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Regulation: Dodd-Frank throws a long shadow on Wall Street

Central clearing could erode market share; New exchanges set to take on banks

For the over-the-counter derivatives markets the signing into law of the Dodd-Frank Wall Street Reform and Consumer Protection Act last month was a watershed moment.

Although the ultimate intention of the new regulations is to make the financial markets sufficiently robust and secure to avoid the systemic failure of the biggest financial institutions, they might also ultimately lead to a break-up of an oligopoly that has been Wall Street’s most lucrative business line for the past 15 years.

In the first half of 2009 the top five banks made $35 billion from trading in derivatives, including interest rate and credit default swaps; and cash instruments such as treasuries and corporate bonds, according to reports compiled by the Federal Reserve. For JPMorgan, the biggest counterparty in the OTC derivatives market, half of its $31.2 billion of trading revenue between 2006 and 2008 came from derivatives.

At the core of the new regulation is the implementation of central counterparty clearing (CCP) for over-the-counter derivatives, increased minimum capital requirements for non-standardized derivatives that cannot be cleared, and the transfer of trade execution from the phone to swap execution facilities that provide advanced pre-trade and post-trade transparency, and regulated exchanges.

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