Testimony of James R. Jones Chairman, American

---

T e s t i m o n y of James R. J o n e s Chairman, A m e r i c a n Stock Exchange, Inc. B e f o r e the Senate C o m m i t t e e on Banking, H o u s i n g and U r b a n A f f a i r s July

My name American

ii,

is James R. Jones.

I am C h a i r m a n

of the

S t o c k Exchange.

I commend for c o n d u c t i n g

S e n a t o r Dodd,

hearings

o v e r the s e c u r i t i e s

Competition, questions

S e n a t o r Heinz

on the q u e s t i o n

legislative

Stability,

the A d m i n i s t r a t i o n ' s

will

the Ad Hoc C o a l i t i o n

Coalition.

Act of 1990.

and futures

as

Markets

The

debate

are a m o n g

industry

shed light on the needs

support

for I n t e r m a r k e t

Stock Exchange

today that

for the i n i t i a t i v e s Coordination

is a participant,

self-regulatory

Luthringshausen

as well

bill addresses.

I also wish to express

the j u r i s d i c t i o n a l

jurisdiction

- the Capital

jurisdictional

in the s e c u r i t i e s

and this h e a r i n g h o p e f u l l y

securities

of federal

proposal

and Fairness

r a i s e d by the current

the m o s t p r e s s i n g

and the C o m m i t t e e

and stock index futures m a r k e t s

the A d m i n i s t r a t i o n ' s

American

1990

concerns

organizations. expressed

in his t e s t i m o n y

in w h i c h

the

along w i t h other The E x c h a n g e

t o d a y by W a y n e

on b e h a l f

of

of the Ad Hoc

shares

-2-

The

increasingly

jurisdiction

has b r o u g h t

warrant

Congressional

contest

t h a t the stock,

markets

comprise

concluded

disadvantaged by the U.S.

Court

CFTC

clause"

marketplaces

of the C o m m o d i t y

review,

of our s e c u r i t i e s

as securities,

will

continue

The A d m i n i s t r a t i o n ' s what c o m m o n

in its

Because

1989

the S u p r e m e

Circuit's

of futurity,

be s u b j e c t

there and

to e x c l u s i v e

t h e r e will be

of l i t i g a t i o n

to test the o u t e r

As a result,

marketplaces

products,

Act

given

to the

U n d e r that d e c i s i o n

At the very least,

and i n s t i t u t i o n a l

recognizes

Circuit

the S e v e n t h

clause."

seriously

interpretation

Exchange

may well

and a p r o l i f e r a t i o n

regulatory

have been

that any p r o d u c t w i t h an e l e m e n t

of the " e x c l u s i v i t y

futures

serious

for the S e v e n t h

futures,

to

exist.

of the e x p a n s i v e

has d e c l i n e d

s t o c k index

initiatives

index

1987 crash,

is now the law of the land.

uncertainty

retail

and s t o c k

that

no one a p p e a r s

to Index P a r t i c i p a t i o n s .

jurisdiction.

bounds

while

concerns

as the B r a d y T a s k Force

the O c t o b e r

our s e c u r i t i e s

relating

is a d a n g e r not just

First,

options,

as a result

recently

decision

action.

Court of A p p e a l s

"exclusivity decision

into focus two p r i n c i p a l

and i n c o n s i s t e n c i e s

Second,

over SEC/CFTC

debate

"one market",

following

bifurcation

heated

the

to d e v e l o p

new

and to t r a d e and m a r k e t

them

to be stifled.

proposal

sense d i c t a t e s

to a d d r e s s - that

these

issues

integrally

linked

-3-

market

segments

must be subject to regulation

and consistent. but,

The Administration's

at the same time,

regulation. futures,

By providing

for SEC oversight the CEA's

undo the effects

of the Seventh

Administration's

proposal will

linked equity and derivative would eliminate

innovative encourage

and useful

markets.

competitive

securities

their development.

the A d m i n i s t r a t i o n ' s to m a i n t a i n i n g

the integrity

new

over stock

index

clause"

decision,

of our

At the same time, barriers

which

the

to development

and,

I, therefore,

to

the

the soundness

products

initiatives,

intrusive

"exclusivity

Circuit's enhance

is unified

is c o m p r e h e n s i v e

avoids u n n e c e s s a r i l y

as well as amending

proposal

bill

that

indeed,

strongly

I believe

and international

of

would

endorse

are critical

competitiveness

of our markets.

