Listen to teleconference

The derivatives provisions of the Dodd-Frank Act were a crucial element of financial reform, promising to bring serious oversight to the unregulated “shadow banking” markets that helped crash the world economy.

Two and a half years later, after much inside-the-beltway debate over implementation, we are beginning to see the first substantial changes in these markets. One striking development: a significant portion of traders who once utilized unregulated derivatives contracts appear to be moving over to classic futures trading rather than deciding to continue dealing in swaps under the new Dodd-Frank rules. The shorthand for this shift is “futurization.”

On Wednesday Jan. 30, AFR held a teleconference for journalists, congressional staff, and others seeking to understand the policy implications of this shift, and why – contrary to the claims of regulatory opponents – it could represent a major gain for financial stability and for the goals of Dodd-Frank.

The presenters were:

• Marcus Stanley, Policy Director of Americans for Financial Reform.
• Michael Greenberger, Professor, University of Maryland Francis King Carey School of Law, and former Director of Trading and Markets at the Commodity Futures Trading Commission (CFTC).
• Wallace Turbeville, Senior Fellow at Demos, previously an investment banker at Goldman Sachs.

Policy and Practice

Michael Greenberger: With the enactment of the Commodity Futures Modernization Act of 2000, Congress effectively decided that “not only should swaps not be regulated by the CFTC as futures, but they should not be regulated by any entity at all.” To correct that error, Title VII of Dodd-Frank sought to create a regulated swaps market based on the futures model.

“No one ever recommended jumping to the ultimate resolution of just treating these products as classic futures, because the banks would’ve never accepted that in the initial rounds of the regulatory environment.” In essence though, that is what seems to be happening.

Marcus Stanley: Some swaps have been repackaged as conventional futures. Others have found a home as futures under new contract models developed by the exchanges.

Signifigance of Futurization

Marcus Stanley: This movement has been controversial in some corners. Scott O’Malia of the CFTC called it a “regulatory nightmare.” But “we should step back and take a broader perspective. Remember that the goal of the derivatives provisions of Dodd-Frank was to move what had been an opaque, unregulated market over into the world of regulated exchanges and clear products…”

Critics suggest that there must be something wrong with the new swaps rules, or that the CFTC has overstepped. “But that’s false. What’s happening here is the underlying logic of the Dodd-Frank Act playing itself out. When we require things to be regulated and cleared and margined, then it’s no longer necessary to dress them up as something they’re not.”

Michael Greenberger: The Dodd-Frank Swaps structure has turned out to be “so similar to the standard classic trading of swaps” that many players have asked themselves: “Why go to this new mechanism that isn’t exactly classic futures? Why don’t we just use the classic futures market [where] there’s never been a failure of a clearing organization…?”

Advantages of classic futures include:

• All brokerages and clearing facilities are heavily regulated, both by the CFTC and by self-regulatory organizations.
• Intermediaries have to be licensed, have to demonstrate competence, are monitored for shady practices and fraud.
• Strong private rights of action – both in federal court and through administrative channels.
• Better enforcement machinery. Everybody who touches the product is held accountable.
• The price is a competitive market price.

Looking Ahead

Wallace Turbeville: On both sides of the swaps/futures boundary, proper regulation is crucial, especially when it comes to block trade and liquidity standards. We will also need to make sure that these new exchanges, in competing for profits, are not unduly influenced by those they are supposed to help police. “Regulators will need to be very diligent about transactions which are cleared.”

Marcus Stanley: Before Glass-Steagall was repealed in 1999, commercial banks and investment banks were motivated to police each other. Futurization, similarly, drives swaps lobbyists to push for better regulation of the futures market.