(John Kemp is a Reuters market analyst. The views expressed are
By John Kemp
LONDON Feb 24 "I have reached a tipping
point," Commissioner Scott O'Malia told an open meeting of the
U.S. Commodity Futures Trading Commission (CFTC) on Feb. 23,
"and can no longer tolerate the application of such weak
standards to analysing the costs and benefits of our
"Our inability to develop a quantitative analysis, or
develop a reasonable comparative analysis of legitimate options,
hurts the credibility of this Commission and undermines the
quality of our rules.
"I believe it is time for professional help," O'Malia told
his fellow commissioners. He warned that he would be writing to
the president's Office and Management and Budget to seek an
independent review of certain rules and to ask for
"recommendations as to how the Commission can improve its
cost-benefit analysis and analytical capabilities".
O'Malia's passionate but carefully scripted comments mark
the latest stage in his evolution from cautious supporter to
chief internal opponent of CFTC Chairman Gary Gensler's efforts
to rewrite derivatives rules and implement roughly 60 new
regulations required by the Dodd-Frank Act.
The commissioner's personal journey mirrors the mounting
pushback from the financial services industry, business groups,
conservative lawyers, free-market thinkers and Republicans in
Congress against the changes mandated by Dodd-Frank as memories
of the crisis fade and attention turns to the burden of
complying with regulations.
Demanding that federal rules be subject to strict,
quantified cost-benefit analysis (CBA) has become a rallying cry
for business groups and conservative scholars seeking to roll
O'Malia cited with approval a recent article on
"Over-regulated America" in the "Economist" magazine. The
Economist singled out the Dodd-Frank Act and complained, "Red
tape in America is no laughing matter. The problem is not the
rules that are self-evidently absurd. It is the ones that sound
reasonable on their own but impose a huge burden collectively."
The magazine recommended "all important rules should be
subjected to cost-benefit analysis by an independent watchdog.
The results should be made public before the rule is enacted."
Last year, O'Malia complained about the lack of quantitative
cost-benefit analysis behind the CFTC's decision to impose
position limits in commodity derivatives. This lack of
quantitative evidence is central to the legal challenge to
position limits being mounted by the International Swaps and
Derivatives Association (ISDA) and the Securities and Financial
Markets Association (SIFMA).
ISDA and SIFMA are represented by the same lawyers who have
already successfully struck down two securities rules on the
grounds the Securities and Exchange Commission failed to perform
and adequate cost-benefit assessments before implementing them.
LEGISLATORS AND REGULATORS
It seems obvious federal agencies such as the CFTC should
have to prove that the benefits of new regulations outweigh the
costs before introducing them. But the reality is more
complicated as even some of the proponents of cost-benefit
analysis acknowledge, and it does not necessarily yield easy
O'Malia cited a paper on "Cost-Benefit Analysis and the
Commodity Futures Trading Commission," written by William
Albrecht, a former acting chairman of the CFTC, given to a
conference in April 2011.
Albrecht noted current law does not require the Commission
to determine whether the benefits exceed the costs nor whether
proposed rules are the most cost effective way to achieve the
stated goals. Section 15(a) of the Commodity Exchange Act (7 USC
19(a)) simply requires the CFTC to consider the costs and
benefits of its actions and evaluate them in five broad areas.
Quantification is not required.
Albrecht concluded that more emphasis on cost-benefit
analysis would, on balance, lead to a more efficient regulatory
regime and that regulators should be required to undertake more
rigorous analysis than they currently do. But he also
highlighted some of the problems that make cost-benefit analysis
more of an art than a science.
"A vast majority of CFTC staff and of the Commission itself
would argue that any detailed CBA of the proposed Dodd-Frank
rules is impossible. They would also argue that it would be
pointless to evaluate rules that are required by the law. And
they would argue that a serious effort at CBA would require
vastly more staff ... to undertake mission impossible," he
"There is a great deal of truth in these concerns. Certainly
to undertake serious CBA of all the Dodd-Frank rules could be as
monumental a task as writing all 60 sets of rules."
In many cases rules are required by law, and the language
mirrors the statute; the CFTC has therefore not subjected the
requirements to a detailed CBA test.
O'Malia complains that even in such cases, "the Commission
always has some level of discretion in determining the means to
achieve mandates". But that comes perilously
close to suggesting the Commission should use its expert
judgement to overturn the intention of elected representatives
DISCRETION VERSUS RULES
Proponents of cost-benefit analysis and smarter regulation
seem confused about how rules should be written and by whom.
The Economist calls for rules to be much simpler: "When
regulators try to write an all-purpose instruction manual, the
truly important dos and don'ts are lost in a sea of verbiage.
Far better to lay down broad goals and prescribe only what is
strictly necessary to achieve them. Legislators should pass
simple rules and leave regulators to enforce them."
But this is unfair. It is precisely what Congress did with
the Dodd-Frank Act (passing broad principles and leaving
officials to fill in the details).
Yet elsewhere in the same article the Economist complains,
"Hardly anyone has read Dodd-Frank ... Those who have struggle
to make sense of it, not least because so much detail has yet to
be filled in: of the 400 rules it mandates, only 93 have been
finalised. So financial firms in America must prepare to comply
with a law that is partly unintelligible and partly unknowable."
Legislators are criticised when they write overly
prescriptive rules and criticised when they delegate the detail
As you would expect, the Economist is not terribly keen on
handing "too much power to unelected bureaucrats" but says this
would be acceptable "if they were made more accountable".
Unreasonable judgements should be subject to swift appeal, and
poor decision-makers should be sacked, according to the
The Economist cites an essay by another proponent of
regulatory reform, Philip Howard, calling for an end to "the
core assumption that regulation should be an instruction manual.
It is far more effective to give general instructions about the
ends to be achieved, economist Friedrich Hayek observed, and
leave it to the different individuals to fill in the details
according to the circumstances." ("Results-Based Regulation: A
Blueprint for Starting Over").
Unfortunately, discretionary application of the rules rarely
suits business (or lawyers) who want stability and
predictability. Much of the complexity and prescriptiveness of
regulations in America is the result of business lobbying, which
has sought to curtail the discretion of regulators and carve out
a myriad of exemptions for special interests.
UNACCOUNTABLE AND UNSTABLE
Presumably, the proponents of smart regulation would require
unelected officials to be guided by CBA in fleshing out the rule
book and exercising discretion in individual cases. But as
Albrecht shows, many costs (and by extension benefits) are hard
to quantify. The results of CBA exercises can be manipulated by
making small changes in the assumptions to influence the
Drafting more general laws, which entails subjecting
implementing regulations to tougher, more quantitative
cost-benefit analysis and trusting regulators with more
discretion, is a superficially attractive model. But the reality
would be messy and impractical.
Cost-benefit analyses would be disputed and open to
manipulation. The process would be enormously costly and
generate an even greater avalanche of documentation. It would
hold regulators to an impossible standard (which often seems to
be the purpose for conservative advocates). And enforcement
would become even more unpredictable and arbitrary.
What is more important, responsibility for making policy
would pass from elected representatives to unelected lawyers,
lobbyists, economists and bureaucrats.
Cost-benefit analysis is seductive, but it is not the simple
solution conservatives such as O'Malia and the Economist seek.
(editing by Jane Baird)