Enactment of the Commodity Futures Modernization Act brings a new regulatory framework to Americas $80 trillion derivatives and futures markets. The focus to date has been on the laws repeal of an 18-year-old prohibition against futures contracts on individual stocks.
Less remarked upon but no less important is that the law opens the way for the convergence of derivatives and futures trading with one of the most powerful technological innovations in commerce today: business-to-business online marketplaces.
Now for the first time, firms that seek to manage risks or increase liquidity using derivative or futures instruments will also be able to capture the benefits of instant, direct-access, real-time pricing and market transparency that Internet-based trading platforms enable. Moreover, those businesses that now procure or sell goods through e-marketplaces will be able to protect against price volatility through the purchase of derivatives products specifically geared to online exchanges.
The Commodities Futures Trading Commission, the agency that will enforce the new regulatory framework, wasted no time. Within a day of enactment, the CFTC granted approval to onExchange Inc., of Waltham, Mass., as the first fully regulated, direct-access electronic derivatives and futures exchange.
With the agencys nod, onExchange is first in the race to establish a thoroughly new approach to trading and clearing regulated futures, as well as spot, forwards, and swaps instruments all on a single, straight-through-processing platform that offers real competitive advantages in terms of credit management, financial and market integrity, liquidity, and price transparency.
The need to overhaul the derivatives markets regulatory framework has grown increasingly urgent in recent years as the traditional trading floors in Chicago and New York have begun to lose market share to foreign competitors that were deploying new technologies and were unfettered by the outdated rules governing the U.S. marketplace.
Recognizing the competitive threat to the United States as the epicenter of this huge marketplace, the CFTC set about reforming the regulatory regime along the lines ultimately adopted by Congress. The framework fosters innovation and the development of new markets and products, while permitting the traditional exchanges to move in new directions.
The new law is a remarkably nuanced structure for financial regulation, one that is centered around core principles that are flexible enough to be responsive to the wide range of products being traded, the many new products being continuously developed, and the varying degrees of sophistication of participants in the market.
The new law translates this policy goal of flexibility into a tiered regulatory structure, providing different levels of scrutiny and regulatory rigor for the different types of markets on which derivatives can now be traded, and the different kinds of customers each of those markets will serve.
At one end of the spectrum are traditional, trading-floor exchanges, which will be subject to the highest level of scrutiny. At the same time, the exchanges will have broader scope to trade new products individual stock futures, for example both to institutional and retail customers. These changes can be expected to increase market volumes considerably.
At the other end will be something new the Exempt Trading Facility that will be almost entirely deregulated but restricted both in the products it can trade (no agricultural products or stock futures, or financial futures) and in limiting participation to principal-to-principal transactions among institutional and high-net-worth individual participants.
Between these two ends of the regulatory spectrum is another new category the Derivatives Trading Execution Facility that will require CFTC authorization to operate, but will be empowered to do so under rules that amount largely to self-regulation.
Given the new regulatory frameworks subtle distinctions between different kinds of trading facilities, products, and market participants, it is certain that issues of interpretation and the need for fine-tuning will arise as the marketplace adapts to its new environment. On the other hand, Americas derivatives and futures market appears poised for a surge of innovation and growth as participants discover the opportunities the new law will unleash.
One business that certainly stands to benefit is B-to-B online procurement, as new specialized products emerge that will enable firms to manage price swings in the online marketplace, lock in long-term price and supply, and increase leverage.
While no one can predict with precision the direction this dynamic market will take under its new regulatory structure, it is very likely this law will prove to be an important building block in the business and financial infrastructure that makes electronic commerce both viable and beneficial.
Mr. Miller of counsel in White & Case's New York office, represented onExchange Inc. before the Commodities Futures Trading Commission in its application for regulatory approval as an electronic derivatives and futures exchange.