Capital Markets Currents
Welcome to 2015. To kick off the New Year in OTC markets news, we are looking at regulations, regulations, and then for a slight change we look at regulations –in Asian markets. On the regulatory front, there are some significant issues that have already made news in the new year, starting with a swaps-related provision buried in the Terrorism Risk Insurance Act that passed both houses of Congress last week and is headed to the president’s desk. Also on the regulatory front, the Commodity Futures Trading Commission is weighing recommendations made by a panel of industry representatives just before the end of the year on how to implement mandatory clearing for non-deliverable forwards (NDFs). Central clearing of NDFs will likely bring significant change to FX OTC derivatives, brining standardization to a fragmented marketplace. Meanwhile, CFTC Chairman Tim Massad is touring Asia to speak with regulators in the region. As global firms are increasingly looking to Asia to expand their trading strategies, we are expecting increased regulatory activity as Asian markets seek to better harmonize with the US and Europe. The new year is looking interesting already.
Dodd Frank Repeal?
The swaps provision buried in the Terrorism Risk Insurance Act (TRIA) that passed Congress and the Senate this week was significant because it prompted an ultimately unsuccessful effort by Sen. Elizabeth Warren to have the provision removed. The Dodd-Frank act had given the Securities and Exchange Commission (SEC) and the CFTC power to regulate swaps margin requirements for commercial end users as well as for financial firms. The provision buried in the TRIA strips the agencies of the power to set margin requirements for non-financial firms. Sen. Warren wanted the provision removed because she sees the provision as another example that Wall Street and its allies Congress and the Senate, plan to dismantle Dodd-Frank piece-by-piece. Supporting her argument, the provision comes right after Section 716 of the Dodd Frank Act was stripped from the law though a piece of legislation buried in the CROmnibus year-end funding bill. Section 716, similar to the Volcker Rule, would have prevented banks from using taxpayer-backed money to trade certain high risk financial instruments.
Critics of Sen. Warren’s efforts say the provision was needed to prevent Dodd-Frank from crippling Main Street rather than Wall Street. “One of these unintended consequences that’s harming our Main Street economy is the mistake that requires burdensome Dodd-Frank regulations intended for Wall Street to apply to farmers, ranchers and small businesses,” said House Financial Services Committee Chairman Beb Hensarling (R-TX). Others see oversight of margin requirements for derivative transactions as an important market protection. “Even though regulators have not proposed to require any margin of commercial end users at this time, it is inappropriate to completely eliminate the ability of central derivatives market regulators to take action in this important area,” wrote the Americans for Financial Reform.
In other regulatory news, the CFTC’s Foreign Exchange Markets Subcommittee has released its recommendations for mandatory clearing of the foreign exchange derivative contracts known as non-deliverable forwards (NDFs). The subcommittee, established by the CFTC in October specifically to study implementation of mandatory clearing, emphasized coordination with European to “limit any negative impact on global liquidity.” That said, the subcommittee sees the mandates rolling out in stages beginning with CFTC clearing determinations being proposed no later than August of this year, and continuing with a three-stage rollout for different participants in the industry from February through August of 2016. The subcommittee, made up of industry representatives from JPMorgan, Deutsche Bank, CLS Group, EBS, FXAll, Traiana, LCH.Clearnet and Kings Peak Asset Management, noted that the decentralized OTC FX market infrastructure will present some challenges in implementation. While the FX industry has for the most part already adopted pre-trade credit checks, several bilateral operational processes may need to be standardized with new processes developed by clearing firms and implemented by their clients. Examples of potentially challenging processes for mandatory clearing include clearing and allocation of voice trades, voice block trades, package trades, and pre-allocated and bunched order trades on Swap Execution Facilities (SEFs).
Meanwhile, this year we expect to see renewed focus on OTC market reform in Asia. Regulatory reform in Asian markets can be particularly complex because of the Asian market’s fragmented nature, with multiple separate jurisdictions playing a role in Asia’s OTC market. Nevertheless, reforms are underway in Asia and are expected to pick up pace. CFTC Chairman Tim Massad is currently touring the region, to meet with regulators and industry leaders and he has stressed in several speeches in recent months the importance of harmonizing regulations with both Europe and Asia. Massad will speak about the impact of global swaps reform on Asian markets at a Futures Industry Association (FIA) Japan meeting in Tokyo later this month. The event will also feature Shunsuke Shirakawa, deputy commissioner for international affairs at Japan’s Financial Services Agency, who will discuss the efforts underway from Japan’s FSA in adopting global standards.
All in all we expect to see much activity on the regulatory front this year, with an increased emphasis on coordination in all three major market regions – the US, Europe and Asia. There will be many challenges along the way, but a more coordinated effort seems to be a growing priority from regulators across the globe. We are happy to discuss the implications of any of the issues outlined in this edition of Capital Markets Currents, or any other trends affecting OTC markets, either offline, or on Twitter at solsteinberg1. Happy New Year and welcome back.