What Is the Commodity Futures Modernization Act (CFMA)?
The Commodity Futures Modernization Act (CFMA), signed into legislation on Dec. 21, 2000, overhauled U.S. financial rules consistent with rapid growth in over-the-counter (OTC) derivatives. CFMA clarified the roles of the Commodity Futures Purchasing and promoting Price (CFTC) and the Securities and Exchange Price (SEC) in regulating an expanded range of futures contracts. It moreover licensed clearing facilities for OTC derivatives, and legalized single stock futures.
Key Takeaways
- The Commodity Futures Modernization Act (CFMA), adopted in 2000, addressed rapid growth in financial derivatives very similar to swaps without delay negotiated by the use of financial institutions.
- The legislation formally exempted over-the-counter derivatives trades between financial firms from routine regulation.
- Mounting spinoff exposures helped to precipitate the 2007-2008 world financial crisis
- The Dodd-Frank Act licensed CFTC to regulate swaps dealers, even though critics contended it did not transfer far enough.
Working out Commodity Futures Modernization Act (CFMA)
Quicker than CFMA, U.S. financial regulation vested oversight of securities purchasing and promoting with the SEC and of commodity futures with the CFTC. The rules did not deal with derivatives not tied to physically commodities, and rapid adoption of the ones gear had located a emerging proportion of the financial area previous the regulatory reach of each corporate.
CFMA largely followed the ideas made in 1999 by the use of the President’s Running Body of workers on Financial Markets, a roundtable of regulators that built-in SEC, CFTC, the Federal Reserve, and the U.S. Treasury. The SEC and CFTC had set aside earlier jurisdictional disputes, agreeing to exempt non-commodity OTC derivatives traded by the use of financial institutions from regulation by the use of CFTC, and to share oversight of single-stock futures.
The Commodity Futures Modernization Act exempted from CFTC oversight most OTC derivatives, in conjunction with financial swaps between institutions and any “hybrid tool that is predominantly a banking product.”
To qualify as an exempt hybrid tool beneath that definition, the spinoff’s issuer had to download price in whole on provide, while the shopper or holder might simply not be required to make subsequent expenses to the issuer very similar to for margin or settlement. The issuer might simply moreover not be topic beneath the spinoff contract’s words to mark-to-market margin must haves, and the spinoff might simply not be marketed as commodity futures.
CFMA put an end to fears OTC derivatives might be challenged or invalidated on the grounds that they had been illegally traded futures. It moreover barred state-level regulation. The legislation impressed the appearance of clearing homes for OTC derivatives.
In addition to, CFMA licensed the checklist and purchasing and promoting of single stock futures, topic to joint oversight by the use of SEC and CFTC. Single stock futures final traded inside the U.S. in 2020, when without equal exchange to record them closed. While single stock futures continue to business abroad, they remain a lot much less commonplace than other equity derivatives, very similar to possible choices.
Criticism of CFMA and Subsequent Changes
Financial regulators weren’t the only ones to note rapid growth in OTC derivatives. While this market grew effectively unregulated forward of passage of CFMA, the legislation’s hands-off way. Throughout the wake of the 2007-2008 world financial crisis, the Financial Crisis Inquiry Price licensed by the use of the U.S. Congress concluded that the pre-emption of derivatives regulation by the use of CFMA “was a key turning point inside the march against the financial crisis.”
As early as 2002, Berkshire Hathaway Inc. (BRK-A) CEO Warren Buffett criticized derivatives as “time bombs, each and every for the occasions that deal in them and the commercial tool.
Buffett’s warning rang true in 2008, when the large and non-transparent derivatives exposures tied to mortgage securities culminated in a financial crash, the collapse of Lehman Brothers, and a government bailout of American International Body of workers, Inc. (AIG) and its Wall Aspect street counterparties.
In line with the Federal Reserve Monetary establishment of New York, the crisis “exposed necessary weaknesses inside the over-the-counter (OTC) derivatives market, in conjunction with the build-up of huge counterparty exposures between market people that have been not correctly risk-managed [and] limited transparency relating to levels of process to be had available in the market and general size of counterparty credit score rating exposures.”
Unregulated derivatives not most straightforward helped to cover such exposures by the use of credit score rating default swaps, however moreover helped to magnify them via collateralized debt duties, the Financial Crisis Inquiry Price found out.
The 2009 Dodd-Frank Act, intended to curb such excesses, licensed CFTC to regulate swaps dealers, and to move the purchasing and promoting of standardized derivatives to regulated exchanges or transfer execution facilities to give a boost to transparency. Critics argued the changes have been largely good looks.
