Dodd Frank’s Next Chapter – Filling Regulatory Gaps in the Derivatives Sphere


By: Kirill Kan

As of July 2, 2012, a total of 221 Dodd-Frank rulemaking requirement deadlines passed. Only 81 have been met with finalized rules (which will become effective 60 days after publication). Despite such delays, Friday, July 6, 2012 marked a turning point in bringing Dodd Frank into practice when the Securities and Exchange Commission unanimously approved rules and interpretations for key definitions of derivative products. These rules mark a big step toward filling the large regulatory gaps in the derivatives sphere.

The rules and interpretations, written jointly by the SEC and the Commodity Futures Trading Commission (“CFTC”), implement provisions of the Dodd-Frank Act that aim to establish a comprehensive framework for regulating over-the-counter (“OTC”) derivatives. Prior to the Dodd-Frank Act, OTC derivatives and the market for such derivatives remained largely free of regulation. But the new regulatory framework’s primary goals are to increase the transparency in the OTC derivatives market and to decrease the chances of counterparty and systemic risk. In addition to enhanced regulation of major market participants, the main mechanism for achieving these goals is to require that the transactions occur through centralized clearinghouses.

Clearinghouses are member-funded organizations that act as intermediaries in clearing and settling trades and netting offsetting transactions. They are intended to provide transparency and liquidity to the market. Whether the goals of the Dodd-Frank Act will be met via a clearinghouse platform is disputed and the effectiveness of the proposed rules remains to be seen.

The adopted SEC rules and interpretations define the terms “swap” and “security-based swap” and further establish whether a particular instrument is a “swap” regulated by the CFTC or a “security-based swap” regulated by the SEC. The SEC action also addresses “mixed swaps,” which will be regulated by both agencies as well as “security-based swap agreements,” which are regulated by the CFTC but over which the SEC has antifraud and other authority.

Regardless of the many gaps still left open in financial regulation generally, derivatives legislation will significantly change the fundamental operation of the derivatives markets and the regulation of market participants. According to SEC Chairman Mary L. Schapiro, “approving the product rules and interpretations is another foundational step in the establishment of a new regulatory regime for derivatives.”

Once the CFTC also approves the final rules, they will become effective 60 days after the date of publication in the Federal Register. Compliance with such rules will be required within 180 days after the date of publication in the Federal Register, leaving financial firms with little time to ramp up compliance procedures and to prepare for a new wave of OTC regulations.


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Fordham Journal of Corporate & Financial Law