Direct Swap Releases Industry Insight: Dodd Frank’s Silver Lining

Share Article --Middle market companies seeking to manage operating risk using commercial hedging transactions have historically had few options, other than expensive and opaque intermediary deals.

Dodd Frank’s Silver Lining

The Advent of Dodd Frank
Middle market companies seeking to manage operating risk using commercial hedging transactions have historically had few options, other than expensive and opaque intermediary deals. Not only has their direct access to electronic platforms been limited, the customized transactions often required by their operations have largely been arranged by banks. In traditional markets controlled by large speculators, corporate end-users historically accepted mediocre outcomes or elected not to conduct transactions.

Until recently, over-the-counter derivatives have been minimally regulated in the US. In response to the 2008-9 financial crises, in July 2010 Congress passed the Dodd Frank Act, which now heavily regulates the derivatives field. The key aspects of Dodd Frank applicable to OTC derivatives include: mandatory transaction clearing, mandatory margin and real-time transaction reporting, among other things.

On July 10, 2012 the Commodity Futures Trading Commission approved important rules implementing Dodd Frank, including the definitions of “Swap” and related terms. These definitions are of particular importance, as the date of their effectiveness triggers the implementation timeline for much of the new derivatives regulation. Now published in the Federal Register, these definitions will become effective on October 12, 2012.

Beginning this fall, the implementation of Dodd Frank’s new derivatives framework will result in a sea of change in markets. Yet corporate treasury departments remain uncertain about the full impact of these new regulations. It is well known that Dodd Frank makes central clearing and mandatory margin the new norm for derivatives transactions in an effort to reduce financial system risk and increase transparency, but it is unknown how new regulation will impact transaction fees. Unquestionably, transactions will become indirectly more expensive, as corporate capital is restricted to satisfy the mandatory margin requirements and greater compliance costs are passed on to end-users.

The End User Clearing Exception
Within the voluminous provisions of Dodd Frank lies a lesser-known but highly important safe harbor designed to help firms that engage in legitimate commercial hedging transactions consistent with their business operations. Called the End User Clearing Exception (EUCE), it has been an integral part of Dodd Frank since its passage.

A Silver Lining in the Dark Cloud
Simply put, if an end-user complies with certain specified requirements, it may directly conduct commercial hedging transactions yet lawfully escape the mandatory central clearing and margin requirements of Dodd Frank. The rules implementing the EUCE were passed the same day as the key definitions noted above, and became effective on September 17, 2012, weeks before the October 12, 2012 regulatory phase-in begins.

Large companies may already have the staff and technology infrastructure to utilize these advantageous Dodd Frank provisions, but middle market firms generally do not. Further, new electronic platforms including Swap Execution Facilities (SEFs) and Designated Contract Markets (DCMs) will enhance electronic access to derivatives, but only to standard (non-customized) products subject to central clearing and mandatory margin requirements, and generally only for sophisticated traders.

A New Derivatives Marketplace
In anticipation of the coming regulatory disruption, a new electronic marketplace has been announced called Direct Swap. Direct Swap takes a different approach, focused on the middle market end-user. Through its patent-pending process and online platform, Direct Swap will allow end-users to directly conduct customized commercial hedging transactions at lower cost while obtaining highly favorable “End User Clearing Exception” treatment under Dodd Frank.

The Direct Swap solution offers end-users a new and highly advantageous method to manage risk arising from their business operations: the proverbial silver lining in the dark cloud of new regulation.

Know more about Direct Swap here:
Contact Direct Swap at: dsinfo(at)directswap(dot)com

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Lisa Helme Danforth
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