Introduction Mr. Chairman and Members of the Committee: The Chicago Board of Trade is pleased to have this opportunity to present its views to the Senate Committee on Banking, Housing, and Urban Affairs with regard to recent events in the world silver market and the adequacy of current federal regulation of cash and futures markets in precious metals, foreign currencies, and financial instruments. We appeared earlier this month before the Senate Committee on Agriculture, Nutrition and Forestry and the House Committee on Agriculture. These Committees, which are the Senate and House oversight committees for the Commodity Futures Trading Commission and the U.S. futures industry, have gained considerable expertise in this specialized and highly complex area and have performed their oversight roles in a most responsible manner since creation of the CFTC in 1974. Many of the matters discussed in this Detailed Statement have already been discussed at great length with these Committees, both recently and in the past. While the particular focus of these hearings is on silver and the regulation of so-called "financial instruments" as proposed and broadly defined in S. 2704, introduced by Chairman Proxmire on May 14, 1980, we believe that it is important for the Committee to keep in mind, at the outset, that our nation's futures markets are highly integrated and centralized institutions truly national and often international in their scope -1 and effect - performing a most important economic function benefiting many sectors of our economy. In 1970 futures trading was essentially limited to agricultural and forest products and a few metals. By the end of the decade, however, the price-discovery and risk-shifting mechanisms of futures trading were also available in foreign currencies, energy resources, and a number of debt obligations, which we call "financial futures" (as distinguished from the very broad definition of that term in S. 2704). Approximately 60 different items are now traded for - 17 at future delivery on our nation's commodity exchanges the Board of Trade. We see nothing but continued expansion in the 1980's, as more and more segments of our economy recognize the important risk-shifting and price-discovery functions performed by our futures markets, and seek development of futures contracts to serve them. In sum, this is an important industry, serving a variety of commercial users and economic groups. Yet the purposes of futures trading remain widely misunderstood. And the industry's growth and expanding economic importance make it a natural target for uninformed criticism, particularly during inflationary or recessionary periods when the price levels that our markets merely reflect are perceived as being too high, or too low, depending on one's particular perspective or vested interest. As two distinguished British students of our markets observe: The ease with which futures trading can be made interest explains much ill-considered official We urge this Committee, as it enters this unfamiliar area of economics and regulation, to keep this admonition in Federal Reserve Chairman Volcker has also cautioned in mind. this regard: I would caution against striking out with The remainder of this statement is devoted to margin authority (including S.2704), recent events in silver, CFTC jurisdiction, and the adequacy of self-regulation and current CFTC tools to protect and perfect the futures markets. Submitted with this Detailed Statement (but bound separately for convenience) is a supplement containing additional background information on futures trading, futures "margins," and financial and precious metals futures in particular. For the Committee's convenience, the following is a brief summary of the material covered in considerable detail in the pages that follow. 1/ Goss & Yamey, The Economics of Futures Trading 47 (1976). 2/ Statement of the Hon. Paul A. Volcker before the Senate Committee on Agriculture, Nutrition and Forestry, May 1, 1980. -3 1. SUMMARY Part I FINANCIAL AND PRECIOUS METALS FUTURES The Role of Financial and Precious Metals Futures. Hedging allows owners and users of a cash asset to protect the value of the asset and "lock-in" guaranteed prices. Hedgers protect themselves by taking opposite positions in the cash and futures markets. By doing so, loss in the cash market can be offset by a gain in the futures market. Futures markets also facilitate determination of prices and dissemination of price information. Items which are traded in the over-the-counter markets are difficult to price accurately. Futures prices, however, are widely disseminated and provide both current price information and the market's best estimate of future a prices. Also, the ability of the futures markets to react 2. quickly to new information tends to minimize price vola- The risk shifting and price discovery functions of futures markets allow more efficient use of resources. Minimization of transaction costs allows greater productivity, and widely quoted, accurate prices permit available resources to be allocated more efficiently. Futures trading in financial instruments and precious metals is no different in substance than trading in oats, wheat or soybeans. Congress recognized this fact in 1974 and again in 1978. The Role of Speculation in Futures Markets. - - Speculation improves the efficiency of futures markets, as speculators provide vital economic services to the proper functioning of the markets. They are both buyers and sellers, tempering rather than contributing to price volatility. They use their own capital to assume a risk of adverse price changes that would otherwise go to the consumer as a middleman's cost of doing business. make money only when they are right, so they spend a lot of time and research trying to be right. They are up-todate on supply and demand factors, thus playing a vital role in the price-discovery process. They Speculators also provide liquidity so that hedging in even large volume may be done with minimal price effects and minimal execution costs. Thus, markets with relatively high levels of speculation are most effective for hedging, |