Diversifying Clearinghouse Ownership in Order to Safeguard Free and Open Access to the Derivatives Clearing Market
Greenberger, Michael, Fordham Journal of Corporate & Financial Law
Implementing the rigorous governance and ownership standards established in the Dodd-Frank Wall Street Reform and Consumer Protection Act1 ("Dodd-Frank Act") for derivatives clearing organizations ("DCOs") will promote free and open access to clearing, and reduce systemic risk within what is now the $700 trillion worldwide notional value derivatives market.2 These statutory standards are central to, and advance the key regulatory tenants of Dodd-Frank: i.e., to restore transparency, capital adequacy, and accountability to what was the previously unregulated over-the-counter ("OTC") derivatives market, by ensuring that swaps are cleared through financially sound DCOs. Also, these rules will promote competition by curtailing the world's large swap dealers' ("SDs") continued control over these markets to the disadvantage of swaps users and smaller dealers wishing to compete on a level playing field.
This article focuses on the importance of swaps clearing to DoddFrank-mandated market reforms and the need for fair and open access to that clearing. Specifically, it shows that implementing objective governance standards for DCOs that include maximum capital requirements for DCO membership will enhance market stability, efficiency, and competitiveness. To this end, the article focuses on clearing - as opposed to the related designated contract markets ("DCMs") or swaps execution facilities ("SEFs") - as clearing lies at the heart of these Dodd-Frank market reforms.3 Also, although the article discusses the Securities and Exchange Commission's ("SEC") proposed rules on DCO governance and ownership in passing, it focuses on the Commodity Futures Trading Commission's ("CFTC") rulemaking for DCOs since the CFTC has jurisdiction over 88% of the swaps market.4
The article is divided into four parts. First, it shows that Congress intended the CFTC to adopt rigorous rules regarding DCO governance and ownership that eliminate the conflicts of interest that has allowed SDs to stifle competition for clearing services and to charge unnecessarily high transaction fees to users of swaps. Second, it explains how pre-Dodd-Frank market forces have limited access to clearing services. Third, it demonstrates that the CFTC's final rule on participant eligibility5 - particularly the $50 million threshold for DCO membership) - promises to both improve swap users' access to clearing and ensure greater stability within the derivatives clearing market. Finally, the article suggests that the CFTC should strengthen its proposed governance standards for DCOs, in order to safeguard swap users' access to clearing against the possibility that the CFTC's participant eligibility requirements fail to increase DCO membership.6
I. DODD-FRANK REQUIRES ALL SWAPS USERS TO HAVE FREE AND OPEN ACCESS TO CLEARING
Dodd-Frank' s almost universal mandatory clearing requirement7 for standardized swaps necessitates that swaps users have "fair and open access"8 to DCOs as well as to SEFs and DCMs. SEFs and DCMs enable price discovery by posting the price and volume of exchangetraded swap transactions.9 The public information generated by SEFs and DCMs ensures price transparency, which in turn promotes market liquidity by allowing swaps dealers to compete for business based on publicly available data.10 DCOs manage (and mitigate) systemic risk by guaranteeing the credit worthiness of swap counterparties, and requiring counterparties to set aside adequate collateral - i.e., margin - to prevent default." In this respect, DCOs eliminate the interconnectedness between financial institutions that contributed to the 2008 financial crisis that was precipitated by cascading counterparty risk emanating from the bankruptcy or need to rescue the likes of Bear Stearns, Lehman Brothers, and AIG.12
Given the importance of clearing to Dodd-Frank-mandated market reforms,13 Congress directed financial regulators to establish rigorous regulations that would ensure well-capitalized market participants' eligibility for clearing membership,14 thereby reducing market concentration, and "mitigat[ing] conflicts of interest" in the operation of DCOs. …