- The Swaps Marketplace: Pre Dodd Frank Act
Trade Execution
Before Dodd Frank, swap trades were executed bilaterally. Each swap transaction was viewed as a separately negotiated contract through which customers traded with limited choice and visibility. Because of documentation and counterparty credit risk impediments, customers traded with limited visibility and limited access to liquidity. To trade, customers suffered the disadvantage of revealing their name, size and market direction to its counterparty.
Counterparty Risk
Before Dodd Frank, customers had to accept and manage risk of their counterparty. In this inefficient marketplace, customers entered swaps trades, but took on additional risk—that of the default risk of their counterparty. Such bilateralism was governed through ISDA Master Agreements that were expensive and lengthy to negotiate. Because of this, customers were operationally limited to a limited number of execution counterparties with whom they could trade. Additionally, customers had to forgo trade anonymity—an important component of optimal execution.
Result
Before Dodd Frank in the swaps marketplace, customers experienced sub optimal execution and considerable risk. Customers were limited in choice of counterparty that reduced their access to liquidity. Customers also had limited knowledge of and access to optimal prices as they became available. Layering the customer’s exposure to the default of its trade counterparty, the marketplace was not only inefficient but handicapped by significant systemic risk.