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The Political Dynamics of Derivative Securities Regulation

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The Political Dynamics of Derivative Securities Regulation Roberta Romanot The U.S. regulation of derivative securities--financial instruments whose value is derived from an underlying security or index of securities-is distinctive from that (~f other nations because it has multiple regulators for .financial derivatives and securities. Commentators have debated whether shifting to the unitary regulator approach taken by other nations would be more desirable and legislation to effect such a ~:hange has been repeatedly introduced in Congress. But it has not gotten very far. This article analyzes the political history of the regulation of derivative securities in the United States, in order to explain the institutional difference between the U.S. regime and other nations' and its staying power. It examines the j;JUr principal federal regulatory initiatives regarding derivative securities (the Future Trading Act of 1921, the Commodity Exchange Act of 1936, the Commodity Futures Trading Commission Act of 1974, and the Futures Trading Practices Act (if 1992), by a narrative account of the legislative process and a quantitative analysis (~f roll-call votes, committee-hearing witnesses, and issue salience. The multiple regulator status quo has persisted, despite dramatic changes in derivative markets, repeated efforts to alter it (by the securities industry in particular) and sh(fting political majorities, because of its support by the committee organization of Congress and by a tripartite winning coalition (if interest groups created by the 1974 legislation (farmers, futures exchanges, and banks). In what can best be ascribed to historical j;Jrtuity, different .financial market regulators are subject to the oversight (~f different congressional committees, and, consequently, the establishment (~f a unitary regulator would diminish the jurisdiction, and hence influence, ()f one (if the congressional committees. The committee system is not, however, a sufficient explanation because committees' jurisdiction can shift over time. Jurisdiction over derivatives has not changed because (~f the stake tJ( the key market players-the 1974 tripartite winning coalition-in its preservation t Allen Duffy/Class of 1lJ60 Professor. Yale Law School. This Article is part of a monograph entitled The Dynamics oj Derivative Securities Regu!lltion, to be published by the American Enterprise Institute. I have benefitted from the comment~ of Ian Ayres, Brandon Becker, Franklin Edwards. Edward Kane, Al Klevorick, Philip Johnson, Jon Macey. Mathew McCubbins, Howard Rosenthal and partidpant~ at a University of Pennsylvania Law School Law and Economics Institute Roundtable, the National Bureau of Economic Research Summer Institute Corporate Finance Workshop, the Hoover Institution Collective Choice Seminar, and faculty workshops at the University of Chicago, George Mason University, University of Michigan, New York University, University of Pennsylvania, University of Southern California and Yale Law Schools, and at the business and law schools of the University of Missouri at Columbia and the University of Oregon at Eugene. I would also like to thank Keith Poole and Howard Rosenthal for making available to me their d-nominate scores for members of Congress. Copyright © 1997 by the Yale Journal on Regulation HeinOnline -- 14 Yale J. on Reg. 279 1997 The Yale journal on Regulation Vol. 14:279, 1997 and because the regulation (~{ derivatives is an issue (~{ low salience to the public. In the absence (~{ a sustained large exogenous shock which could ff)CUS public attention on the regulatory regime and could alter the incentives (~{ the coalition partners to support it, we can predict with considerable confidence that, regardless q change in administration or congressional majority, the dispersed organization (if U.S. regulatory institutions offinancial markets will remain. Introduction 282 I. The Origins of Federal Regulation of Futures: The Future Trading Act of 1921 285 A. Economic Conditions on the Farm 286 B. The Legislative Process 288 I. The Role (if Committees 288 2. The Hearings on Futures Trading 291 3. Output ofthe Process: The Final Bill 296 C. Saliency (if Futures Trading: Tracking Public Opinion 297 D. Analysis ofthe House Vote on the Future Trading Act.. 300 E. What Did Farmers Gain From Futures Regulation'! 