Top 10 OTC Derivatives Events of 2013: Regulatory Recap

By Sol Steinberg

Originally published on TABB Forum 

From launching a platform for trading USD swaps, to completing production testing with credit hubs for pre-trade clearing certainty, to celebrating the clearing of an inaugural trade under the new regulations, 2013 continued the momentum in the changing OTC swaps markets. 

10. US Clearing Mandate Phases Take Effect: Affects IRS in USD, GBP, EUR & JPY; CDS for CDX & iTraxx indices. Key dates were March: Swap dealers, MSPs & Active Funds; June: Hedge Funds, Asset Managers & Regional Banks; September: Third Party Investment Managers & ERISA Pension Plans; and October: US branches in foreign locations.

9. Swap Futures Spread: These products continue to capture market attention, whether as a distraction to completing necessary preparations for regulatory changes or as a margin lite alternative offering new hedging opportunities. CME’s DSF traded more than $100 billion in notional in its first year, with more than 40k contracts “delivered”; meanwhile the number of Clearing Members using Eris has more than doubled and OI growth is upward of 250%. One view is that swap futures undermine regulatory goals and do not foster competition – or at least fragment liquidity, being vertical instruments; while the opposite view asserts they are a natural evolution to compliment swaps and shall coexist in harmony.

8. CFTC Commissioner House Cleaning: Jill Sommers stepped down in July, with interdealer-broker EVP Christopher Giancarlo sought as a replacement. Amanda Renteria, a candidate thought to succeed Chairman Gary Gensler, withdrew her name before consideration. Gensler asked not to be renominated for the post in June after having considered the possibility back in March, acknowledging much work remained. Bart Chilton also ended his tenure and was replaced by Sharon Bowen.

7. First FCM Quits US Swaps Clearing Service: BNY Mellon closes clearing doors due to pricing competition to attract clients in an already low to negative margin business, increased capital requirements, and technology costs to comply with operational needs, such as pre-trade risk management.

6. CFTC Skeleton Crew: During the government closure in October, the CFTC shrank personnel from about 680 to 30, with stymying monitoring impacts to the OTC Derivatives market, particularly as new rules began on Day Two of the shutdown. In addition to further delays on rule making and MAT & DCO application reviews, Chairman Gensler actually took to the phones himself to call traders and address issues.

5. Swap Data Repositories Go Live:  Real-time reporting through SDRs such as DTCC’s service (https://rtdata.dtcc.com/gtr/dashboard.do) gleams transparency. Users seek to incorporate this data into valuation processes, mindful of possible duplication in reporting or data field standard differences. The vendor-created SDR View tool aggregates data for easy consumption, and coupled with the CFTC weekly swaps report, publicly displays pricing, activity and terms. One blemish has been the CFTC announcing a swaps market size undercounting in the data up to $55 trillion, to be addressed with a TAC review before MAT determinations.

4. Swap Execution Facilities Arrive: SEF rules were finalized in May calling for impartial access, minimum trading functionality such as RFQ at 2, time delay criteria for trade display, and addressing block protocol. Footnotes 88 & 513 – in addition to five no action relief issuances on reporting – FCM obligations and more were each last-minute confusion points, although participants have until February 2014 to comply with the trading mandate. SEF trading began cautiously, more as testing in October, with about 20 platforms now competing for market share with different products, technology and pricing.

3. Manipulated ISDAFix Broken: In August evidence surfaced that swaption traders colluded with rates traders to benefit from position values before settlement, where brokers profited via commissions by buying/selling as many IRS necessary to move the benchmark rate to the desired level. ISDAFix is set daily in six currencies by bank submissions and is used to value swaptions, determine interest on annuities, performance of structured notes, and borrowing costs on bonds. The measure began renovation in September to be based on electronically traded swaps using firm actionable prices of actual underlying transactions, where the aim is to discontinue the bank submission model within six months.

2. Substituted Compliance: The EU and US devised the Path Forward accord to resolve how trades booked in one jurisdiction would be affected by the other and avoid conflicting regulatory regimes. Announced in July, the deal only partly resolves how swaps rules will apply cross border as fragmented liquidity pools are emerging due to inability of foreign participants to comply with local rules. CFTC determinations for specific jurisdictions continue but may not cover all aspects. Effectiveness of the accord has been questioned as litigation has ensued from ISDA, SIFMA & IIB.

1. The Volcker Rule: Section 619, finalized by the FED, FDIC, OCC, SEC & CFTC, takes effect mid-2015, seeking to eliminate proprietary trading while distinguishing between market making and hedging (which is best performed by “transaction pattern” surveillance). The rule limits how firms can invest in alternative assets, and the ABA may take legal action over the impact to CDOs backed by TruPS. Optimists assert splitting lending from broker-dealer functions may result from the rule.