CFTC Commissioner Chilton Advocates the Regulation of Massive Passives and E-Traders

FTC Commissioner Bart Chilton provided the keynote address at the April 30th Technology Advisory Committee. In his speech, Commissioner Chilton emphasized the “categorical” importance of getting all the Dodd-Frank rules in place in an “appropriate manner.” He emphasized this point with what he asserted was the lack of sufficient regulation of (i) “Massive Passives” (traders responsible for the “financialization” of commodity markets), and (ii) “Cheetahs” (high-frequency traders).

Commissioner Chilton also discussed the need for an “End-User Bill of Rights” (first proposed last month). Such a “Bill of Rights,” he urged, must consist of the following:

  1. Right to reasonable Dodd-Frank implementation.
    “Dodd-Frank needs to be implemented and needs to be implemented quickly, but that does not mean it should be done chaotically.
  2. Right to legal certainty.
    “The Commission needs to provide the market as much legal certainty as possible as we move through a challenging implementation period.”
  3. Right to be heard.
    “Many end-users are not used to having their swaps activity subject to CFTC regulation.”

Lofchie Comment:  All three of Commissioner Chilton’s themes (that he disapproves of pension plans holding large longs, that he disapproves of fast traders, and that he thinks that there should be an End-User Bill of Rights) are familiar.

Assuming his general points are correct (contrary to much academic literature), in order to agree with his calls for more regulation, you must believe the CFTC is so smart that it can determine (i) the right level of investment by pension plans (since he does not plan to ban trading in futures by pension plans (known to the Commissioner as “massive passives”)) and (ii) the right amount of speed that can be used by electronic traders (since he does not plan to ban electronic trading), in each case, that will produce “correct” prices in the futures markets. It is implausible that the government can be so omniscient that it can regulate in this way. How would one know that the “correct” price had been found? And how much would it cost to regulate in this manner in order to achieve this “correct” result? And how effective could this regulation of U.S. pension plans be if pension plans in Europe and Asia are permitted to do what pension plans in the United States are prohibited from doing? In short, it seems to be that the Commissioner advocates a substantial plan of government regulation, for which the academic support is (at best) divided and for which there is no certainty of success, but that hardly matters because there is no way to know if one is being successful. 

As to the third point, this is largely a complaint about the conduct of the CFTC: (i) it adopts rules that are impractical to implement on unrealistic schedules; (ii) its rules are confusing; and (iii) it does not take comments from market participants until it issues no-action letters on the eve of its rules’ effectiveness.  So we can all support an End-User Bill of Rights, and in fact, we can go further.  We would argue that all citizens (even lawyers) are entitled to the rights which Commissioner Chilton advocates.  We hope that he and the CFTC generally will take his Bill of Rights to heart.

Quote from Craig Pirrong (“Streetwise Professor“):  Professor Pirrong asserts that Commissioner Chilton’s argument that “massive passives” drive up prices to incorrect levels should be subject to criticism.  Here is an excerpt from Professor Pirrong:

“First of all, 20 percent in 13 years is less than 2 percent per year – that is, less than the rate of inflation: the CPI is up almost 30 percent over those 20 years, meaning that the real price of energy has fallen. I say again: the real price of energy – per Chilton’s own numbers – have fallen.

“I also note Chilton’s continued focus on the rise in oil prices, and his complete refusal to acknowledge the collapse of natural gas prices precisely during the period in which his Massive Passive bogeymen have allegedly driven commodity prices generally, and energy prices particularly, far above what they ‘should’ be. If ‘speculation’ by ‘massive passives’ (or whoever) can cause prices to become completely unhinged from fundamentals, why has natural gas moved in the exact opposite direction from oil?”

Click here to view Commissioner Chilton’s speech in full (links externally to CFTC website).
See also: Commissioner Chilton’s Remarks on Market “Meltdown Moments”; TAC Meeting Agenda and List of Participants.