Big Five disconnect affiliates to avoid SEFs

Fri Feb 14, 2014 4:15pm EST

NEW YORK, Feb 14 (IFR) - The Big Five US banks are in the process of removing parent entity guarantees for their London-based affiliates for all interdealer swaps trades, in an effort to sidestep onerous Dodd-Frank provisions set to go into effect this weekend.

Goldman Sachs, JP Morgan, Morgan Stanley, Bank of America Merrill Lynch and Citigroup are all taking steps to remove the parent guarantees, according to high-level legal officials at two of the five banks and an interdealer broker that services the firms.

The officials said these steps are considered legal and above board by US regulators, which have mandated swaps trading on electronic exchanges known as swap execution facilities from February 15.

The banks are removing the guarantees to ensure their European affiliates can continue to trade with European dealers without getting caught by the SEF mandate - a move that could potentially exacerbate the bifurcation of liquidity in the swaps market.

"At the moment the push is still for banks to move non-US activity offshore," said the interdealer broker executive. "The rationale is they don't like SEFs."

Rates swaps in benchmark maturities across euros, US dollars, and sterling will be mandated for SEF trading starting this weekend. The shift comes amid widespread concerns about the impact on interdealer swaps trading that occurs outside the US.

Recently published agency guidance on the reach of the Dodd-Frank rules into other legal jurisdictions was helpful for providing clarity, according to market participants. However, the guidance stopped short of granting banks the relief they were hoping for leading up to the mandate regarding foreign affiliates having permission to trade off-SEF.

None of this will affect credit ratings or the affiliates' standing with clients, according to one of the bank lawyers, who confirmed the affiliates will still maintain the parent entity guarantee when transacting with clients.

In the interdealer market, counterparty creditworthiness tends to be determined by internal analysis and so the move is not expected to alter the firms' standing with other dealers in Europe, according to the lawyer.

The disconnection of the entities from one another will likely cause further bifurcation in the swaps market, as dealers assume the SEF mandate will lead to separate euro-centric and US-centric liquidity pools.

"My guess is we will end up with possibly a London US dollar interest rate market and a New York US dollar market," said the broker. "The euro and sterling markets will likely be London-centric, because there isn't enough liquidity in those two to have a two-tiered market."

Bifurcation of liquidity as a result of Dodd-Frank has been a subject of debate in the market for several years, and just last month ISDA released a report stating that euro and US dollar interest rate swaps markets were beginning to fragment.

Spokespeople at all five banks declined to comment.

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