The soon-to-be-finalised Dodd-Frank financial reform bill will introduce greater transparency and accountability to the over-the-counter (OTC) derivatives market in the US, but it has left a number of questions unanswered.
The US Congress's harmonised version of the financial reform package includes requirements for exchange trading and central clearing of OTC derivatives. The bill also calls for data collection and publication of OTC derivatives trades through clearing houses or swaps repositories, with the aim of improving market transparency and allowing regulators to monitor trading activity.
But the task of specifying which types of instrument should be standardised, listed on exchange and cleared centrally has been delegated to the Securities and Exchange Commission (SEC) and Commodities Futures Trading Commission (CFTC) regulatory bodies.
Under the reform bill, both the SEC and CFTC will be given responsibility to regulate the OTC derivatives market, curb irresponsible practices and excessive risk taking. The regulators will have “broad enforcement authority to punish bad actors that knowingly help clients defraud third parties or the public”.
The bill also handed power to the CFTC and SEC to pre-approve contracts before they can be accepted by clearing houses. But according to John Jay, senior analyst at consultancy Aite Group, more clarity will be required to determine how this process will be handled.
“On any given day, the volumes that need to be cleared could be tremendous, so its hard to see how this would be made operational unless the regulators have a matching engine with the ability to process pre-approved contract types,” Jay told theTRADEnews.com.
The Dodd-Frank bill recognises that certain types of contracts will not be suitable for trading on exchange or for central clearing and Jay suggests this could amount to 10-15% of total OTC derivatives trading. These highly customised transactions must still be reported to improve overall market transparency and accountability.
“Broker-dealers may be wary of giving up a competitive advantage by revealing too much information on exotic OTC instruments, but my guess is that regulators will only request broad information on the type of OTC derivative, notional size and counterparties,” said Jay. “Earlier versions of the bill touted the possibility of a higher capital charge for exotic OTC instruments, which isn't addressed in the latest version.”
The US House of Representatives has approved the bill but the Senate is not due to hold its vote until the middle of July.