ISDA Reflects on 5-Years of Dodd-Frank, Proposes Fixes

Reflecting on the five-year anniversary of the Dodd-Frank Act, the International Swaps and Derivatives Association (ISDA) issued a briefing note on July 20, 2015, that tracks the progress made since the law’s historic enactment and outlines several outstanding issues that still need attention.

So, what changes have we seen?  Since the CFTC’s clearing mandate went into effect in 2013, a large portion of interest rate derivatives (IRD) and credit default swaps (CDS) are now centrally cleared, with trades executed on SEFs being reported to Swap Data Repositories (SDRs).  For IRD, 76.5% of average daily notional volume was centrally cleared in 2014 and for CDS that number totaled 74.7%, according to ISDA SwapsInfo data. Following made available to trade (MAT) rules  being implemented, in February 2014, more than 50 percent of IRD and 65 percent of CDS index average daily notional volume traded on swap execution facilities (SEFs). In addition, so far, 104 swap dealers have registered with the CFTC. 

While all of these are notable achievements, ISDA notes that are several areas of possible improvement for the implementation of Dodd-Frank:  

Cross-border harmonization: Fragmentation of liquidity across geographical lines results in an increase in costs and a more difficulty in unwinding large transactions. To alleviate some of the liquidity issues brought on by differences in U.S. and E.U. regulations, ISDA recommends allowing U.S. counterparties to apply overseas rules when trading outside domestic jurisdictions, if the laws are equivalent.

• Clearing: Given the rise in importance for central counterparties, more needs to be done to ensure resiliency on issues such as transparency for margin methods, and minimum standards for stress tests.  The CFTC also requested further regulatory input on acceptable recovery tools for central counterparties and conditions for resolution for when problems occur.
• Commercial end users: Legislative action is needed to make clear that end users who hedge through centralized treasury units (CTUs) in order to net and consolidate their hedging activities are eligible for the clearing exemption. Many CTUs classify as financial entities under Dodd-Frank, subjecting them to clearing requirements.
• Reporting: Regulators need to identify and agree on what data best enables them to monitor trading conditions.  In addition to developing and then adopting standardized product transaction identifiers and reporting formats, ISDA recommends rescinding Dodd-Frank’s SDR indemnification requirements in order to enable more cross-border data distribution.
• Capital: Like margin rules, capital rules should also be consistent so no participant is at a disadvantage to its competitors or counterparties in another country.  ISDA believes regulation should be “coherent and appropriate to the risk of a given activity” and that special attention should be given to the financing costs for borrowers and hedging costs for end users.

The agency also recommends further clarification for margin rules achieve consistency and reduce disputes, to targeted modifications of SEF rules to boost trading and expedite cross-border harmonization, provisions that will allow a SEF or a SEF user to petition for the removal of a MAT determination if liquidity conditions change, and mandating  final CFTC registration for swap dealers and major swaps participants to allow regulatory certainty.To read ISDA’s note in full, please click here.