New Paradigms and Familiar Tools in the New Derivatives Regulation

Title VII of the Dodd-Frank Wall Street Reform Act is a study in contrasts. On the one hand, Dodd-Frank transforms the U.S. approach to derivatives regulation from a lasses-faire, almost no oversight paradigm into one featuring heavy supervision, supervision focused on the safety and soundness of derivatives markets participants. The commitments to capital and margin requirements, clearinghouses and international cooperation reflect a European vision of financial intermediaries as heavily regulated utilities, rather than the more traditionally American willingness to tolerate the speculative aspects of capital markets. On the other hand, the tools that Dodd-Frank employs to pursue safety and soundness draw inspiration from those that private market actors have employed for centuries. Adopting a more heavily regulated banking paradigm for the formerly (mostly) unregulated derivatives markets, but using market based tools to advance the goals of safety and soundness, might seem like two regulatory reforms working at cross-purposes. However, it may be a sign that real changes in the United States’ vision of well-functioning derivatives markets—providing options for sophisticated investors, but not ones laden with hidden systemic risk—are being pursued incrementally, even after comprehensive regulatory reform.