307 D. Futures Regulation in the New Deal: The Commodity Exchange Act of 1936 311 A. Creation ofthe Federal Price Support Program and Futures Regulation : 312 B. The Legislative Process : 314 C. The Changing Market Conditions (~{ Cotton, Regional Alliances and Popular Opinion 317 D. Analysis (if the Senate Vote on the CEA 320 E. The Legacy (~{the New Deal 326 m. Setting the Stage for the Dispersion of Financial Market Regulation: The 1974 Reforms 329 A. Choice (~{ Venue for Reform 330 B. The Futures Legislative Process in the Turbulent Politics (~{ the I 970s : 333 C. Creation (~{ the CFTC: The Debate over an Independent Futures Regulat()r 335 I. The Farm Groups' Position 335 2. Supportfor an Independent Futures Regulator 336 3. Opposition to an Independent Futures Regulator 338 D. Enactment (~{ the Commodity Futures Trading Commission Act: Analysis q the House Vote on Agency Independence (the Sisk Amendment) 342 280 HeinOnline -- 14 Yale J. on Reg. 280 1997 The Political Dynamics of Derivative Securities Regulation E. Differences Between the House and Senate on Independence 346 F. The Conference Committee's Reconciliation 350 IV. The Battle over Financial Futures Regulation: 1975-92 353 A. The SEC's Initial E.fjrJr(s at Sh(tiinx the Jurisdictional Balance 354 B. Jurisdictional Controversies in the I 980s 356 C. The New Dynamics (~f the Reauthorization Process in the I 990s .. 361 I. The Administration's Involvement in the Reauthorization Process 362 2. The Reauthorization Hearings 363 3. Maneuvering in the Senate Protracting the Reauthorization .. 365 D. The Vote on the Bond-Wirth Market Competition Amendment...... 368 I. The Amendment's Stratexy: Expanding the Issue-Space to Alter the Status Quo 368 2. Analysis ofthe Vote on the Amendment 370 E. Aftermath (if the Bond-Wirth Amendment 375 F. Prognosis on the Winning Political Coalition's Stability 378 Conclusion 380 Table 1. 1921-22 Congressional Witnesses 384 Table 2. Periodical Coverage, 1900-94 385 Table 3. Vote on Future Trading Act of 1921 by Party and Region 387 Table 4. Descriptive Statistics for 1921 House Vote Regression Variables 388 Table 5. Logit Regressions of 1921 House Vote on Future Trading Act 389 Table 6 Bills Introduced to Regulate or Prohibit Futures Trading, by Congress, 1901-96 390 Table 7 1932-36 Congressional Witnesses 391 Table 8 Vote on Commodity Exchange Act of 1936 by Party and Region 392 Table 9 Descriptive Statistics for 1936 Senate Vote Regression Variables 393 Table 10 Logit Regressions of 1936 Senate Vote on Commodity Exchange Act. 393 Table II. Match Rates for Voting Senators, Paired by State, on the CEA 395 Table 12. 1973-74 Congressional Witnesses 396 Table 13. Vote on Sisk Amendment by Party and Region 397 281 HeinOnline -- 14 Yale J. on Reg. 281 1997 The Yale Journal on Regulation Vol. 14:279, 1997 Table 14. Descriptive Statistics for 1974 House Vote Regression Variables 398 Table 15. Logit Regressions of 1974 House Vote on Sisk Amendment .. 399 Table 16. 93d Congress Ideology Comparisons across Chambers .400 Table 17. 1990-91 Congressional Witnesses .401 Table 18. 1989-91 Congressional Witnesses 402 Table 19. Descriptive Statistics for 1991 Senate Vote Regression Variables 403 Table 20. Probit Regressions of 1991 Senate Vote on Bond-Wirth Amendment 404 Table 21. Match Rates for Voting Senators, Paired by State, on the Bond-Wirth Amendment 406 Introduction The regulation of financial markets in the United States is dispersed. Securities are regulated by the Securities and Exchange Commission (SEC) while derivatives on securities-financial instruments whose value is derived from an underlying security or index of securities-are regulated by a variety of agencies. Options on securities are regulated by the SEC; futures and options on futures by the Commodity Futures Trading Commission (CFTC); and off-exchange-traded forward contracts, options, and swaps are typically not subject to any federal regulation (unless undertaken by an institution which is itself federally regulated, such as banks). This multiplicity of regulatory authority has been the principal bone of regulatory contention for decades, as regulators, interest groups and legislators have sought to shift jurisdiction to their preferred agency. Even when a regulator does not object to another's jurisdictional grab, market participants have contested the agencies' authority to do so in court. This Article analyzes the political history of futures regulation in the United States in order to explain what would otherwise appear to be the anomalous persistence of multiple financial market regulators in the United States. The U.S. regulatory scheme for derivative securities is distinctive from that of other nations, which have one regulator for both financial derivatives and securities. While some commentators have contended that multiple regulators foster efficient regulation, competition, and product innovation I, others have maintained that it would be desirable to have a single regulator, to I. See. e.g.. Edward J. Kane, Regulatmy Structure in Futures Markets: Juri.wlictional Competition between the SEC, the CFTC, and Other Agencies. 4 J. Fur. MARKETS 367 (19X4). 282 HeinOnline -- 14 Yale J. on
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