Note: August represents the 500th issue of Futures magazine dating back to its origin as Commodities magazine in February 1972. As part of that celebration we have digitized some important stories from the past and are presenting some of the major events in the industry. Here we recount the the passage of the Commodity Futures Modernization Act and repeal of Shad-Johnson.
Commodity Futures Modernization Act
The Commodity Futures Modernization Act of 2000 (CFMA) was welcome legislation for the futures industry; recognizing its growth, value and maturity over the previous several decades. Regulations would be principle based allowing for more flexibility in rolling out new contracts and overseas contracts would be more accessible. The big prize was the repeal of the Shad-Johnson Accord as the London International Financial Futures and Options Exchange (Liffe) had plans to launch single stock futures—including those on U.S. companies—and Congress realized it had to act to prevent losing a potential huge market.
Competition in futures had always meant innovation, finding the next big market; as once a futures contract became established it was game over. With very few exceptions there was little direct competition among exchanges. The world had just seen the exception as Liffe, slow to move into electronic trading, saw its largest contract, the 10-year German Bund Futures, escape to Frankfurt and Eurex.
Liffe was hungry for a victory and it saw single stock futures as a possible lucrative new asset class. This was a problem for U.S. regulators. The Shad-Johnson accord was a compromise that smoothed the way for stock index futures. The Securities and Exchange Commission (SEC) has lost its fight to regulate futures on interest rate—which after all were securities— a decade prior, when provisions within the legislation authorizing the Commodity Futures Trading Commission (CFTC) provided the new agency have exclusive jurisdiction over commodity futures, which were broadly defined to include the fledgling financial future revolution. This was thanks to the brilliant legal work of Philip McBride Johnson, who as outside counsel for the Chicago Board of Trade worked to add the following phrase in its definition of commodity futures in the legislation: ‘all goods and articles … and all services, rights and interests in which contracts for future delivery are presently or in the future dealt in.’
A decade later Johnson’s name would go on the compromise that would allow futures exchanges to list futures on broad based indexes but not individual stock or narrow based indexes. Johnson was also responsible for allowing for cash settlement of futures, which was no small task and necessary because there was no way to make delivery on 500 stock components of an index.
Now with the threat from London, Congress prepared to knock down Shad-Johnson. But the jurisdictional problem remained and the compromise cut the baby in half by creating a new asset class: Security Futures Products, not fully futures or securities. It also gave joint regulatory jurisdiction to the CFTC and SEC.
Chicago Board Options Exchange Chairman and CEO Bill Brodsky successfully lobbied Congress that single stock futures were very similar to options on securities and should not have a regulatory advantage. That meant that the new products would not have futures style margining but be subject to the same 20% margin rules of options. They would be subject to taxers that support the SEC and would not get the benefit of 60/40 tax treatment as other futures contracts do.
The CFMA was necessary to clarify the CFTC’s jurisdiction—or lack thereof—of over-the-counter swaps and provide clarity to its jurisdiction of retail foreign exchange trading. On the first count it accomplished this and many blame the financial excesses of the last decade to it. On the second count, it did not and the CFTC’s jurisdiction over retail forex returned to the courts until regulation was further defined in Dodd-Frank.
The repeal of Shad-Johnson was a late element due to the competitive threat from Liffe. Many potential exchanges sprung up but the regulatory environment made it difficult. There were two exchanges to trade SSF that launched: Nasdaq-Liffe Markets and OneChicago, a 50-50 partnership between the CBOE and Chicago Mercantile Exchange with the CBOT having a 10% stake. The regulatory structure prevented the products from taking off—as they have in numerous other jurisdictions—but OneChicago has survived and has slowly but surely built up its volume.
The CFMA has been blamed—perhaps unfairly—for a lot of the financial ills that followed but it also allowed for a more efficient way of approving new futures contracts both at home and abroad for trading in the United States. There was an explosion of futures volume in the 21st century and the CFMA should get some credit for this.