Dodd-Frank from a legal perspective

The law firm Kleinberg, Kaplan, Wolff & Cohen, P.C. released a Legal Update earlier outlining the impact the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 is likely to have on derivatives trading. Following is a summary of that update.

1. Comprehensive System of Regulation—The Dodd-Frank Act creates a comprehensive framework for regulating over-the-counter (OTC) derivatives as well as swap dealers and certain other designated participants in the derivatives markets. Jurisdiction for this regulation is split between the Securities Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) based on the whether the derivative is security based or not. Much of the scope and impact of the Dodd-Frank Act will depend on regulations the CFTC and SEC are directed to create within 360 days of its enactment.

2. Clearing of Derivatives Contracts—One of the largest changes made by the Act is to move OTC derivatives to exchange-traded, standardized contracts with clearinghouses. This will resolve the current lack of transparency and counterparty credit risk present in OTC trades. While the Act does not require all OTC products to move to exchanges, it charges the CFTC and SEC to determine which should be subject to clearing based on a number of criteria. Additionally, the Act provides certain exemptions for some derivatives through an “end user” exemption.

3. Regulation of Dealers and Major Swap Participants—The Dodd-Frank Act provides comprehensive registration requirements, as well as capital and margin requirements, and rules governing business conduct and record keeping. Dealers that are banks will be subject to capital and margin requirements set by their banking regulators. Further, banks that want to receive advances from any Federal Reserve credit facility must move its derivatives business to a non-bank affiliate. Further rules and regulations will be forthcoming from the CFTC and SEC.

4. Pre-Emption of State Law—The Dodd-Frank Act precludes state discussion over the use of credit default swaps for speculative purposes by providing that states may not regulate swaps as insurance.

5. Key Role of CFTC and SEC—Much of the impact of Dodd-Frank will not be felt until the CFTC and SEC have promulgated a number of regulations. Areas that require attention include:

· Type and number of derivatives contracts subject to the clearing requirements

· Scope of the end-user exemption

· Regulations governing swaps clearing organizations and exchanges

· Scope of the swap dealer and major swap participant definitions

· Capital and margin requirements imposed on entities

To view the Update in its entirety, go to Impact of Dodd-Frank Wall Street Reform and Consumer Protection Act on Derivatives Trading.

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