Dodd-Frank Act

Interest rate derivatives are one of the most tightly regulated financial instruments in the U.S. financial system. This is largely due to their systemic risk potential and central role in the 2008 financial crisis, which led to sweeping reforms under the Dodd-Frank Act. Before 2010, most derivatives were traded over the counter (OTC).

The post-crisis regulatory regime made interest rate derivatives safer and more transparent, but at the cost of accessibility and affordability. Compliance, clearing, margin, and reporting rules have:

• Raised fixed and variable costs for banks;
• Reduced dealer participation in smaller transactions; and
• Discouraged smaller companies from hedging due to complexity and cost.

As a result systemic risk is lower, but market access is harder and hedging is more expensive - especially for small and mid-sized companies.

Company Eligibility

A company must satisfy the requirements listed in the table below to trade OTC on a platform such as BlockMargin.

These requirements ensure that only legitimate, sophisticated companies use uncleared OTC FRAs - and that they do so to manage real business risks, not to speculate. They also ensure the bank can legally face the company, meet its reporting and compliance obligations, and that regulators can track the trade if needed.

Bank Eligibility

The bank can trade a bilateral OTC FRA with a company only if it is a registered, compliant Swap Dealer that follows all CFTC rules for fair dealing, reporting, and recordkeeping - and only if the company qualifies as an ECP end-user. If a bank is not registered as a swap dealer it can still engage in FRAs provided it stays within certain volume limits

Mandatory Clearing Exception

The Dodd-Frank act requires standardized derivatives to be cleared through a central counterparty (CCP) (such as CME Clearing or LCH) instead of being traded and settled directly between the two parties (OTC). There is an exception to the mandatory clearing rule if:

• The FRA is used to hedge or mitigate commercial risk;
• Reports that exemption through its counterparty or SDR.

This exception does not cover Individuals nor Financial Counterparties (e.g. hedge funds)

Mandatory SEF Trading Exception

The mandatory SEF trading rule applies only to swaps that are both subject to mandatory clearing and have been determined by at least one SEF to be “Made Available to Trade” (MAT). Since FRAs are not subject to the clearing mandate and have not been designated as MAT by any SEF, they are not required to be traded on a SEF and may therefore be executed over-the-counter (OTC).