Thursday, June 23, 2011
Gainesville Coins has been receiving a number of inquiries regarding the impact of the Dodd-Frank financial overhaul bill on the silver and gold market. Specifically, we have been asked whether the legislation has any similarity to the U.S. government’s actions in 1933 that removed gold coins from circulation and made it illegal for U.S. citizens to own gold. The Dodd-Frank legislation DOES NOT impact the individual investor’s ability to own gold and silver.
The impact of the Dodd Frank legislation on the precious metals market is to restrict the ability of brokerages from providing investors the ability to trade in over the counter (OTC) futures, including gold and silver futures.
There are two venues to trade derivatives, including futures – the over the counter derivatives market, and the exchange traded derivatives market. Over the counter derivatives are traded off an exchange. For precious metals investors, the CME is the main exchange for gold and silver derivatives, including futures and option. The legislation only impacts those trades that DO NOT occur on an exchange. Futures and options that trade on an exchange are not affected.
In an OTC futures transaction, the buyer and seller enter into an agreement to buy or sell gold at a predetermined price, quantity, and date. The difference between an OTC futures contract and an exchange traded futures contract is that in a OTC transaction, these terms are not standardized. Like exchange traded derivative contracts, OTC contracts have margin requirements set to ensure that both parties will perform on their obligation to either buy or sell. However, unlike exchange traded futures, these transactions are not centrally cleared. This means that a failure to perform by one side of the transaction could result in economic harm to the other side of the transaction. This is known as counterparty risk. Futures traded on an exchange, like the CME, do not subject either party to counterparty risk, and this is the reason for the changes being made through the Dodd Frank legislation.
During the financial crisis of 2008, OTC derivatives, specifically OTC derivatives tied to BBB tranches of subprime mortgages caused a near total financial meltdown when AIG was unable to perform on its obligation. AIG had written hundreds of billions of dollars in OTC credit default swaps on BBB tranches of subprime mortgage securitizations. When these securities went down in value on the housing market implosion, AIG did not have sufficient cash to pay the buyers of this insurance. This is one of the main reasons for the Dodd-Frank Legislation. Because these derivative contracts were over –the-counter, and not centrally cleared, AIG’s failure to perform on its obligation raised the possibility of a cascade of financial failures. The Federal Government was ultimately forced to intervene to stop the financial contagion. Removing the risk of counterparty failure, and thus moving much of the OTC derivatives market onto an exchange, is one of the key drivers behind this legislation.
With all that said, hopefully with some clarity, Gainesville Coins would like to re-iterate that there IS NO IMPACT on individual’s ability to own gold or silver. The only impact is on the ability of an individual to buy gold and silver in the OTC market. There is no change to gold and silver futures traded on an exchange.
Finally, it should be noted that there are exceptions to this legislation. For example, if you can qualify as a Qualified Eligible Participant (QEP), you are exempt from this legislation. For example, to qualify as a QEP, you would need to show a net worth of $1 million in assets. Also if you can prove that you can satisfy the obligations created by an OTC futures transaction within 28 days, you would also be exempt. It is up to each brokerage house to determine whether an individual investor qualifies under these exemptions. As a final note, the Dodd-Frank legislation only impacts leveraged or margined OTC transactions. These changes go into effect on July 15th, 2011.
Read the entire article HERE.