What is the Commodity Futures Modernization Act (CFMA)?
The Commodity Tomorrows Modernization Act (CFMA), signed into law on Dec. 21, 2000, overhauled U.S. financial regulations in response to rapid growth in over-the-counter (OTC) derivatives. CFMA shed the roles of the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) in regulating an expanded range of futures constricts. It also authorized clearing facilities for OTC derivatives, and legalized single stock futures.
Key Takeaways
- The Commodity Futures Modernization Act (CFMA), took in 2000, addressed rapid growth in financial derivatives such as swaps directly negotiated by financial institutions.
- The law formally exempted over-the-counter derivatives sellings between financial firms from routine regulation.
- Mounting derivative exposures helped to precipitate the 2007-2008 wide-ranging financial crisis
- The Dodd-Frank Act authorized CFTC to regulate swaps dealers, though critics contended it did not go far enough.
Sympathy Commodity Futures Modernization Act (CFMA)
Before CFMA, U.S. financial regulation vested oversight of securities trading with the SEC and of commodity futures with the CFTC. The overs did not address derivatives not tied to physical commodities, and rapid adoption of these instruments had placed a growing proportion of the pecuniary arena beyond the regulatory reach of either agency.
CFMA largely followed the recommendations made in 1999 by the President’s Hold down a post Group on Financial Markets, a roundtable of regulators that included SEC, CFTC, the Federal Reserve, and the U.S. Treasury. The SEC and CFTC had set aside ago jurisdictional disputes, agreeing to exempt non-commodity OTC derivatives traded by financial institutions from regulation by CFTC, and to allowance oversight of single-stock futures.
The Commodity Futures Modernization Act exempted from CFTC oversight most OTC derivatives, classifying financial swaps between institutions and any “hybrid instrument that is predominantly a security.” To qualify as an exempt hybrid thingumabob under that definition, the derivative’s issuer had to receive payment in full on delivery, while the buyer or holder could not be demanded to make subsequent payments to the issuer such as for margin or settlement. The issuer could also not be subject under the unoriginal contract’s terms to mark-to-market margin requirements, and the derivative could not be marketed as commodity futures.
CFMA put an end to fears OTC derivations could be challenged or invalidated on the grounds they were illegally traded futures. It also barred state-level fixing. The law encouraged the creation of clearing houses for OTC derivatives.
In addition, CFMA authorized the listing and trading of single stock expects, subject to joint oversight by SEC and CFTC. Single stock futures last traded in the U.S. in 2020, when the last swop to list them closed. While single stock futures continue to trade overseas, they remain less customary than other equity derivatives, such as options.
Criticism of CFMA and Subsequent Changes
Financial regulators weren’t the on the contrary ones to note rapid growth in OTC derivatives. While this market grew effectively unregulated before phrase of CFMA, the law’s hands-off approach. In the wake of the 2007-2008 global financial crisis, the Financial Crisis Inquiry Commission authorized by the U.S. Congress concluded that the pre-emption of spin-offs regulation by CFMA “was a key turning point in the march toward the financial crisis.”
As early as 2002, Berkshire Hathaway Inc. (BRK-A) CEO Warren Buffett judged derivatives as “time bombs, both for the parties that deal in them and the economic system.”
Buffett’s warning give someone a tinkled true in 2008, when the huge and non-transparent derivatives exposures tied to mortgage securities culminated in a financial fall, the collapse of Lehman Brothers, and a government bailout of American International Group, Inc. (AIG) and its Wall Street counterparties.
According to the Federal Retain Bank of New York, the crisis “exposed significant weaknesses in the over-the-counter (OTC) derivatives market, including the build-up of large counterparty exposures between market-place participants which were not appropriately risk-managed [and] limited transparency concerning levels of activity in the market and overall extent of counterparty credit exposures.”
Unregulated derivatives not only helped to conceal such exposures by means of credit delinquency swaps, but also helped to magnify them through collateralized debt obligations, the Financial Crisis Inquiry Commission establish.
The 2009 Dodd-Frank Act, intended to curb such excesses, authorized CFTC to regulate swaps dealers, and to move the occupation of standardized derivatives to regulated exchanges or swap execution facilities to improve transparency. Critics argued the changes were on the whole cosmetic.