WASHINGTON The U.S. futures regulator unveiled on Wednesday a key piece of its plan to toughen rules on trading in the vast swaps market, making clearer which firms will have to set aside more funds to cover their deals.
After last-minute wrangling that underscored the strain facing agencies trying to implement the biggest financial regulatory overhaul since the Great Depression, the proposal defined who will be subject to capital and margin requirements as swap dealers and major swaps participants.
The chairman of the Commodity Futures Trading Commission stressed that the rules were not intended to apply to many commercial companies beyond the big banks that are the main target of the crackdown.
"It's not our intent to capture end users in the swap dealer definition," Gary Gensler told a public hearing, where he also got the agency's general counsel Dan Berkovitz to clarify that only "two handfuls" of firms would be deemed major swaps participants.
High-frequency trading firms that play a market-making role could be deemed swaps dealers, Berkovitz said.
Two of the five top CFTC officials immediately raised red flags that the net would be too broad, and voted against the plan.
"I have concerns that many end-users will be unintentionally swept up in the dealer definition and be subject to significantly higher costs to hedge their commercial risk," said Commissioner Scott O'Malia, a Republican who once worked as a risk officer in the utilities sector.
On Tuesday evening it had been unclear whether the agency could unveil the rule at its scheduled meeting -- the latest sign that the underfunded CFTC was struggling with timelines on key regulations amid intense lobbying from Wall Street banks and U.S. corporations that use swaps to manage risk.
The CFTC must agree on the rule with the five-member U.S. Securities and Exchange Commission, slated to take up the proposal at a Friday hearing.
Lawyers worked on the draft beyond midnight, but Gensler stressed the two agencies were working collaboratively.
"There are times that we disagree -- you could probably if you were very clever look through this document and figure out through questions and footnotes where some of the disagreements are," Gensler said.
The CFTC will accept public comments for 60 days before finalizing the proposal by July, which will require another vote by commissioners from both agencies.
The ambitious deadline was set by Congress for its overhaul of the $600 trillion over-the-counter swaps market, a key part of Dodd-Frank financial reforms.
LOBBYING ON THRESHOLDS
In recent months, the CFTC has faced lobbying by companies ranging from Morgan Stanley to fund BlackRock to power utility Exelon that argued they should not be required to tie up additional capital unnecessarily.
The rules, which effectively divide those who trade swaps into three categories with tiered regulation, are intended to limit systemic risk stemming from the heavy concentration among a handful of big participants.
JPMorgan, Bank of America, Goldman Sachs, Citigroup and Morgan Stanley together held about $171 trillion in over-the-counter swaps at mid-year, more than 95 percent of the market, data shows.
But many commercial companies and big hedge funds hold the other side of those positions, either to manage their own risk or speculate on prices, and fear being saddled with bank-like capital requirements that would increase their costs.
The proposal set out several exemptions to the rule defining a "swap dealer", the top, most heavily regulated tier of participant, including a $100 million maximum notional swap holding and a maximum 15 counterparties.
It said the definition of a mid-tier "major swap participant" would exclude swaps traded to hedge commercial risk, including prices, foreign exchange and interest rates.
The definition would test firms' current and future uncollateralized risk exposure in credit, equity and other commodity swaps. It has an even stricter test for firms viewed as having enough risk exposure through swaps potentially to threaten the stability of the U.S. financial system.
DOES THE RULE STRIKE A BALANCE?
Some thought the CFTC would be careful not to capture too many players.
"I doubt if the definition will be too broad, because those that are captured by the definition will be subject to a lot of regulations at that point," said Neela Gollapudi, interest rate strategist at Citigroup Research in New York.
"Any market impact will happen gradually," Gollapudi said.
But other analysts said the limits were too tight.
"My opinion is that this is an extraordinarily low bar that is not realistic within the confines of the market," said Dennis Rosenfeld, president of Quantitative Interest Applications Inc, a financial risk management advisor in Bainbridge Island, Washington.
Gensler tried to alleviate concerns, saying he believed new margin requirements, still to be proposed at a hearing in the New Year, should focus on uncleared swaps between financial entities, not swaps with end-users.
He said the CFTC, the SEC and the Federal Reserve would hold a meeting with industry on capital and margin requirements on December 10.
(Additional reporting by Rachelle Younglai, Ayesha Rascoe, Elinor Comlay, Richard Leong, Joshua Schneyer; Editing by Russell Blinch and Dale Hudson)