Non-financial companies that use over-the-counter (OTC) derivatives to hedge risks, such as currency, interest rates, and fuel costs, are facing myriad decisions regarding the execution and management of those financial tools under the Dodd-Frank Wall Street Reform and Consumer Protection Act.
While management is still responsible for making the business decisions, under Dodd Frank the board is now charged with some specific oversight responsibilities. The regulatory reform, which is going into effect in phases this year, will lead to changes in business strategy, funding, operations, and accounting related to the use of derivatives.
Derivatives are agreements between a corporation and a bank that derive their value from underlying assets, such as interest rate payments, currency, commodities, stock, or any other financial instruments that can be traded. Meant to manage future uncertainty, derivatives often occur in the form of swaps and futures. The Dodd-Frank reforms, which include SEC and Commodities Futures Trading Commission (CFTC) rules, regulate the swap market. The futures market is already regulated by the CFTC.
Some in the political and regulatory communities perceive derivatives as a key contributor to the 2008 financial crisis. One of the goals of the Dodd-Frank derivatives provisions is to lessen risk and increase stability in the market. This comes with increased compliance, reporting, and recordkeeping requirements, which will lead to increased costs and changes related to the use of derivatives.