Regulatory Reform

The ‘Dodd-Frank Wall Street Reform and Consumer Protection Act’ will have a number of important effects on energy trading.

First, by requiring the spin-off of commodity swap desks from traditional banks, the Act will alter the exposure of hedgers to counterparty credit risk. Traditional banks generally offer much stronger credit quality than stand-alone swaps dealers. In addition, swaps dealers would be prohibited from receiving any individual federal assistance (bailouts) in case of distress. If a swap dealer is liquidated under the ‘Orderly Liquidation Authority’ provision of the Act, over-the-counter counterparties could face significant losses.

The Act will significantly expand the volume of exchange-based trading, especially between financial institutions. While commercial end-users will have the option to trade over-the-counter, these commercial end-users will need to prove to the CFTC that the end-user is able to meet all financial obligations. By mandating exchange clearing for most trades, the systematic risk posed by major market participants will be greatly reduced; furthermore, the CFTC’s ability to monitor major market participants will be enhanced.

Lastly, increased market transparency will lower trading costs for all market participants. After an implementation delay of 1-2 years, the trade price of all standardized trades will be immediately published to the market. This system is currently active within global equity markets, among others, and will allow traders to better evaluate prices offered by swaps and options dealers.