US in Compromise on Derivatives Trade Rules

By Michael Mackenzie and Gregory Meyer in New York


Commissioners on the US Commodity Futures Trading Commission voted 4 to 1 to pass long-awaited derivatives trading rules on Thursday that preserve voice-based transactions in conjunction with electronic platforms.

The compromise on trading systems is seen as a victory for the established over-the-counter swaps business, which is dominated by global banks and interdealer brokers. It comes after an intense lobbying effort by Wall Street since the Dodd-Frank Act was signed into law nearly three years ago.

The final rules for trading on Swap Execution Facilities, seen as a way to reform OTC derivatives without forcing them on to an exchange, have been watered down from the original proposals made in late 2010 by the CFTC.

Bart Chilton, one of the five CFTC commissioners, said: “What is in front of us today has parts I like, parts I don’t like, that’s what compromise means.”

One key area of contention has been a rule governing how many quotes a customer can request from a bank. The original Sef proposal required customers to submit requests for quotes from at least five others in order to boost competition, but that figure will start at two for an initial period of 12 months, subsequently rising to three.

“Unfortunately, these rules are not as strong as they should be or as they could have been,” said Dennis Kelleher, president of Better Markets, an advocacy group. “Wall Street again got what it wanted: a few loopholes, a few weaknesses and a few ambiguities inserted here and there.”

In contrast, those in the vanguard of running electronic-based Sefs say the CFTC is setting the swaps market on the road towards greater use of computerised trading that will usher in more transparency and break Wall Street’s dominance of this sector.

“Compared to where we were in 2008, this is a huge step towards transparency and competition in the swaps market,” said James Cawley, chief executive at Javelin, an electronic system that plans to register as a Sef. “There is no doubt in my mind that the market is forever changed and will look very different in 18 months’ time.”

Other companies that have signalled an intention to register as a Sef include Bloomberg, MarketAxess and Tradeweb, while Icap and Tradition have set the pace among the interdealer brokers by rolling out platforms ahead of the final rules. Bloomberg is currently suing the CFTC in an effort to equalise margin rules between Sefs and exchanges that plan to trade swap futures.

The outlook for Sefs has changed dramatically since the rules were first proposed. IntercontinentalExchange, which operated an electronic energy swap platform that was a Sef prototype, has since transformed these swaps into futures to let traders avoid the regulatory burdens that come with registering as a major swap participant or dealer.

Another final rule involved transactions of large trades known as blocks that can be reported with a delay to the broader market. The OTC market is renowned for large notional trades in the hundreds of millions of dollars between banks and between banks and institutional investors.

The CFTC also voted for a minimum block size of $460m for two-year swaps, $240m for fives, $170m for 10s and $120m for 30-year contracts. Those block sizes will increase after 12 months.