CFTC grants last-minute relief on CME commodity swaps

NEW YORK/WASHINGTON Fri Oct 12, 2012 7:46pm EDT

NEW YORK/WASHINGTON (Reuters) - U.S. regulators granted a last-minute reprieve to CME Group Inc and big energy traders on Friday, giving them until the end of the year to convert billions of dollars in commodity swaps to futures contracts.

By saying that a swathe of widely traded energy, metals and agricultural swaps would not be counted toward a threshold triggering costly new regulations until December 31, the Commodity Futures Trading Commission brought relief to big traders like BP and Cargill Inc, which have argued that new rules covering "swap dealers" were meant for banks, not merchants.

The delay, under intense negotiation up to the last moment, also gives the CME more time to revamp its rules so that customers can conduct their trades as "futures" contracts, not swaps, making them exempt from a key measure of big dealers. Rules requiring traders to tally swaps take effect from Monday.

Rival IntercontinentalExchange Inc had announced months ago that all its contracts would automatically convert to futures by the deadline. But the CME's transition was less certain, as many of its contracts are first agreed in the over-the-counter market as bilateral "contingent swaps" before being converted to futures on its Clearport platform.

In the past, the "swaps" market was distinguished from the highly regulated futures market because trades were typically conducted bilaterally, prices were opaque and regulation was almost nonexistent.

But under the Dodd-Frank financial overhaul, "swap" contracts will fall under significant new regulations, which some critics say now make them even more onerous to trade than futures contracts.

While the industry is likely to welcome the delay, the fact that it was announced at the 11th hour may intensify criticism that CFTC Chairman Gary Gensler is moving too fast with the reforms, creating more confusion than clarity.

"We brace ourselves for the results of new regulations meant to bring transparency to the market that have in reality brought confusion, concern and do not inspire confidence in the CFTC's leadership," U.S. Sen. Pat Roberts, ranking Republican of the Senate agricultural committee, said in a statement, calling for Agriculture Committee hearings on the agency's leadership.

At least one CFTC commissioner, Scott O'Malia, agreed with that criticism.

"The fact that market participants are fleeing the Commission's swap regulations is proof that the Commission has not developed clear and cost-effective rules," O'Malia said in a statement. Noting that the CFTC has had to issue several other special reprieves from deadlines, O'Malia added, "The Commission should never have gotten to the point where it was forced to issue such last-minute piecemeal relief."

For ICE and CME, the stakes for getting it right are substantial. Over-the-counter energy clearing generated about $400 million or 30 percent of ICE's revenue last year, and about $300 million, or 9 percent of the CME's.

SWAPS TO FUTURES

The 2010 Dodd-Frank Wall Street overhaul law empowered the CFTC and the Securities and Exchange Commission jointly to police the $648 trillion over-the-counter market.

A key pillar of the law requires companies that make markets in swaps to register, hold additional capital and post collateral to back their trades.

Industry players have been waiting for more clarity from the CFTC on how to determine whether they meet the definition of a "swap dealer." Under rules approved in April, most companies will be deemed dealers if they trade more than $8 billion of swaps in a 12-month period.

Also on Friday the CFTC said it would give energy firms that deal in swaps with public utilities more time to comply with requirements that any such firm that trades more than $25 million in swaps must register as a dealer. In addition, the CFTC late Friday issued a broader temporary exemption on how all energy, agricultural and metal swaps are counted toward the swap dealer threshold.

In economic terms, the switch from a swap to a future is wholly semantic - the new "futures" contracts are identical to the swaps. But by converting their trades into futures, some big traders could fall below the $8 billion threshold and avoid the new rules.

The CFTC said it believed the delay was warranted "in order to provide participants in the market ... sufficient time to determine whether and in what manner to transition those swap activities to similar products in the futures markets that will become available in the near future, and to enable any such transition to proceed in an orderly manner".

Separately, the CME gave new details on how it will build out its long-successful Clearport business model, which allows traders to clear swaps deals as futures contracts, to one where the contracts will trade as futures from the get-go.

It will withdraw a proposal it had made last month that would allow customers to trade off-exchange futures contracts in unlimited size for certain illiquid markets, called 9(B)iii trade types, essentially mimicking swaps deals.

But it will press ahead with a plan for lower block-trade thresholds from next week, which will allow customers to negotiate bigger deals as off-exchange futures trades. Such limits are typically set at higher levels for the most established, liquid futures contracts.

(Reporting by Jonathan Leff in New York, Sarah N. Lynch, Emily Stephenson and Aruna Viswanatha in Washington, Ann Saphir in Chicago; editing by Gerald E. McCormick, Dale Hudson, Bernard Orr, Matthew Lewis and Sofina Mirza-Reid)

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