The Commodity Futures Modernization Act (P.L. 106-554)
Prepared for Members and Committees of Congress
The last act of the 106th Congress was to pass an omnibus bill that included the Commodity
Futures Modernization Act (H.R. 5660; P.L. 106-554), the most significant amendments to the
regulation of derivatives trading in 25 years. Derivative financial instruments are those that gain
or lose value as some underlying rate, price, or other economic variable changes. Derivatives
traders can speculate on future trends in financial assets (such as stocks or currencies) or
commodities (oil, metals, pork bellies) without actually owning the underlying items. Derivatives
may be employed to reduce financial risk or in risky speculation on future prices and rates. These
contracts do not fit in the jurisdictional boxes of financial regulation, and inter-agency quarrels th
have occurred over the years. The 106 Congress approved an overhaul of derivatives regulation
which codified the unregulated status of certain derivatives, permitted the exemption of other
currently-regulated contracts from oversight by the Commodity Futures Trading Commission
(CFTC), and permitted the trading of a new kind of contract: a futures contract/security hybrid
based on the stocks of individual corporation. This report will not be updated further.
Developments in derivatives regulation will be tracked in CRS Report RS21401, Regulation of
Legal Certainty for Swaps and Off-exchange Derivatives..............................................................1
Exchange Trading and Clearing of Swaps.......................................................................................2
Deregulation of Exchange-based Futures Trading..........................................................................3
Futures Contracts on Single Stocks.................................................................................................4
Author Contact Information............................................................................................................6
he Commodity Futures Modernization Act of 2000 (CFMA) enacted the most sweeping
amendments to derivatives law since the creation of the Commodity Futures Trading
Commission (CFTC) in 1974. Provisions included major changes in the Commodity T
Exchange Act (CEA) regarding the regulation of exchange-traded futures contracts, over-the-
counter (OTC) derivatives, and “security futures,” contracts based on individual stocks (which
were previously prohibited).
The CFMA’s provisions generally followed the recommendations contained in a November 1999
report by the President’s Working Group on Financial Markets, which consists of the Federal 1
Reserve, the Treasury, the Securities and Exchange Commission (SEC), and the CFTC. The
principal recommendations of the report were as follows:
• to remove uncertainty about the legal and regulatory status of over-the-counter
(OTC) derivatives, bilateral transactions between sophisticated parties that do not
involve non-financial commodities with finite supplies should be excluded from
the Commodity Exchange Act (CEA); that is, the CFTC should have no
• the OTC derivatives markets should be allowed to adopt features of the CFTC-
regulated, exchange-based derivatives marketplace, such as exchange trading and
clearing houses; and
• exchange-traded futures and options that are not sold to small public investors
and that are based on financial variables (as opposed to physical commodities
with finite supplies, considered more susceptible to price manipulation) may not
require regulation under the Commodity Exchange Act. The act should therefore
be amended to let the CFTC exempt financial futures and options from much of 2
Apart from its substance, the Working Group’s report was remarkable in that the four agencies,
which had a history of jurisdictional quarrels, unanimously agreed on a redrawing of the
regulatory lines. The CFMA was shaped significantly by the Working Group’s report, although it
differed in certain important aspects. The major provisions of the CFMA are discussed below.
A long-standing question in derivatives regulation was whether the Commodity Exchange Act
applied to contracts that were not traded on futures exchanges. A plain reading of the pre-2000
law suggests that it did: in 1974, Congress gave the CFTC exclusive jurisdiction over all contracts
“in the character of” futures contracts, and mandated that such contracts, with certain exceptions,
should only be traded on CFTC-regulated exchanges.
1 Over-the-Counter Derivatives Markets and the Commodity Exchange Act: Report of the President’s Working Group
on Financial Markets. November 1999. 35 p.
2 For background on these and related issues, see CRS Report RL30434, The Commodity Futures Modernization Act of
2000: Derivatives Regulation Reconsidered.
