Before Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, the swaps market was the world’s largest dark market. The market for derivatives — both futures and swaps — has a notional value of more than $300 trillion, or more than $20 worth of derivatives for every dollar of output produced by the U.S. economy.
This market, though in many ways essential for market participants to manage risk, was ultimately a major contributor to the 2008 financial crisis. Before the Dodd-Frank Act, many derivatives were largely unregulated, information on pricing and volume was unavailable to the public, and there was no international agreement on best practices. Market competition and integrity was undermined by a lack of transparency, and, ultimately, the price paid was one of the worst financial crises on record.
It’s a fairly gloomy story, one that Commodities Futures Trading Commission Chairman Gary Gensler articulates in an April article — but it may have a happy ending. In 2009, G-20 leaders met in Pittsburgh and came to an agreement.
“All standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end‑2012 at the latest,” the report says. “OTC derivative contracts should be reported to trade repositories. Non‑centrally cleared contracts should be subject to higher capital requirements.”
Since then, regulators, policymakers, and market participants around the world have been working diligently on building a framework that would not only effectively regulate domestic derivatives trading but would allow for practical international trade. Nearly four years down the road, Gensler and European Commissioner Michel Barnier were able to announce the “Path Forward,” a framework that achieves many of the ambitions set out in 2009.
“The Path Forward responds to the G-20 commitment to lower risk and promote transparency in the over-the-counter derivatives markets, which were are at the heart of the financial crisis,” reads a joint statement released by the U.S. Commodity Futures Trading Commission and European Commission. “As a result of the joint collaborative effort, in many places, final rules are essentially identical, even though the regulatory calendars are not always synchronized.”
The organizations point out that the majority of global swaps and derivatives business is conducted in either the United States or the European Union, and that a “significant” amount of this business is conducted cross-border. Because of this, both the U.S. and EU have legitimate claims to the authority to regulate trading activity. But different regulatory standards and different enforcement agencies create a massive problem for business and is a roadblock for economic activity.
But over the past few years, the regulatory frameworks of different nations have trended in the same direction. Between the U.S. and EU, the frameworks are now similar enough to be nearly interchangeable. “Recognizing the high degree of similarity that already exists between our respective requirements, we seek to address conflicts of law, inconsistencies, and legal uncertainty that may arise from the simultaneous application of EU and US requirements,” the joint statement says.