Law Commons^™

Basel Iii E: Synthetic Financing By Prime Brokers, Christian M. Mcnamara, Andrew Metrick

Journal of Financial Crises

Hedge funds rely on “prime brokerage” units within banks to provide leverage. With the enhanced capital requirements and new liquidity standards introduced by Basel III driving up the cost to banks of engaging in such financing, prime brokers have begun to offer an alternative means of providing hedge fund clients with leveraged exposure to securities. Known as synthetic financing, this alternative requires the prime broker to enter into derivatives contracts with the clients. Under the Basel III framework, the ability of banks to hedge and net such derivative positions results in capital and liquidity costs for synthetic financing that are …

Informed Trading And Cybersecurity Breaches, Joshua Mitts, Eric L. Talley

Faculty Scholarship

Cybersecurity has become a significant concern in corporate and commercial settings, and for good reason: a threatened or realized cybersecurity breach can materially affect firm value for capital investors. This paper explores whether market arbitrageurs appear systematically to exploit advance knowledge of such vulnerabilities. We make use of a novel data set tracking cybersecurity breach announcements among public companies to study trading patterns in the derivatives market preceding the announcement of a breach. Using a matched sample of unaffected control firms, we find significant trading abnormalities for hacked targets, measured in terms of both open interest and volume. Our results …

'Deriving' An Understanding Of The Extraterritorial Applicability Of The Commodity Exchange Act, Gabrielle Schwartz

St. John's Law Review

(Excerpt)

This Note argues that courts should return to using a holistic approach, similar to the traditional “conducts” and “effects” test previously used by courts to analyze extraterritorial securities and commodities claims, to assess claims brought under the CEA. Furthermore, this Note argues that both the Commodity Futures Trading Commission and private individuals including foreign plaintiffs, should be permitted to bring these claims to uphold Congress’s intent in establishing a regulatory regime and maintaining the integrity of the international derivatives market. Part I discusses the history of derivative regulation and how both court decisions and statutory changes have created the …

Piling On? An Empirical Study Of Parallel Derivative Suits, Stephen J. Choi, Jessica Erickson, Adam C. Pritchard

Articles

Using a sample of all companies named as defendants in securities class actions between July 1, 2005 and December 31, 2008, we study parallel suits relying on state corporate law arising out of the same allegations as the securities class actions. We test several ways that parallel suits may add value to a securities class action. Most parallel suits target cases involving obvious indicia of wrongdoing. Moreover, we find that although a modest percentage of parallel suits are filed first, over 80 percent are filed after a securities class action (termed “follow-on” parallel suits). We find that parallel suits and, …

The Mechanisms Of Derivatives Market Efficiency, Dan Awrey

Cornell Law Faculty Publications

These are not your parents' financial markets. A generation ago, the image of Wall Street was one of floor traders and stockbrokers, of opening bells and ticker symbols, of titans of industry and barbarians at the gate. These images reflected the prevailing view in which stock markets stood at the center of the financial universe. The high point of this equity-centric view coincided with the development of a significant body of empirical literature examining the efficient market hypothesis (EMH): the prediction that prices within an efficient stock market will fully incorporate all available information. Over time, this equity-centric view became …

Over-The-Counter Derivatives In A Global Financial Marketplace: The Case For Uniform Global Identifiers And Compatible Reporting Requirements In Substituted Compliance Comparability Determinations, Kimberly R. Thomasson

Catholic University Law Review

The 2008 financial crisis prompted a global regulatory overhaul of over-the-counter derivative markets. The Dodd-Frank Act mandated the CFTC and SEC to issue new rules and regulations to bring the majority of the OTC derivative market out of the dark on onto regulated exchanges. Similar action was taken in the European Union and other G20 nations. There has been a push to harmonize rules for OTC derivatives across jurisdictions to make the market more efficient and eliminate regulatory arbitrage. This Comment focuses on the process for a regulated entity in the US and EU to “substitute compliance” with its home …

