The Thorny and Multifaceted Issue of OTC Derivatives Regulation and the Obama Administration Proposals

Regulating financial innovation has never been an easy affair given the tradeoffs involved. Yet the global financial crisis has brought this issue into sharp focus. As a result, the regulation of OTC derivatives has dominated the global regulatory reform agenda since the Lehman Brothers’ catastrophe and the AIG debacle. Lack of transparency in OTC markets and the complexity of relevant instruments has become an issue of fundamental importance, due to their systemic implications. The unrestrained of use of credit derivatives, especially of credit default swaps, increased both the interconnectedness of the different segments of the global financial network and the system’s fragility. To counter the systemic ramifications of OTC derivatives trading, the U.S. Treasury and the EU Commission have issued legislative proposals pertaining to standardization of OTC derivatives and the establishment of central counterparty facilities that would make possible the move from bilateral to multilateral trading. Both measures are intended to enhance transparency in OTC derivatives markets and increase the resilience of the financial system.

This issue of Lombard Street focuses on the regulation of OTC derivatives with contributions from leading experts from the legal practice and academia. The contributors to the issue highlight the role of credit derivatives in the global financial crisis (Blair and Gerding, Avgouleas) and the inherent tension between financial innovation and regulation (Glass, Curtin, Avgouleas). They provide a critical analysis of the relevant U.S. Treasury proposals (Blair and Gerding, Curtin, Glass). Blair and Gerding, Glass, and Curtin debate in a thought-provoking manner the potential impact of the Treasury proposals in enhancing the transparency of OTC derivatives markets and buttressing systemic stability. They also explain the obstacles to the implementation of these proposals. In this context, Blair and Gerding, Curtin, and Glass provide a number of practical recommendations for the restructuring of credit derivatives regulation. Finally, Glass discusses the rulemaking role of ISDA and Avgouleas explains the case for bringing relevant ISDA committees under international public interest oversight.