Swaps and futures: two sides of the same coin

Swaps and futures: two sides of the same coin

The Dodd-Frank Act of 2010 has been blamed for many things. Suffocating regulation is often cited. A new bureaucracy and scores of new restrictions. The CFTC, the SEC, the Fed and brand new agencies have been charged with taming the swaps behemoth. In the "too-little-too-late category," I offer another.

As so often happens when the US Congress gets involved (I am neither a commie liberal nor a retro conservative, having held my CFTC chairmanship as a political Independent, a rare breed in the first Reagan Administration), Dodd-Frank succumbed to the fiction that swaps are somehow "different" from futures contracts. This is why its Chapter 7 meanders for hundreds of pages on that false assumption and has borne a dual form of regulation that no one seems to like very much.

Let's compare the structures of the two products. Overwhelmingly, futures contracts track changes in asset prices and result in a payment of price changes between the parties. Futures contracts are often used to hedge against adverse price movements that impact daily commercial activity. And they are used by others to bet that those changes do or do not occur. In virtually all cases, swaps perform the same functions.

The CFTC never said otherwise. In 1989, it issued a "policy statement" that it would not regulate swaps as futures contracts if restricted in certain ways. In 1993, it reformulated the same position in formal regulations. Both actions assumed that, otherwise, swaps were subject to the full panoply of rules governing futures contracts, including the general ban (with a few exceptions) against off-exchange transactions.

The Commodity Futures Modernisation Act of 2000, another stumble by the Congress that was largely repealed by Dodd-Frank, told the CFTC politely to "butt out" and so the agency did until the Great Recession exposed its many flaws. But Dodd-Frank created its own confusion.

Under Dodd-Frank, swaps continue to be viewed separately from futures contracts. It defined "swaps" on a stand-alone basis. It created new categories of registered entities, such as Swap Execution Facilities, Major Swap Participants, Swap Dealers, etc. It gave swaps tied to securities to the Securities and Exchange Commission.

Why? The only impediment to treating swaps as futures appeared to be the CFTC's qualified on-exchange mandate. A paragraph or two of new legislative language could have corrected that (or, even easier, a reversion to former CFTC policy).

Instead, at the urging of swap lobbyists (where are they if I ever suffer an IRS audit?), Congress took the bait. The result is hundreds of pages of legislative text and scores of new regulations. Another example of our tax dollars at work.

I have nothing against swaps. They are a huge and valuable tool. They should be allowed, ever privately, for the same services that futures provide. But a large part of existing futures regulation could have been adapted to monitor swaps, leaving the CFTC's exemptive authority to deal with those that least mimic futures contracts.

It is not about whether members of the Congress are underpaid (a recent lament from some) but how they earn their keep. Perhaps, after the next financial crisis, sensibility will return.


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