The History of Derivatives: A Few Milestones
EFTA Seminar on Regulation of Derivatives Markets, Zurich, 3 May 2012 Steve Kummer (research and redaction) and Christian Pauletto (concept and speech delivery) Policy and Trade in Services Division
State Secretariat for Economic Affairs SECO
Federal Department of Economic Affairs FDEA
This presentation contains a selection of records and events that constitute a part of the history of derivatives. It relates how derivatives date back as far as Antiquity. Derivatives were first instruments developed to secure the supply of commodities and facilitate trade as well as to insure farmers against crop failures. Over time, derivatives started to serve in addition other purposes such as a source of funding but also the search for quick profits. This presentation also shows that derivatives were regulated from the very beginning. The degree of regulation of derivatives varied across the years, among jurisdictions and depended on, for example, the political but also religious contexts. Some forms of derivatives were banned and later allowed or the other way round. The history of derivatives also provides evidence that the first derivatives markets were “over-the-counter” (OTC). However, negotiating and contracting mostly took place at specific locations, which, early in the history of derivatives, already displayed various characteristics of organised derivatives markets. Derivatives exchanges came later, but once established, trading of derivatives mainly occurred on their premises. The trend only reversed in the early 1990s.
The Cradle of Derivatives
“If any one owe a debt for a loan, and a storm prostrates the grain, or the harvest fail, or the grain does not grow for lack of water; in that year he need not give his creditor any grain, he washes his debt-tablet in water and pays no rent for the year.”
This text is the 48th law out of 282 contained in the Code of Hammurabi. Hammurabi was a king of Babylon who reigned, according to some sources, from around 1792 to 1750 BC. Hammurabi engraved the eponymous code on stone steles. This code counts among the oldest written body of laws known today and covers almost all the aspects of civil as well as
commercial laws of that time. It deals to a great extent with contractual matters, establishing for example the wages to be paid to an ox-driver or to a doctor. It is renowned to be the most complete code of the Mesopotamian laws that have been conserved until today. In terms of contracts, one may recognise in this 48th law a kind of contract that once translated into a more modern language would stipulate the following: A farmer who has a mortgage on his property is required to make annual interest payments in the form of grain, however, in the event of a crop failure, this farmer has the right not to pay anything and the creditor has no alternative but to forgive the interest due. Experts in the field of derivatives would classify such a contract as a put option. In another word: If the harvest is plentiful and the farmer has enough grain to pay his mortgage interest, the put option would expire worthless. If his harvest fell short, however, he would exercise his right to walk away from making the payment. 1
In Ancient Mesopotamia, with a view to encouraging trade and securing the supply of commodities, both in time and geographical distance, the rulers’ codes actually required that purchases, sales and other commercial agreements be in written form in order to provide buyers and sellers with the greatest possible legal certainty to engage in trade. The purpose was to minimise the “your word against mine” maxim in case of disputes. Merchants of the city-states of the region thus developed, in addition to the codes, commercial contracts. Records of such contracts have been found in cuneiform script on clay tablets. Some types of contracts were arrangements on the future delivery of grain that stipulated for instance...
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