However, in the 1980s, an off-exchange market in derivatives grew up. The major dealers in this
OTC market were banks and securities firms, and the principal instrument was the swap contract.
Although swaps are clearly “in the character of” futures contracts – they serve the same economic
purposes and are often interchangeable – the CFTC did not move to assert its jurisdiction. The
CEA’s exclusivity provisions remained, however, and were seen as a source of “legal risk” to the
swaps market. That is, if a court had ruled that swaps were in fact illegal, off-exchange futures
contracts, trillions of dollars in OTC derivative contracts might have been rendered void and
The CFMA specifies that the CEA does not apply to contracts between “eligible contract
participants” (which include financial institutions, regulated financial professionals, units of
government, nonfinancial businesses or individual persons with assets over $10 million, and
others whom the CFTC may approve) based on “excluded commodities,” defined as financial
products and indicators (which are thought to be less susceptible to manipulation than physical
commodities with finite supplies).
Derivatives based on agricultural commodities, however, may be traded only on CFTC-regulated
exchanges, because of concerns about price manipulation – “corners” and “squeezes”– in those
The CFMA creates a third group of “exempt commodities,” which includes all commodities that
are neither financial nor agricultural. (In today’s markets, these are primarily metals and energy
products, but derivatives introduced in the future will fall into the “exempt” category as well.)
OTC derivatives in exempt commodities may be traded by eligible contract participants without
CFTC regulation, except that certain provisions in the CEA against fraud and manipulation apply
to these markets.
The CFTC continues to have jurisdiction over exchange-traded futures contracts based on either
excluded (financial) or exempt (other nonagricultural) commodities. There are active markets in
both exchange-traded and OTC derivatives based on financial and energy products.
While the Working Group’s report did not envision a “retail” swaps market, in which small
investors could participate, the creation of such a market was considered by Congress. Section 22
of S. 2697 (as introduced) directed the President’s Working Group to prepare a report on the
possibility of marketing swaps to individuals. H.R. 4541, as reported by the House Banking
Committee, directed bank regulators to draft rules that would permit the establishment of a retail
swaps market. The version of H.R. 4541 passed by the House did not include such provisions.
The CFMA as enacted directed regulators to study the issue. The Working Group issued a report
in December 2001, finding that there was no commercial interest in buying or selling retail
swaps, and therefore no need for Congress to establish a regulatory framework.
In 1993, the CFTC addressed the issue of legal uncertainty by issuing regulations exempting
financial swaps, a form of OTC derivatives, from the CEA. (A separate exemption permitted
trading of certain OTC contracts based on energy products outside the CEA.) Under the swaps
exemption, swaps were not considered futures (subject to the exchange trading requirement and
other CFTC regulations) as long as they met several conditions that distinguished them from
exchange-traded contracts. Among the conditions was a requirement that swaps must be
bilaterally negotiated agreements and not traded on an exchange or exchange-like facility open to
multiple buyers and sellers.
However, in the late 1990s there was interest in creating multilateral swaps exchanges, and at
least one such facility began operations. An exchange, where bids and offers would be exposed to
a large number of market participants, could bring more liquidity to the swap market, and make
price information more widely available, allowing businesses and others to manage their financial
risks more efficiently and economically.
The CFMA permits the use of exchange-like electronic facilities for the trading of OTC
derivatives based on excluded (financial) commodities. OTC electronic trading facilities are also
permitted for the exempt commodities (energy, minerals, etc.), with some CFTC oversight.
The 1993 exemption removed swaps from CEA regulation so long as contracts were not
guaranteed by a centralized clearing house (as exchange-traded futures and options are). In other
words, to qualify for the exemption, each party to a swap had to bear the risk of the opposite
party’s default. A clearing house – where a number of dealers guarantee all contracts and
collectively assume the risk of default – could increase confidence in the market, and reduce the
risk that the failure of a single large swap dealer would have repercussions throughout the
financial system. As in the case of swaps exchanges, many market participants feel that clearing
houses would be beneficial to the market.
