Understanding Systemic Risk in Global Financial Markets

CHAPTER 12The Dodd-Frank Act and Counterparty Credit Risk

INTRODUCTION

This chapter explores Title VII of the Dodd-Frank Act, which heavily regulates over-the-counter (OTC) derivatives markets. We will develop an understanding of the level of counterparty exposure through looking at historical data of the notional outstanding, gross market value, gross credit exposure, and collateral associated with OTC derivatives markets. We will then explore how Title VII of the Dodd-Frank Act works to reduce the counterparty exposure faced by participants in the OTC derivatives market through setting mandatory clearing and other requirements.

After you read this chapter you will be able to:

• Distinguish between notional outstanding, gross market value, gross credit exposure, and collateral.
• Show the degree to which OTC derivatives markets are characterized by counterparty exposure.
• Explain the evolution of the U.S. regulatory approach toward OTC derivatives.
• Describe key provisions of Title VII of the Dodd-Frank Act.
• Discuss criticism of Title VII.

MEASURING COUNTERPARTY EXPOSURE IN THE OTC DERIVATIVES MARKET

In this chapter we explore how Title VII of the Dodd-Frank Act works to reduce the counterparty exposure faced by participants in the OTC derivatives market. Before doing so, it will be useful to understand the various ways that counterparty exposure can be measured and to look at historical data to explore the degree to which the OTC derivatives market is characterized by counterparty ...