The Derivatives Revolution: A Trapped Innovation and a Blueprint for Regulatory Reform

Abstract:     

Derivatives are the instrument of choice by the vast majority of market participants who employ them to carry out the risk redistribution economic function key to the existence of modern financial markets. Due to their importance, derivatives are said to be the most successful and radical financial innovation of all time. The recent crisis however proves how risk taking and risk re-distribution, predominantly carried out with derivatives needs to be made stronger and safer. The book provides a conceptual framework for and an analysis of legislative and regulatory intervention, aimed at ensuring that risk taking is credible as it is carried out by entities that are both subject to appropriate supervision and financially sound. The disclosure paradigm employed so far to indirectly discipline the industry must be overcome and a new regulatory framework had to emerge, introducing essential principles of prudential oversight to whom all market players must be subjected. As derivatives can originate from registered issuers, financial institutions, as well as private pools of assets (hedge funds, private equity funds), the regulatory approach should provide for the introduction of an activity based, principle based set of rules, which should employ incentives based regulation in an internationally coordinated regulatory intervention. The reform should solidly rest on four pillars: (1) a review of derivatives oversight; (2) a review of the disclosure paradigm resetting the role and function of disclosure; (3) strengthening the derivatives’ trading infrastructure; and (4) development of specific corporate governance recommendations. The work continues by assessing the merits and shortcomings of the Dodd-Frank Wall Street Reform and Consumer Protection Act and concludes that the Act despite certain positive features fundamentally fails to deliver a well-crafted, thoughtful reform and presents several structural defects.

Number of Pages in PDF File: 38

Keywords: Derivatives, Dodd Frank, Wall Street, Reform, Clearing, OTC, Corporations, Governance, Regulatory reform, electronic execution, markets, securities, SEC, CFTC, Swaps, dealer, swap dealer, major swap participant, ISDA, swaps execution facilities, sef, EE, clearing house, CCP, netting