The Dodd-Frank “Wall Street Reform and Consumer Protection Act” (also known as Dodd-Frank act) was passed as a bill by President Barack Obama in 2010. The act was passed after the financial crisis in 2008-09 to plug all the loop holes in the financial industry and avoid any such crisis to happen in future. It was considered as an extensive refor covering most parts of financial services in the USA. Principal objectives of the Dodd-Frank Act are:
Promote financial stability of the USA Financial Market
Improve accountability and transparency throughout the financial system
Control systematic risk
Improve transparency in OTC derivatives unregulated market
The Dodd-Frank Act has 16 titles (major sections) and each one of them is focusing on specific aspects of regulation where Transparency or trade reporting guidelines are specified under chapter VII of the Dodd-Frank act.
The trade reporting or transparency act provides all the guidelines related to OTC derivatives transaction reporting including product scope, structure, pricing, unique swap identifier, Reporting party concept, Collateral and Valuation reporting etc.
The key aspects of the act are specified below:
Financial stability reform: The Dodd-Frank Act creates a core organization as the Financial Stability Oversight Council (FSOC) with the aim to identify all the risks in the US financial market arising from different financial companies within or outside of the financial market. The council is responsible for overseeing various regulatory agencies and devise roles of all of them.
Regulatory agencies reform: The act also created new regulatory agencies for stricter oversight and regulation. Some of them are Commodity Futures Trading Commission (CFTC), Securities Exchange Commission (SEC) etc. They were also given enhanced authority to jointly regulate the derivatives market
Credit rating agency reform: The act introduces different compliance and reporting requirements for rating agencies. The rating agencies played a crucial role in the last financial crisis and this new rules aim to curb their freedom.
Unique Identifier- CFTC proposes a unique identifier also known as USI (Unique Swaps Identifier) for all trade reporting to identify the position/trade uniquely
Volker rule provision: The act imposes restrictions on the US banks in terms of their engagement in proprietary trading.
Capital requirements: The act imposes stricter capital requirement standard for financial institutions.
Standardization: The act imposes standardization of certain derivative contracts, central clearing, organized trading platforms, categorization of market participants and transaction reporting requirements to improve market transparency and mitigate systemic risk.
Electronic Trading: The act requires financial institutions to use different organized trading platform for trading of OTC derivatives.
Central Clearing: The act mandates central clearing of standardized swap contracts through a central clearing organization (DCO) or clearing house. Central clearing helps to mitigate credit risk for OTC derivative trades significantly.
Reporting: The act requires all transactions on OTC derivatives to be reported to global trade repositories on real time basis as early as technologically possible.
CFTC also looks for Single sided reporting which means only one of the parties is expected to report the trade to the regulator
Collateral and margin requirements: The act also prescribes collateral and margin requirement standards for centrally cleared transactions in order to mitigate counterparty credit risk.