A crucial change in the way financial derivatives are packaged and sold on Wall Street is enabling traders to bypass new regulations aimed at limiting reckless speculation, enhancing the prospect of another derivatives crisis, warn some market participants.
Under the Dodd-Frank financial reform law adopted by Congress in 2010, investors are required to set aside significant sums of cash to cover losses on their derivatives trades -- money they could otherwise plow into additional investments. That policy came in response to the financial crisis that began in 2007, when major financial institutions found themselves unable to cover hundreds of billions of dollars in shortfalls on derivatives trades.
But traders have recently forged a path around these so-called margin requirements in order to allow them to harvest larger profits via larger bets: They are repackaging some derivatives known as swaps into another financial product known as futures. Futures are less stringently regulated, meaning investors can stake out larger positions while reserving smaller amounts of cash.
“As the market gravitates to the cheaper platform -- and it’s cheaper because it’s unsafe -- that creates risk for everyone,” James Cawley, CEO of trade execution firm Javelin Capital Markets, told The Huffington Post.
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