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.In 1998, following alegislative moratorium preventing the CFTC from taking additional regulatory action inthe area of OTC derivatives, Congress asked the President s Working Group on FinancialMarkets ( PWG ) to conduct a study of OTC derivatives markets and to developlegislative recommendations.In 1999 the PWG issued its report, Over-the-CounterDerivatives Markets and the Commodity Exchange Act ( 1999 PWG Report ), and theunanimous recommendations advanced in that report became the basis for some of the mostsignificant reforms to the derivatives markets since the CFTC s creation.The Commodity Futures Modernization Act of 2000The Commodity Futures Modernization Act of 2000 ( CFMA ), amending the CEA,took as its starting point the recommendations in the 1999 PWG Report on OTCderivatives.Most fundamentally, the PWG had concluded that the trading of OTCfinancial derivatives between certain sophisticated counterparties (which mainly includesregulated financial institutions, state and local governments, and certain businesses,pension funds, high net worth individuals, and other institutions) should largely beexcluded, as opposed to exempted, from the CEA.The primary justifications forrecommending exclusion for such transactions were a determination that most OTCfinancial derivatives (e.g., interest rate swaps) were not susceptible to manipulation and thatthe counterparties in such transactions did not need the same protections as smaller,unsophisticated market participants who relied on intermediaries to conduct theirtransactions.The CFMA excluded a broad range of transactions from most provisions of the CEA,thereby providing much needed legal certainty for the burgeoning OTC derivativesmarkets.In general, the exclusions provided by the CFMA depended, as did the PWGrecommendations, upon the types of assets being traded, the sophistication of thecounterparties, and where and how the transactions were executed.The CFMA createdseveral new definitions to facilitate the exclusions:" Excluded commodity: generally includes financial assets such as securities andcurrencies, interest rates, exchange rates, economic measures or indexes of risk,return, or value, and contingencies beyond the control of the parties." Eligible contract participant: the main type of sophisticated investor that includesfinancial institutions, registered market professionals (e.g., broker-dealers andfutures commission merchants), other institutional investors, and certain high net worthindividuals." Eligible commercial entity: a certain eligible contract participant (as definedabove) that deals in one or more commodities as part of their business. 40 Martin T.Bannister (Editor)" Trading facility: a catch-all term for either a physical or electronic facility wheremultiple participants are able to trade with each other through mutually availablebids and offers.Thus the CFMA excluded from most provisions of the CEA, including the antifraudprovisions, the following:" Agreements, contracts, and transactions in excluded commoditieso between eligible contract participants that are not executed on a trading facility;oro between eligible contract participants, on a principal-to-principal basis, andexecuted on an electronic trading facility." Agreements, contracts, and transactions in assets, other than agriculturalcommodities, between eligible contract participants are subject to individualnegotiation by the parties and are not executed on a trading facility.In addition, the CFMA excluded transactions in hybrid instruments that are (asdetermined by a predominance test ) chiefly securities, and electronic trading facilities thatlimit trading to certain types of transactions that are otherwise excluded.However, the CFMA went further than (and actually contradicted) the PWGrecommendations in this area by exempting certain transactions in exempt commodities.The CFMA also defined exempt commodities to mean a commodity that is not anexcluded commodity or an agricultural commodity.In practice, exempt commoditiesinclude mainly metals and energy products.Under the CFMA, agreements, contracts, andtransactions in exempt commodities are exempt from most provisions of the CEA (but notincluding the antifraud provisions or other powers of the CFTC) if they are betweeneligible contract participants and not executed on a trading facility or if they are betweeneligible commercial entities on a principal-to-principal basis and traded on an electronictrading facility.In addition to addressing swap transactions, the CFMA also included several otherimportant aspects:" It clarified the CFTC s jurisdiction over certain retail foreign currencytransactions." It repealed the eighteen year-old Shad-Johnson ban on single-stock futures andother security future products and implemented a system of coordinatedregulation for such products." It provided legal certainty that products offered by banks would not be regulated asfutures contracts.The CFMA also codified a regulatory relief proposal developed by the CFTC.Inearly 2000, the CFTC proposed a New Regulatory Framework in an effort to modernize theregulatory structure of the U.S.futures markets.In November 2000, the CFTC approved rulesimplementing this framework, but the CFMA superseded this action and the rules werewithdrawn.In large part, the CFMA borrowed from the CFTC s framework and created athree-tiered structure for the trading of derivatives that distinguishes among markets History of the Current Regulatory Framework 41based on the types of contracts traded and the sophistication of the market participants.The upper tier resembles a traditional futures exchange (with some importantmodifications), while the two lower tiers are permitted to operate largely outside of theCEA.The Commodity Futures Trading CommissionThe CFTC Act established the CFTC as an independent federal agency with exclusivejurisdiction over the futures markets.The executive structure of the CFTC is similar tothat of the SEC.The Commission consists of five Commissioners, appointed tostaggered five-year terms by the President, with the advice and consent of the Senate.The President also designates one of the Commissioners to serve as Chairman, but unlikethe SEC, the Senate must separately confirm this designation.Regulated Entities Markets, ClearingOrganizations, Intermediaries, SROsUntil the year 2000 it had been a fairly consistent principle in the federal regulation ofU.S.futures markets that futures transactions had to occur on registered or regulatedexchanges and that off-exchange trading of futures were appropriately banned.Thisrequirement became especially pronounced following the creation of the CFTC by theCFTC Act of 1974 and the concurrent expansion of the term commodity to includealmost any conceivable agricultural, physical, financial, and intangible interest (e.g.,interest rates) or contingency asset (except onions).In sharp contrast to the foundingmodel of futures regulation, today s futures markets are characterized by a risk-based,tiered approach to regulation.MarketsThe CFMA prompted a comprehensive overhaul of both the structure and the regulationof U.S.futures markets.Previously, the regulatory approach to futures trading in theUnited States was one-size-fits-all
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