A quick view on the unintended consequences of the Dodd-Frank Act – on the five year anniversary.
July marked the fifth year anniversary of the Dodd-Frank Act being signed into law by President Barack Obama. The weighty 848-page tome had its tentacles in everything ranging from derivatives clearing, reporting and trading, to bank resolution, consumer protection and financial market supervision. The big question is whether the derivatives world is a safer place to do business in?
The answer is mixed. On the positive side, as ISDA points out, central clearing is well established, with approximately 75% of interest rate derivatives (IRD) and credit default swap (CDS) index average daily notional volume now cleared, according to data submitted to US swap data repositories (SDRs). In addition, over half of reported interest rate derivatives transactions are now traded on a swap execution facility (SEF) while transparency has improved since all swaps are required to be reported to an SDR. Moreover, the ink is almost dry on US margin rules for non-cleared derivatives while capital rules are being phased in.
Several challenges though remain. For example, ironically, central counterparties, the safe ports of call, are now more systemically important and additional work is needed to ensure that they are more resilient. ISDA is calling for greater transparency on margin methodologies and minimum standards for stress tests. It also recommends further regulatory input on acceptable recovery tools and the conditions for resolution that do not involve use of public funds.
There are also complaints about regulations working at cross purposes. For example, the Basel III‘s Supplemental Leverage Ratio (SLR) on cleared transactions effectively punishes banks for collecting margin from customers. This makes the process more difficult as well as expensive which seems to be in direct conflict with the clearing objectives of Dodd Frank. Also, the rule could add to systemic risk because as clearing firms withdraw, activity is left in the hands of a concentrated few.
The lack of harmonisation is another well documented concern. The US was first out of the starting gate while Europe is still hammering out the finer details. These different interpretations of the G20 recommendations and ensuing regulatory standards are leading to fragmented derivatives markets, which in turn, is impeding the ability of the end user to access efficient and liquid markets to manage their risk.
ISDA believes that targeted amendments of US SEF rules would not only encourage more trading on these venues but also help to facilitate cross-border harmonisation. The greater flexibility in execution methods in certain cases would bring US rules closer to those proposed in Europe.
Given the enormity of Dodd Frank, it is not surprising that there are several kinks to be ironed out. However, there is no guarantee that they will be sorted out in another five years’ time.
