Buyside attacks OTC clearing proposals
NEW YORK, April 19 (IFR) - Negotiations between the 300 US funds preparing to clear interest-rate and credit default swaps in June, as part of the second wave of the Dodd-Frank clearing mandate for over-the-counter derivatives, are growing increasingly contentious.
Buyside firms are crying foul on an industry clearing document they perceive to be unfair, while dealers are refusing to budge on terms, and predicting that higher clearing fees are inevitable.
The Clearing Addendum, launched in 2010 by the International Swaps and Derivatives Association and Futures Industry Association, provides a template to document the relationship between a clearing member and its customers for clearing over-the-counter swaps.
"The Addendum should have had greater buyside input at the start. Now we are working with a template that puts buyside firms at a disadvantage," said Matthew Kerfoot, a partner at Dechert representing buyside firms involved in the negotiations.
"Buysiders are already struggling with getting their documentation and operational capabilities in order, so being stuck at the negotiating table with a handful of possible FCMs isn't helping," he added, referring to so-called futures commission merchants.
One key sticking point involves a dealer's right to terminate client swap orders or to refuse to fill future orders without giving notice. Dealers also have the right to demand unlimited margin, according to Kerfoot.
If a client were to have its book terminated, it would need to port those trades to another FCM. Robust portability agreements allow for consolidation of swap positions when a buyside firm defaults. But the industry is struggling with making portability a reality.
"FCMs can't simply agree to accept another book of trades without first seeing the trades and understanding the exposure they're taking on," said Michael Dawley, co-head of futures and derivatives clearing at Goldman Sachs. "It's too risky for an FCM to blindly sign on to a blanket porting arrangement with all clients."
Hitches in the negotiations are coming at an inconvenient time. FCMs have been barely turning a profit in providing clearing services mid-way through the first wave of mandated clearing that began on March 11.
Part of the profit constraint comes from a regulatory requirement for FCMs to fund the margin for client positions intraday, and that is leading dealers to consider raising fees or requiring clients to pre-fund trades so FCMs do not have to post their own cash.
It is a development the buyside will hardly welcome with open arms, particularly as internal structures and risk models at FCMs are generally held close to their chests.
"I think it's making it difficult for us that we have so little visibility into clearing member activities and models," said Michele Kunitz, head of the legal regulatory and trading team at Babson Capital Management.
"We are hearing that fees are going up to cover funding gaps and that FCMs need to be provided certain capabilities and leeway to maintain market safety, but we really don't have a sense as to where fees will end up.
With the number of different negotiations, documents, new account setups and regulatory rule-makings and action, it's easy to get overwhelmed."
(This article will be published in the April 20 issue of International Financing Review, a Thomson Reuters publication; www.ifre.com)
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