swaps. here is an excerpt from a report from the CRS:
full reportLegal Certainty for Swaps and Off-exchange Derivatives. A long-standing question in derivatives regulation was whether the Commodity Exchange Act applied to
contracts that were not traded on futures exchanges. A plain reading of the pre-2000 law
suggests that it did: in 1974, Congress gave the CFTC exclusive jurisdiction over all
contracts “in the character of” futures contracts, and mandated that such contracts, with
certain exceptions, should only be traded on CFTC-regulated exchanges.
However, in the 1980s, an off-exchange market in derivatives grew up. The major
dealers in this OTC market were banks and securities firms, and the principal instrument
was the swap contract. Although swaps are clearly “in the character of” futures contracts
– they serve the same economic purposes and are often interchangeable – the CFTC did
not move to assert its jurisdiction. The CEA’s exclusivity provisions remained, however,
and were seen as a source of “legal risk” to the swaps market. That is, if a court had ruled
that swaps were in fact illegal, off-exchange futures contracts, trillions of dollars in OTC
derivative contracts might have been rendered void and unenforceable.
The CFMA specifies that the CEA does not apply to contracts between “eligible
contract participants” (which include financial institutions, regulated financial
professionals, units of government, nonfinancial businesses or individual persons with
assets over $10 million, and others whom the CFTC may approve) based on “excluded
commodities,” defined as financial products and indicators (which are thought to be less
susceptible to manipulation than physical commodities with finite supplies).Derivatives based on agricultural commodities, however, may be traded only on
CFTC-regulated exchanges, because of concerns about price manipulation – “corners”
and “squeezes”– in those markets.
Exchange Trading and Clearing of Swaps.
Exchange Trading. In 1993, the CFTC addressed the issue of legal uncertainty
by issuing regulations exempting financial swaps, a form of OTC derivatives, from the
CEA. (A separate exemption permitted trading of certain OTC contracts based on energy
products outside the CEA.)
Under the swaps exemption, swaps were not considered
futures (subject to the exchange trading requirement and other CFTC regulations) as long
as they met several conditions that distinguished them from exchange-traded contracts.
Among the conditions was a requirement that swaps must be bilaterally negotiated
agreements and not traded on an exchange or exchange-like facility open to multiple
buyers and sellers.
However, in the late 1990s there was interest in creating multilateral swaps
exchanges, and at least one such facility began operations. An exchange, where bids and
offers would be exposed to a large number of market participants, could bring more
liquidity to the swap market, and make price information more widely available, allowing
businesses and others to manage their financial risks more efficiently and economically.
The CFMA permits the use of exchange-like electronic facilities for the trading of
OTC derivatives based on excluded (financial) commodities.