agencies are federal executive departments, like, say, the Department of Transportation or Department of Agriculture. Other agencies exist outside the executive departments. The latter are referred to as independent agencies, because they report to both legislative and executive branches of government and the president's power to dismiss the agency head or its commissioners is limited. This independent structure insulates the agency from the political winds that sweep over Washington. The best-known independent agencies are probably the Federal Reserve Board, the Federal Communications Commission, the Federal Trade Commission, and the CFTC's sister agency, the Securities and Exchange Commission.

The Commodity Futures Trading Commission is another independent agency. Though less well known, it is of critical importance to the stability and prosperity of global financial markets. It was established in 1974 on the initiative of some visionary leaders of the Chicago commodity futures exchanges. The new agency assumed responsibility for regulating commodity futures markets—a role that, from the 1920s¹ until then, had been performed by the Department of Agriculture. The CFTC operates under the statutory framework of the Commodity Exchange Act (CEA),² a law that was originally passed in 1936 but has been amended several times since.

      The CFTC is composed of five commissioners who serve staggered five-year terms. They are chosen by the president and confirmed by the Senate. No more than three of the five commissioners can be of the same political party. The commission is a creation of Congress, which has delegated power to it. The delegation is necessary because derivatives markets are so large, vast, and ever-changing that close scrutiny is necessary. Congress does not have the time or expertise to exercise daily oversight over them. So it delegated authority to the commission, which the commission is to wield in a fashion shielded from the expediencies of short-sighted politics.

The US derivatives markets—regulated by the CFTC—are the world's largest, most developed, and most influential. They are relatively unmatched in their depth and breadth. They provide deep pools of trading liquidity at low transaction cost and with minimal friction, and facilitate participation by a vast and diverse array of global counterparties. They are also some of the world's fastest growing and technologically innovative markets of any kind.

      Price Discovery

      US derivatives markets are outstanding at providing efficient and undistorted price discovery. Farmers look at the prices set on agriculture futures exchanges to determine for themselves whether they are getting fair value for the crops they sell to local grain elevators. At the same time, the grain elevators use futures market prices as the basis for what they offer local farmers at harvest. The US Department of Agriculture uses that same information to make price projections, determine volatility measures, and make payouts on crop insurance.

      The value of many of the world's most important agricultural, mineral, and energy commodities is reliably established in US futures markets. Importantly, those prices are set in US dollars. Dollar pricing of the world's commodities provides an enormous and unparalleled advantage to American producers in global commerce. Thanks to dollar pricing, neither producers nor consumers in the United States need a currency hedge on top of their commodities hedges.

US derivatives markets are also considered to be some of the world's best regulated. The United States is the only major country in the Organization for Economic Co-operation and Development to have a regulatory agency specifically dedicated to derivatives market regulation: the CFTC. There is a connection between singularly focused federal regulation and having the world's most competitive derivatives markets. For over 40 years, the CFTC has been recognized for its principles-based regulatory framework and econometrically driven analysis. The CFTC is respected around the world for its depth of expertise and breadth of capability. Too often underfunded, at times underestimated, certainly underrecognized, the CFTC is unquestionably the most innovation accommodating market regulator in Washington's alphabet soup of agencies. And, oh yes, unlike almost every other federal financial regulator, markets and institutions

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