Tax Treatment Of Derivative Instruments, Oluwaseun Viyon Ojo

Oluwaseun Viyon Ojo

The article provides an analysis of the various types of derivative instruments traded on the capital markets. As derivative instruments become frequently tradable in the Nigerian Financial market in the near projected future, it is expedient that the concerned companies plan adequately for the tax implications of such transactions and the appropriate tax authorities know how to treat the instrument of derivatives for the purpose of imposition of relevant taxes. This paper therefore dealt with the treatment of these instruments under the Capital Gains Tax Act (CGTA) and Companies Income Tax Act (CITA), though there are no specific rules for …

Reframing Financial Regulation, Charles K. Whitehead

Charles K Whitehead

Financial regulation today is largely framed by traditional business categories. The financial markets, however, have begun to bypass those categories, principally over the last thirty years. Chief among the changes has been convergence in the products and services offered by traditional intermediaries and new market entrants, as well as a shift in capital-raising and risk-bearing from traditional intermediation to the capital markets. The result has been the reintroduction of old problems addressed by (but now beyond the reach of) current regulation, and the rise of new problems that reflect change in how capital and financial risk can now be managed …

The Systemic Risk Paradox: Banks And Clearinghouses Under Regulation, Felix B. Chang

Faculty Articles and Other Publications

Consolidation in the financial industry threatens competition and increases systemic risk. Recently, banks have seen both high-profile mergers and spectacular failures, prompting a flurry of regulatory responses. Yet consolidation has not been as closely scrutinized for clearinghouses, which facilitate trading in securities and derivatives products. These nonbank intermediaries can be thought of as middlemen who collect deposits to ensure that each buyer and seller has the wherewithal to uphold its end of the deal. Clearinghouses mitigate the credit risks that buyers and sellers would face if they dealt directly with each other.

Yet here lies the dilemma: large clearinghouses reduce …

Rolling Back The Repo Safe Harbors, Edward R. Morrison, Mark J. Roe, Christopher S. Sontchi

Faculty Scholarship

Recent decades have seen substantial expansion in exemptions from the Bankruptcy Code's normal operation for repurchase agreements. These repos, which are equivalent to very short-term (often one-day) secured loans, are exempt from core bankruptcy rules such as the automatic stay that enjoins debt collection, rules against prebankruptcy fraudulent transfers, and rules against eve-of-bankruptcy preferential payment to favored creditors over other creditors. While these exemptions can be justified for United States Treasury securities and similarly liquid obligations backed by the full faith and credit of the United States government, they are not justified for mortgage-backed securities and other securities that could …

Gambling On Our Financial Future: How The Federal Government Fiddles While State Common Law Is A Safer Bet To Prevent Another Financial Collapse, Brian M. Mccall

Brian M McCall

Equity Derivatives And The Challenge For Berle’S Conception Of Corporate Accountability, Janis Sarra

Seattle University Law Review

With the proliferation of equity derivatives and related structured financial products, the North American conception of corporate governance faces a new and distinct challenge to its underlying premises.This Article analyzes these developments with a focus on the implications for director and officer accountability and corporate sustainability, using the occasion of the third symposium of the Adolf A. Berle, Jr. Center on Corporations, Law & Society to consider whether Berle’s analysis of corporate accountability offers any insights into how to address the uncoupling of economic interest and legal rights in corporate governance. Part II of this Article sets the context for …

Hedge Funds And Risk Decoupling: The Empty Voting Problem In The European Union, Wolf-Georg Ringe

Seattle University Law Review

The law must remain adaptive and responsive to the constantly changing challenges of our society and our business life. One of the most pressing challenges of the past years is the emergence of alternative investment funds, in particular hedge funds, which masterfully exploit the traditional categories of corporate law, financial derivatives, and risk management. This Article is only concerned with the first of these two forms— negative decoupling.9 It looks at the various forms of negative riskdecoupling strategies and tries to shed light on their overall desirability. Three distinct theoretical perspectives are used as an analytical framework to examine the …

Diversifying Clearinghouse Ownership In Order To Safeguard Free And Open Access To The Derivatives Clearing Market, Michael Greenberger

