Wednesday, January 18, 2012
Rena S. Miller
Analyst in Financial Economics
Specialist in Financial Economics
In the wake of the 2008 financial crisis, amid the perception that the unregulated over-the-counter (OTC) derivatives market contributed to systemic risk, the Dodd-Frank Act (P.L. 111-203) sought to remake the OTC market in the image of the regulated futures exchanges. Reforms included a requirement that swap contracts be cleared through a clearinghouse regulated by one or more federal agencies. Clearinghouses require traders to put down cash (called initial margin) at the time they open a contract to cover potential losses, and they require subsequent deposits (called maintenance margin) to cover actual losses to the position. The intended effect of margin requirements is to prevent firms from building up uncapitalized exposures so large that default would have systemic consequences.
While addressing systemic concerns, the clearing of derivatives also imposes the cost of posting margin on those trading derivatives. Many nonfinancial firms argued during the debate over the Dodd-Frank Act that their use of derivatives posed no systemic threat and thus they should not be subjected to the cost of clearing these OTC derivatives. This particular debate came to be known as “the end user debate.” As a result of these concerns, the Dodd-Frank Act included a broad exemption from the clearing requirement for firms that are primarily nonfinancial in nature. Nevertheless, such firms have continued to be concerned that Dodd-Frank could impose indirect costs on them, or that the rulemaking process by the Commodity Futures Trading Commission (CFTC) and the Securities Exchange Commission (SEC) could do so. As such, some legislation in the 112th Congress, such as H.R. 1610, S. 947, S.Amdt. 814 to H.R. 2112, S. 1650, H.R. 2779, and H.R. 2682, addresses potential indirect costs to “end users.”
In addition, concern about derivatives has been fueled by sharp rises in commodity prices— particularly oil—in 2008 and early 2011. Such steep jumps, along with high price volatility in a range of commodities, have fostered apprehension that financial speculation in derivatives might be creating such volatility in commodity prices. For instance, during the course of 2008, oil prices doubled to more than $145 per barrel and then fell by 80% before rebounding, while there was little evidence suggesting disruption of physical supplies. In early 2011, there was again a run-up of about 20%, sending gasoline prices to near 2008 highs. Such severe fluctuations tend to anger consumers, and thus can become an issue for Congress. In the 112th Congress, a number of bills, such as H.R. 2328, S. 1200, H.R. 3006, S. 1598, H.R. 2003, H.R. 3313, and S. 1787 seek to address the impact financial speculation and derivatives may have on spot commodity prices. Other bills introduced in the 112th Congress aim to either tighten or loosen other aspects of derivatives regulation, in the wake of the Dodd-Frank Act, such as H.R. 2586, H.R. 3045, H.R. 3283, and H.R. 1573.
This report focuses primarily on legislation introduced in the 112th Congress. Additional background on how derivatives work, their role in the financial crisis, and the impact of the Dodd-Frank Act on their regulation can be found in another CRS report cited below.
Date of Report: December 27, 2011
Number of Pages: 9
Order Number: R42129
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