Dodd Frank: How Will the Rule Impact Swaps and Derivatives in Europe?

1 March 2012

The Dodd Frank rule will have a significant effect on the European swaps and derivatives market, alongside other regulation that will cause many businesses to alter their operations.
Originally signed into law in the US in July 2010, the act was conceived as a means of tackling the recession that spread across the globe in previous years, helping to protect the financial industry from future debt and potential financial instability.

The legislation proposed to cover a number of areas, including a comprehensive regulation of financial markets, an increased transparency of derivatives and consumer protection reforms.
In addition, the law focuses on creating various measures that aim to boost international standards in the financial industry, while making the regulation of credit rating agencies tighter.

It is not the only law that will affect Europe, as one other piece of legislation that will impact the continent's swaps and derivatives industry is the European Market Infrastructure Regulation (EMIR).

This law presents a reporting obligation for over-the-counter (OTC) derivatives, a clearing obligation for eligible OTC derivatives and measures to decrease counterparty credit risk.
Such changes will have many consequences for businesses, with Celent's report Dodd Frank and EMIR Derivatives Reforms: Future Scenarios and the Impact on Derivatives Technology predicting that a wide number of market structure changes could arise.

David Easthope, research director of capital markets at Celent and co-author of the report, said: "In the end, we predict a two-tier swaps market with distinct dealer-to-dealer execution platforms and dealer-to-client platforms, based on the evolution of existing mechanisms and new market entrants.

"At the same time, divergent approaches to regulation and rule application mean that the resulting market structure can vary across instrument class and by region."

Cubillas Ding, research director of finance and risk at Celent and co-author of the report, added that swap dealers and counterparties will witness the most extensive effects on their business models and IT budgets.

One particular component of the Dodd Frank legislation that is unsettling some members of the European Union is the Volcker Rule.

It is designed to prevent US banks from engaging in dangerous investments, but the European Commission is planning to speak out against the legislation to US treasury secretary Timothy Geithner, reports the Wall Street Journal.

The news provider has reported that European commissioner for the internal market Michel Barnier, is hoping to speak to Mr Geithner about the rule next month (February).

His plans to speak out against the Volcker Rule follow a discussion with UK chancellor of the exchequer George Osborne, with many experts in the field worried that the regulation may hinder European markets, which could bring on particularly adverse effects in the current economic climate.

Speaking to the Wall Street Journal, Jaret Seiberg, senior policy analyst with Guggenheim Securities, said: "When foreign governments are complaining that a rule could have systemic ramifications, that has to be a message that regulators hear.

"The irony is that Volcker was intended to reduce the risk of a systemic crisis, yet we're hearing from foreign governments that it could actually provoke one by reducing liquidity in the trading of sovereign debt."

In addition to the EMIR and Dodd Frank laws, specialists in the European financial industry may have to adapt to new regulations that specifically govern the derivatives market.

According to Reuters, European commissioner for the internal market Michel Barnier is set to revamp the laws in the particular industry, urging banks to move away from the OTC market and instead engage in trading on open exchanges.

If confirmed, these new rules will mean that all deals must be recorded centrally in an effort to make the market easier to monitor, enabling financial risks to be assessed more effectively.
Therefore, with the Dodd Frank and EMIR laws, as well as plans for a potential revamp of Europe's governance of the derivatives market, specialists must ensure that they keep aware of any regulation changes and alter their approaches accordingly.

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