Faculty Scholarship

Implementing the rigorous governance and ownership standards established in the Dodd-Frank Wall Street Reform and Consumer Protection Act3 for derivatives clearing organizations (DCOs) will promote free and open access to clearing and reduce systemic risk within what is now the $700 trillion notional value derivatives market. Such standards are central to and advance the key regulatory tenants of Dodd-Frank: i.e., to restore transparency, capital adequacy, and accountability to what was the unregulated over-the-counter (OTC) derivatives market by ensuring that swaps are cleared through financially sound DCOs. Also, these rules will promote competition by curtailing large swap dealers‘ (SDs) control …

A Transactional Genealogy Of Scandal: From Michael Milken To Enron To Goldman Sachs, William W. Bratton, Adam J. Levitin

All Faculty Scholarship

Three scandals have reshaped business regulation over the past thirty years: the securities fraud prosecution of Michael Milken in 1988, the Enron implosion of 2001, and the Goldman Sachs “ABACUS” enforcement action of 2010. The scandals have always been seen as unrelated. This Article highlights a previously unnoticed transactional affinity tying these scandals together—a deal structure known as the synthetic collateralized debt obligation involving the use of a special purpose entity (“SPE”). The SPE is a new and widely used form of corporate alter ego designed to undertake transactions for its creator’s accounting and regulatory benefit.

The SPE remains mysterious …

International Financial Standards And The Explanatory Force Of Lex Mercatoria, Cally Jordan

Faculty Papers & Publications

The global financial crisis has cast a strong light on some hitherto obscure corners of the financial world, provoking an outpouring of calls for concerted international action. “Hard law” having disappointed, can “soft law”, in the form of international financial standards, substitute for traditional national legislation. This article examines some of the difficulties associated with the “international standards as soft law” discourse.

First of all, conceptual problems in the “soft law” discourse itself reveal profoundly different patterns of legal thought cutting across national boundaries, resulting in different understandings of international financial standards. Secondly, recent experience, over the past decade, with …

Regulation Of Speculation In The Financial Market: Focusing On Derivative Instruments, Christopher Chao-Hung Chen

Christopher Chao-hung Chen

This article argues that market speculation is a conduct to acquire benefits by undertaking risk. Derivative instruments are powerful tools for market participants to conduct market speculation, which may help hedging, market making and completing investment market. However, pure and excessive speculation might cause net loss of market efficiency and create external costs. Some speculative transactions may imply asymmetric information. Market speculation might also lead to market abuse and even systemic risk. These reasons provide the basis to regulate market speculation by derivatives trading. This paper argues that Taiwan law might build on current regulatory model centring on the type …

The Extraterritorial Provisions Of The Dodd-Frank Act Protects U.S. Taxpayers From Worldwide Bailouts, Michael Greenberger

Michael Greenberger

The significant extraterritorial scope of the derivatives regulation within the Dodd-Frank Wall Street Reform and Consumer Protection Act promises to foster rigorous international standards for financial regulation that will restore transparency and stability to the global derivatives market. At present, that market exceeds $700 trillion notional value, or over ten times the world GDP. Despite opposition from Wall Street to the present extraterritorial application of almost all of Dodd-Frank’s derivatives regulation, the plain language of the statute requires implementing that regulation on an appropriate extraterritorial basis in order to protect U.S. taxpayers from bailing out financial institutions engaging in foreign …

Implementing Dodd-Frank: A Review Of The Cftc‟S Rulemaking Process: Testimony, Michael Greenberger

Michael Greenberger

The Relationship of Unregulated OTC Derivatives to the Meltdown. It is now accepted wisdom that it was the non-transparent, poorly capitalized, and almost wholly unregulated over-the-counter (“OTC”) derivatives market that lit the fuse that exploded the highly vulnerable worldwide economy in the fall of 2008. Because tens of trillions of dollars of these financial products were pegged to the economic performance of an overheated and highly inflated housing market, the sudden collapse of that market triggered under-capitalized or non-capitalized OTC derivative guarantees of the subprime housing investments. Moreover, the many undercapitalized insurers of that collapsing market had other multi-trillion dollar …

