When Regulators Collide: Financial Market Stability, Systemic Risk, Clearinghouses and CDS

Abstract

This Article demonstrates that regulatory collisions are an unintended consequence of well-meaning, post-financial crisis reforms by both public and private market regulators in the over-the-counter derivatives market. Many of these reforms are designed to regulate systemic risk. As this Article argues, however, potential regulatory collisions are themselves a critical, but hidden, source of systemic risk. Such collisions are problematic both because they hamper the effective regulation of systemic risk and because effective mechanisms for preventing or resolving such conflicts do not exist.

This Article analyzes the potential for regulatory collisions among domestic, international, public, and private market regulators overseeing the over-the-counter derivatives market. It uses case studies to illustrate several types of regulatory collision risks. These case studies focus on post-financial crisis reforms, including the Credit Derivative Determination Committees of the International Swaps and Derivatives Association, the G20’s clearinghouse mandates, and Dodd-Frank’s Titles VII and VIII.

In sum, this Article argues that the effective regulation of systemic risk in the over-the-counter derivatives market requires both (1) ex-ante, preventative conflict resolution mechanisms to decrease the risk of regulatory collisions, and (2) ex-post, restorative conflict resolution mechanisms to promote market stability when regulators collide. It concludes by proposing strategies oriented towards the development of such resolution mechanisms.

Keywords: clearinghouses, credit default swaps, financial crisis, ISDA, International Swaps and Derivatives Association, Dodd-Frank, systemic risk, financial derivatives, Securities Exchange Commission, Federal Reserve, Commodity Futures Trading Commission

JEL Classification: K20, G20, F30, F00