SEC vs CFTC: There Can Be Only One - Part One

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The derivatives industry is currently engaged in a bitter struggle. On one side, you have the turbulent and increasingly restive options industry. Opposing them is the assembled might of the futures industry.

What has driven these two complementary marketplaces apart and set their members at each otherís throats? Has one of the usual suspects like payment for order flow or penny pricing once again reared its ugly head? Not this time. The cause of this latest conflict can be traced back to one of the oldest open wounds in the derivatives world ñ regulation.

THE CONFLICT BEGINS
Strife is nothing new to the options markets. Ever since the dawn of multiple listing in 1999, the options exchanges have been locked in a no-holds-barred struggle for dominance. Compared to the Wild West free-for-all that is the options markets, the futures markets seem relatively tame. Why is there such a dissonance between the two marketplaces? It can all be traced back to that ever-present bogeyman known as regulation.

AND THEN THERE WERE TWO
While most countries treat the two product classes the same for regulatory purposes, the U.S. regulates options and futures as separate products. To make matters worse, the U.S. has assigned two different regulatory bodies to oversee these markets. As you can imagine, this dual regulatory system has caused no shortage of headaches and remains the source of a great deal of consternation.

Although this dual regulatory structure is unpopular in the options industry, it has proven to be a distinct competitive advantage for the futures industry. While the options exchanges battle over virtually identical products, the futures exchanges have carved out sheltered fiefdoms for their product lines. This is because futures, unlike options, are non-fungible products.

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IT'S GOOD TO BE THE KING
Futures exchanges trade distinct contracts that are not interchangeable. In essence, they are monopolies in their particular product lines. This lack of strategic competitors within the U.S. has not gone unnoticed by the options industry.

With every major options exchange struggling to maintain its market share against identical competitors, the lure of monopolistic products is quite compelling. They have begun churning out wave after wave of futures products in the hopes of capturing some of that monopolistic magic.

As a result, the derivatives marketplace has been flooded with proprietary products that blur the line between futures and options. These new products donít fall under the purview of either the SEC or the CFTC. Instead, they are dual-regulatory products that require the oversight of both regulatory organizations.

PROBLEMS WITH THE SEC
This wave of dual-regulatory products has re-opened some very old wounds in the derivatives industry. For decades, the futures industry has been overseen by the  CommodityFutures Trading Commission (CFTC), a specialized regulatory body whose sole purpose is to govern the futures markets.

However, the options markets have languished for decades under the oversight of the Securities & Exchange Commission (SEC), a regulatory body whose primary focus is the equity markets. The lack of a specialized regulatory body for options has left many in the industry feeling like second-hand citizens when it comes to regulatory resources.
With most of the SECís knowledge and expertise centered on equities, they have been slow to adapt to the competitive realities of the options marketplace.

This is hardly a new complaint. After all, it took the CBOT five years just to get the concept of options past the SEC back in the 1970s. All these years later, options exchanges still have to struggle to get their regulator to understand the unique needs of their marketplace.


Continued in Conclusion...
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