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This episode aired on BloombergTV on Apr 19, 2012

Swap Dealer

A major aspect of the Dodd-Frank regulation is taming the derivatives industry. One area of particular focus is defining what exactly a swap dealer is, and how one should operate. The law states that any entity entering into over $8 billion in swaps, discounting any swaps used to hedge business exposures, will be considered a swap dealer. This is an important distinction, because anyone qualifying as such will be subject to increased regulation and oversight.

Q. So we got some clarification today on the definition of “Swap Dealer” today. Important?

A. Definitely. One of the important aspects of Dodd-Frank related to getting the derivatives industry under control… it had been largely unregulated going into the collapse. So Dodd Frank mandated that “swaps dealers” be subject to a whole host of rules relating to how swaps could be traded, collateralized, and cleared. And also how the relationship between swaps dealers and customers would work.

Q. OK, sounds noble. But there had been a lot of industry angst over the CFTC and SEC’s first cut at defining who was a “swaps dealer” subject to the rules, right?

A. Yes. Originally, they proposed a rule that said any entity entering into more that $100mm notional value of swaps would be subject to the rule. That would have picked up a lot of so-called “end users”: farming co-ops, for example, that are really using the swaps to manage their businesses. The new rule expands that number to $8 billion, and it will move down to $3 billion over time.

Q. $100 million to $8 billion is a big jump! Is that too high a hurdle?

A. You have to remember that the overall global swaps market is estimated to be something like $700 Trillion dollars… bigger than you can imagine, almost. So $8 billion threshold is still going to pick up the vast majority of the activity and certainly all the real players.

Q. Were there other key changes in the definition?

A. Yes. In computing the number, you’re allowed to exclude swaps that hedge your own business exposures. Very tough to enforce, frankly, but overall the rule will still force the vast majority of major swaps activity under the “swaps dealer” rules.

Q. And do we think this is really going to help limit the volatility that these derivatives introduce into the system?

A. It’s got to help, especially as we move to more and more of these things being guaranteed by a clearinghouse, reducing counterparty risk, and traded on exchanges, so they have more uniform terms and there’s greater visibility on where the liabilities are. But $700 trillion is an awfully large beast to try to tame!