Berkeley Undergraduate Journal

Derivatives are financial instruments whose price is determined based on the value of another commodity, stock, currency, interest rate or similar item. Most often, they are structured as swap contracts which amount to an exchange of cash flows: on a certain date, one party gives the other a fixed amount and the other is required to put forth an amount based on the current market price. The fixed payer has sold the risk of price movement and the fixed receiver has bought that risk. Derivatives have gained popularity in the past few decades given their exemption from certain provisions in the Bankruptcy Code and their over-the-counter status that long freed them from any type of regulatory oversight.

After the 2008 financial crisis, the U.S. government enacted regulatory changes domestically via the Dodd-Frank Act, which put derivatives under the jurisdiction of the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). Most major types of derivative transactions must now use clearinghouses as their middleman (Skeel, 2011). The goal of a clearinghouse is to measure the risk of loss on a default and require the clearing member to pre-fund it through margin deposits. The interplay between banks, regulatory agencies and clearinghouses has developed a new norm for the drafting of derivative contracts and the clearing procedures involved in the modern exchange platform. My research suggests that although the contracts that have remained under the jurisdiction of the new reforms are becoming less hazardous, there exist new threats stemming from the transformation of swap agreements into less regulated futures contracts.