Letter from Sir Brian Williamson to Mr Giles Radice MP (9 April 1999)
REGULATION OF TRADING SCREENS IN THE US
At our recent lunch, I promised to set out more fully the impossible position we find ourselves in with the Commodities Future Trading Commission.
As we discussed, LIFFE's move from floor trading to screen trading makes it imperative for us to provide screen trading facilities to firms in all major financial centres. The Investment Services Directive provides us with the right to do so in all European countries, and we are currently negotiating with the regulatory authorities of a number of other countries for permission to operate within their jurisdictions. For most of these jurisdictions we foresee no problems. This includes Japan, which has been notoriously resistant to foreign interests in the past.
By contrast, the United States looks impenetrable to us at present. In order to place facilities in the United States to enable the trading of LIFFE's financial products, the Exchange needs the approval of the CFTC (LIFFE's equity products would require SEC approval). In the past, this would have taken the form of a "no-action letter", in which the CFTC would acknowledge that, subject to certain conditions being met, it would not seek to prosecute a foreign market for operating in the US without being recognised as a domestic market subject to CFTC regulation. EUREX, the Swiss/German market which represents one of LIFFE's major competitors, was granted approval to operate under that regime in February 1996. At that time, LIFFE was still predominantly a floor-based market and did not wish (nor did it have the technical capability) to place screen-trading facilities in the US.
The growth of electronic trading, and the increasing number of exchanges who wished to gain direct entry to the US market, put pressure on the CFTC to move to a more formal regime with a clear statutory basis. In consequence the CFTC stopped considering further applications for no-action relief and Chairperson Born announced in March 1998 that the CFTC intended to publish a "concept release" (that is, a consultation document) requesting industry comment as to how terminals installed in the US for trading on non-US exchanges should be regulated.
Almost before the ink was dry on that statement, the CFTC starting prevaricating about the way ahead. By early April 1998 the CFTC had decided to bypass consultation on the concepts involved and seek consultation immediately on draft rules; they envisaged that these would be published by the end of the month. If they had stuck to this approach and timetable, LIFFE could have been approved under the new rules in mid-1998.
Instead, the CFTC bowed to pressure from the US markets and reverted to the idea of a concept release. This was published on 24 July 1998, with a sixty-day comment period. Throughout the latter part of 1998 LIFFE was continually assured by CFTC staff that the new rules would be in force by the end of 1998. In the event draft rules were only published in March 1999, a year after the original announcement. Those draft ruleswhich covered both the location of screens in the US and the use of order routing systems to place orders with foreign marketswere sufficiently onerous to move three of the CFTC Commissioners (that is, all but Chairperson Born) to add riders to the published document noting their "significant reservations" about the complexity and burdensome nature of the proposed rules. The initial reaction to the draft rules by the US brokerage community has been to agree with these reservations and resist the proposals, notwithstanding that they are keen to get more direct access to foreign markets. Given such resistance (and the inevitable resistance from US markets) it seems unlikely that final rules will be in place before mid-year at the earliest, and a much later date cannot be ruled out from US markets) it seems unlikely that final rules will be in place before mid-year at the earliest, and a much later date cannot be ruled out.
If LIFFE is to provide direct access to its market to US participants it needs to install electronic "hubs" there, provide connections between the hubs and members' systems, and then ensure full testing of the Exchange's and the members' systems. Realistically, such construction and testing will take at least four months to complete and cost the Exchange some £3 million. The Exchange has been ready to commence this work since the beginning of the year so that the systems would be able to be operational from mid-year. The lack of a clear timetable, and the distinct possibility that the rule will not be implemented in the foreseeable future, makes it difficult to justify the Exchange committing its resourcesand those of its members in the USin such a way. Furthermore there comes a point (which may have already been reached) beyond which members will refuse to contemplate introducing and testing new software until after the new year because of the Year 2000 problem. This means that the endless delays by the CFTC may mean that LIFFE will not be able to extend screen trading to the US until mid-2000, a year after its target date.
We have worked closely with the Financial Services Authority and HM Treasury to address this problem but it remains a serious and significant obstacle to LIFFE's commercial development, and one exacerbated by the fact that both EUREX and MATIF have been granted access to the US under the old regime, an option not now available to LIFFE.
I will keep you informed of any progress towards resolving this somewhat intractable issue and am seeing Chairperson Born next Wednesday. Howard Davies of the Financial Services Authority will also be seeing her.