Thursday, July 22, 2010

Lincoln-Feinstein Colloquy Reveals that CFTC Should Prohibit Event Derivatives Contracts as Against the Public Interest

In a colloquy with Senator Diane Feinstein on Section 745 of Dodd-Frank, which authorizes the CFTC to prevent the trading of derivatives contracts that are contrary to the public interest, Senator Blanche Lincoln agreed that Section 745 should be broadly construed to prevent derivatives that exist predominantly to enable gaming through event contracts, such as the Super Bowl, and serve no commercial or hedging purpose. These types of event contracts would not serve any real commercial purpose and would be contrary to the public interest.
Similarly, continued Sen. Lincoln, national security threats, such as a terrorist attack, war, or hijacking pose a real commercial risk to many businesses in America, but a futures contract that allowed people to hedge that risk would also involve betting on the likelihood of events that threaten US national security, and would be contrary to the public interest.

Firms facing financial risk posed by threats to national security may take out insurance, added Senator Feinstein, but they should not buy a derivative. A futures market is for hedging, she reasoned, it is not an insurance market.

From 1974 to 2000, the Commodity Exchange Act required the CFTC to prevent trading in futures contracts that were contrary to the public interest. But the Commodity Futures Modernization Act of 2000 stripped the CFTC of this authority. It is the intent of Congress in Dodd-Frank that the term ``public interest’’ in Section 745 should be broadly construed so that the CFTC may consider the extent to which a proposed derivative contract would be used predominantly by speculators or participants not having a commercial or hedging interest. Thus, the CFTC will have the power to determine that a contract is a gaming contract if the predominant use of the contract is speculative as opposed to a hedging or economic use. (Cong. Record, July 15, 2010).

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