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Derivatives reform: Evolution, not revolution

- "The Dodd-Frank Wall Street Reform and Consumer Protection Act stands to be the most sweeping overhaul of US financial regulation in decades. In this article, we focus primarily on those provisions in the legislation that deal with the regulation of OTC interest rate derivatives markets."
• "Almost all OTC derivatives, including those for interest rate swaps, swaptions and credit default swaps will be affected by the legislation. However, we expect the bill to lead to a continued evolution of the interest rate derivatives market – we do not foresee any immediate changes to market structure."
• "Central clearing is likely to be beneficial to the market, reducing systemic risk and improving market transparency, as long as the number of clearinghouses is not allowed to proliferate (as this reduces the benefit of multilateral netting)."
• "Clearing in itself should not impose a very heavy collateral or cost burden on large banks. The burden may actually be larger for users with higher funding costs."
• "Considering the potential systemic impact of the failure of a clearinghouse, it is crucial to ensure that margining methods and capital requirements across clearinghouses are consistent. We see a risk that clearinghouses could become the new GSEs: “too big to fail”, yet run for private profit."
• "Of all the provisions in the legislation, we view the requirement that trades be publicly reported as having the greatest impact on the liquidity of derivative markets. These requirements should lead to greater transparency around pricing and tighter bid-ask spreads for smaller market participants."
• "However, if real-time reporting is implemented in illiquid products that involve a small number of large trades among sophisticated investors, it may reduce the incentive for dealers to make markets, and significantly reduce depth."
• "For plain vanilla swaps, existing electronic platforms may be able to transition into swap execution facilities without too many impediments, as long as certain requirements are met."
• "However, for more illiquid products, the best possible outcome for investors would be the evolution of facilities where most trading is done via “block trades” with reporting delays as this could retain the benefits of bilateral trading."
• "Standardization of even plain vanilla products is non-trivial. We discuss the surprising challenges involved and their ancillary impact on accounting practices."
Barclays Interest Rate Strategy 20100630

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