WASHINGTON (Reuters) - Big banks won key concessions in the battle over who dominates the $630 trillion derivatives markets as the top U.S. regulator adopted watered-down rules to bring swaps onto exchange-like trading platforms.
The rules constitute a compromise that critics say means supervisors have fewer tools in hand to rein in the opaque derivatives trading between two parties that was among the causes of the 2007-2009 credit meltdown.
They are part of a global crackdown on financial markets, aimed at increasing transparency by making prices visible to more than just the two trade counterparties and give regulators more grip on the vast trading activities.
The five members of the Commodity Futures Trading Commission had struggled for months to agree on the rules as banks lobbied fiercely to keep the changes to their profitable business as small as possible.
“While the rules finalized today have some important reforms, they were also needlessly weakened in key areas,” said Dennis Kelleher, who heads Better Markets, a lobby group for greater transparency in financial markets.
The rules set standards for new platforms to trade swaps called Swap Execution Facilities (SEF), designed to make trading less opaque as part of the Dodd-Frank law overhauling Wall Street practices, using lessons learned from the crisis.
The Dodd-Frank law of 2010 threatens one of banks’ most profitable businesses worth billions of dollars in revenues each year, and is expected to lower prices for bank clients, such as investors and hedge funds.
The SEF rules are one of the CFTC’s last remaining building blocks in implementing Dodd-Frank, triggering rising speculation that Chairman Gary Gensler - whose term expires at the end of the year - could soon leave the agency.
Only Republican Commissioner Jill Sommers voted against the SEF rule, though two other related rules were adopted on 3-2 splits, with the Democrats in the majority.
In a sign of how fundamental the changes for the industry are despite the compromises, the Securities Industry and Financial Markets Association (SIFMA), an investment banking lobby, said it “strongly disagreed” with the commission’s rules.
“(We) believe as drafted (the rules) will negatively impact investors and hinder the ability of American businesses to manage risk contrary to intent,” SIFMA head Kenneth Bentsen said in an emailed statement.
The swaps market had modest beginnings in the 1980s, offering companies risk management tools but rapidly started to attract speculators, causing it to mushroom out of regulators’ ability to oversee in the following decades.
(Graphic with key metrics of the swaps market: link.reuters.com/beh28t)
In an important nod to an industry dominated by big banks, such as Citigroup Inc, Bank of America Corp and JPMorgan Chase & Co, the CFTC lowered the number of quotes clients need to collect from banks.
Firms such as Blackrock and Fidelity as well as hedge funds will have to speak to three banks before entering into a swap, which will put an end to bilateral trading but is less onerous than the number of five proposed earlier.
The outcome was a “massive convenience” for the largest banks, said Will Rhodes, an analyst at Tabb Group, a market structure research and consultancy firm.
“I don’t think it’s going to have the same impact in terms of ... the decentralization of risk that would have occurred had there been a requirement (for five quotes) in place.”
Critics of the industry say the lower the number, the smaller the move away from bilateral trading.
The rules will also allow banks to continue to negotiate deals over the phone, a practice critics say is hard to monitor.
Derivative brokers such as ICAP Plc, GFI Group Inc and Tullett Prebon Plc, which sign up for the bulk of trading between banks, had lobbied hard to retain so-called voice-broking, the core of their business.
The interdealer brokers have all announced plans to set up a SEF, but there is also a host of new entrants, such as Bloomberg LP, TradeWeb, which is majority-owned by Thomson Reuters, and MarketAxess.
The debate about the request-for-quote, or RFQ, trading system has been the subject of a fierce debate in the commission, with Gensler sticking to a minimum of five and the other commissioners pushing for a lower number.
Even Gensler’s fellow Democrats - Bart Chilton and Mark Wetjen - disagreed with Gensler’s tough line, and the debate had delayed the vote for months. The fact that the final vote was split makes it susceptible to legal challenges.
Wetjen is seen as the possible next chairman of the CFTC should Gensler leave, but a perception among the political left that he is weak toward the big banks could hurt his chances.
Amanda Renteria, the former chief of staff of Democratic Senator Debbie Stabenow, has been mentioned by lobbyists and others as a possible next chairwoman.
Stabenow told Reuters this week that Renteria was talking to the Obama administration about a number of possible positions but declined to elaborate.
“I understand that she’s under consideration for a number of different positions, and ... I believe she would be a tremendous asset to the administration,” Stabenow said.
Renteria could not be reached for comment.
Asked about his future after the Thursday meeting, Gensler would only say he was focusing on the work that remains to be done at the CFTC, such as finalizing the cross-border remit of the agency’s rules, another thorny issue.
Reporting by Douwe Miedema; Editing by Lisa Von Ahn and Kenneth Barry