Derivatives are (economic) tools and, like most tools, can be used as well as misused. In the most elementary sense, it is to prevent misuse – to prevent the use of the rifle to commit murder, in terms of Working's analogy – that a need arises for regulation.

Kahn, in his seminal work on the economics of regulation (largely in the context of public utilities) made the interesting point that ‘economics emerged in the eighteenth and nineteenth centuries as an attempt to explain and to justify a market system’. Therefore, to classical economists, regulation would clearly represent an exception to standard economic prescriptions. Kahn regarded regulation as, in essence, the ‘explicit replacement of competition with governmental orders’ as a means of ensuring ‘good performance’.

Overall, economic theory suggests that regulation is justified in three kinds of situations:

1. • to prevent serious distortions to competition and the abuse of monopoly power;

2. • to protect ordinary people in circumstances where information is difficult or costly to obtain and mistakes could seriously affect their welfare; and

3. • to compensate for externalities in situations where the social costs of market failure exceed the private costs after factoring in the costs of regulation.