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June 30, 2000

SEC and CFTC May Have Future Together

By William Hoffman

Peace may be at hand in a two-decades old turf battle between the SEC and the CFTC, which might finally result in an agreement on futures contracts on individual stocks.

Legislation is one of the expected fruits of the peace treaty.

Christi Harlan, spokeswoman for Sen. Phil Gramm (R-Texas), said Gramm's banking committee hopes to hold joint hearings with the Senate Agriculture, Nutrition and Forestry Committee on the Commodity Futures Modernization Act of 2000.

That bill, which was introduced by Indiana GOP Senator Richard G. Lugar, would provide support allowing trading among U.S. investors of futures contracts on individual securities.

Harlan said trading the instruments is something that can be done in overseas markets, "and if U.S. markets are to maintain their dominance, it's something that should be available here."

"This time they may actually do it," said Lee Korins, president of the Security Traders Association, referring to past Congressional efforts to allow the trading of single-stock futures.

Korins added that the latest attempts demonstrate that the commodities exchange have strong lobbyists.

Foreign Markets

Futures contracts on individual stocks are currently traded on at least eight foreign exchanges.

Single-stock futures were banned from U.S. markets in 1982, after a turf battle between the Commodity Futures Trading Commission and the Securities and Exchange Commission, over which agency would regulate them.

But executives from the CFTC and the SEC, as well as from the Chicago Board of Trade and the Chicago Mercantile Exchange, testified before Congress in May that regulators could soon settle their differences over margin requirements, insider trading, and other issues.

Robert E. Whaley, a professor of finance at Duke University's Fuqua School of Business, in Durham, N.C., said the regulators' discussions would be most productive if they led Congress to consider merging the SEC and CFTC.

The U.S. is the only country that maintains separate regulatory agencies to oversee equity and futures trading, he said.

But if legalizing single-stock futures trading is the only result, Whaley said traders and investors are likely to be disappointed.

"Futures markets [for single stocks] are contributing virtually nothing to profits in [foreign markets]," he said.

Where they are traded on foreign exchanges, single-stock futures account for less than one percent of total trading volume. These foreign exchanges include markets in Australia, Mexico, Hong Kong and Sweden.

Yet single-stock futures are far riskier than comparable products, such as options. With an option, an investor's loss is capped at the premium that was paid for it. With futures, the potential downside is bottomless.

Some old trader and investor regulations for equities markets do not exist for futures. For example, the Commodities Exchange Act contains no prohibition on insider trading.

Futures can also be highly leveraged. The margin requirement on equities is 50 percent; on futures contracts, the margin may be as low as five percent. The General Accounting Office expressed concerns in an April 2000 report that stock manipulators could use small moves in the price of underlying securities to engender big swings in the price of single-stock futures.

Despite the controversies, Korins said, "the issue has not evoked a lot of discussion [among traders]. And it probably won't, until it's too late to do anything about it."

Harlan said, "My impression is it's more likely to be used by bigger institutions as a hedging device, and not [to be] hugely attractive to individual investors."

Decimalization Priorities

Whaley said decimalization could take some of the wind out of the push for single-stock futures. Futures are best used to reduce the spreads on which assets are traded. It is uncertain whether spreads even on the highest-priced equities could be significantly reduced once decimal-priced trading takes hold.

"If they're introduced, it's incumbent on Congress to make sure that the terms of using a futures contract on stocks should be the same as on trading stocks," Whaley said. "There should be symmetry on margins and there should be symmetry on taxes. Otherwise, it's not fair."