Regulating Derivatives

MotivationIn recent years, derivatives have developed with an unbelievable speed thanks to the needs of financial market and to the innovation of high technology. Not only the volume of derivative transactions have increased greatly, but derivatives have been used in a much wider scope and the innovations of derivatives make any attempt to list the types of derivatives look ridiculous. Since the time that derivatives entered the modern financial market, they have been closely associated with "risks", producing risks or hedging risks. Regulating derivatives is part of the effort to regulate the overall financial activities. However, due to the special characteristics of derivatives and the crisis caused by them, many states have strengthened their efforts on special legislation regarding regulating derivatives. At the same time, international co-operation and co-ordination in this field have continued to make some progress. This article aims to introduce and discuss to some extent the regulatory frameworks and measures with respect to derivatives in western states, and at the same time, to give some preliminary suggestions to the regulatory framework in China on the basis of an analysis of the current regulatory reality. In addition, this article may to some extent help some people clarify or correct some vague or even wrong understanding/ viewpoints of derivatives and the regulation of them.Method of ResearchThe paper resorts to normative analysis. The research of the regulation of derivatives in the United States as well as at the international level lays the basis for the analysis of the current situation of the regulation of derivatives in China. The conclusions of the paper is built on combining the advanced experience of foreign countries with the unique features of the current situation in China.Contents and ConclusionThe main body of the thesis consists of five chapters.Chapter One gives a brief introduction to derivatives. Derivatives may be defined as instruments deriving from some underlying instruments. They can be classified into exchange derivatives/over-the-counter derivatives or forwards/options. Now swaps (further classified into interest rate swaps and foreign exchange swaps) have become more and more important among all types of derivatives. Not only end users but also dealers can derive various benefits from the use of derivatives. The risks of derivatives, which have scared many people, are actually no difference compared with other financial instruments as far as the types of risks are concerned, i.e., credit risk, market risk, operating risk and legal risk. However, derivatives risk management for banks proves to be very difficult due to the complex nature of derivatives and the difficulties in measuring these risks (credit risk in particular).The United States leads the world in both the use of derivatives and their regulation. Chapter Two gives an introduction to and further analyses the regulatory framework and conflicting viewpoints regarding derivatives in the United States. The United States does not have uniform legislation over the regulation of derivatives and the regulation has been realized by means of regulating various financial institutions that are active derivative dealers. The majority of the dealers are bank and their affiliates, securities firms and their affiliates and insurance companies and their affiliates. Accordingly, authorities responsible for the regulation of derivatives include bank regulators, securities regulators and insurance regulators. However, the regulatory responsibilities and measures are inconsistent among the regulators. Consequently, the regulatory requirements are different for the same type of derivatives. This situation has aroused the attention of the regulatory authorities. The last part of this chapter provides a discussion of the conflicting views on derivatives between government authorities and the academy --- strengthening the regulation v. maintaining status quo.The extensive and intensive...