Dodd Frank reduces or eliminates Rogue Trading and other financial disasters due to a failure of risk management by requiring central transaction clearing, margining, and enterprise risk management. Additionally, Buy Side and Sell Side would execute transactions through a Swap Execution Facility (SEF or Interbank Broker) or Designated Contract Facility (DCF or Futures Exchange). Transactions are ultimately reported to the Regulators (CFTC, SEC) by Swap Data Repositories (SDR’s). This makes all transactions transparent to the market and Regulators. SEF’s and DCF’s update the market through market data services. SDR’s update the Regulators. All in “real time”. Central Clearing requires confirmation and posting of initial margin plus daily settlement of variation margin according to daily price changes.
- One Market Price for All
- Transaction Transparency to All
- Eliminates Counterparty Risk
- Eliminates Operational Risk
Large Bank and Non Bank Financial firms will be required to provide firm wide Stress Tests annually that demonstrate capital and liquidity adequacy to withstand any catastrophic market or credit event such as a Stock Market Collapse or Sovereign Debt Default.
The New Risk Management Standard Summary:
- Margin Derivative Transactions
- Capital and Liquidity To Carry Derivative and Credit Exposure Through Any Catastrophic Event
Dodd Frank thus reduces systemic risk by setting a new risk management standard for significant market participants as well as eliminating counterparty and operational risks due to derivative transactions.
Failing institutions could be liquidated before they become a threat to the US Financial System without help from the US Taxpayer.
In fact, large banks are now required to provide the Fed with Liquidation Plans (updated annually) in the case they are liquidated. These Plans must be detailed enough to enable the FDIC to provide Depositors access to their funds within one day of a major bank failure.
Buy Side firms need to change the way they trade derivatives to eliminate counterparty and operational risk and reduce execution costs. They also need to upgrade their Risk Management Process (Click Best Risk Management Practices below) to maximise derivative rewards and minimise any risk in these uncertain times. These may include significant improvements in Risk Technology and Market Data management.