Legal aspects of OTC derivatives : reducing uncertainty through legislative reform

Since their inception in the late 1970s, OTC derivatives have fundamentally changed financing practices in the world. As many Asian "developing" markets like Korea have noticed the advantages of OTC derivatives, they have begun to permit those transactions, at least since the late 1980s. For these latecomers, issues familiar in other "developed" markets have often recurred, and regulators must fix the extent of a proper regulatory approach within their own regulatory traditions. As a general principle, for the proper appreciation of OTC derivatives from a legal perspective, it is crucial to understand two overlapping areas: (1) the relationship between the form and economic substance of each product, and (2) the link between OTC derivatives and "hedged transactions" or "economic positions" of the users. Misunderstanding these critical features leads to overlooking the evolving nature of derivatives in general and overemphasising the risk of OTC derivatives in particular. This Study proposes flexibility and creativity, stability, and global harmonisation as the three pillars of a viable legal framework for OTC derivatives. Firstly, since OTC derivatives exist for their flexibility and creativity in dealing with the particular needs of market participants, legal systems should meet such market needs. Secondly, as OTC derivatives have given rise to substantial concerns about systemic failure, the legal system is responsible for ensuring the availability of contractual devices designed by market participants to protect themselves and (collectively) the financial system itself. Thirdly, any legal response to these products in each jurisdiction should be consistent with that of other jurisdictions. Against this background, this Study concludes that there still remains considerable uncertainty in several areas of the Korean law as it tries to deal with legal issues inherent in OTC derivatives. This Study proposes legislative reform as the best method to reduce such legal uncertainty. This conclusion can also be true of any new financial products in any developing or underdeveloped markets