The CFMA provides for the establishment of clearing houses for OTC derivatives, establishes
certain regulatory requirements for them, and allows their operators to choose whether to be
regulated by the CFTC, the SEC, or a banking regulator. In the two years following enactment of
the CFMA, neither exchanges nor clearing houses have supplanted to any major degree the
existing dealer market structure.
The pre-2000 Commodity Exchange Act provided for a uniform, one-size-fits-all system of
regulation of futures trading. By and large, institutional and professional trades were regulated the
same as trades involving small public customers, and it made no difference whether the
underlying commodity was corn, natural gas, or an interest rate. The CFMA replaces this uniform
system with a three-tiered system of regulation. The CFMA authorizes registered futures
exchanges to create two new types of markets, which would be subject to less regulation (or
virtually no regulation) depending on who is allowed to trade. Thus, there are now three types of
futures market permitted by law.
First are the markets designated as contract markets. Contract markets are subject to generally the
same degree of regulation as pre-2000 futures exchanges. To qualify for contract market status, an
exchange must follow 17 core principles to maintain fair, open, and competitive markets.
Contracts based on agricultural commodities and trades involving retail customers are generally
confined by the CFMA to markets of this type.
Second, the exchanges may establish derivatives transaction execution facilities. These DTEFs
could offer only contracts based on commodities whose deliverable supply was “nearly
inexhaustible,” where manipulation was “highly unlikely,” or where there was no underlying cash
market (as in certain financial indicators, rates, or ratios). In addition, eligible traders would be
limited to eligible contract participants and to others who traded through a futures commission
merchant, or broker, that belonged to a clearing house and had net capital of at least $20 million.
DTEFs must register with the CFTC, but the degree of regulation would be less stringent and
comprehensive than that applicable to contract markets – 8 core regulatory principles apply,
rather than 17.
Third and finally, the CFMA provides that a market where all contracts are based on excluded
commodities and where all traders, including brokers’ customers, are eligible contract
participants, can be an exempt board of trade. Exempt boards would not have to register with the
CFTC at all, and would be exempt from all provisions of the CEA, except for anti-fraud and
manipulation rules. However, if the CFTC determines that an exempt board has become a
significant source of price discovery (that is, if this derivatives market sets prices in the
underlying cash market), it can require the board to disclose daily trading data.
As of early 2003, the exchanges have not moved to create exempt boards of trade or DTEFs. In
other words, futures trading continues much as it was before the CFMA.
The 1982 Shad/Johnson agreement divided regulatory jurisdiction over futures and options based
on securities and stock indexes between the CFTC and the Securities and Exchange Commission
(SEC). One provision of Shad/Johnson is a ban on futures contracts based on single stocks. H.R.
4541 as introduced permitted such contracts to be traded on futures exchanges with certain
restrictions. The CFTC was to be the primary regulator, but was required to consult with the SEC
before approving single-stock contracts, and the SEC was to receive price, volume, and other
market data. The SEC would have had enforcement authority regarding insider trading, price
manipulation, and other violations of the securities laws that might involve futures on single
stocks. Finally, the Federal Reserve would have authority to set margins for single-stock futures
(as it does for stock index futures and stocks themselves), but could delegate this authority to an
intermarket board including the CFTC and the SEC.
S. 2697 as introduced contained similar provisions regarding the regulation of single-stock
futures, but would have permitted the trading of single-stock futures on stock exchanges, as well
as on futures markets. S. 2697 also specified that any market where single-stock futures were
traded would have to maintain a real-time audit trail of all transactions in those contracts.
