Update: Financial Regulatory Reform

This past Monday Senator Christopher Dodd, Chairman of the Senate Committee on Banking, Housing and Urban Affairs, presented a 1,336 page draft bill on financial regulatory reform. The text includes 226 pages on OTC market reform which will be debated by his Committee next week. Additional proposals are expected soon from the Senate Committee on Agriculture, in addition to H.R. 4173, the bill passed by the House of Representatives on December 11, 2009.

'Commercial end-user' exemptions from mandatory clearing are an important point of debate among legislators, with certain market participants claiming that mandatory clearing increases transaction costs. On that note, two quotes from the bill are particularly relevant:

"Clearing more derivatives through well-regulated central counterparties will benefit the public by reducing costs and risks to American taxpayers, the financial system, and market participants."

"Trading more derivatives on regulated exchanges should be encouraged because it will result in more price transparency, efficiency in execution, and liquidity."

Impact on hedging: Following this rationale, Senator Dodd's bill contains a very narrow exemption to clearing requirements for commercial end-users. If Senator Dodd's proposal becomes law, all swaps and options that can be cleared must be cleared, unless one of the parties to a trade is too small to meet the eligibility requirements of an exchange. Markets would be allowed 180 days to comply with the legislation once it becomes law.

We will continue to monitor legislative developments as Congress begins the unusually active pre-election period. If you have any questions, please write or call.