Reform Adds More Twists to a Convoluted Derivatives World [View all]

[Bill USA]

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Reform Adds More Twists to a Convoluted Derivatives World[/font]

By JESSE EISINGER, ProPublica


When the architects of the Dodd-Frank regulatory overhaul flinched from the most effective solution — breaking up the banks so that none would be too big to drag down the financial system — they forced regulators of the derivatives market into a cumbersome and potentially dangerous workaround.

Those regulators are feverishly making lots of important, arcane rulings that are being followed only by insiders. They are replacing an opaque system prone to failures with a new, huge Rube Goldberg-like system that may reduce global financial risk. Or it may not. Nobody knows, not least the regulators themselves.

The Commodity Futures Trading Commission, led by Gary Gensler, approved rules last month that would require derivatives clearinghouses to open their membership to firms that have as little as $50 million in capital. A clearinghouse is a central body through which trades take place. It is supported by its financial firm members. For instance, if JPMorgan Chase enters into a derivatives transaction with Goldman Sachs, their deal would go through a clearinghouse, which is liable for the trade if one of those banks fails.

The big banks that dominate derivatives trading resisted letting in smaller firms, arguing that doing so would make the clearinghouses vulnerable. They have a point: a clearinghouse with a bunch of undercapitalized members would be more prone to failure, unable to pony up when one side of a trade defaults, and we would be back where we started.


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