Dodd-Frank Reversal?

November 24, 2013


Margin Call is a 2011 American independent drama film written and directed by J.C. Chandor. The film takes place over a 36-hour period at a large Wall Street investment bank and highlights  initial stages of the financial crisis of 2007–08.

In the closing scenes of this movie derivative traders are told to sell everything. The bank is possibly Lehmans but could be AIG and we see a long shot of the trader floor with traders feverishly executing trades.

One wonders if these trades are OTC toxic derivatives sold perhaps to banks in Europe. Is this why Europeans are dragging their feet on financial reform of shadow banking?

The EU is as slow to bring about Banking Union as it is to bring about reform of the shadow banking industry. Proposals regarding a Financial Transaction Tax are hardly debated, never mind agreed.

According to Unfinished_Mission_2013 

A Report BY Americans for Financial Reform & the Roosevelt Institute:

“Our recent experiment with unregulated derivatives produced instability and set our economy back. the key elements of reform—universal supervision, transparency through exchange-trading and price reporting, and central clearing—are tools for reclaiming the powerful good these financial instruments can provide. there remains much to be done to realize that goal.”

Global cooperation to achieve that goal is required.

“When European authorities, together with authorities from a number of other G20
countries, criticized the U.S. CFTC for moving too quickly and aggressively in implementing
its rules. the Europeans objected to the CFTC enforcing its regulations on
U.S.-parented entities trading derivatives outside the U.S.”

In 2008, the U.S. derivatives industry operated along two parallel regulatory frameworks and market structures. The futures and options markets, was firmly regulated; the unregulated swaps market, also known as the over-the-counter (OTC) derivatives market, was toxic.

Its three years since the Dodd-Frank Act was approved. Its aim was to fix the problems posed by the unregulated swaps market. Reforms though clearly visible as to structure and content, still are not in place.

The following reforms are required:

“… At the September 2009 Summit of the G20 Leaders in Pittsburgh, it was agreed that OTC derivatives should come under regulation and oversight, and that:

All standardized OTC derivative contracts should be traded on exchanges or
electronic trading platforms, where appropriate, and cleared through central
counter parties by end-2012 at the latest. OTC derivative contracts should be
reported to trade repositories. Non-centrally cleared contracts should be subject
to higher capital requirements.

This statement points to three major conditions of reform:

  • The first is the key principle of universal supervision. There can no longer be a carve out for OTC derivatives that makes them exempt from supervision. Universal supervision represents a reversal of the explicitly deregulatory mandate of the United StatesCommodity Futures Modernization Act of 2000.
  • The second is transparency. Moving onto exchanges and mandated reporting are actions designed to help shine light onto the markets, for the benefit of the regulator as well as for competition and the wider public advantages that stem from transparency. Meanwhile, price transparency makes the market work better for all participates, while also giving regulators a crucial tool in examining systemic risk.
  • The third is clearing. The mandate to clearing through central counter parties is designed to reduce the amount of credit risk accumulating in the system overall—the well-established purpose of central counterparty clearing—and also to locate credit risk where it is best supervised by regulatory authorities. Requiring capital for non-centrally cleared contracts is both a tool to encourage central clearing and a component of sound banking practice.”

“In the United States, this basic architecture for derivatives reform was quickly codified as Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act and signed into law in July 2010, less than a year after the Pittsburgh G20 summit. The relatively fast legislative action in the U.S. has been followed by slow-moving regulatory implementation. Although the law directed the CFTC and the U.S. Securities and Exchange Commission (SEC) to draft the appropriate implementing regulations within a year, it is now three years later and the job is not complete. Nevertheless, the CFTC in particular has been insistently moving the ball forward. By count, a little more than one-half of the rule-making has been completed. That leaves another one-half yet to be finished. this kind of crude accounting, however, can be misleading. On the one hand, where rules are not yet complete, they are nevertheless substantially underway. On the other hand, where rules are complete, some of the deadlines for changes to market practice lie in the future, so that a completed rule does not yet mean the market is functioning any differently.”

In the EMU that has still to stress test its banking system due in 2014, the long-delayed implementation of above measures makes risk exposure to repeat of 2008 more likely; this risk remains hidden in its shadow banking system.



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