Henry T. C. Hu

Misunderstood Derivatives: The Causes of Informational Failure and the Promise of Regulatory Incrementalism

* Founder of the Journal of Portfolio Management and investment advisor. t Marrs McLean Professor in Law and Associate Dean for Academic Affairs, School of Law, University of Texas at Austin. B.S. 1975, M.A. 1976, J.D. 1979, Yale University. I have benefited substantially from the suggestions of or discussions with Mark Gergen, Sten Gustafson, Robert Hamilton, Douglas Laycock, Richard Markovits, Bruce Neel, Charles Silver, and Jay Westbrook. I also wish to thank David Gunn, Burt Martin, Rosser Newton, Joseph Perez, Jon Pratter, and David Pryor for invaluable library and research assistance, and the Exxon Education Foundation and the University of Texas Law School Foundation for financial support. Unless expressly indicated otherwise, this work speaks as of January 1, 1993.

Swaps, the Modern Process of Financial Innovation and the Vulnerability of a Regulatory Paradigm

FINANCIAL INNOVATION PROCESS ............................... 335 I. THE SWAP AND THE SWAP DEALER: BASIC CONCEPTS ..... 346 A. The Swap as an Exchange of Cash Flows ............... 347 1. The Interest Rate Swap ........................ 347 2. The Currency Swap ........................... 353 B. The Swap Dealer ................................... 354 1. Role .......................................... 354 2. Risks for the Swap Dealer ...................... 358 II. MODEL TWINS: THE SWAP AND THE BIS ACCORD ......... 363 A. Swaps: Uses and Growth ............................. 363 B. The BIS Accord and the New Generation of Financial Regulation ......................................... 366 1. The Rationale for Regulation .................. 366 2. Constraints on Unilateral Intervention and the Emergence of the BIS Accord .................. 370