Know your onions – US financial reform

On 21 July the "Dodd-Frank Wall Street Reform and Consumer Protection Act" was signed by President Obama.

We keep hearing reporters referring to it as a massive piece of legislation 2319 pages long and yes it is massive and encompassing all manner of different areas and yes there are parts that will upset many in the financial world but let’s cast a look at the process of getting to this point.

First those 2319 pages

By dint or a strange typeface each page has just 130 to 140 words on it, a mere third of the content of a normal page of UK legislation.

Then the content

It is intrinsically complex stuff but the style is to cross refer to other legislation and include changes to existing rules so that without an intimate knowledge of other Acts you do not actually know what has been changed or what the real relevance and implications are.

As an example in section 721 on definitions the Dodd-Frank Act says:

 7 (a) IN GENERAL.—Section 1a of the Commodity Exchange Act (7 U.S.C. 1a) is amended—
……
(4) in paragraph (9) (as redesignated by paragraph (1)), by striking "except onions" and all that follows through the period at the end and inserting the following: "except onions (as provided by the first section of Public Law 85–839 (7 U.S.C. 13–1)) and motion picture box office receipts (or any index, measure, value, or data related to such receipts), and all services, rights, and interests (except motion picture box office receipts, or any index, measure, value or data related to such receipts) in which contracts for future delivery are presently or in the future dealt in"; 

The ACT has been taking a particular interest in that part of the legislation which covers OTC derivatives and which imposes a mandatory central clearing requirement, meaning that margin (cash collateral) would be required against derivative positions.

In May 2009 the US Department of Treasury announced its intention to seek legislation on OTC derivatives which prompted the ACT to make written submissions to the key US politicians in July 2009, explaining the need for suitable exemptions for non financial companies. The administration started the process with a Bill from the US Department of Treasury whereupon the House of Representatives prepared its own different version. Not to be left out a further version was drafted by the Senate, thus tripling the drafting work for US lawyers. After much debate, Committee work and amendments you end up with two Bills approved by the respective chambers which need to be further negotiated and reconciled into the final version. Given all this apparent duplication it is a wonder they have managed to finalise the legislation in about a year.

As for the specifics on derivatives, there is a carve out so that we expect most non financial companies will be outside the clearing obligation, unless they are large enough to be a "major swap participant". The SEC and CFTC (Commodity Futures Trading Commission) will decide what constitutes major but in assessing size of positions they have to exclude those "held for hedging or mitigating commercial risk". After all the fuss it looks as if things should be OK for non financials.

Meanwhile the EU is heading down the same path of imposing mandatory central clearing. Although there will be exemptions for derivatives done by non financial companies the exact definitions and boundaries are not yet clear.

By Martin ODonovan