Commodity Futures Modernization Act (CFMA)

What is Commodity Futures Modernization Act (CFMA)?

The Commodity Futures Modernization Act (CFMA), signed into law on December 21, 2000, updated commodity trading laws especially for non-physical products such as over-the-counter (OTC) derivatives.

Understanding Commodity Futures Modernization Act (CFMA)

The Commodity Futures Modernization Act precisely defined the difference between a commodity and security and stated that derivative transactions would no longer have regulation as either a futures contracts or as a securities trade. A commodity is a necessary good used in the production of other goods or services which is changeable with other goods of the same type. A security is a negotiable financial instrument that is interchangeable, holds some form of monetary value, and can be traded.

The CFMA also clarified the responsibilities of two separate regulatory agencies, the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC), to eliminate overlapping jurisdictions between the two agencies and establish specific enforcement activities for each.

Before the CFMA the difference between commodities and securities had not been precisely defined under old regulations. Earlier regulations saw futures contracts and options on futures contracts under the jurisdiction of the CFTC unless they were otherwise exempt. Yet, stock options and other derivatives based on the indices of interest rates, overall stock markets and specific baskets of stocks might be considered securities.

After the CFMA was enacted various financial contracts were exempt from prior laws. For example, while regulatory oversight had previously applied to transactions in financial derivative products between two financial institutions, the CFMA reduces such monitoring for transactions in many nonphysical commodities when the two parties to the contract do not execute such an agreement on a trading exchange. However, regulators may still enforce various laws that prohibit fraud and price manipulation.

Although the CFMA did repeal previous bans of the trading of single-stock futures contracts, trades are subject to specific provisions that are enforced by both the CFTC and the SEC. The CFMA includes predefined procedures to specify each commission’s regulatory authority over these contracts.

Another provision of the CFMA is that it limits or eliminates the regulatory authority of the CFTC over transactions in specific financial instruments such as security warrants, mortgages, repurchase agreements and foreign currencies.

The law also defines the regulation of swap agreements. Swaps with a basis on the price, yield, value or volatility of a security or group of securities are not subject to specific rules for reporting transactions. However, the SEC will continue to enforce laws that prohibit fraud, price manipulation, and insider trading.

The CFMA also allowed for trading single stock futures, which had not been legal in the U.S. even though such contracts traded in other countries. These are futures contracts that function the same way as those for other commodities but are contracts that call for delivery of a predefined number of shares of a specific stock.