Derivatives Reform Three Years after Dodd-Frank: One Step Forward, Two Steps Back

After months of delay, U.S. derivatives reform finally moved from back-burner status last week, when the Commodity Futures Trading Commission (CFTC) approved regulations aimed at forcing derivatives trading — and depending on the source, either a major culprit of or contributor to the financial crisis — out of the shadows. This means that many types of previously unregulated derivatives will now have to trade on open platforms.

Now, for the bad news: In what are some are calling a watered-down rule, investment firms would be required to request price quotes for a derivatives contract from only two banks rather the five called for in an earlier proposal. Fewer price quotes, critics of the rule say, ultimately will make the market less competitive.

Derivatives Battle Brewing in D.C.

Even as the CFTC is moving to finalize long-awaited rules, Congressional lawmakers are considering legislative bills intended to unwind some of those recently enacted requirements. For example, one bill before the House Agriculture Committee would exempt banks from the rules in cases where their activities are for hedging purposes. The transparent, if not nonexistent, line between hedging and prop trading became apparent in JPMorgan’s London Whale fiasco from last year. Nevertheless, the bills — seven in all — have garnered bipartisan support among the House Financial Services Committee.

Whether the bills would clear the House and find footing in the Senate remains to be seen. However, one thing is certain: Regulators responsible for writing the rules implementing the Dodd-Frank Act face intense pressure from both political parties on top of a barrage of lobbying from Wall Street groups.

More Delays on Global Coordination

On the global front, progress on derivatives reform, including making over-the-counter (OTC) derivatives more transparent, has faced challenges of its own despite a 2009 G20 pledge to overhaul the market. Although leaders of the G20 economies had planned to have rules in place by the end of 2012, differences over such things as cross-border regulation have proved challenging. G20 leaders have now extended the deadline to September.

Making matters worse is the lack of coordination between regulators in the United States. Earlier this month, the Securities and Exchange Commission issued rules on cross-border activities that in some ways contradicted rules already adopted by the CFTC. Without coordination at home, it is even less likely that we will find solutions to more complex cross-border issues.

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