Stock Index Futures Jurisdiction Unified adjunct

linked markets

investor confidence.

futures markets individually

October

across

is a necessary

to reduced market risk for all market participants

to increased

systemic

regulation

each have taken a number

and in concert,

weaknesses 1987 crash,

stock index

While the securities

and

both

to remedy the most serious

that became regulatory

futures markets

of steps,

and

all too apparent disparities

continue

after the

between

stock and

to thwart c o m p r e h e n s i v e

-4-

measures Report

to further reduce market

identified

procedures,

margin,

risk.

coordinated

circuit breakers,

The Brady Task Force

clearance

and surveillance

and s e t t l e m e n t as areas t h a t

\

require

unified

linked markets

responses.

Moreover,

is necessary

to implement

preemptive

volatility.

By providing

Administration's

a single

to address

measures

future market

of

crises

and

to deal with market

consolidated

bill promotes

regulator

regulation,

the soundness

the

of our markets

as

a whole.

Disparate and equities oversight, exchanges

margin requirements

also require unified

as the Administration currently

requirements conditions,

which may contribute

liquidity

margin

requirements

specifically

has proposed. speculative

to market

payment

could be reduced, to levels

Different margin

of the different margin,

and affecting

stable,

securities.

regulation,

functions

Futures

market

risk by impacting

systems.

Likewise,

when markets

far lower than those

are required

levels may be appropriate

of futures

SEC

and hedge m a r g i n

abruptly during rapidly declining

market

relatively

can increase

for stock index futures

for

in v i e w

and equity or options

but margin levels must be set to minimize

market

as a whole and permit better evaluation

Margin

levels must be coordinated

because

risk to the

of credit

our markets

risk.

are

/

interactive;

margins established

in the futures,

options,

and

-5-

equity markets margin

levels

inevitably

is much too important

financial

markets

instincts

of individual

coordinated regulator, reduce

impact each other.

to continue

margin regulation

exchanges.

the level of risk resulting in required margin

of

of our

to the competitive Therefore,

under the oversight

as the Administration's

or decreases

to the health

to be subject

futures

The setting

bill provides,

of a single will

from precipitous

serve to

increases

levels under varying market

conditions.

Adequate critical unified

for cross-margining,

market efficiencies, regulation.

and exchanges the overall

It is essential

exposure

improve

that clearing assess

of clearing members

of funds to meet changing market

Similarly,

to facilitate of member

integration exchange

of securities

clearance

risk in relation

to A

of one regulator

conditions.

the timely assessment

firms,

corporations

and permit more efficient

deployment

condition

by

in related markets.

system under the oversight

risk assessment

which can provide

also would be facilitated

be able to accurately

cross-margining will

systems

a single regulator clearing

agencies

of the financial would promote

the

and futures

systems.

From a broader perspective,

we also must keep in mind

that we may not yet have experienced

all possible

challenges

to

-6-

the

stability

of our markets.

of i n t e r n a t i o n a l domestic risks

securities

and global

t h a t may be even more d i f f i c u l t our m a r k e t s

and f u t u r e s

exchanges

innovative

these

exists

for t r a d i n g

on a 24 hour basis. new systems will

regulator

the u n i f i e d

have a l r e a d y

course

facilitates

this

the w o r l d w i d e securities

scheme

new market

to g r a p p l e

with than Securities

are w o r k i n g

towards

We c a n n o t

know

Again,

fully w h a t providing

technologies,

is the m o s t

and,

and f u t u r e s

efficient

I believe,

new

a

comparable

The A d m i n i s t r a t i o n ' s

important goal

market

and bill

will

improve

of all of our d o m e s t i c

markets

unified regulation and i n n o v a t i o n

innovation

split

fosters

Some have intermarket

and that the C F T C has done m o r e to f o s t e r than has the SEC.

securities industry competition

not impede

in our markets.

that a j u r i s d i c t i o n a l

competition

will

is not the case.

today is f i e r c e l y

in the d e v e l o p m e n t has b e e n

This

competitive,

of new s e c u r i t i e s

furthered by SEC

initiatives

to

that

and futures.

competitiveness

technology

and of n e w

impose

for s e c u r i t i e s

of action.

competitiveness

Moreover,

suggested

may

introduce.

