Dr. James A. Overdahl is a vice president in the Securities and Finance Practice at NERA Economic Consulting. Before joining NERA, he was chief economist and director of the Office of Economic Analysis for the US Securities and Exchange Commission (SEC). He was their principal economic advisor on policy, rulemaking, and litigation support. From 2002 to 2007, he was chief economist and director of the Office of the Chief Economist for the US Commodity Futures Trading Commission (CFTC).
Some of the policy issues he has advised the SEC on are: credit default swaps and other OTC derivatives, high-frequency trading, securities lending, short selling, market data fees, credit rating agencies, structured financial products, Sarbanes-Oxley provisions, and new products. He advised the CFTC on such issues as: exchange-traded futures and options, OTC energy derivatives, commodity price speculation, risk management and hedging, new products and markets, algorithmic trading, position limits and error trades.
He spoke from Washington, D.C. last Thursday with Sarah Rudolph.
Q: What have been your biggest challenges at NERA so far?
A: It’s actually been a smooth transition, since much of the work that NERA does closely resembles work I did at the CFTC and SEC. Many of our clients need to prepare for litigation, certainly something we did at the CFTC and SEC, in those cases providing litigation support for the enforcement divisions of each regulator.
Now I’m working in a very similar role with clients who have concerns about potential enforcement action or who are currently engaged in a legal proceeding. That’s one aspect of the work. Another big part of what NERA does is provide independent analysis on various matters – working on research studies on different niches of the market for particular clients. That’s familiar territory for me because at the CFTC and SEC we often did very applied research on issues of interest to both commissions.
Q: What sorts of firms are your clients at NERA?
A: A diverse set of financial services firms and commodity based firms. We mainly work through law firms, since many of these cases are at various stages of legal proceedings.
Q: When you moved from the CFTC to the SEC, was there a difference in the nature of your work?
A: I think the analytical work is much the same. The theory-evidence approach to addressing issues in the marketplace is very much the same. My work is primarily empirically based. We try to gather data that will help inform the commissioners and other policymakers in government factual matters related to a particular issue.
Q: You were just named the spokesman for the FIA Principal Traders Group. The press release says your role is to talk about the group’s view on public policy issues. What message are they trying to get out?
A: First, just one clarification: I am serving as an advisor to the FIA PTG and as a media resource to address questions from the media related to Principal Trading.
I think the main message is they want to improve public understanding of how this particular set of market participants fits into the electronic marketplace, and to address particular industry issues in the public debate.
Q: Can you give me an example of an issue that is important to the group?
A: One example is the issue of direct market access. If you look at the FIA’s web site, in late April there was a report assembled by many people who are now part of the Principal Traders Group. The report provides a series of recommendations related to best practices in DMA in terms of risk controls, and it also provides a great deal of factual information about what DMA is, what the issues are and how they should be addressed. That’s an example of the type of work the group contemplates doing: identifying an issue, such as DMA, and then coming up with a set of recommendations that the group members agree upon. You’ll see there’s quite a bit of information on the web site on what DMA means and the issues involved.
The report was put out in April, before the FIA PTG was formed, but it was put together by many of the firms that are now members of the FIA PTG. [The report has been circulated to regulators]
Q: Most of the media reports about the formation of the group characterized it as representing “high frequency traders”. But as my boss, John Lothian, pointed out in his newsletter, it is more accurate to say it represents independent proprietary traders. Is there an important distinction between high frequency traders and proprietary traders?
A: What this group has in common is that they are principal traders. One reason they did not use the term “proprietary trading” is that it has become confused in the public’s mind with proprietary trading at banks. They used the term “principal traders” to make it clear that we’re not talking about hedge funds or proprietary trading at banks. We’re talking about principal trading firms. Now, within that group there are some who rely heavily on high frequency trading and others who do not, so I don’t think you can characterize the group strictly on that dimension. What they have in common is that they are trading based on their own capital and their own accounts. The thing that is important about this group is that they do not have customers. That clearly distinguishes them from other segments of the marketplace.
Q: Does the group feel they are misunderstood in other ways? Are there misconceptions?
A: I think rather than listing out a number of misconceptions, they felt there was a need to improve public understanding on the role they play in markets and help improve public understanding on some of the issues they face. One issue that is important to the group is co-location. What this group is interested in is making sure there is fair access to co-location facilities and making sure it is offered in a transparent and non-discriminatory way. I think the FIA Principal Traders Group is sympathetic toward the CFTC’s objectives with the proposal, to make sure there is fair access to these facilities, understanding of course that there are different classes of co-location and different services required by different groups of traders.
Q: What is your opinion of the financial reform bill that is in negotiations as we speak? Do we need regulatory reform and is this the right kind?
A: Some of these reforms will clearly affect principal traders’ businesses. Most of those in the FIA PTG trade in the exchange environment. The fact that the reform legislation will drive more OTC business onto exchanges – this group feels that is something they would look on with favor.
Another issue in the reform bill, and I’m not sure of its status right now, is position limits. One version of the bill would give the CFTC the authority to enact federally mandated position limits. That would be a big change from many markets where position limits are set at the exchange level – to being set at the Federal level. That’s one thing the group is looking at closely.
Central counterparty clearing is another important part of the financial reform bill. I think this group sees advantages to a migration of OTC contracts not only to exchanges but also to central clearing.
Another issue is error trade policy. The group’s position is that these policies should focus on trade certainty. Currently, each exchange has its own error trade policy. In forming these policies, each exchange has to decide how much they value trade certainty vs. what they call “price integrity.” Within the FIA PTG there is certainly a feeling that they place high value on trade certainty. Above all they want to make sure their transactions will stand and not be subject to arbitrary cancelation.
Q: Is that something that came up in particular because of the May 6 market disaster?
A: Yes. It has been an issue people within the industry have been aware of for a while, but it certainly became more pronounced on that day.