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Economic Analysis-Senate Passes Dodd-Frank Act

Thursday, July 15th, 2010

 Financial Reform Headed to President for Signature

By Jeffrey Owen Herzog

 

 -The reform package does not radically alter the financial system

-Mitigation of systemic risk will depend on regulators’ ability to coordinate

-Significant loopholes make derivatives and activity restrictions very slight

 

New Legislation Aims to Combat Systemic Risk and Moral Hazard

The Senate voted today 60-39 to approve the Obama administration’s regulatory reform package, also known as the Dodd-Frank Act of 2010, which resulted from negotiations between the House and Senate organized by Senator Chris Dodd and Representative Barney Frank.

Although the bill entails a number of notable changes for the banking system, a considerable amount of the legislation defers to regulators for study, definition, and implementation of the legislative language, suggesting it will take many months before the final regulatory picture is in place.

Negotiations took place within the context of a razor-thin Democratic majority in the Senate. The legislation’s credit risk retention requirements and activities restrictions are small relative to changes imposed by the Glass-Steagall Act of 1933. The reform package will increase overall capital and liquidity requirements in the banking system.

 

The Dodd-Frank Act of 2010 – Major Implications for the US Financial System

Derivatives: Banks may hedge their own risk, but certain derivatives must be conducted in separately capitalized affiliates.

Banking institutions may trade in-house foreign exchange and interest rate swaps, gold and silver swaps and derivatives to hedge their own risk.

Agricultural, energy, metals, equity and nonstandard (non-centrally-cleared) credit default swaps must move to a separately capitalized affiliate.

 With foreign exchange and interest rate derivatives representing 92% of the notional value of all derivatives, the derivatives provisions of the Dodd-Frank Act apply only to a portion of the total derivatives market.

Finance arms of end-user companies will be exempt from central-clearing requirements. The Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) will coordinate joint supervision of derivatives operations.

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