Derivatives Clearinghouses: Clearing the Way to Failure

One of the major components of Dodd-Frank was a comprehensive regulatory framework for over-the-counter derivatives. A key feature of this framework is a requirement that many of these derivatives be cleared through central counterparty clearinghouses. Clearinghouses have long played a stabilizing force in many markets, but Dodd-Frank’s regulatory mandate may adversely affect the way they operate. Risk management by clearinghouses and market participants could suffer, and improper risks could find their way into clearinghouses.

If a clearinghouse were to fail, there would be tremendous pressure for the government to bail it out in the name of financial stability. Dodd-Frank’s derivatives framework should be reconsidered before it destabilizes the financial system. A better approach would empower market participants to decide whether to use clearinghouses and would allow clearinghouses the regulatory latitude to effectively manage their risks.