Out of the Black Hole: Regulatory Reform of the Over-the-Counter Derivatives Market

Abstract

Unregulated OTC derivatives have been at the heart of recent systemic or near systemic collapses. After each financial crisis, governments worldwide proclaim that the OTC market has to be regulated for transparency, capital adequacy, regulation of intermediaries, self regulation, and strong enforcement of fraud and manipulation. But, aided by the passage of time, Wall Street always deflates those aspirations with aggressive lobbying. The present financial reform regulatory effort may be the only chance to get this issue right before the country devolves into a further financial quagmire with more bankruptcies and more job losses. This paper is a chapter of Make Markets Be Markets that presents a comprehensive plan for what must be done to fix our broken financial system. Specifically the chapter focuses on the role of derivatives in the recent financial crisis and put forth a number of recommendations to H.R. 4173 (Wall Street Reform and Consumer Protection Act of 2009) to enhance the regulatory reform.

The paper was prepared as a chapter in the Make Markets be Markets report for the Roosevelt Institute, March 2010.

Keywords: OTC, Financial Crisis, Swap, Swap Dealer, Major Swap Participant, CFTC, Commodity Futures Trading Commission, CFMA, Commodity Futures Modernization Act, Dodd-Frank Wall Street Reform and Consumer Protection Act, CDS, Credit Default Swap, Clearing, DCO, Derivatives Clearing Organization, SEF, Swap Ex