Hang Up the Phone, Swaps Traders

By Scott Patterson

 

WASHINGTON—Swaps trading is one the last bastions of Wall Street where brokers arrange deals over the phone.  That clubby way of doing business could go the way of the rest of Wall Street, where trading takes place on computers, under a roughly 500-page draft set of rules designed to push the market away from the opaque world of over-the-counter, phone-based trading, into more transparent electronic venues.

The thinking: Open markets are safer, cheaper and less prone to manipulation.

The rules, circulated Thursday at the Commodity Futures Trading Commission, lay out guidelines for so-called swaps execution facilities, or SEFs, the electronic trading venues for swaps mandated by the Dodd-Frank financial overhaul of 2010.

Originally proposed in early 2011, the final version of the rules have been widely anticipated by bankers, brokers and traders who dominate the multitrillion dollar market for swaps, complex contracts in which firms "swap" the returns on assets such as currencies, energy products and interest rates.

Among the most contentious parts: the so-called 15-second rule, which requires firms that have negotiated a trade between two parties to post the trade on a SEF for 15 seconds before executing it and giving other market players the chance to offer a potentially better deal.

That could keep brokers from doing many trades over the phone, which is how much swaps trading is done today, without exposing the deals to the rest of the market.  As it stands, the rules are certain to meet opposition from swaps-trading firms whose business could be threatened. Industry players, from giant banks to global brokerage firms, have lobbied heavily to water down the SEF rules for more than two years.

The original SEF proposal sparked a firestorm of industry complaints. The final rules will be reviewed by CFTC board members, who could potentially vote on it at a Nov. 15 meeting. The rules are subject to negotiation and the final version could be different from what the agency proposed this week.

Several commissioners have expressed concerns about how the 15-second rule works and whether it is fair to investors. The rules aren't set to take effect until 2013.

Backers of the 15-second rule say it gives other trading firms the ability to post more competitive bids and offers, making the swaps cheaper to trade and prices more transparent.

But brokers who currently execute trades between large swaps dealers say the requirement would harm the market for derivatives. Firms might be reluctant to post competitive orders that others could jump in front of. The 15-second rule "will create uncertainty and risk in the swaps market," Chris Giancarlo, executive vice president of the brokerage firmGFI Group Inc, told a congressional panel on swaps rules in October 2011.

CFTC Chairman Gary Gensler has argued that the SEF rules will make the market for swaps operate more like the futures market, where most trades take place electronically.

What's more, not all swaps trades will fall under the 15-second rule. Brokers receiving a call from a client won't have to post the order on a SEF to do the trade if they phone five separate firms to fill the order, according to a person familiar with the rule.

While many market participants will push back against the rules, others are taking advantage of what they see as an opportunity to break into one of the biggest markets in the world, long dominated by a select group of firms.

Already, roughly 30 firms have said that they plan to offer a SEF, according to Tabb Group. One firm that is cobbling together a SEF, Javelin Capital Markets, was launched in 2009 by James Cawley, a veteran of the derivatives markets. Operating out of a spare 10th floor office in midtown Manhattan, Javelin already has signed up a list of big clients and dealers who will be able to post orders on Javelin's trading venue. Mr. Cawley says SEFs are "the future of the swaps market."

Not everyone agrees. Big brokers that dominate swaps trading say that many deals are so big that any attempt to execute a trade in the open will result in a major price move, damaging customers and the market and discouraging trading. Brokers often execute swaps trades to the tune of tens of millions, if not hundreds of millions, of dollars at a time.