One of the goals of the Dodd-Frank Act is to mitigate systemic financial risk by establishing a central clearinghouse for derivatives. But how close is the financial community toward achieving that goal?

“Many swaps were not collateralized prior to Dodd-Frank,” said Julian E. Hammar, Of Counsel at Morrison & Foerster. Hammar was the third of four presenters at the Derivatives Regulatory Update webinar held on March 31, 2015, sponsored by the Global Association of Risk Professionals.

Clearing swaps mitigates risk not just through requiring margin collateral (and thereby reducing) credit risk. It also imposes an “operational discipline” Hammar said, with the daily mark-to-market margin transfer, as opposed to less frequent transfers characteristic of over -the-counter (OTC) markets prior to Dodd-Frank.

However, critics of the Central Counterparty (CCP) argue that mandatory clearing concentrates risk at clearinghouses. Hammar referred to the failure of two clearinghouses, one in Paris in 1974, and the other in Kuala Lumpur in 1983, which had catastrophic results. Critics are calling for a larger number of clearing parties, and a larger number of asset classes, to offset the risk.

The U.S. Commodity Futures Trading Commission (CFTC) market risk advisory committee will meet on April 2, he said, reminding the audience that the regulatory landscape is still changing.

Derivatives Update_3_chart

Now that most swaps are subject to mandatory clearing, the percentage cleared has increased from 16 percent in 2007 to 74 percent in 2012.

Hammar believes that the next type of swaps to be put under a clearing mandate will be the non-deliverable forwards (NDFs). He explained that an NDF is an instrument based on emerging market currencies that are not deliverable, and is settled in US dollars. Following their October 2014 meeting, the Global Markets Advisory Committee of the CFTC recommended that NDF clearing be coordinated with European regulatory bodies, which recently deferred action on NDF mandatory clearing. “We will wait and see how the CFTC reacts,” he said.

Hammar commented briefly on variation margin requirements. “Variation margin must be paid and collected daily,” he said, “and it is already in widespread use.” There are some differences between U.S. and Basel regulators, however. The U.S. is more restrictive, requiring that variation margin be in cash.

Hammar’s final comments were directed to the phasing-in of the new regulations, and how it would affect transactions subject to an eligible master netting agreement (EMNA).ª

Click here to view the webinar. Hammar’s portions are slides 18-23, and 38-41.

Click here to read about the fourth presentation.