WASHINGTON Wall Street banks and Chicago commodity traders on Thursday traded blows before the top U.S. derivatives regulator on whether new rules for swaps unduly favor one or the other of the two groups.
The Commodity Futures Trading Commission is drawing up rules for swaps, which are speculative financial instruments that were unregulated at the time of the 2007-09 crisis and were widely blamed for exacerbating it.
Investment banks, which dominate the $650 trillion swaps market, worry clients will stop using swaps and turn to futures instead because while similar, the new rules have made futures cheaper.
But at a public hearing, CFTC Chairman Gary Gensler, a Democrat, did not seem overly concerned that rules being written by the regulatory staff will bring about changes in financial markets.
"Approximately eight-ninths of the derivatives market place (is) swaps and until recently was unregulated. Now we bring regulation to both sides, is it not just natural there might be some realignment?" said Gensler.
He addressed a full room that included many industry representatives, while others watched the debate on screens in an adjacent corridor, underscoring the wide interest.
Swaps are often traded over the phone in bilateral deals, with a small group of so-called dealers, including Citigroup, Bank of America and JPMorgan Chase & Co having the vast majority of the market.
These banks often trade with each other through brokers such as ICAP and Tullett Prebon, who are outspoken critics of the CFTC's rules.
FUTURE OF SWAPS
Under the CFTC's new rules required by the Dodd-Frank law overhauling the financial industry, trading needs to move to exchange-like platforms, with clearing houses standing between buyers and sellers, and data must be reported publicly.
One of the topics under debate is the bigger amount of collateral, or margin, that market parties need to set aside as safety buffers when trading swaps.
Futures and options have a one-day margin period, which means that counterparties ask for enough collateral to be set aside to withstand one day of market swings.
For cleared swaps, the margin requirement is five times as high and for uncleared swaps, it is 10 days, making these instruments far more costly to trade.
It is also easier to delay data reporting in futures than it is for swaps through so-called large block trades. These may be hidden from sight for some time, allowing market parties to trade without showing their hand.
Ironically, swap industry participants, whose markets have long been unregulated, have now started to say that with tougher rules for swaps, a flight into futures would mean less strict regulation and could lead to increased risks to the financial system.
Such remarks did not go down well with representatives of the futures industry.
The suggestion that futures are less regulated "is just unacceptable to have to listen to," said an agitated-sounding Bryan Durkin, chief operating officer at CME, the world's largest futures exchange.
CFTC Commissioner Bart Chilton concurred, saying swaps had been at the center of the worst financial crisis since the 1930s.
"It's not all bad that some of these swaps are becoming futures... Swaps were part of the problem and so it doesn't bother me that we see some of the futurisation," Chilton said, speaking to the conference over the phone.
Half of the respondents in a recent study by UBS said they were more likely to use futures instead of swaps because of the new rules, up from just 18 percent in the previous study in March 2011.
In October, the IntercontinentalExchange changed its energy swaps products to futures to avoid the increased regulatory burden.
Futures exchanges, such as the CME Group, and much-smaller rival Eris Exchange have launched products that promise the same features as swaps at a far lower cost, stepping into the opportunity created by the new rules.
The meeting is timely because the CFTC is finalizing rules for exchange-like trading platforms for swaps - known as Swap Execution Facilities - the details of which will determine how costly swaps trading is.
"It's critical that we complete these rules. The commission is close to that, and hopefully we can do that in February," Gensler told the meeting.
(Reporting by Douwe Miedema; editing by Sofina Mirza-Reid and Kenneth Barry)