Overview

The regulation of the over-the-counter derivatives market required by the recently enacted regulatory reform legislation has received a great deal of attention, both because of the size and importance of the derivatives market generally and the complexity and breadth of the requirements that will be imposed.

However, other less-discussed provisions of the legislation impose additional restrictions by treating derivatives as extensions of credit by a bank where the bank is subject to counterparty credit risk. Those provisions will require banks, and in some cases their affiliates, to calculate and limit the total amount of credit exposure to any one counterparty based on derivatives transactions and a number of other types of transactions.

Related changes will affect the treatment of derivatives with private equity and hedge funds advised or sponsored by banking organizations. When effective, these changes will likely require significant revisions to banking organizations’ risk management systems for derivatives in particular, and credit exposures generally, and might result in a decrease in derivative volumes over time. This client memorandum outlines these changes, which go into effect in stages over the next few years.

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