By Douwe Miedema
WASHINGTON Dec 20 On Monday, Oct. 15, top U.S.
derivatives regulator Gary Gensler watched a mock ceremony to
mark the start of a broad overhaul of the swaps industry that
started that day.
In a conference room at the Commodity Futures Trading
Commission (CFTC), two senior staff members cut a white ribbon
hanging over a copy of the 2010 Dodd-Frank act.
Yet the preceding Friday, the agency had slipped through a
batch of letters to grant exceptions to the rules it was now
The last-minute changes, critics say, were a telling sign of
the overly aggressive way in which Gensler - himself a former
Goldman Sachs banker - is tackling the post-crisis
clean-up of Wall Street.
The agency's staff has sent out more than 50 letters
granting temporary reprieve from the rules after industry
complaints this year.
So far the CFTC has completed two-thirds of the rules
Congress told it to write to revamp a swaps markets blamed for
exacerbating the 2008 financial crisis. The clampdown may make
the business far less lucrative for the large investment banks
that dominate it.
What remains to be done - rules that govern swap trading
platforms, safety buffers for uncleared swaps, and guidance on
how the agency's rules apply abroad - are the final building
blocks that need to be put in place in coming months.
A failure to complete the process in a smooth and timely
fashion could drive away investors already worried the
watchdog's clampdown will make swaps more expensive to use.
"By any measure, (the CFTC) has really done a terrific job,
under incredibly adverse circumstances," said Dennis Kelleher,
who heads Better Markets, a Washington-based group advocating
tougher rules for the financial industry.
A groundswell of discontent about the CFTC's handling of the
rules was only to be expected, he said, as the $650 trillion
derivatives industry - largely in use by financial speculators -
is being regulated for the first time.
"(In) every part of the process ... we've seen Wall Street
use its unlimited resources to either kill, cut or loophole
first the law, and then the regulations," Kelleher said.
At around $200 million, and only slowly rising over the past
years, the CFTC's budget has not kept up with the its vastly
expanded powers over the swaps market, eight times the size of
the futures market it already oversaw.
The U.S. financial industry equally spent hundreds of
millions of dollars on lobbying Washington to put more
business-friendly measures in place in each of the past two
years, according to research group Open Secrets.
The stakes for the industry are high. Wholesale derivative
brokers such as ICAP, Tullett Prebon, GFI
- which arrange deals between banks - are in the dark
about what business will look like.
They plan to set up swaps trading platforms - called Swap
Execution Facilities, or SEFs - a key prong in the Dodd-Frank
law to end the practice of bilaterally agreed deals between
brokers for their clients over the phone.
"We would prefer to see the (rules) finalised and move
forward," MarketAxess Chief Executive Rick McVey told Reuters.
"All of us have now been investing lots of money for two years
to be a SEF and we still don't have certainty."
The rough outlines of the rules are clear, but details such
as how much dealing can still take place over the phone, and
below which threshold swaps need to delist are crucial in
determining how profitable the business will be.
Investment banks such as JPMorgan, Bank of America
, Citi and Goldman Sachs are keenly awaiting
another decision, which will determine how profitable swaps
trading is for these big derivative houses.
Together with a host of bank regulators, the CFTC is
determining how much safety margin swap traders will need to put
up to protect against counterparty default, something that is
likely to raise the cost for such deals.
Banks are worried that investors will start using contracts
such as futures if swaps trading becomes too expensive. Futures
can be used much in the same way as swaps, but the banks say
they are less sophisticated.
CHALLENGED IN COURT
An even thornier issue is how the CFTC's rules apply to
banks abroad. In July, the CFTC issued an order that drew anger
from European and Asian regulators, who blamed the regulator for
encroaching on their territory.
Two commissioners said last week they hoped to finalise the
order this year, possibly easing the rules for foreign dealers.
With only a few days left before the Christmas holiday, it's
another big outstanding task.
And even if the CFTC succeeds in putting out the order, it
is unlikely to include the issue of how it relies on foreign
regulators, which could determine how much business foreign
banks can do with U.S. rivals.
The CFTC is also fighting industry challenges in court. Last
week, it booked a legal victory against the mutual funds
industry when a judge ruled in favour of a rule two trade groups
had sought to overturn.
It is still appealing a September court ruling that threw
out a rule to curb speculation in commodity markets by capping
trading positions to a maximum limit. At the same time, it is
drawing up a new rule, should the appeal fail.
With those bits of the business unfinished, lawyers will
remain busy telling clients which rules to comply with for
several more months. But even they admit that the CFTC's job was
a formidable one from the beginning.
"I understand that regulators make the point it's very
difficult," said Anna Pinedo, a partner at law firm Morrison
Foerster in New York. "You've got a market that is huge, that's
international and that grew up without regulation."