Commodity Futures Modernization Act of 2000 - The CFMA As Implementation and Expansion of The PWG Report

The CFMA As Implementation and Expansion of The PWG Report

Title I of the CFMA adopted recommendations of the PWG Report by broadly excluding from the CEA transactions in financial derivatives (i.e. “excluded commodities”) between “eligible contract participants.” The definition of “eligible contract participant” covered the same types of “sophisticated” parties as the existing “swaps exemption” in its definition of “eligible swap participants”, but was broader, particularly by adding permission for individuals with assets of $5 million rather than $10 million, if the transaction related to managing asset or liability “risk.” The PWG had recommended “considering” an increase in this threshold to $25 million, not a reduction for actual hedging.

Such “eligible contract participants” could enter into transactions on or off “electronic trading facilities” without being subject to any of the regulatory oversight applicable to futures. The only exception was that the transactions would be subject to the rules for the new “Derivative Clearing Organizations” authorized by the CFMA, if the transaction used such a clearing facility. The CFMA did not require that standardized transaction use a clearing facility. It only authorized their existence, subject to regulatory oversight. The PWG Report had recommended permitting “standardized” contracts, so long as they were subject to regulated clearing.

Title I’s biggest departure from the PWG Report recommendations was in extending most of the same exclusions to non-financial commodities that were not agricultural. These “exempt commodities” were, in practice, mostly energy and metal commodities. As discussed below in Section 4, these transactions were subject to the “anti-fraud” and “anti-manipulation” provisions of the CEA in some, but not all, circumstances. The PWG Report had recommended that exemptions for such transactions remain in the control of the CFTC, although it had recommended the continuation of those regulatory exemptions.

Title I also resolved the issue of “hybrid instruments” by defining when such an instrument would be considered a “security” subject to security laws and excluded from the CEA even though it had a “commodity component.” Equivalent treatment of bank products was provided in Title IV.

Title I retained the CEA’s existing preemption of state gambling and other laws that could render a CFTC exempted transaction illegal. It made that preemption applicable to all exempted or excluded transactions.

Title I also created a new system under which three different types of exchanges could be established based on the types of commodities and participants on such exchanges.

Title II of the CFMA repealed the 1982 Shad-Johnson Accord that had prohibited single stock and narrow stock index futures and replaced that with a joint CFTC and SEC regulated “security futures” system.

Title III established a framework for SEC regulation of “security-based swaps.” The PWG Report had not addressed this issue.

Title IV established a framework for CFTC regulation of “bank products.” This included coverage of deposit based “hybrid instruments”, but went further. The PWG Report had not dealt with these issues beyond how Title IV overlapped with Title I.

The CFMA did not provide the CFTC or SEC the broader “risk assessment” authority over affiliates of futures commission merchants or broker-dealers that the PWG Report had recommended.