in all o t h e r countries,

responsible

markets

and d i s s e m i n a t i n g

over linked m a r k e t

regulatory

rapid development

encountered.

here and a b r o a d

technologies

information,

single

and f u t u r e s

trading mechanisms

those which

risks

The a m a z i n g l y

The and

products and

and

-

-7-

oversight,

w h i c h has been r e s p o n s l v e

Competition less

between

intense

futures

and s e c u r i t i e s

if the SEC o v e r s e e s

CEA " E x c l u s i v i t y

to c o m p e t i t i o n

"exclusivity SEC's

clause."

approval

Participations of the

product

element

The S e v e n t h

clause".

exchanges

will

by the CEA's

expansive

interpretation

new l e g i s l a t i o n ,

and,

indeed,

lacks any

is an u n r e a s o n a b l y

particularly

since

the S e v e n t h

Circuit

an e x t r e m e l y

broad v i e w of w h a t

constitutes

futurity

to f i n a n c i a l

instruments.

securities

c o u l d be argued to have

under

court's

rationale,

a number

thought

to be clearly w i t h i n

I a p p l a u d the A d m i n i s t r a t i o n ' s effects

of the court's d e c i s i o n

has taken in regard

of f u t u r i t y

and thus the d e c i s i o n

the d o m a i n

onerous

of t r a d i t i o n a l

some e l e m e n t

c l o u d o v e r w h i c h agency has j u r i s d i c t i o n

and

securities

requirement,

Indeed,

that a

marketplace,

and i n s t i t u t i o n a l

this

the

- Index

have to d e m o n s t r a t e

contract,

I belfeve

the

has n u l l i f i e d

in a s e c u r i t i e s

retail

is not a futures

created

Circuit

Without

for t r a d i n g

of futurity.

this

be no

futures.

also a d d r e s s e s

new p r o d u c t

a r g u a b l y will

for t r a d i t i o n a l

investors,

index

and i n n o v a t i o n

- based on the c o u r t ' s

designed

intended

proposal

of an i m p o r t a n t

"exclusivity

securities

stock

markets

Clause"

The A d m i n i s t r a t i o n ' s barriers

and p r o - c o m p e t i t i v e .

may cast a

in a r e a s p r e v i o u s l y of the SEC.

initiative

by p e r m i t t i n g

to u n d o the

instruments

such

-8-

as Index Participations

to be traded

on securities

exchanges

under the SEC's oversight.

The principal are two-fold.

effects

First,

analysis

considerable

commencing litigation, albeit U.S.

trading

Circuit's

that the A m e r i c a n

in a new judicial

new investment

and futures

Participations burgeoning

or similar products.

global markets,

saddled with a legal

decision.

domestic

The and and

and in subsequent gloss

on the CEA,

has been denied

unencumbered

regulation,

and trade abroad instruments

markets

that may not

marketing,

vehicle

But foreign markets,

securities

decision

Stock Exchange

in Index Participations,

has resulted

investors.

develop

products

have applied to developing,

that a useful

bifurcated

of securities

under the Seventh

resources

other exchanges

Circuit's

it is less likely that securities

will pursue development survive

of the Seventh

to

by

are encouraged

to

such as Index Thus,

at a time of

securities

framework that operates

markets

are

to our competitive

disadvantage.

Second, markets market program

have lost the benefits volatility trading

determined Indeed,

in being denied

Index Participations, of a possible

by alleviating

that Index Participations

Index Participations

means of tempering

market pressure

and index arbitrage.

our

The SEC,

generated

by

in fact,

have this potential.

were developed

following

calls by

-9-

the SEC and others, basket-type program

after the 1987 crash,

products

trading

intra-day trends

individual

to purchase

market

securities have,

customers,

regimen

applicable

public,

futures

Securities

could be readily

are associated

were

as some

to the

and hedging,

The futures market has a far more

account

account executives.

approvals

Many

futures.

procedures,

and commodities;

vehicles,

stock index futures

merchants

and

are p r e c l u d e d

requirements

of course,

and whereas

counterpart.

are not fungible,

institutions

Margin

and were designed primarily

functions.

in m a r k e t

In the eyes Of the

with speculation

equities,

hedging

adapted

for futures commission

commodity

the

with

to suggest,

customer base than its securities

clearance/settlement securities

of

and institutional

and it is impractical

and commodities

from trading

instruments

to participate

to futures customers.

nor is registration securities

have been denied

that Index Participations

not long term investing. retail

and thereby

for both retail

that such products

limited

impact

do.

