Ups and Downs of Changing Landscape
The US House of Representatives passed a sprawling bill, called the Wall Street
Reform and Consumer Protection Act of 2009 or H.R. 4713, in December.
Derivatives trading and investment advising are among the many activities
affected by the 1,300-plus-page regulatory behemoth.
While additional provisions may be inserted into the bill as it makes its way
through the Senate and the final law may be different, much of what’s there will
probably remain. The table below lists certain items relevant to commodity
trading advisors and futures markets.
Regulators blame unregulated credit default swaps for the collapse of Lehman
Brothers and the difficulties of AIG, the insurance company. So, moving these
over-the-counter derivatives to clearinghouses is a top priority. The main issue
is that a handful of big dealers, especially investment banks, control OTC
derivatives and have an advantage in price information.
Commodity Futures Trading Commission Chairman Gary Gensler recently commented:
“Can you imagine if other markets operated similarly to the over-the-counter
derivatives marketplace, where the dealer is the only one with the information?
It would be like buying an apple from the supermarket when the price of the
apple is kept private.”
By contrast, of course, futures and options on futures are regulated and traded
on exchanges. The Futures Industry Association says it has long favored “closing
gaps in the regulation of derivatives and promoting the value of the price
discovery and hedging benefits provided by futures markets.”
The Association, in a statement on the topic, described the 2009 bill as an
important step in this process and said, “We look forward to working with the
Senate to further improve this legislation.”
The US is not the only country moving to regulate OTC derivatives. The European
Commission announced a similar agenda in October, including higher capital
requirements for customized OTC derivatives transactions and mandates that all
standardized contracts be traded in regulated venues.
“It is encouraging that Europe and the United States are moving in the same
direction regarding regulatory reform,” Mr. Gensler told the Global Markets
Advisory Committee in December. “Reform starts with bringing transparency to the
opaque over-the-counter markets,” he said.
Futures traders may benefit if OTC derivatives become more like futures and
trade in venues where prices are transparent and counterparty risk is
controlled. This could eventually result in new markets where there are
opportunities to implement some futures trading strategies.
Wall Street Reform Act of 2009, Selected Highlights
Regulate over-the-counter derivatives, with certain exceptions
Require hedge fund managers to register with the SEC
New rules for advisors registered with both SEC and CFTC
Assessments on broker-dealers for investor protection fund
Account protection for futures contracts held in a portfolio
Another part of H.R. 4713 could be less benign. The bill requires hedge fund
managers, including those already registered with the CFTC, to register with the
Securities and Exchange Commission. This may mean more record keeping and time
spent responding to SEC questions and examinations.
However, the bill exempts managers with less than $150 million in assets under
management, so it will not affect smaller commodity trading advisors. For those
with over $150 AUM, new rules are to be determined. The Act directs the CFTC and
the SEC to establish rules as to the form and content of reports to be filed by
investment advisors that are registered with both agencies.
This is to be done within 12 months after the enactment of the Private Fund
Investment Advisers Registration Act of 2009 and the governors of the Federal
Reserve System are also to be consulted. Congress appears to believe that the
SEC and CFTC will work together effectively, while liaising with the Federal
Mr. Gensler has said that his “agency has a long history of cooperation with
other agencies, including periodic joint enforcement meetings, memoranda of
understanding and surveillance briefings.” But there have been stories of
bureaucratic turf battles between the SEC and the CFTC, going back years.
Moreover, the reporting requirements for double-registered advisors will serve a
number of different goals. The SEC is supposed to prevent fraud by individual
advisors. But the main rationale for the new legislation is to nip in the bud
future financial crises. Systemic risk management became a priority after the
Hence the role of the governors of the Federal Reserve System in setting
reporting requirements. They are likely to want information on leverage, for
instance, for the purpose of monitoring systemic risk.
On a separate issue, the CFTC continues to consider whether to set position
limits in energy markets. The agency appears to favor doing so. Mr. Gensler says
there are position limits in many agricultural markets.
“In setting position limits for certain agricultural commodities, the CFTC
sought to ensure that the markets were made up of a broad group of market
participants with a diversity of views,” he says. “Similarly, working with the
exchanges, such position limits were set for energy futures as recently as
Another argument regulators make in favor of position limits is that energy
futures are a large and important market. More than 315 million energy futures
and options contracts were traded on CFTC-regulated exchanges through October of
2009. The largest contract in crude oil by volume, NYMEX’s West Texas
Intermediate, accounted for 114 million contracts, equivalent to 114 billion
barrels of oil with a notional value of nearly $7 trillion, according to Mr.
In 2008, Congress gave CFTC more authority over certain energy derivatives
trading. Contracts traded on exempt commercial markets can be subjected to the
same regulation as exchange-traded futures if they have a significant price
discovery function. In July the CFTC decided that the ICE Henry LD1 Fixed Price
Contract traded on the Intercontinental Exchange has such a function.
More than 40 additional energy contracts, including natural gas and electricity
contracts currently traded on exempt commercial markets, are being considered
for their role in price discovery. The regulator asked for public comment on
these contracts. Clearly, there is a trend to extend futures regulation to
instruments that trade outside regulated exchanges.