The Commodity Futures Modernization Act of 2000: An Overhaul of the Financial Landscape
The Commodity Futures Modernization Act of 2000 (CFMA) marked a significant milestone in the financial world when it was signed into law by President Clinton on December 21, 2000. This sweeping legislation brought about a comprehensive revision of the Commodity Exchange Act (CEA), aiming to address disagreements between two regulatory agencies: the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC).
The CFMA was a direct response to a conflict arising from the SEC’s plan to ease broker-dealer regulations for securities firms engaged in Over-the-Counter (OTC) derivatives. The CFTC contested this proposal, sparking a power struggle over the legality of derivatives for securities and the oversight under the CEA.
To provide clarity and exclusions in the status of OTC derivatives and hybrid instruments, the CFMA introduced a range of statutory exemptions and exclusions. Additionally, it addressed ambiguous provisions regarding nonretail swaps under the Securities Act of 1933 and the Securities Exchange Act of 1934. Although the law sought to address regulatory concerns, it faced criticism following the Enron failure and the rescue of American General Insurance.
The CFMA’s true impact came to light during the 2008 financial crisis. Credit default swaps emerged as a significant concern, creating a crash course in a previously unfamiliar investment for the general public. Credit default swaps functioned as insurance policies protecting lenders if borrowers defaulted on loans. Unlike traditional insurance policies, anyone could purchase credit default swaps, including speculators who had no direct interest in the loan being repaid.
While lenders sought protection through credit default swaps, speculators bet on the failure of borrowers, making these swaps a risky investment. The credit default swap market experienced explosive growth, reaching $62.2 trillion by the end of 2007 before collapsing to $38.6 trillion in 2008. This lack of transparency and the massive market size raised concerns about systemic risks to the economy during the 2007-2010 financial crisis.
The CFMA’s treatment of credit default swaps drew considerable attention. Some argued that credit default swaps should have been regulated as insurance, while others believed that the CFMA hindered legal tools for declaring credit default swaps illegal under state gambling laws. The exclusion of credit default swaps from state gaming laws and insurance regulations was a contentious point that allowed the market to grow unchecked, contributing to the financial crisis.
