Dodd-Frank made derivatives safer, fairer, and more transparent.
That was the view from at least one financial player as he testified in front of the House Agriculture Committee about the systemic risks of the potential failure of clearinghouses.
“Let me start with a clear statement. Dodd-Frank made derivatives markets safer and more stable,” said Amias Moore Gerety Special Advisor QED Investors, and a former US Treasury Department of Official, “These reforms have made our economy stronger, not only because they will help prevent financial crises, but also because the stability and safety of U.S. financial markets is a significant competitive advantage for the U.S. as a global economic power.”
Moore described a derivative market in the pre-2008 crisis which was akin to the financial version of the wild, wild, west, with little to no rules.
“In the lead up to the crisis, derivatives markets grew exceptionally rapidly and volume increases were driven significantly by trades made between global banks. The opacity of the market meant that this interconnected web of exposures were neither clear to regulators nor to the firms themselves. The complexity of these markets developed because of the structure of the transactions, the credit relationships between the players, and the weakness of risk management and backend processing capacity.” Gerety stated forcefully.
Gerety continued, “To make matters worse, there was an explicit statutory bar against the CFTC or SEC taking actions to set standards for this market which, in 2008, was measured at $673 trillion dollars globally.”
Gerety singled out: collateralized debt obligations (CDOs), CDO squred, and CDO synthetic- as three especially complex, especially unregulated derivatives whose toxicity “unraveled in the mortgage meltdown.”
As such, he argued, Dodd-Frank was necessary to provide transparency and order back into the complex world of derivatives.
“Most importantly and most directly, Dodd-Frank gave the CFTC and the SEC explicit, comprehensive authority to oversee their respective derivatives markets according to the same standards that we uphold for other financial markets.” Gerety stated. “Strong standards and oversight have made the U.S. a global destination for financial investment and helped support our position as a global economic power.
“Next Dodd-Frank required pre- and post-trade transparency for all derivatives transactions, attacking the risk of uncertainty and lack of documentation that featured prominently in the pre-crisis derivatives markets. Dodd-Frank required capital and margin rules for all dealers in derivatives, so that large players could not simply ignore the real financial risks of daily market moves, but had to collect margin from each other and also fund their derivatives positions with shareholder equity and retained earnings — known as capital.”
As the potential repeal of Dodd/Frank little attention has been paid to the new oversight of derivatives even though it’s hard to argue with Gerety’s contention that the nature of their trading prior to reform was a contributing factor to the crisis.