Derivatives regulations should shore up financial system

Derivatives regulations should shore up financial system

Under the Dodd-Frank Act, many derivatives will move from over-the-counter trading to exchanges or electronic trading systems. What will this mean for Putnam funds?

The Act sets the broad outlines for regulation, which will be implemented through the new powers of the Securities and Exchange Commission and the Commodities Futures Trading Commission in greater detail over the next year or two. Financial companies such as Putnam will begin using a central clearing platform for derivatives trading.

Will the same types of derivatives be available to the funds?

The same types of derivatives will generally be available to the funds, and the funds will be able to continue implementing the same strategies and capabilities that they employ today. As a result of the movement of derivatives to exchanges and central clearing platforms, there may be less customization of special types of derivatives, but the more widely used types of derivatives will remain available.

Will Putnam be able to trade with the same institutions?

Overall, we do not expect substantial changes in our institutional trading relationships. With the exception of banks, most types of institutions that currently trade derivatives are unlikely to change significantly as a result of the legislation. In the case of banks, the legislation requires that certain types of derivatives – those that do not involve hedging risk, interest rates, or foreign currencies – be moved into separately capitalized, non-bank affiliates. In sum, we do not anticipate disruption in our derivatives trading.

Do the new derivatives trading rules involve any new costs for the funds?

The combination of new regulations and capital requirements will generally raise the costs of derivatives trading. To some extent, the costs will be borne by all funds and institutions, like Putnam, that trade derivatives. For example, trading on central clearing platforms rather than over the counter is likely to involve somewhat higher costs. The new law also has higher capital requirements for dealers and major swap participants.

Are the reforms in derivatives trading likely to help reduce risk in the financial system?

Most of the provisions of the law are likely to increase the stability of the financial system, which is the primary intention. The reforms in derivatives trading, in particular, should increase transparency and help to build a greater barrier between derivatives markets and securities markets. Higher capital requirements should also reduce the risk in the financial system that comes from leverage.

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