Originally published in the "Agents of Change" 2007 Special Issue
Philip McBride Johnson says, without a doubt, his greatest economic contribution to the history of futures was helping the Commodity Futures Trading Commission (CFTC) win exclusive jurisdiction over regulating commodities trading — in which he played the leading role in securing by drafting key jurisdictional provisions of the Commodity Futures Trading Commission Act of 1974 that made the CFTC the sole regulator of the U.S. futures industry.
“That was absolutely critical,” he says.
Johnson also played a key role in broadening the definition of commodities to include futures on financial instruments like interest rates.
Johnson, who heads the exchange-traded commodities, futures and derivative products practice group at Skadden, Arps, Slate, Meagher & Flom LLP, has devoted nearly all of his 45 years in the practice of law to the U.S. laws, regulations and agencies governing the markets in futures contracts, options, swaps and other derivative instruments.
He laid the legal foundation for the development of the first interest rate futures contract and event futures, the first cash-settled futures, the first stock index, the first central exchange for securities options and the first national self-regulatory organization for the futures brokerage community — the National Futures Association.
Until the early 1970s, all U.S. futures trading was concentrated in farm products (wheat, corn, etc.) and the U.S. Department of Agriculture (USDA) regulated those contracts. Only those farm products were regarded as "commodities" subject to USDA regulation.
By the early 1970s, exchanges were beginning what would become a torrent of new futures contracts involving assets and industries different from agriculture. The Chicago Mercantile Exchange (CME) launched futures contracts on foreign currencies, there were precious metal futures on the Commodity Exchange Inc. (Comex) and the New York Mercantile Exchange (Nymex) began its foray into the energy field with its heating oil contract. None of these exchanges were regulated by the USDA.
Industry players knew someone would step forward to regulate them. But who?
“Upon reflection, the answer was a dizzying array of possible regulators as well as the prospect that all of them might claim the right to act as regulator,” Johnson says.
For example, foreign currencies, on which the CME had begun to trade futures contracts, were of keen interest to the U.S. Treasury Department and the Federal Reserve because of their relationship to the U.S. dollar and the balance of payments; and to the Department of Commerce because currency values affect the import/export equation and to each of the 50 state banking authorities.
Also, the Chicago Board of Trade (CBOT) was developing the world's first futures contract on interest rates.
“There was understandable concern that, left to evolve on its own, the regulatory structure for these new products would create chaos: A multitude of authorities jostling with each other for supremacy, disagreeing on policies, making conflicting demands on the futures community. The futures markets could suffocate in that environment and, even if not, the costs of compliance would be astronomical,” Johnson says.
As outside counsel to the CBOT, he was directed to make every effort to assure that CFTC would be the exclusive regulator of the futures markets and that its jurisdiction covered everything that is traded for future delivery: Meaning, the definition of commodity had to be expanded from farm products to every conceivable object of futures trading.
That was a huge task, but the Yale University law graduate did just that. For exclusive jurisdiction, he provided language to congressional staff and it was adopted. However, the same provision in the House version contained a second clause preserving the jurisdiction of other federal agencies which nullified the CFTC's exclusivity.
“So in the Senate, I provided to congressional staff a short phrase to place between the two clauses: “Except as hereinabove provided,” which was adopted and enacted into law. This phrase was intended to assure that, where the CFTC had exclusive jurisdiction, it preempted other agencies. The courts later affirmed that reading,” he says.
In expanding the definition of “commodity,” he concluded that identifying specific items could generate opposition from other regulatory authorities. For example, mentioning “securities” could generate opposition from the Securities and Exchange Commission (SEC). “I borrowed a phrase from the Uniform Commercial Code that did not mention any specific thing but was nevertheless extremely broad: ‘all goods and articles … and all services, rights and interests in which contracts for future delivery are presently or in the future dealt in.’ Congress adopted that language and the courts subsequently confirmed that its breadth included a vast array of things, including securities,” he says.
That language not only captured all of the planned non-agricultural futures at that time but opened the door to futures trading in abstractions like indexes, weather and climate patterns and events carrying economic risk.
Above all, Johnson adds, this effort in the aggregate has saved the futures community billions of dollars in compliance costs and generated similar revenues from new product expansion.
As great as an achievement as that was for the future of the futures industry — it was not Johnson’s only major contribution.
Johnson served as chairman of the CFTC from 1981 to 1983, reaching an agreement with then SEC Chairman John Shad, known as the Johnson-Shad Accord, allowing the first stock index futures to trade under exclusive CFTC regulation and, more important, resolving considerable legal doubt whether futures contracts could legitimately call for settlement in cash, which opened the way for many of today’s futures contracts not only in indexes but in other phenomenon where physical delivery is either impossible or cumbersome.
At that time exchanges were applying with the CFTC to create futures on stock indexes and that drew a lot of SEC attention. “What [Shad] was agreeable to was as long as the index contained a lot of stocks, or was broad based as we called it, and as long as the contracts were cash settled so no one’s out there scrambling to buy stocks in the stock market, then he could live with that under CFTC exclusive jurisdiction,” Johnson says.
That approval also completely took off the table the listing of single stock futures for trading for trading on U.S. exchanges. On that point they “agreed to disagree.”
Johnson has also contributed to the development of the new financial instrument division of a New York exchange and the creation of the world’s first futures contracts on a U.S. Dollar Index, the European Currency Unit and emerging market Brady Bonds.
As for the future of the derivatives industry, Johnson says there are so many possible contracts that can be developed on the retail level along the lines of futures contracts that are risk management tools for the things that the retail public worries about like their interest rates and their mortgages.
“Every home owner with a variable mortgage rate has the same kind of risk that a bank does when it makes a loan. The bank is probably hedging it’s risk that interest rates will fall, but the homeowner has no way to hedge that interest rates will rise,” Johnson says.” “Or health insurance. There’s no reason in the world why you couldn’t develop, if you could get the right data, a health insurance index that would be traded in sizes of $2,500 so when I get a notice from my employer that health rates are rising this year again, maybe I can find something in the futures market of a size that I can handle that will help offset some of that.”
Johnson has an extensive international practice, advising exchanges and institutions located outside the United States, including Canada, France, Hong Kong, Japan and Russia.
In 1980, Johnson took some time in the southeast coast of Puerto Rico to write the first modern treatise in the field, originally named “Commodities Regulation” but now called “Derivatives Regulation,” is well-established as the leading authority in its field through 25 years of continuous print and four editions.
A funny thing is that, for someone who’s now such an expert in the field, he was reluctant at first about what that kind of practice would mean for his career.
“At that time I was in antitrust and that was the most profitable department at any law firm, and I was doing just fine, thank you!” he says, adding, “in retrospect it was a brilliant move.”
Johnson was honored by the CBOT a year ago for doing the legal work, which required changing federal law, on the world’s first interest rate futures contract. “The product was a Rich Sandor creation but I note it as a major personal contribution because something like 50% of all futures volume in the world today involves interest rates,” he says.