Treasury and Investment Management

Deregulation of Futures Exchanges

Background The Futures Trading Practices Act of 1992 authorized the Commodity Futures Trading Commission (CFTC) to permit less regulated "professionals only" futures trading in the United States. For this purpose, professionals are considered to be entities and individuals with assets that tend to exclude the general public from participation. In 1993, the CFTC exempted a number of "professionals only" markets from its regulatory structure, including the over-the-counter (OTC) derivatives market. The futures exchanges were not exempted.

While trading in derivatives occurs both on exchanges and in OTC transactions, there are differences between these markets. Exchanges are organized public marketplaces in a centralized environment. The exchanges are noted for the following characteristics: open and competitive trading; publicly available price transparency; clearing firm financial requirements; and clearing systems that eliminate counterparty risk. OTC transactions involve privately negotiated contracts between institutional customers. Each party to the transaction must take the credit risk of the counterparty and the price of the trade is confidential. In many cases, OTC products may prove to be better risk management tools than standardized exchange-traded products. OTC dealers frequently hedge their risks using exchange-traded products.

Recent legislative proposals would amend the Commodities Exchange Act to permit the futures exchanges to operate a "professional market." This would be a largely unregulated market designed for trading by "appropriate persons." Federal regulators would retain their anti-fraud and anti-manipulation authority, but this authority would be limited by their inability to enforce certain recordkeeping and reporting requirements that exist under current law. Futures exchanges point to competitive pressures from the deregulated OTC market in urging a similar relaxation of rules for the commodities exchanges.

While most state and local governments are precluded from trading directly in futures, this option is available for public pension funds. In addition, state and local governments often use derivative products for risk management purposes. For example, debt and investment transactions often involve swaps based on futures products prices and might include interest rate derivatives that are used to hedge against interest rate movements. Although used less frequently, debt and investment transactions also might involve currency derivatives used to hedge against changes in foreign exchange rates and commodity derivatives that are used to hedge against future price changes.

GFOA Policy The Government Finance Officers Association (GFOA) opposes legislative proposals to relax standards for exchange-traded derivatives and those provisions that would create a "professional trading market." It is clear that even a market composed primarily of institutional investors or those with a particular asset threshold must have a means of ensuring market integrity, price dissemination and adequate protections against fraud, manipulation, and other trading abuses. GFOA believes that deregulating commodities futures exchanges could put public pension funds and other state and local government funds at risk. GFOA urges Congress to consider carefully the potentially negative effects that the deregulation of futures exchanges could have on the integrity of the financial markets, including the perception that they are less safe or stable than under the current environment.

  • Publication date: June 1997