Cracking the Preemption Code: The New Model for OTC Derivatives

Abstract

Following the 2008 financial crisis, Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) established a comprehensive regulatory regime in 2010 for over-the-counter (OTC) derivatives. From a state law perspective, Congress could have chosen to put more cops on the beat by repealing preemption that was added to the Commodity Exchange Act (CEA) in 2000 by the Commodity Futures Modernization Act (CFMA). Instead, Congress embraced preemption, extending it beyond gaming and bucket shop laws that were previously preempted by the CFMA. Given the size and complexity of the OTC derivatives markets, together with new required market structure changes, Congress chose to carry out OTC derivatives regulation exclusively through federal agencies with the requisite expertise.

Aside from those at the CFTC who were close to Title VII when it was drafted, it was not immediately apparent in 2010 what Congress had done for the OTC derivatives markets by resetting the preemption clock back to 1974, which was when Congress conferred exclusive jurisdiction on the CFTC for commodity futures. The concern was that Congress had gone the other way and repealed preemption for swaps, based on changes to CEA §12(e)(2), which provided (and continues to provide) preemption of state gaming and bucket shop laws solely for contracts that are excluded or exempt under the CEA. In 2000, the CFMA added §12(e)(2) to the CEA at the same time that the CFMA excluded swaps from the CEA. Because Dodd-Frank repealed this exclusion in 2010 and brought swaps back into the CEA under the new Title VII regulatory regime, Congress moved swaps out of §12(e)(2) and into §2(a)(1)(A), the exclusive jurisdiction clause, using the same approach it had in 1974 for futures.

Unfortunately, the change to CEA §12(e)(2) could leave the impression that preemption had been repealed. Even were someone to shift their attention to the CEA’s exclusive jurisdiction clause, this was not enough, since to achieve preemption for swaps it also took excluding them from CEA §12(e)(1). This is the CEA’s concurrent jurisdiction clause, which Congress added in 1982 for off-exchange contracts. This exclusion from §12(e)(1) is provided in amended CEA §2(d) through a long list of enumerated section references, making preemption for swaps more difficult to decipher.

This article examines these changes and the coherent and well-designed preemption model that Congress adopted in 2010 for CFTC-regulated swaps and SEC-regulated security-based swaps.

Keywords: preemption, commodity exchange act, derivatives, swaps, repeal, bucket shop laws, exclusive jurisdiction, dodd-frank, CFTC, SEC, security-based swaps

JEL Classification: G18, G28, G38, K22