Wednesday, February 18, 2009

Major Changes Brewing for the Futures & Derivatives Markets

Jim Hamilton reports that the House Agricultural Committee has approved legislation that would dramatically alter the regulation of the futures and derivatives markets. The legislation includes numerous provisions, and a few are worth highlighting.

First, the bill would give the Commodity Futures Trading Commission (CFTC) authority to initiate and conduct criminal litigation for violations of the Commodity Exchange Act if the US Attorney General has declined to bring criminal proceedings. Currently the CFTC and SEC only have the authority to initiate civil litigation for violations of their respective Acts, and can only recommend criminal proceedings to the DOJ. Thus, this expansion of the CFTC’s authority would give the agency a much more powerful presence in the futures and derivative markets.

Second, the bill would limit speculative position limit exemptions to “bona-fide hedgers” (i.e. those futures market participants seeking to hedge their price exposure to commodities stemming from production or consumption of those commodities). An important effect—and the probable aim—of this change would be that commodity swap dealers would no longer be exempt from position limits, and commodity index funds and other funds that enter the futures markets through these dealers would in turn be subjected to position limits. The imposition of these limits on commodity funds could potentially reverse the influx of investors into futures that has occurred in the last few years which many believe has led to “excessive speculation”, increased volatility, and artificially high prices.

Third, the bill contains a number of provisions geared towards reining in the unregulated credit default swap market. These provisions give the CFTC the authority to require mandatory clearing of CDSs at CFTC regulated exchanges and to temporarily ban both regular and “naked” CDSs under certain circumstances. While these and other provisions in the bill are still in very early stages, what is clear is that Congress will be very aggressive in pursuing major regulatory changes in the futures and derivatives markets, and we are likely to see equally aggressive legislation for the capital and banking markets in the near future.