The passage of the Dodd-Frank Act was a historic effort in the wake of the 2008 financial crisis to modernize and tighten federal oversight of the nation’s financial services sector.
Among these reforms were a variety of much-needed new rules to bring more transparency and accountability to the derivatives industry. The new law, for example, provides regulators with more power to regulate the over-the-counter (“OTC”) derivatives market, requires more derivatives to be traded on exchanges rather than in private transactions, and requires data collection to improve market transparency.
As sweeping as it is, this new regulatory framework for the derivatives industry is more a framework than a detailed set of rules, and there are many blanks for regulators to fill. As a consequence, policymakers must still be wary of unintended consequences as they implement the law.
A particular example deserving of this special attention is the pending regulations of so-called “end users” in the OTC derivatives market. No one doubts that the abuse of some forms of exotic derivatives contributed to the systemic risk that led to the 2008 crisis. But derivatives are an important tool used by major American manufacturing and service companies (“end users”) to manage and protect against risks—not create them. These derivatives contribute little—if anything—to systemic risk.
