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February 2, 2006

The Great Options Debate: Poor regulation, new competition

By Mark Longo

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Every year, the Futures Industry Association (FIA) gathers in Chicago to discuss the state of the derivatives industry. Normally, the bulk of their discussion centers on the futures markets. However, a significant portion of this year's meeting was devoted to the vagaries of the options business. Options executives held panels on a variety of topics ranging from the expansion of the options business to the evolution of market making. The highlight of all of this options coverage was definitely the "Exchange Leadership Panel." Here the heads of the U.S. options exchanges sat down for a colorful and sometimes heated discussion about the state of their industry.

Ganging Up on the SEC

This year's panel began by addressing the ongoing bane of the options world regulation. While the futures markets enjoy the oversight of a specialized regulator, the Commodities Futures Trading Commission (CFTC), the options markets don't have that luxury. Their regulator is the SEC, an organization whose primary focus is the regulation of the equity markets. As a result, the options markets often feel like a forgotten stepchild when it comes to regulation. From the SEC's refusal to address payment for order flow to its baffling desire for penny option pricing, the SEC has incurred the ire of many within the industry.

"The SEC's take on competition is essentially to sit back and let us claw at each other," complained Neil Wolkoff, Chairman & CEO of the American Stock Exchange. Now, with options exchanges launching their own futures products, the specter of dual oversight is causing even more regulatory headaches.

"The U.S. regulatory scheme is goofy in the way that it separates options and futures," complained Bill Brodsky, Chairman & CEO of the Chicago Board Options Exchange. "In every other country, options and futures are considered one product in terms of regulation. Unfortunately, we have a unique and somewhat insane regulatory situation in this country."

Dissatisfaction with the SEC's track record, combined with frustration over the hassles of dual regulation, has given birth to a new movement in the options industry. The goal of this movement is to merge the CFTC with the SEC. This would create one body that is responsible for all oversight in the U.S. derivatives markets. Proponents of this plan hope that the efficiencies of the former will miraculously transform the latter into an able regulator.

"It would be nice if some of the CFTC's culture, which is much more progressive, could rub off on the SEC," commented Sharon Brown-Hruska, a commissioner with the CFTC.