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Regulatory Delay Sparks More Concern over Dodd-Frank

Source: WSJ - Deborah Solomon & Victor McGrane

Posted on 07 Jun 2011

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Amid fears the holdup might disrupt the $583 trillion derivatives market and spark a wave of lawsuits, banks, investors and companies are scrambling to cope with uncertainty caused by regulators' delays in fleshing out the Dodd-Frank financial-overhaul law.

Although regulators have yet to issue final rules in the affected areas, more than 100 new derivatives requirements in the law take effect on July 1. The holdup raises concerns that a large swath of the financial system might be thrown into legal gray areas.

The impact is in the over-the-counter market for derivatives, which are contracts whose value varies with the value of something else—some other financial instrument or some commodity or currency. Those who use and trade derivatives will become subject to a host of provisions, such as business-conduct rules and restrictions on certain trades.

Market participants said there is a chance derivatives trading could slow considerably as firms fret over potential legal repercussions from conduct that could be seen as improper.

The Commodity Futures Trading Commission and the Securities and Exchange Commission were supposed to finish rules creating a new regulatory framework for trading and clearing derivatives by July 21, the anniversary of when the law's signing.

The vast majority of the rules won't be complete by then. The law dictates that a host of provisions related to the rules go into effect 360 days after the law's passage, which is July 16.

CFTC Chairman Gary Gensler said last week that both the CFTC and SEC are aware of the problem and are coming up with lists of Dodd-Frank provisions that might need further clarification before the deadline. He said the guidance, to be on the agency's website before July 16, will ensure that the deadline will "not be an event at all" for market participants. A spokesman for the SEC said it soon will "provide guidance to remove any uncertainty...."

Some lawyers said that, in the worst case, certain derivatives known as swaps could enter legal limbo. Dodd-Frank repeals parts of a 2000 law that says swaps, which are contracts to exchange one asset or liability for another in the future, don't have to be traded on exchanges or other open platforms. The new law says most of them do, though certain customized swaps can still be traded over the counter; regulators, however, haven't finalized the rules governing the new regime.

So lawyers say the legality of some trades after July 16 could be in question. Some market participants worry that even if regulators say over-the-counter swaps aren't illegal, people still could bring lawsuits seeking to declare trades null and void.

"Despite whether the regulators act, these contracts won't be protected from the trial bar. This could prove hugely disruptive to businesses," said Rep. Frank Lucas (R., Okla.), chairman of the House Agriculture Committee.

He and some other Republicans support legislation to delay the deadline for most Dodd-Frank derivatives provisions. That plan faces long odds in the Democrat-controlled Senate.

Some nonfinancial businesses that use derivatives to hedge business risks, known as corporate end users, are worried they may not be able to legally engage in over-the-counter derivatives trading after July 16.

For instance, current law lets certain businesses trade over-the-counter derivatives even if they don't meet the asset or net-worth requirements. This exemption appears to end July 16, said Sam Peterson, a senior adviser at Chatham Financial, a Philadelphia consulting firm.

Tom Deas, treasurer for Philadelphia-based chemical company FMC Corp. and president of the National Association of Corporate Treasurers, said, "Any uncertainty about the future environment is one more hurdle to get over for a company to make a decision to invest and grow their business and ultimately sustain and grow jobs."

Lawyers said that in other cases, the problem is regulators haven't provided clarity on how to comply with provisions, such as those tied to rules that aren't yet final.

For example, business-conduct rules have only been proposed, not made final. But after July 16, swap dealers have to come up with new forms, systems and procedures to comply with those new standards. Lawyers said it is unclear how a firm would comply with rules that aren't fully outlined.

Also, regulators haven't made final the rules that will determine who qualifies as a swap dealer.

"Any company that takes their compliance obligation seriously faces an awful lot of dilemmas as to what do you do to be in compliance with the law when the law is murky at best," said Guy Dempsey, a partner with Katten Muchin Rosenman LLP, which represents derivatives participants.