Not many people know the meaning of “swap” (as in a financial hedge, not flea market). Only the most sophisticated investors actually understand the complexities of buffering risk by exchanging cash flows. Under Dodd–Frank, however, federal regulators have been tasked with assuming control of this market, in which hundreds of trillions of dollars are in play.
The result isn’t pretty.
For example, the government’s 160-page definition of “swap” (with 1,448 footnotes) is crammed with phraseology that could be mistaken as caricature, such as this bit of “clarification”:
For purposes of determining whether one of the criterion in either paragraphs (a)(1)(iv)(A) through (a)(1))(iv)(D) of this section or paragraphs (a)(1)(iv)(H)(1) and (a)(1)(iv)(H)(2) of this section is met, the term issuer of the security included in the index includes a single issuer of securities included in the index or a group affiliated entities as determined in accordance with paragraph (c)(1) of this section (with each issuing entity of an asset-backed security as defined in section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77)) being considered a separate entity). [Emphasis in original.]
And this gem:
To the extent that a mixed swap is subject to the mandatory clearing requirement (see section 2(h)(1)(A) of the CEA, 7 U.S.C. 2(h)(1)(A), and section 3C(a)(1) of the Exchange Act) (and where a counterparty is not eligible to rely on the end-user exclusion from the mandatory clearing requirement (see section 2(h)(7) of the CEA, 7 U.S.C. 2(h)(7), and section 3C(g) of the Exchange Act)), this alternative regulatory treatment will not be available.
Until recently, swaps were largely unregulated by virtue of being customized contracts negotiated between private parties. Like a great many other financial products and services, they were swept up in the regulatory frenzy that followed the collapse of the housing market, the failure of major financial firms, and the resulting shock to the economy. But investors themselves instituted major reforms in the derivatives trade long before Dodd–Frank came along.
The CFTC issued 49 final rules and orders on swaps between September 2010 and December 2012. Within the 1,979 pages of new rules there are nearly 4,000 distinct tasks for swap dealers and participants. Among them:
[A]s the affiliation definition applies to the worldwide equity market capitalization and outstanding indebtedness criteria of the public information availability test, a reference entity or an issuer of securities included in an index that itself does not have a worldwide market value of its outstanding common equity held by non-affiliates of $700 million or more or outstanding notes, bonds, debentures, loans, or evidences of indebtedness (other than revolving credit facilities) having a total remaining principal amount of at least $1 billion, may aggregate the worldwide equity market capitalization or outstanding indebtedness of an affiliated entity, regardless of whether that affiliated entity itself or its securities are included in the index, to satisfy one of these criteria.
Obviously, the real beneficiaries of these regulations are the lawyers who will bill countless hours for parsing such nonsense.
The problem cannot be solved by merely simplifying the regulatory language. The problem is government straying way, way beyond its proper functions. As the swaps regulations make abundantly clear, there are just some things in life that Washington isn’t meant to manage.
