Regulation of Hybrid Instruments Under the Commodity Exchange Act: A Call for Alternatives
60 Pages Posted: 11 Nov 2010 Last revised: 25 Mar 2011
Date Written: 1990
In 1936, Congress enacted the Commodity Exchange Act (“CEA”'). It later gave exclusive jurisdiction over commodity futures contracts to the Commodity Futures Trading Commission (“CFTC”'). The CEA requires that all commodity futures contracts be traded on commodity exchanges that are registered with the CFTC as “contract markets.”' The CEA further grants plenary jurisdiction over commodity option contracts to the CFTC. With this jurisdiction, the CFTC has banned most forms of commodity options contracts in which public customers may participate, unless such contracts are traded on a contract market.
In recent years, financial firms have developed a number of “hybrid”' instruments that defy easy classification as either commodity futures or commodity options contracts, in which case they are subject to the CFTC's jurisdiction, or traditional securities or other instruments, in which case they are subject to the Securities and Exchange Commission (“SEC”') or some other federal regulatory body. In reality the hybrid instruments have characteristics of both classes of instruments, and their dual nature has led various agencies to claim jurisdiction over them. In particular, the CFTC has sought jurisdiction over those hybrid instruments whose characteristics appear to fall within the scope of its authority, but the CFTC has not developed a coherent theory, in light of general policy concerns and the legislative policies behind the CEA, to determine when regulation is appropriate. The CFTC has rendered several interpretations and adopted various rules allowing some hybrid contracts to be traded outside contract markets, but at the same time it has prohibited other hybrid transactions. These efforts have aroused much opposition and controversy because of industry concerns that the form of hybrid instruments that are permitted to be traded off the exchanges is too restrictive.
This article examines the CFTC's treatment of hybrid instruments. It argues that the current regulations are too restrictive: they hamper innovation, restrict competition to the trading exchanges, and are unnecessary in light of alternative regulatory schemes and in light of the CFTC's limited role in protecting public investors. This article argues instead that the CFTC or Congress should permit large institutions and sophisticated investors to trade hybrid commodity instruments without being subject to CFTC regulations. The article will first examine the scope of the CEA as traditionally and recently applied, and then it will review several hybrid products that have been developed to date. Finally, the article analyzes the CFTC's rule making efforts and suggests areas that need to be expanded to allow the continued development of hybrid instruments.
Keywords: Commodity Exchange Act (CEA), Commodity Futures Trading Commission (CFTC), Commodity Futures, Contracts, Exchanges, Commodity Options, Securities and Exchange Commission (SEC), Hybrid Instruments, Swaps, Re-Purchase Agreements (Repos), Stand-By Commitment
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