I would emphasize as securities

investors

stock index-based

liquidity

as institutions

designed

the market

and index arbitrage.

In addition, opportunity

that could deflect

for market

and

are different

IPs were m a r g i n e d

as alternative

as

investment

serve mainly s p e c u l a t i o n

IPs were designed

for

and

for the securities

-i0-

marketplace; market with

and

the m a n y d i f f e r e n t

certainty;

anything

initiatives

less will

serious

competitive

constructive

framework make

stress that absolutely

on a s e c u r i t i e s

u n d e r the law.

inviting

further

will

to to

proposal

remove

and foster d e v e l o p m e n t

a

of

statute

that the s t a t u t o r y

c l e a r that a p r o d u c t

exchange

laws,

is e s s e n t i a l

confusion the CEA,

in w h i c h

approved

or in the s e c u r i t i e s

and not a futures

This

regulatory

the s e c u r i t i e s

or any o t h e r

exchange

and t h e i r u s e f u l n e s s

it is i m p o r t a n t

i n d e e d be a security,

purposes

under

their

s h o u l d be p e r m i t t e d

Congress

and

new products.

I would

trading

and i m p r o v e

the A d m i n i s t r a t i o n ' s

clause",

impediment

development

and i n t e r n a t i o n a l l y ,

By e n a c t i n g

"exclusivity

and j u r i s d i c t i o n a l

d e t e r new p r o d u c t

to create new i n s t r u m e n t s

participants. the

legal

are to m a i n t a i n

domestically

in our view,

product.

require

or fail b a s e d on t h e i r m e r i t s

amending

would

markets

If our m a r k e t s

competitiveness,

market

Index P a r t i c i p a t i o n s

securities

innovation.

succeed

of the c o m m o d i t i e s

its c u s t o m e r base w e r e not c o m p a t i b l e ,

a successful

The

features

markets

contract,

for all

if we are to avoid

and p o s s i b l e

the I n t e r n a l

securities

for

litigation

Revenue

or f u t u r e s

Code,

are

referenced.

In closing, there

is s e r i o u s

I would a c k n o w l e d g e ,

disagreement

as we all know,

a b o u t the impact

of s t o c k

that index

-ii-

futures

t r a d i n g or of d i s p a r i t i e s

securities CFTC

between

m a r g i n on m a r k e t v o l a t i l i t y .

Most

a n d S E C h a v e come to w i d e l y d i f f e r i n g

market

effects

October

of p r o g r a m t r a d i n g

1989 m a r k e t break.

the multiplicity

of c o m p l e x

drawn.

W h a t e v e r the cause,

for investors,

and

recently,

conclusions

in t h e i r s t u d i e s

These disagreements

however,

of the

are r o o t e d

for m e m b e r

firms,

conclusions the problem and

the on the

facts and t r a d i n g p a t t e r n s

m u s t b e a n a l y z e d b e f o r e any p l a u s i b l e

one

futures

in

that

can be remains

a real

for m a r k e t makers,

e a c h of w h o m b e a r s u n i q u e r i s k s as a r e s u l t of v o l a t i l e m a r k e t s - particularly

r a p i d l y d e c l i n i n g ones.

It d o e s not h e l p s o l v e the p r o b l e m to say t h a t a l i n k between

s t o c k index futures t r a d i n g and v o l a t i l i t y

has not b e e n

proven.

O u r m a r k e t s do not h a v e the l u x u r y of t i m e to w a i t

"proof",

if it e v e r comes.

mechanisms

We n e e d to p u t

to e n h a n c e i n v e s t o r c o n f i d e n c e

in p l a c e n e w a n d to a s s u r e t h a t we

can withstand

and s u r v i v e e x t r e m e and i n c r e a s i n g l y

unpredictable

market pressures.

proposal, derivative

by consolidating markets,

I believe the Administration's

r e g u l a t i o n of o u r e q u i t i e s

aims to p l a c e all m a r k e t

s t r o n g e r p o s i t i o n to w i t h s t a n d

for

such pressures

segments

and in a m u c h

- n o w and in the

future.

I a p p r e c i a t e this o p p o r t u n i t y to s h a r e m y v i e w s w i t h the Committee.