Diversifying Clearinghouse Ownership In Order To Safeguard Free And Open Access To The Derivatives Clearing Market, Michael Greenberger

Michael Greenberger

Implementing the rigorous governance and ownership standards established in the Dodd-Frank Wall Street Reform and Consumer Protection Act3 for derivatives clearing organizations (DCOs) will promote free and open access to clearing and reduce systemic risk within what is now the $700 trillion notional value derivatives market. Such standards are central to and advance the key regulatory tenants of Dodd-Frank: i.e., to restore transparency, capital adequacy, and accountability to what was the unregulated over-the-counter (OTC) derivatives market by ensuring that swaps are cleared through financially sound DCOs. Also, these rules will promote competition by curtailing large swap dealers‘ (SDs) control over …

An Altered Derivatives Marketplace: Clearing Swaps Under Dodd-Frank, Eduard H. Cadmus

Fordham Journal of Corporate & Financial Law

Though over a year has passed, the impact of the Dodd Frank Act remains unclear. This Note examines the provisions of the Act that relate to swap transactions within the context of pre-reform and postreform markets. In order to reduce the uncertainties inherent in unregulated swap transactions, the Act employs a comprehensive framework, which includes mandatory clearing through derivative clearing organizations, extensive reporting requirements, margin requirements, and position limits. This Note argues that, in doing so, the Dodd Frank Act addresses the fundamental failures of pre-reform derivative markets. However, the importance of the role for derivative clearing organizations under this …

The Extraterritorial Provisions Of The Dodd-Frank Act Protects U.S. Taxpayers From Worldwide Bailouts, Michael Greenberger

Faculty Scholarship

The significant extraterritorial scope of the derivatives regulation within the Dodd-Frank Wall Street Reform and Consumer Protection Act promises to foster rigorous international standards for financial regulation that will restore transparency and stability to the global derivatives market. At present, that market exceeds $700 trillion notional value, or over ten times the world GDP. Despite opposition from Wall Street to the present extraterritorial application of almost all of Dodd-Frank’s derivatives regulation, the plain language of the statute requires implementing that regulation on an appropriate extraterritorial basis in order to protect U.S. taxpayers from bailing out financial institutions engaging in foreign …

Credit Risk Transfer Governance: The Good, The Bad, And The Savvy, Houman B. Shadab

Articles & Chapters

Goldman Sachs and American International Group on the eve of the 2008 financial crisis were bound together through a web of credit risk transfer (CRT) contracts in the form of credit default swaps (CDSs) and synthetic collateralized debt obligations (CDOs). Synthetic CDOs enabled certain hedge funds to profit from the ultimate bursting of the housing bubble due to the funds’ savvy in understanding CRT better than their counterparties. This Article constructs a novel theory of CRT that extends the insights of creditor governance theory to CRT transactions. By doing so, this Article establishes a framework for good CRT governance. CRT …

Derivatives: A Twenty-First Century Understanding, Timothy E. Lynch

Faculty Works

Derivatives are commonly defined as some variation of the following: a financial instrument whose value is derived from the performance of a secondary source such as an underlying bond, commodity or index. But this definition is both over-inclusive and under-inclusive. Thus, not surprisingly, derivatives are largely misunderstood, including by many policy makers, regulators and legal analysts. It is important for interested parties such as policy makers to understand derivatives, because the types and uses of derivatives have exploded in the last few decades, and because these financial instruments can provide both social benefits and cause social harms. This Article presents …

Implementing Dodd-Frank: A Review Of The Cftc‟S Rulemaking Process: Testimony, Michael Greenberger

Congressional Testimony

The Relationship of Unregulated OTC Derivatives to the Meltdown. It is now accepted wisdom that it was the non-transparent, poorly capitalized, and almost wholly unregulated over-the-counter (“OTC”) derivatives market that lit the fuse that exploded the highly vulnerable worldwide economy in the fall of 2008. Because tens of trillions of dollars of these financial products were pegged to the economic performance of an overheated and highly inflated housing market, the sudden collapse of that market triggered under-capitalized or non-capitalized OTC derivative guarantees of the subprime housing investments. Moreover, the many undercapitalized insurers of that collapsing market had other multi-trillion dollar …

