Regulatory Uncertainty Still Dominates Swaps

By Sol Steinberg, OTC Partners

Originally published on TABB Forum

Regulators continue to struggle to revamp the OTC swaps space, leaving the industry uncertain of the final rules. Here’s perspective on some of the top stories shaping the industry outlook.

Regulations remain top concerns in the OTC space as regulators wrestle with issues such as cross-border recognition of clearinghouses, margining requirements for uncleared swaps, and whether requiring banks to separate certain swaps trading functions from banking operations will help reduce risk. The ongoing debate on various regulatory issues underscores how many of the regulations that will govern OTC swaps still remain unresolved.

The unfinished regulatory landscape is one reason for the continued interest in swaps trading volumes. It has been hard to chart a clear picture of the size of the industry post-Dodd-Frank. Conflicting reports from dealers that have either cut or grown their derivatives holdings, and irregular volumes from swaps trading facilities indicate the post-regulatory OTC swaps market is still taking shape.

SEF volumes rising from summer months.

Interest rate swaps trading volumes on swaps execution facilities (SEFs) dipped during July and August, according to TABB Group. But at least one major SEF indicates that the summer lull may be over. Over the summer, total notional volume traded on-SEF for cleared interest rate swaps dropped 26 percent, from $2.67 trillion in June to $1.98 trillion in August, according to TABB analyst Colby Jenkins.

Meanwhile, Tradeweb indicates that the month of September started strong. More than 110 institutional derivatives trading clients executed more than $230 billion of global interest swaps on its request-based SEF in the first two weeks of September. Tradeweb’s September figures represent a 20-fold increase from October of last year, the company says.

Massad is hopeful that dual recognition of clearinghouses with the EU will win approval.

Commodity Futures Trading Commission chairman Tim Massad says the agency is nearing an agreement with European regulators on the issue of cross-border recognition of clearinghouses. The CFTC is finalizing the steps for an “equivalent system” for recognition of swaps clearinghouses in Europe, Massad said during his opening statement for the first CFTC open meeting since he took office. These are the final legal steps necessary for European recognition of US clearinghouses under the “dual registration” structure. If the U.S. is not granted equivalence by Dec. 15, European banks that are members of U.S. clearinghouses will be subject to much higher capital requirements, which may cause some of them to pull back from U.S. markets.

The CFTC approved two rules at its September open meeting, one related to hedging for small utilities and another related to margin requirements for uncleared swaps. The first rule allowed small and government-owned utilities to transact swaps and other hedging transactions with counterparties who might not be registered dealers. This was to allow them to hedge energy prices without unduly burdening their businesses. The agency also passed a rule requiring swaps dealers and major swaps participants to post and collect margin in bilateral swaps trades they engage in with each other that aren’t centrally cleared.

Judge dismisses cross-border rules suit filed against CFTC by SIFMA and others .

U.S. District Court Judge Paul Friedman last week dismissed a lawsuit challenging the CFTC’s cross-border guidance. While dismissing the case, Judge Friedman ordered the CFTC to assess and provide a reasoned explanation of the costs and benefits of its cross-border swaps dealer registration requirements, record-keeping rules and other cross-border regulations. Judge Friedman said the CFTC’s errors were of form, not substance.

The suit had been filed in December by the Securities Industry and Financial Markets Association (SIFA), the International Swaps and Derivatives Association (ISDA) and the Institute of International Bankers (IIB). CFTC Chairman Tim Massad praised the ruling, saying it “rejected a sweeping injunction of the rules that are at the heart of Dodd-Frank’s overhaul of the swaps markets.”

Citigroup outpaces rivals in growth of derivatives.

Citigroup has grown its derivatives holdings by 69 percent over the past five years, Bloomberg News is reporting. At the end of June, Citigroup had $62 trillion of open derivatives contracts, up from $37 trillion in June 2009. The growth of derivatives instruments that the government has tried to regulate and reign in since the financial crisis puts Citigroup on a different track compared to its rivals. During that same period, JPMorgan trimmed derivatives programs 14 percent, to $68 trillion; Goldman Sachs grew its holdings by 13 percent, to $58 million; and in aggregate the top 25 firms with the largest derivatives holdings reduced the gross notional value of their contracts to $297 trillion at the end of March, from a peak of $333 trillion in mid-2011. Most of the Citigroup’s derivatives are in interest-rate swaps, and it has amassed the largest stockpile of interest rate swaps.  Bank officials say that the growth is due to client demand.

Regulators may delay until mid-2016 rules requiring banks to separate swaps unit

Banks may win another year-long delay to the deadline by which they must separate some of their swaps trading out of the banks. The Dodd-Frank Act requires banks to move certain equity, commodity and non-cleared swaps outside of bank units that have deposit insurance and access to the Federal Reserve’s discount window. The deadline, currently set for July 2015, may be pushed back to July 2016.

The rule originally applied to more types of derivatives, including interest rate swaps, but was scaled back so that the large interest rate swaps market no longer has to be separated out. Banks emjoy huge cost and margin advantages by keeping the swaps trading in the bank, but regulators in favor or the rule believe separating out these functions will make banks safer.  

More perspective on Alibaba’s IPO

When Alibaba’s stock opened at $92.70 per share, putting its market cap at more than $228 billion, it officially became the largest IPO in US stock market history. FactSet’s John Butters put it in more perspective: “Based on yesterday’s closing prices for the companies in the S&P 500, Alibaba would be one of the largest 15 companies in the S&P 500 by market capitalization,” he said. “It would rank 12 in the index overall, ahead of companies in more ‘traditional’ industries such as Pfizer ($193.9 billion), IBM ($193.3 billion), and Coca-Cola ($183.3 billion).”