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Johnson: The true "secret" of the Shad-Johnson Accord
23 December 2011
Philip McBride Johnson looks back on a key moment in derivatives regulation.
December 7, 2011 marked the 70th anniversary of the Japanese attack on Pearl Harbor that marked America's entry into World War II.
It was also the 30th anniversary of a lesser moment - the unveiling of the "Shad-Johnson Accord," a peace treaty between the Commodity Futures Trading Commission (yours truly) and the Securities & Exchange Commission (led by John Shad) establishing the CFTC's right to regulate futures contracts on major stock indexes, the first time the SEC had ceded jurisdiction over an equity-based financial product.
I had spent many months in Washington during the CFTC's birthing process in 1973-74 advocating that the new agency should regulate exclusively all futures trading regardless of the nature of the underlying asset.
To get there, I offered a new definition of the term "commodity" that preserved jurisdiction over a long list of farm products (the law at the time) but added "all goods and articles" to absorb all tangible assets, "rights and interests" for intangibles (including securities) and "services" for all forms of the same.
The Congress obliged, giving the CFTC explicit "exclusive jurisdiction" over futures on all forms of a "commodity" as massively redefined.
So, I was in no mood to back-track as CFTC Chairman when the futures exchanges sought permission to trade futures on the leading stock indices. John was accommodating (though his staff - I am told - were not happy).
But the Accord did something more than that. It contained a requirement that stock index futures must be cash-settled. Under no circumstances could the underlying securities be delivered.
So what? While the term "futures contract" was not defined in the CFTC's enabling statute, it was repeatedly described there as an instrument calling for "delivery" at maturity. That description appears over 30 times in the Commodity Exchange Act.
The result was a massive legal uncertainty whether an instrument could qualify as a "futures contract" absent a delivery right and obligation. If not, it would fall outside the CFTC's remit and its legality might be challenged. At a minimum, it would be vulnerable to regulation by any authority wishing to assert it, a disaster in the making.
But the Accord made absolutely clear that an instrument can be a futures contract even if it banned delivery. Case closed.
As a result, futures exchanges can now offer futures contracts on pure abstractions where delivery not only does not occur but is not even possible, without fear of legal challenge. Weather-related futures are only one example.
Philip McBride Johnson is a former chairman of the CFTC