No SEC-CFTC Merger — Shad-Johnson 2?

It appears settled that the Obama administration's overhaul of financial regulations will not include a CFTC-SEC merger. This is disappointing, especially because the administration is apparently foregoing this no-brainer reform just to avoid the inevitable turf wars in Congress.

My disappointment aside, the fact that the SEC and the CFTC will both continue to exist as independent agencies probably means that we're headed for a new Shad-Johnson Accord, this time for OTC derivatives. This requires a bit of explanation.

The SEC and the CFTC share jurisdiction over the derivatives markets—or, more accurately, they split jurisdiction over the derivatives markets. The relationship between the two agencies has been awkward at best, and frequently openly hostile. Prior to 1981, it was unclear which agency had jurisdiction over which derivatives markets (less clear than usual, that is), and both agencies claimed as much authority as possible. In 1981, however, then-SEC chairman John Shad and then-CFTC chairman Phil Johnson finally sat down and hammered out an agreement clarifying each agency's jurisdiction, which became known as the Shad-Johnson Accord.

Under the Shad-Johnson Accord, the CFTC was given jurisdiction over all futures (which included futures on stock indexes), options on futures and commodities, and certain futures and options on futures on stock indexes. Shad-Johnson gave the SEC jurisdiction over options on individual securities, options on certain indexes of securities, and exchange-traded options on foreign currency. (I'm ignoring some issues in Shad-Johnson, such as the Treasury Amendment and the question of OTC options on foreign currencies, the SEC's veto authority over stock index futures, and the prohibition on single-stock futures. Trust me, you don't want to go there.)

You get the picture. Welcome to U.S. financial regulation.

Now that the Obama administration has decided to bring OTC derivatives into the regulatory fold, they have to decide how to allocate regulatory authority over OTC derivatives. In theory, the administration could give exclusive jurisdiction over OTC derivatives to one agency or the other. That option obviously has the benefit of simplicity. However, early indications are that the administration is going to split jurisdiction over OTC derivatives, in effect creating Shad-Johnson 2.

A recent article in the NYT reported that Shad-Johnson 2 is already being formulated:

[O]fficials said this week that Mr. Gensler [the CFTC chair] and Mary L. Schapiro, his counterpart at the S.E.C., had reached an informal understanding that would enable their respective agencies to share authority over the derivatives market.

However, the way Gensler worded his testimony last week suggests to me that the CFTC isn't wild about sharing jurisdiction over OTC derivatives with the SEC. Gensler stated:

The term "OTC derivative" should be defined, and the CFTC should be given clear authority over all such instruments. To the extent that specific types of OTC derivatives might best be regulated by other regulatory agencies, care must be taken to avoid unnecessary duplication and overlap.

Gensler's not-so-subtle attempt to give the CFTC default jurisdiction over all OTC derivatives suggests that Shad-Johnson 2 is far from finalized.

It'll be interesting to see how this plays out. Well, interesting to me, at least.