Comment Letter to the CFTC on Proposed Rule 89 FR 4896-Should the CFTC Not Regulate Certain Event Contracts?
This office submitted a comment letter to the Commodity Futures Trading Commission (CFTC) regarding Proposed Rule 89 FR 4896. As a law firm specializing in futures and derivatives law, we understand the critical importance of effective risk management tools in today’s financial markets. The truth is the U.S. futures markets are among the most, if not the most liquid and transparent financial markets in the world. The comment letter advocates for the inclusion of event futures contracts as bona fide risk transfer mechanisms, a move that could significantly enhance market stability and resilience. Also, the CFTC is certainly capable of regulating event contracts as it already regulates financial indexes and interest rate contracts used as benchmarks and instruments of global risk transfer.
Key Points from Comment Letter:
Systemic Risk Management: Modern portfolio theory (MPT) does not adequately address systemic risks. These are risks that affect large portions of the market simultaneously. Historical events, such as the 2008 financial crisis and recent climate-related disasters, have shown that traditional diversification strategies can fall short during systemic shocks. Futures markets have provided an invaluable platform for hedging against catastrophic market risk. By introducing futures contracts for catastrophic events, even of the magnitude of environmental disasters, market participants can better manage potential losses and enhance overall financial stability.
Comparison with Catastrophic Insurance Futures: The introduction of catastrophic insurance futures contracts by the Chicago Board of Trade (CBOT) in 1992 serves as a historical precedent for the effective use of futures in managing catastrophic risks. The exchange was prescient in foreseeing that contracts designed to transfer risks associated with large-scale events would be valuable to the insurance industry. Even if, for the sake of argument public policy reasons might justify excluding some event contracts, excluding them based on the idea that they are the province of the gaming industry overlooks how the futures markets already function to hedge against systemic risk, and the public good that is served by this function. Event contracts share similarities with catastrophic events in terms of the possible systemic risks they pose to the market. Allowing futures contracts for such events can provide a structured risk transfer mechanism that benefits global market stability.
Game Theory Perspective: From a game theory standpoint, the inclusion of futures contracts for catastrophic events can create a more resilient market structure. When market participants can hedge against systemic risks, the overall market becomes less susceptible to panic and systemic failures. This strategic interaction benefits all participants by effectively distributing risk. This reduces the likelihood of extreme outcomes that can destabilize the financial system. Utilizing the concept of Nash equilibrium, where each participant’s strategy is optimal given the strategies of others, highlights how such hedging can lead to a stable equilibrium and a more robust financial environment.
Application for Futures Markets: The established concept of bona fide risk transfer mechanisms in existing futures markets extends beyond traditional definitions associated with gaming. The futures market has successfully managed significant risks impacting global financial markets, including systemic and catastrophic events-interest rate contracts and financial market index contracts. By considering the inclusion of election and other event contracts within this framework, the CFTC can enhance the market's ability to manage a broader range of risks. This approach aligns with the overarching goal of providing robust risk management tools to market participants.
In conclusion, recognizing and incorporating futures contracts as bona fide risk transfer mechanisms for systemic risks and catastrophic events aligns with the fundamental purposes of futures markets. I disagree with some of the Commissioners who expressed reservation about political event contracts requiring the CFTC to have to police federal or state elections. This reasoning suggesting a level of scrutiny by the Commission into causal variables is not applicable to the Commission's regulation of financial futures or interest rate contracts so why would it apply to election and other event contracts? The Commission helps enable the process of price discovery and orderly markets just as it does with interest rate and financial contracts-it does not need to know if buyers and sellers are wrong in their assessment of supply and demand.
My comment letter urges the CFTC to look beyond the definition of gaming and consider the critical role of risk transfer in enhancing market stability and protecting against significant financial disruptions that the CFTC already does well. If the Commission can regulate contracts that serve as global benchmarks for the interest rate market and indexes representing the largest equity markets in the world, it can handle event contracts.
R Tamara de Silva
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For more details, please refer to the full comment letter submitted by R. Tamara de Silva, Managing Attorney at De Silva Law Offices, LLC.
We are committed to advocating for innovative solutions that strengthen the financial markets and protect market participants.
For further information or to discuss how these developments may impact your business, please contact us at tamara@desilvalawoffices.com.