INTRODUCTION Contributed by: Carl Kennedy, Daniel Davis, Stephen Morris, Matthew Kluchenek, Alexander Kim and Nicholas Gervasi, Katten Muchin Rosenman LLP
Katten Muchin Rosenman LLP 50 Rockefeller Plaza New York New York 10020-1605 USA
Tel: +1 212 940 8800 Fax: +1 212 940 8776 Web: katten.com
Introduction to Derivatives Derivatives have become an integral part of the global financial landscape, with transaction volumes growing dramatically over the years. These powerful, capital- efficient financial instruments, whose value is derived from the value of underlying assets such as stocks, bonds, commodities, currencies, interest rates and market indexes, play a crucial role in risk management and speculative opportunities worldwide. The derivatives industry has undergone significant changes, shaped by global events like the 2008 financial crisis, which prompted a wave of regula - tory reforms aimed at enhancing market stability and transparency. Today, derivatives are traded on regu - lated exchanges and via the over-the-counter (OTC) markets in major financial centres around the world, including New York, London, Tokyo, Singapore and Hong Kong. There are several main types of derivatives, each with its own unique characteristics and purposes. • Futures: contracts obligating the buyer to pur - chase, or the seller to sell, an asset at a predeter - mined future date and price. These are traded on regulated futures exchanges. • Commodity options: contracts giving the buyer the right, but not the obligation, to buy or sell an asset at a set price within a specific period. Options on futures are traded on regulated futures exchanges, while OTC options are bilaterally executed between two parties off-exchange. • Forwards: customised contracts between two par - ties to buy, sell and deliver an asset at a specified
future date for a price agreed upon today (which is often modified during the course of the contract). • Swaps: agreements to exchange cash flows or other financial instruments between parties over a set period. • Contracts for Difference (CFDs): these are deriva - tives that allow traders to speculate on price move - ments of assets, settling the difference in value between opening and closing prices in cash, with - out physical delivery of the underlying commodity. CFDs are deemed to be swaps in the United States but are considered a distinct type of derivatives product in some other jurisdictions. While derivatives are powerful tools for risk man - agement, allowing businesses to protect against price volatility, currency fluctuations and interest rate changes, they also carry significant risks, including market, credit and liquidity risks. Most jurisdictions place considerable restrictions on who can trade derivatives, how these instruments are traded, and whether certain post-execution activities (eg, man - datory clearing, imposition of margin, risk mitigation measures) must occur. The regulatory environment for derivatives varies by country but has seen increased oversight and reform over the last decade. The primary regulatory bodies in some of the most active trading jurisdictions (by trading volumes) include: • the U.S. Commodity Futures Trading Commission (CFTC); • the European Securities and Markets Authority (ESMA);
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