Trading of single-stock futures raised questions of regulatory jurisdiction. Would they be traded
on stock exchanges, futures exchanges, or both? Would traders be subject to securities regulation,
futures regulation, or both? H.R. 4541 as reported by the Agriculture Committee viewed single-
stock futures as futures contracts to be traded on futures exchanges under CFTC oversight. The
House Commerce version of H.R. 4541, on the other hand, treated single-stock futures as
securities, and gave the SEC the primary regulatory role. In September 2000, the SEC and CFTC
reached an agreement on how these instruments should be traded and regulated. The two agencies
coined the term “security futures” for single-stock or narrow-index futures contracts. The
agreement called for them to be traded on both stock and futures exchanges, with all traders
subject to the core principles of both futures and stock regulation. Clearing houses that cleared
security futures would have to be linked, and margin requirements for security futures would
have to be at least as high as margins for comparable stock options. Transaction fees that apply to
sales of stock and stock options would not apply to security futures.
The final CFMA incorporated the CFTC/SEC agreement, except that securities transaction fees
will apply. The tax treatment of single-stock futures resembles the treatment of stock options
(which are taxed under normal capital gains rules) rather than that of standard futures contracts,
which receive special treatment. The law permitted trading of security futures to begin one year
following enactment, but the process of writing regulations was time-consuming, and trading had
not begun by year-end 2002.
H.R. 4541 was marked up by three House committees in the 106th Congress. H.Rept. 106-711
contains the three versions: Part 1 is the Agriculture Committee mark-up, Part 2 is Banking, and
Part 3 is Commerce.
On June 27, 2000, the House Agriculture Committee reported H.R. 4541. The principal
amendments were: (1) to permit U.S. futures brokers to sell certain foreign stock index futures
contracts traded on foreign exchanges to U.S. citizens; and (2) to require OTC derivatives
clearing houses to register with some regulatory agency. (Registration was voluntary in the bill as
introduced.) H.R. 4541 was then sent to the committees on Commerce and Banking.
On July 20, 2000, the House Commerce Committee marked up H.R. 4541. The Commerce
version gave the SEC considerably more authority over single-stock futures than did the bill as
introduced, including the power to set margin requirements. Differences between the Commerce
version and the Agriculture Committee’s included (1) the Commerce bill allowed single-stock
futures to be traded on stock exchanges, as well as on CFTC-regulated futures exchanges; (2)
Commerce would have allowed the SEC to enforce the insider trading rules that apply to stocks
on futures exchanges where single-stock futures were traded; and (3) the Commerce version
required the National Futures Association to establish suitability standards for traders of single-
On July 27, 2000, the House Banking Committee marked up H.R. 4541. Its version would have
(1) permitted the development of a retail swaps market, outside of CFTC regulation, provided that
the contracts were offered by a bank to customers with over $5 million in assets and that the
banking regulators had issued customer protection rules; (2) created antifraud provisions for retail
derivatives; (3) gave the Fed supervisory authority over OTC derivatives clearinghouses; and (4)
excluded from CFTC authority banking and securities products offered by banks, brokers, or
On June 29, 2000, the Senate Agriculture Committee finished its markup of S. 2697. Changes to
the bill included (1) the SEC and CFTC would have to notify each other if either approved single-
stock futures for trading by markets under its jurisdiction (the bill as introduced required agency
approval, not just notification); (2) a requirement for harmonization of trading costs between
single-stock futures and stock options; (3) U.S. futures brokers would be allowed to sell foreign
stock index futures, provided that the index was not based on U.S. stocks; and (4) the National
Futures Association would be required to develop an industry-wide suitability disclosure
A version of H.R. 4541 that incorporated elements of all three House markups was passed by the
House under suspension of the rules on October 19, 2000. S. 2697 never came to a vote on the
On December 14, 2000, identical bills H.R. 5660 and S. 3282 were introduced, after negotiations
among House and Senate committees, regulators, and executive branch agencies. On December
20, H.R. 5660 was incorporated by reference into H.R. 4577, the Consolidated Appropriations
Act, which was passed by both houses of Congress. On December 21, 2000, this omnibus
measure, which now included the Commodity Futures Modernization Act of 2000, became P.L.
Specialist in Financial Economics