Will The Cftc Defy Congress's Mandate To Stop Excessive Speculation In Commodity Markets And Aid And Abet Hyperinflation In World Food And Energy Prices: Analysis Of The Cftc's Proposed Rules On Speculative Position Limits, Michael Greenberger

Michael Greenberger

On January 26, 2011, the Commodity Futures Trading Commission issued the Notice of Proposed Rulemaking on Position Limits for Derivatives pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act. The proposed rules are designed to implement the historic Congressional mandate of the Commodity Exchange Act, as amended by Section 737 of the Dodd-Frank Act, to ban excessive speculation from the derivatives market, i.e., the speculation which exceeds the need for liquidity by commercial handlers hedging price risk in these markets. Section 737 is the result of multi-year consideration by Congress, during which a strong consensus was reached there …

Making Sense Of The New Financial Deal, David A. Skeel Jr.

All Faculty Scholarship

In this Essay, I assess the enactment and implications of the Dodd-Frank Act, Congress’s response to the 2008 financial crisis. To set the stage, I begin by very briefly reviewing the causes of the crisis. I then argue that the legislation has two very clear objectives. The first is to limit the risk of the shadow banking system by more carefully regulating the key instruments and institutions of contemporary finance. The second objective is to limit the damage in the event one of these giant institutions fails. While the new regulation of the instruments of contemporary finance—including clearing and exchange …

Overwhelming A Financial Regulatory Black Hole With Legislative Sunlight: Dodd-Frank’S Attack On Systemic Economic Destabilization Caused By An Unregulated Multi-Trillion Dollar Derivatives Market, Michael Greenberger

Michael Greenberger

It is now accepted wisdom that it was the non-transparent, poorly capitalized and almost wholly unregulated over-the-counter (“OTC”) derivatives market that lit the fuse that exploded the highly vulnerable worldwide economy in the fall of 2008.[1] Because tens of trillions of dollars of these financial products were pegged to the economic performance of an overheated and highly inflated housing market, the sudden collapse of that market triggered under-capitalized OTC derivative guarantees of the subprime housing market; and the guarantors’ multi-trillion dollar interconnectedness with thousands of other OTC derivatives’ counterparties within that OTC market (through interest rate, currency, foreign exchange, and …

Overwhelming A Financial Regulatory Black Hole With Legislative Sunlight: Dodd-Frank’S Attack On Systemic Economic Destabilization Caused By An Unregulated Multi-Trillion Dollar Derivatives Market, Michael Greenberger

Faculty Scholarship

It is now accepted wisdom that it was the non-transparent, poorly capitalized and almost wholly unregulated over-the-counter (“OTC”) derivatives market that lit the fuse that exploded the highly vulnerable worldwide economy in the fall of 2008.[1] Because tens of trillions of dollars of these financial products were pegged to the economic performance of an overheated and highly inflated housing market, the sudden collapse of that market triggered under-capitalized OTC derivative guarantees of the subprime housing market; and the guarantors’ multi-trillion dollar interconnectedness with thousands of other OTC derivatives’ counterparties within that OTC market (through interest rate, currency, foreign exchange, and …

Will The Cftc Defy Congress's Mandate To Stop Excessive Speculation In Commodity Markets And Aid And Abet Hyperinflation In World Food And Energy Prices: Analysis Of The Cftc's Proposed Rules On Speculative Position Limits, Michael Greenberger

Faculty Scholarship

On January 26, 2011, the Commodity Futures Trading Commission issued the Notice of Proposed Rulemaking on Position Limits for Derivatives pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act. The proposed rules are designed to implement the historic Congressional mandate of the Commodity Exchange Act, as amended by Section 737 of the Dodd-Frank Act, to ban excessive speculation from the derivatives market, i.e., the speculation which exceeds the need for liquidity by commercial handlers hedging price risk in these markets. Section 737 is the result of multi-year consideration by Congress, during which a strong consensus was reached …