Advisor Warns Dodd-Frank Could Make Derivatives Too Expensive

Feb 15 2011 | 10:32am ET

New regulations on derivatives could make them too expensive for the corporations, banks and pension funds that have come to depend on them, says derivatives advisor Frank Iacono.

Iacono has presented his suggestions for amending the legislation in a letter to the U.S. House of Representatives Financial Services Committee which is holding hearings on aspects of the Dodd-Frank Act on Tuesday, February 15.

“With the best of intentions, Dodd-Frank was designed to reduce the risk of a systemic meltdown similar to 2008. The problem is that the bill over-reaches in some regards and is still inadequate in others,” said Iacono, whose firm is derivatives specialist Riverside Risk Advisors.

Derivatives, which Warren Buffet once termed “weapons of mass destruction,” are contracts tied to a financial benchmark like commodities, interest rates or mortgages. They constitute a multi-trillion dollar business and permeate much of the financial world but until now, they have gone basically unregulated. Under Dodd-Frank, they would trade on exchanges, like stocks, so prices would be plain to see. Dodd-Frank also calls for measures to ensure the parties to derivatives contracts can make good on their commitments—perhaps by putting money down.

Critics, like Ianoco, say such measures could price some players out of the derivatives market:

“Making the derivatives market affordable is good for everyone,” he said. “Unfortunately, the derivatives market could dry up for some parties if access to it is made prohibitively expensive.”
 
Riverside Risk Advisors proposes a broader end-user exemption, which would in effect limit margin and clearing requirements to those end-users deemed large enough to pose a meaningful risk to the financial system—the so-called “major participants.”
 
At the same time, Riverside Risk Advisors said Congress should consider alternative measures to address counterparty risk including updated capital reserve requirements for federally-insured banks and more meaningful disclosure in financial reports.
 


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