Derivatives and futures law is the collection of laws that regulate trading in derivatives and futures. Derivatives and futures law involves regulations. It also involves compliance. Practicing derivatives and futures law requires identifying applicable laws and regulations, creating a compliance plan and helping clients negotiate business transactions. Attorneys in the area of law may also help their clients defend against enforcement actions.
What are futures and derivatives?
A derivative or future is a financial contract where the value of the contract depends on how another entity performs. It’s a contract that may involve a good like corn or wheat, or it may involve cash, bonds or equity. Futures allow a buyer and seller to agree on a contract to perform while the specifics of the contract depend on something that happens in the future. A future is a type of derivative.
A future doesn’t require the purchaser to actually take possession of what they contract to buy. Sometimes, the purchaser resells their interest to another party. Other times, they agree for the parties to exchange only the difference between the price of the future and the actual price of the underlying entity at the date specified in the contract.
Are derivatives traded on the stock exchange?
Some derivatives are traded on the stock exchange. Other times, the parties trade derivatives directly. Modern legislation has pushed more and more derivative trades to stock exchanges like the New York Stock Exchange.
What is the practice of futures and derivatives law?
The practice of futures and derivatives law is part contract law and part finance law. A derivatives and futures lawyer must understand and apply the laws and regulations that apply to derivative transactions. In addition, they must help their clients negotiate favorable agreements and carefully prepare contracts. They must know how to help their client choose what financial instrument best meets their needs. Futures and derivatives law requires knowledge of finance law and the ability to negotiate with other parties and draft an effective contract.
In the practice of derivatives and futures law, clients may include any of the following:
- Pension fund operators
- Insurance companies
- Hedge fund operators
- Private equity funds
- Commodity advisers
- Other investment advisers
A futures and derivatives lawyer does work that is both transactional and regulatory. Their work is transactional in that they must prepare and negotiate contracts. Their work is regulatory in that they must understand how to implement a wide variety of laws including securities and commodities laws, tax laws and even bankruptcy laws. If there’s a disagreement regarding a futures contract or an allegation of a violation, a futures and derivatives attorney may need to be a litigator. Futures and derivatives lawyers must have a strong ability to understand and implement a complex body of law. They must also have the interpersonal skills to negotiate contracts and resolve disagreements.
Laws that regulate futures and derivatives
There are a number of laws that regulate derivatives and futures on a national level. Some of these laws are:
- Grain Futures Act of 1922
- Commodity Exchange Act of 1936
- Commodity Futures Trading Commission Act of 1974
- Commodity Futures Modernization Act of 2000
- Dodd Frank Wall Street Reform and Consumer Protection Act of 2010
More recent laws overrule earlier laws in whole or in part.
Why do derivatives and futures exist in the financial market?
Derivatives and futures help producers manage financial speculation. For example, a wheat producer might sign a futures contract to sell their wheat in four months for a certain price. Four months from now, the price might be lower, or the price might be higher. The wheat producer knows that they’re going to receive a certain price for their wheat no matter what happens. The wheat producer doesn’t have to worry about price fluctuations when they make the decision to grow wheat.
For the purchaser, a futures contract allows them to potentially profit from speculation. If they believe that the price of wheat is going to be higher at the time of sale, they can enter in a contract with the hopes of earning a profit. If they’re right, they can resell the wheat at the higher price and keep the difference. Derivatives and futures allow producers to manage risk. In theory, these transactions stabilize the economy.
The Commodity Futures Trading Commission
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 delegates significant lawmaking authority to the Commodity Futures Trading Commission (CFTC). Under the Act, the Commission can make rules that derivatives and futures traders have to follow. They are enforceable rules that have the same effect as federal law.
Futures and derivatives rules are found in Title 17, Chapter 1 of the Code of Federal Regulations. Some of the regulations include:
- Principals are liable for the acts of an agent
- Traders must keep books and other records of transactions
- Mandatory reporting
- Risk assessment requirements
- Requirements for the handling of funds
- Production of statements
- Voting if it’s applicable to the situation
- Rules to handle conflicts of interest
The purpose of the CFTC is to encourage traders to operate in a transparent manner. The CFTC operates with the goal of keeping markets competitive while managing risks. They aim to protect the markets from fraud and upheaval. The CFTC has its headquarters in Washington with satellite offices in several cities throughout the United States.
The Securities and Exchange Commission
The Securities and Exchange Commission also plays a role in developing rules for trading futures and derivatives. The SEC and the CFTC have a joint regulatory authority for certain types of transactions. The Dodd-Frank Act expands the authority of these agencies into regulating more types of financial products.
Derivatives and futures enforcement proceedings
If federal regulators believe that a person or business entity violates a derivatives and futures regulation, they may pursue an enforcement action. Enforcement officials may bring an action to an administrative law judge. They may also bring an action in a U.S. District Court. Because derivatives and futures regulations are federal regulations, enforcement actions also occur in federal courts unless there’s corresponding state law that applies.
Enforcement officials typically work for the CFTC’s Division of Enforcement. They also work for the Department of Justice. Officials from the CFTC’s Division of Enforcement may refer cases to the U.S. Department of Justice. CFTC officials may also provide technical assistance to cases prosecuted through the U.S. Department of Justice.
Who practices futures and derivatives law?
Futures and derivatives lawyers gravitate towards cities with a heavy involvement in finance and financial trading. Futures and derivatives lawyers tend to practice in larger cities and with larger firms. Because of the complexities of futures and derivatives regulations, and because financial trading tends to gravitate towards certain places, attorneys in the field tend to work in large groups in financial centers.
Lawyers in the industry must have the ability to grasp and apply complex finance regulations. Because futures and derivatives are a niche area of business law that also involves contracts and negotiations, attorneys who practice in the area of law must have a wide range of skills. Most futures and derivatives attorneys receive specialized training in applicable coursework while in law school. They may also have training in the financial industry outside of their legal career. In addition to attorneys in private practice, futures and derivatives lawyers also work for the CFTC and the SEC. Within these organizations, they likely specialize in an area of expertise like rule-making or enforcement.
Why Become a Futures and Derivatives Lawyer?
Any business hoping to participate in the purchase or sale of futures and derivatives depends on a future and derivatives attorney to help them comply with the law. The field of law is always changing. Futures and derivatives law can be both challenging and financially rewarding. Because the financial sector impacts an entire economy, the work of a futures and derivatives lawyer reaches beyond only clients. Futures and derivatives lawyers perform important work that ripples throughout the economy.
Helping clients compete in the marketplace
Futures and derivatives attorneys help their clients compete in the futures and derivatives market in a way that’s lawful and advantageous. Futures and derivatives law is transactional as well as regulatory. Attorneys in the field must understand a complex body of changing law and help their clients comply with the law in a way that advances their business interests.