Commodity Futures Modernization Act Explained

The Commodity Futures Modernization Act, enacted in 2000, was an attempt to define what a commodity was as it related to trading and futures investing. Because of differing opinions between the Securities Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC), the government was forced to step in and create the law. However, this act had some long-term effects that continue to reverberate throughout the market.

What are commodities?
Commodities are products that can be bought and sold according to fairly universal prices across the board. The products are essentially the same in quality, regardless of manufacturer. Examples of commodities are beef, wheat, oil and copper. Products that aren't commodities, such as radios, tennis shoes and mouthwash, have varying value depending on the manufacturer and the quality of the product.

What is the history of commodities?
Originally, farmers would bring in their crops after harvest to sell to brokers. The brokers would purchase the crop at a set price and turn around and re-sell to others. Eventually, farmers and brokers started creating contracts where the farmer would promise to deliver a certain amount on a certain date in the future, and the broker agreed to pay a certain price on that future date. These types of contracts became bought and sold as investment vehicles.

How did the Commodity Futures Modernization Act come about?
In the early 1970s, there were overlapping duties concerning regulation and the sale of futures on single stocks, among others. In the early 1980s, Congress took action to prohibit the sale of single stock futures, a sort of derivative security, in order to get the conflict worked out. A bill to lift the prohibition on single stock sales was introduced by Rep. Thomas W. Ewing on December 14, 2000. By December 21, 2000, the Commodities Futures Modernization Act was passed.

The passage restored more flexible and less obtrusive regulations for commodities and futures markets. Most important, the act prohibited the SEC and the CFTC from regulating certain new financial products, such as credit default swaps. An "Enron Loophole" in the act also enabled energy traders to trade in unregulated markets. Unfortunately, credit default swaps and the "Enron Loophole" have emerged as key factors in the recent financial crisis.