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A swap is a contract between two parties promising the exchange of the cash flow of one security for another. The most popular swaps are interest rate swaps, which allow firms to hedge against changes in interest rates. Interest rates swaps can be standardized contracts cleared on exchanges, but there is also a market for over the counter swaps that are not cleared, and it is this market regulators are hoping to make more open through the new rules.
OTC swaps are custom contracts negotiated between two parties, typically a dealer and a client or between two dealers. The dealers tend to be big banks, the clients large corporations like equipment makers Caterpillar or Deere& Co. looking to hedge various risks in their businesses. It is estimated the notional, or face amount, of the securities involved in the OTC swaps market is $300 trillion dollars here in the United States. Part of Dodd-Frank mandates these swaps eventually be cleared on exchanges, but many feared certain products would be classified as swaps, so the vote today clarifies what will, or will not be regulated as one under the new rules.
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