OpenCRS has posted a report entitled Key Issues in Derivative Reform. According to it, derivatives reform will likely center around two issues:
- Clearing OTC swaps through an independent third party. In the past, big firms were acting as the clearinghouse for their own transactions, which was deemed OK since they were “too big to fail”
- Not burdening the end user of financial derivatives too much — this means keeping derivatives attractive for nonfinancial institutions as a means of hedging business risk.
A good example form the report on how a business uses financial derivatives to hedge risk:
a firm can protect itself against increases in the price of a commodity that it uses in production by entering into a derivative contract that will gain value if the price of the commodity rises. A notable instance of this type of hedging strategy was Southwest Airlines’ derivatives position that allowed it to buy jet fuel at a low fixed price in 2008 when energy prices reached record highs. When used to hedge risk, derivatives can protect businesses (and sometimes their customers as well) from unfavorable price shocks
